Insurance contract law reform: remaining draft clauses
The Law Commission of England & Wales and Scottish Law Commission have recently published a second set of draft clauses for inclusion in the proposed Insurance Contracts Bill. This is a further step in the ongoing final stages of the long consultation process that has been on foot since the commencement of the law reform project in 2006.
The first set of draft clauses were published on 28 January 2014, and the limited consultation on those clauses has now closed (click here to see previous Briefing Paper on the first set of draft clauses). DWF Fishburns made submissions to the Law Commissions on that first set of draft clauses.
The second set of draft clauses and accompanying notes were released on 10 March 2014 and can be found at http://lawcommission.justice.gov.uk/consultations/insurance-draft-clauses.htm. The Law Commissions again invited comments on the basis of a limited consultation.
Once again, the clauses have been described as a "first draft". However, while there will undoubtedly be alterations and further drafts, it is understood that as regards the main substance of their content, they represent and embody the feedback already received by the Law Commissions. It should be noted that the clause numbers in the second set of draft clauses do not always dovetail with the clause numbers in the first set of draft clauses.
The second set of draft clauses relate to the following areas:
2. Insurers' remedies for fraudulent claims by members of group insurance schemes; and
3. Contracting out of the legislation.
Addressing each area in turn:
1. Warranties (Clauses 8 - 10)
Subject to the contracting out provisions (which are discussed further below), the provisions of the draft Bill as to warranties are intended to apply to both consumer and non-consumer insurance contracts.
Clause 8 seeks to abolish “basis of contract” clauses in non-consumer insurance (thereby mirroring the provisions of the Consumer Insurance (Disclosure and Representations) Act 2012). The prohibition on “basis of contract” clauses in non-consumer insurance contracts will be one of the mandatory provisions of the Bill.
That is to say, provisions under which representations made by an insured in connection with a proposal for insurance, or a proposed variation to an insurance contract, are converted into warranties by means of a provision of the policy are to be prohibited.
It is important to note that it will still be possible under the Bill to include warranties in policies of insurance, but they will need to be expressly agreed with the insured.
Clause 9 addresses the consequences of breaches of warranty. Under the provisions of clause 9, breaches of warranty will now serve to suspend insurers' liability, rather than operate to discharge it (as is presently the position). Insurers’ liability will be suspended both for losses occurring after the breach (but before it has been remedied), and also for losses “attributable to something happening” during the period of breach. The Law Commissions’ notes accompanying the draft clauses suggest that warranties should be viewed as risk control measures.
Clause 9(4) states that insurers’ liability can be restored if and when the breach of warranty is remedied.
Breach of some warranties cannot be remedied – The Law Commissions’ notes accompanying the draft clauses give the example of an insured that gives a warranty that an alarm system will be inspected every 6 months, but then misses a 6 monthly alarm inspection and is therefore in breach of the warranty. The Law Commissions take the view that although such a breach of warranty cannot strictly be remedied, inspection after say 7 months would mean that the risk then reverted to “essentially” that which had been contemplated by the parties. Thus the suspensory effect of the breach of the alarm inspection warranty, the Law Commissions say, would only be for 1 month (the month during which there had been no inspection).
Further examples of how these draft clauses are intended to operate appear in the notes which accompany the draft clauses.
A subsequent breach of warranty will not affect a prior claim.
Clause 10 provides that, if a policy term goes to reduce the risk of a particular type of loss, or loss at a particular location or time, breach of that term cannot be relied on by an insurer to exclude, limit or discharge liability for loss of a different kind, or loss at a different time or location.
Although these clauses represent a significant change in the law relating to warranties, and pose numbers of different issues and conundrums for the future, the Law Commissions’ previous consultations suggest that the policies behind these provisions do have wide support.
The Law Commissions’ notes accompanying the draft clauses give the example of a vessel which, in breach of warranty, sails into a war zone. The vessel suffers some damage whilst in the war zone, but is only lost after she sails away from the area. The breach of warranty has apparently been rectified, but the insured should still be unable to recover as the loss is attributable to an event during the period of breach. It is not difficult to see how a more complex factual scenario might give rise to many complex issues, and the resultant potential uncertainty as to the application of the new law.
