DMC Category Rating: Developed

Background
Between December 1993 and May 1994, the insured (the Gottliebs) made four claims on their household policy with Axa. The first (Claim 1) was made in December 1993 and concerned dry rot damage. Claim 2 was made in February 1994 for damage following an escape of water in a bathroom. Claim 3 in July 1994 was for storm damage and Claim 4 in May 1994 concerned a further escape of water in another bathroom.

Insurers alleged that Mrs Gottlieb, acting for herself and her husband, made a fraudulent claim for alternative accommodation as part of Claim 1, and, in respect of Claim 2, knowingly submitted a forged invoice for electrical work. No allegations were made in respect of Claims 3 and 4, both of which had been paid in full before the allegedly fraudulent acts had been committed.

By judgment dated 7 May 2004, the High Court held that Mrs Gottlieb had been fraudulent in respect of Claim 1 from late September or early October 1999 and in respect of Claim 2 from 20 June 2000. By September/October 1999, insurers had already paid over £30,000 for repairs plus £4,500 for alternative accommodation on Claim 1 and £14,250 on Claim 2. Subsequently, and before discovering the fraud, they paid a further £9,406 for repairs and over £16,000 for alternative accommodation on Claim 1. No further payments were made on Claim 2.

Insurers brought proceedings to recover all payments made in respect of all four claims. At first instance, the judge held that the first two claims were tainted by the fraud, but that Claims 3 and 4, which were genuine and had been paid before any fraud was committed, should stand.

Different approaches
There are three possible ways to deal with a fraudulent claim on an insurance policy. It can be treated as a breach of the post-contractual duty of utmost good faith, enabling insurers to avoid the policy from the beginning (so that all claims paid under the policy can be recovered). Another approach is to follow general contractual principles, such as repudiation and (possibly, in the insurance context) breach of warranty. The third alternative is to employ a special, common law rule for dealing with fraudulent insurance claims.

Lord Hobhouse in Manifest Shipping Co Ltd v Uni Polaris Co Ltd (The Star Sea) [2001] UKHL 1, favoured the existence of a special rule, which would mean that the whole claim was void, even if part of it was genuine: "The law will not allow an insured who has made a fraudulent claim to recover. The logic is simple. The fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing". A similar approach was taken by Lord Justice Mance (who gave the leading judgment in this case) in Agapitos v Agnew [2002] EWCA Civ 247.

Under the common law rule, where all or part of a claim is fraudulent (or where fraudulent devices are used to promote what started out as a genuine claim), the insured cannot recover in respect of any part of the claim. After there has been a fraudulent act, all sums paid out in ignorance of the fraud are recoverable, including sums relating to the genuine part of the claim (Direct Line Insurance v Khan [2002] Lloyd's Rep 364).

Insurers in this case were not relying on utmost good faith or on contractual principles, but solely on the common law. This appeal, therefore, was concerned with the scope and effect of the common law rule in relation to:

1. Genuine, separate claims made under the same policy but paid in full before any wrongful act was carried out (Claims 3 and 4);
2. Claims, part genuine, part fraudulent, where interim payments of genuine parts of the claims had been made before the fraudulent acts were committed (Claims 1 and 2);

Court of Appeal Judgment
Claims 3 and 4
The Court of Appeal agreed with the High Court that Claims 3 and 4 should be upheld. Lord Justice Mance could see no basis for giving the common law rule retrospective effect on separate claims under the same policy that had already been paid before any fraud occurred.

There was no need in this case to consider the position where a separate, genuine claim had not yet been paid by the time of the fraud. Lord Justice Mance, however, found some force in the argument that the common law rule "should be confined to the particular claim to which any fraud relates".

Claims 1 and 2
The real issue was whether insurers could recover interim payments in respect of genuine losses made prior to any fraud connected with the same claim. The insured argued that the common law rule only had prospective effect from the date of the fraud. In other words, after an act of fraud had been committed, the insured could not thereafter recover in respect of any part of the claim, but payments made prior to the fraud and in respect of genuine loss were unaffected.

The Court of Appeal unanimously disagreed. The insureds were seeking to reduce the severity of a rule that was deliberately designed to operate in a draconian and deterrent fashion. "The policy of the rule is to discourage any feeling that the genuine part of a claim can be regarded as safe - and that any fraud will lead at best to an unjustified bonus and at worst, in probability, to no more than a refusal to pay a sum which was never insured in the first place".

Unless there is some special condition in the policy, an insurance indemnity is payable from the moment an insured peril causes loss (or, in the case of liability insurance, when the insured's liability to the third party is ascertained and quantified). The effect of a fraudulent claim is retrospectively to remove or bar the insured's right to claim that indemnity from the insurer.

If a fraud is committed in respect of an otherwise genuine claim which has already accrued but not been paid, the whole claim is forfeit (Galloway v Guardian Royal Exchange (UK) Ltd [1999] Lloyd's Rep 209. Interim sums paid towards a claim are made on the assumption that an obligation to indemnify exists or will arise. If the whole claim later becomes forfeit, then any such payments cease to have any basis and are recoverable by insurers, either because they were made on a false premise, or for consideration which wholly failed.

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