Marine & Transit - July 2010
Insurance law reform: Bad faith and increased remedies for the
policyholder?
Law Commission proposes damages if insurers breach duty
of good faith
What remedies does a policyholder have if an
insurer does not pay a valid claim or only pays the claim after
protracted delay? Current insurance law in England and Wales
is not in line with the general law on damages for breach of
contract. Insurance law is an exception to the usual rule
that where a party breaches a contract, the other party can claim
damages for any actual or foreseeable losses suffered. So,
while a policyholder can sue the insurer for the actual money owed
under the policy plus interest, the policyholder cannot claim
damages for any further loss arising from the delay in payment.
The Law Commission has been considering this
issue and has published a paper proposing changes to the law in
this area. The Law Commission believes the law in England and
Wales should be changed to bring it more in line with that applying
in Scotland and other jurisdictions such as Australia, Canada and
the United States, where an insurer is under an implied obligation
to pay a proper claim following a reasonable period for
investigation. The paper can be found at http://www.lawcom.gov.uk/ under the
link to “consultations”.
Presently under English law, Sprung v
Royal Insurance (UK) Ltd [1999] establishes that no
additional damages can be claimed for a wrongly refused
claim. Insurers rejected a policyholder’s claim for damage to
a factory by vandals. The policyholder succeeded in
establishing that the damage claim should have been paid.
However by then his business had been lost and the English court
rejected a claim for separate damages for lost opportunity to sell
the business during the period. The reasoning behind the
authority is that under an insurance contract, the insurer
undertakes to hold the policyholder harmless. If there is a
covered claim, the insurer is thereby in breach of contract and
accordingly a payment under the policy is in fact a payment in
damages. However the law does not provide for damages for
failure to pay damages.
The related aspect is that there is a mutual
obligation on the parties to an insurance contract to observe the
utmost good faith. While an insurer’s refusal to pay or delay
in paying a claim may certainly be a breach of good faith, the
court has held that damages are not payable for such breach
(Banque Financiere v Westage Insurance Co).
Section 17 of the Marine Insurance Act 1906 (which applies also to
general insurance) provides that, if the obligation of utmost good
faith is not observed, the contract can be avoided by the other
party. This has been regarded as the only remedy available
for such a breach, however this can be potentially unfair to
policyholders as in such a case the premium only is refunded rather
than the (usually much higher) claim paid.
Consumers and small businesses have an
alternative remedy, by way of the Complaints Procedure to the
Financial Ombudsman Service. The FOS can compensate for late
payment of claims by awarding interest, by damages for distress and
inconvenience and in appropriate cases, by damages for financial
loss. However, this remedy is not available to larger
commercial interests. Insurers generally can also be
penalised by the FOS for breach of statutory duty under the
industry’s applicable rules for handling and paying insurance
claims. However that will be of little assistance to a
policyholder who has suffered loss as a result.
The Law Commission concludes that the law on
this issue is out of line with usual contract principles and those
applying in other significant comparable jurisdictions. It
also appears unfair to policyholders and could be seen as
undermining confidence in insurance law and the insurance industry.
Two approaches are proposed by the Law
Commission to change the law in this area. The first would be
to provide specific legislation containing guidelines on how
insurers must deal with claims, such as investigating and deciding
claims fairly and paying claims within a reasonable time once
established and agreed. Such legislation could also contain
the remedies where the insurer is in breach, such as damages for
other foreseeable losses.
The other approach would be to reverse the
decision in Sprung v Royal Insurance.
However, the Law Commission is not convinced this would be the best
way forward. The Commission otherwise recognises that
(subject to the application of the Unfair Contract legislation for
consumers) in commercial insurance this area is generally best left
to freedom of contract. The Commission considers that while
insurers must be able to refuse invalid claims, the default
position should rather be that the insurer bears the risk of
unreasonable conduct in refusing a claim, unless this liability is
properly excluded by a specific contract term.
The period of consultation has now closed and
the further views and conclusions of the Law Commission on this
issue are awaited with interest in due course.
Emma Rice,
Solicitor
Weightmans LLP