'Mercandian Continent'

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K/S Merc-Scandia V. Lloyd's Underwriters (The ‘Mercandian Continent)

English Court of Appeal: Walker and Longmore LJJ; Carnwarth J: [2001] 2 Lloyd’s Rep. 563:
Jonathan Hirst QC and Andrew Lydiard, instructed by Clyde & Co, for the defendant underwriters
Simon Rainey QC and David Foxton, instructed by Messrs Jackson Parton, for the claimant shipowners

What did the case decide?
In the context of a direct claim against liability underwriters under the UK Third Parties (Rights against Insurers) Act, 1930, where underwriters relied on the defence of their assured’s breach of the duty of utmost good faith under section 17 of the UK Marine Insurance Act of 1906 (MIA), the Court of Appeal decided that:

1. it was only appropriate to invoke the remedy of avoidance under s.17 in a post-contractual context (namely, after the contract had been concluded) in situations analogous to those where the insurer had the right to terminate for breach;

2. there was a continuing duty on the assured to refrain from a deliberate misrepresentation or concealment of material facts intending to deceive the insurer. The facts would be material if they had ultimate legal relevance to a defence under the policy. However, the remedy of avoidance would not apply unless the fraudulent conduct was such as to justify termination of the contract.

3. the giving of information pursuant to an express term of the contract was an occasion when good faith should be exercised. However, since it is a contractual obligation, the remedy for fraudulent misinformation must be commensurate to the insurer’s contractual remedies.

Case Note contributed by Dr. Aleka Mandaraka Sheppard  : DMC Category Rating: Developed

Summary of the Facts
This litigation concerned a claim for indemnity under a third party liability insurance obtained by ship-repairers based in Trinidad, for negligence that occurred during repairs of a vessel.

Liability arose to the claimant shipowners under the ship-repair contract.The claimants obtained leave to serve English proceedings out of the jurisdiction against the assured ship-repairer, relying on an English jurisdiction agreement entered into between the shipowners and the ship-repairers’ assistant manager.

The ship-repairers and their liability underwriters had been (incorrectly) advised by Trinidad lawyers that there would be a limitation of time advantage, if the case against the ship-repairers proceeded in Trinidad. Acccordingly, the solicitors for the ship-repairers challenged English jurisdiction, alleging lack of authority of the assistant manager. In support of this, the managing director and the chairman of the ship-repairers concocted a forged letter. The discovery of the forgery caused the application to set aside the writ to be abandoned and the underwriters withdrew from the liability litigation.

The ship-repairers were found negligent in the liability action and judgment was given in favour of the shipowners. The ship-repairers went into liquidation and the shipowners obtained a winding up order against them. This enabled the shipowners to proceed against the ship-repairers’ liability underwriters, pursuant to the provisions of the Third Parties (Rights against Insurers) Act, 1930.

In the light of the forgery by the assured ship-repairers, which took place during the litigation between shipowners and ship-repairers, the underwriters avoided the policy and – in the claim against them by the shipowners - raised the defence they would have had against their assured, namely breach of s.17 of the MIA 1906 and/or breach of an express contractual term in the insurance policy prohibiting fraudulent claims by the assured.

Issues in the Case
Is the duty of good faith continuous after the insurance contract has been made generally or only in defined categories? The following categories were considered:
a) when the assured was making and pursuing a claim on the policy;
b) when there was an express or implied contractual duty to supply information to enable the insurer to make a decision.

At first instance, the judge, Aikens J., had held that the duty did not extend post-contractually unless (a) the insurer was being invited to renew or vary the risk, or (b) the assured was prosecuting or pursuing a claim on the policy. Neither of these arose in this case. He found that the concoction of the letter constituted fraud but that fraud was not material to the underwriters’ liability to indemnify the shipowners under the third party liability insurance. The underwriters appealed.

On appeal to the Court of Appeal, Lord Justice Longmore, following the suggestion put forward by Lord Hobhouse in the Star Sea, divided the defences advanced by the insurers into (i) the contractual defences and (ii) the good faith extra-contractual defences.

(i) Contractual Defences
The fraud relied upon by the insurer was in relation to jurisdiction and arose four and a half years before the liability of the assured ship-repairer to the present claimant shipowners was established. At the time of the fraud, no claim had arisen on the policy and there could be no suggestion that the assured had made a fraudulent claim. The underwriters suffered no prejudice as a result of the assured’s fraudulent conduct because English jurisdiction would have been maintained even if the letter had not been produced. He therefore found that the fraud was not relevant to the insurers’ liability under the policy and the judge was correct in his conclusion on this issue. Accordingly, underwriters could not invoke the express term of the contract and render the policy void.

The question then was whether the underwriters could achieve by statute what they could not achieve by contract.

(ii) The Good Faith Defence (an over-arching principle)
Longmore LJ rejected the submission of the claimant shipowners’ counsel that "there are only some occasions when the requirement of good faith exists post-contract" and accepted the submission of the insurers’ counsel that "the duty is a continuing one". He said, the categories in which it may apply include:

(a) Fraudulent claims: Longmore LJ stressed that the remedy of avoidance which is available under s. 17, would be only appropriate in a post-contractual context in situations analogous to those in which the insurer would have a right to terminate the contract for breach. For this purpose, (A) the fraud must be material to the insurer’s ultimate liability and (B) the gravity of the fraud or its consequence must be such as would enable the insurer to terminate for breach of contract. It is in this way that the law of post-contract good faith can be aligned with the insurer’s contractual remedies.
(b) Variations
to the risk were treated more robustly by Longmore LJ than had been suggested in the Star Sea. He stated that the right of avoidance only applies to the variation, not to the original risk.
(c) Renewals:
a duty of good faith exists when the insured seeks to renew the contract of insurance. It is never suggested that, although the breach takes place during the currency of the earlier contract, the earlier contract is avoided as well as the renewal.
(d) "Held covered"
cases were treated as variations to the risk to the extent that the result is a variation of the contract because an additional premium has to be assessed. But if they are only an exercise by the assured of rights which he has under the original contract they are puzzling, he said. However, he added, it was never suggested that lack of good faith in relation to a matter held covered by the policy avoids the whole contract.
I(e) Insurer’s right to information during the policy:
the giving of information pursuant to an express or an implied term of the contract attracts the obligation of good faith. Since the obligation stems from the contract, the remedy for fraudulent misinformation must be commensurate with the insurer’s remedies for breach of contract. The insurer would not be able to avoid the contract with retrospective effect unless he could show that the fraud was relevant to his ultimate liability under the policy.
(f) Liability policies:
good faith may be implied if the insurer decides to take on the assured’s defence to a claim. The duty imposed on the insurer is to exercise his defence in good faith

Looking at the categories analysed by Longmore LJ, it seems that, although it was said that the duty of good faith is continuous, the examples given, apart from (e) Insurer’s Right to Information and (f) Liability Policies, fit into the pre-contractual category. Renewals (c) are, of course a new contract and the duty of pre-contractual good faith has not been doubted.

It is doubtful, however, whether the "held covered" clauses (d) can be classed in the category of variations (b). If the notice provision of the clause is not complied with, the clause will provide the consequence of breach, or alternatively, if there is a wilful breach to deprive the insurer from the additional premium, the breach will fall in the category of a fraudulent claim. It seems also that variations of the policy are treated as a new contract, which may not always be the case.

No remedy was suggested by Longmore LJ in the situation when the insurer is in breach of good faith in the conduct of his defence in the case of liability insurance.


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