2. Insurers' remedies for fraudulent claims by members of group insurance schemes (Clauses 11 - 12)
Our previous Briefing Note dealt with the Law Commissions’ proposals as regards insurers’ remedies for fraudulent claims. A slight amendment is now proposed by the Law Commission to the text of clause 11 as previously circulated. New clause 11(2) provides that a claim may be fraudulent when it is made, or become fraudulent as a result of a later act (i.e. potentially embracing the concept of fraudulent devices in support of an otherwise valid claim).
Under a group insurance scheme cover is obtained by a policyholder for the benefit of a group of scheme members who are not themselves policyholders (e.g. an employer obtaining a policy for the benefit of employees, or a landlord obtaining a policy for the benefit of tenants). These provisions are drafted on the basis that each of the scheme members are consumers.
If an insured under a group insurance scheme makes a fraudulent claim, the Bill provides that it will be treated as if the insurer and the fraudulent member entered into a separate insurance contract (i.e. the cover for the remaining members will be unaffected).
As far as the fraudulent claim is concerned, the insurer will have no liability to pay the fraudulent claim. The insurer will also have the choice of terminating its liability to pay the fraudulent member in respect of losses suffered after the fraudulent act (although it will remain liable for losses prior to the fraudulent act that are properly indemnifiable).
Under the provisions of the Bill an insurer would not be able to contract out of this provision so as to place a consumer in a worse position than would have been the case under the draft Bill.
3. Contracting Out (Clauses 15 - 17)
Clause 15 of the draft Bill operates to prohibit contracting out of the default provisions of the Bill in a consumer context. The new provisions on warranties, remedies for fraudulent claims, late payment of insurance claims and good faith therefore apply to all consumer insurance contracts as a mandatory regime (provisions of the Bill in relation to the duty of fair presentation and the abolition of “basis of contract” clauses do not apply on a mandatory basis to consumer insurance, as those issues are addressed by provisions of the Consumer Insurance (Disclosure and Representations) Act 2012).
Clause 16 sets out the Law Commissions’ intention that the business insurance law reforms are to be a default regime that the parties should generally be able to contract out of. Certain provisions are still to be a mandatory minimum protection for insureds, though, notably parties cannot contract out of the abolition of “basis of contract” clauses (clause 8 of the draft Bill), and provisions relating to deliberate or reckless late payment of insurance monies (refer to our first Briefing Note for further information in this regard).
If an insurer wishes to contract out of the provisions of the Bill, under the provisions of clause 17 (the transparency requirements) it will need to make sure that it takes sufficient steps to draw “the disadvantageous term” (i.e. the term which places the insured in a worse position when compared to the default provisions of the Bill) to the attention of the insured; further, “the disadvantageous term” must be clear and unambiguous as to its effect. When considering whether these provisions have been complied with, the court will look at the characteristics of the insured and the circumstances of the transaction (the relative sophistication of the insured and the involvement of a broker will be matters that are relevant).
Examples of how these draft clauses are intended to operate appear in the Law Commissions’ notes which accompany the draft clauses. The third such example relates to a sophisticated insurance buyer (“S”) purchasing cover through Lloyd’s. The example proceeds on the basis that, following the passage of the Bill into law, Lloyd’s underwriters and brokers have developed two standard wordings which seek to exclude liability for damages for late payment, and provide for the policy to be terminable in the event of breach of warranty. These wordings are assigned codes of LC1 and LC2.
S approaches the insurance market through its broker seeking cover for a ship which it has chartered to transport cargo. The underwriter prepared to take the risk on favourable terms explains that it wishes to exclude liability for damages for late payment, and also wants the policy to be terminable in the event of breach of warranty. S’s broker, who has authority to bind S, accepts the underwriter’s terms and writes the codes for the new wordings (LC1 and LC2) onto the slip, which the underwriter stamps.
Assuming the standard wordings developed in the market are clearly drafted as to their effect, the Law Commissions take the view that the exclusions would be effective, and would satisfy the transparency requirements. The Law Commissions note that the Lloyd’s market is “fast-paced…, and [the Law Commissions] would not want to interfere unnecessarily with its operation”. The underwriter discussed the provisions with S’s broker, who should either know of the standard wordings LC1 and LC2, or find out what they are before binding S.
The contracting out provisions (including the transparency requirements) will not apply to settlement agreements reached between insurer and insured.
Responses to the Law Commission
As part of its limited consultation, the Law Commission has asked for comments on the draft clauses. Responses should be emailed to:
DWF is participating in the consultation process and any readers of this Briefing Note who have views on the draft clauses are invited to contribute to the response.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.