Summary:
Manifest Shipping Ltd., as Owners of the Star Sea, claimed against the underwriters, Uni-Polaris Insurance Co., under an insurance contract for hull and machinery risks governed by English law, for the constructive total loss (‘CTL’) of the Star Sea caused by fire. The underwriters put forward defences under section 39(5) and section 17 of the Marine Insurance Act of 1906.
Section 39(5) provides: "In a Time policy there is no implied warranty that the ship shall be seaworthy at any stage of the adventure, but where, with the privity of the assured, the ship is sent to sea in an unseaworthy state, the insurer is not liable for any loss attributable to unseaworthiness".
Section 17 provides: "A contract of marine insurance is a contract based upon the utmost good faith and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party." 
The House of Lords decided, approving the decision of the Court of Appeal, that the defence under section 39(5) failed, as there was no proof of  “privity” of the assured shipowners. As for the section 17 defence, the underwriters had to show – which they could not - that the claim was made fraudulently. Whilst the court accepted that the section 17 duty of utmost good faith continued to apply after the contract was originally concluded, it held that it ceased to apply once the parties were in litigation.

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

Facts
Three ships, the Star Sea, the Centaurus and the Kastora were beneficially owned by the Kollakis family. Each was registered under a one-ship company, which -in the case of the Star Sea - was Manifest Shipping Ltd. A group insurance cover had been renewed for another year over the 40 vessels in the fleet. All three ships were effectively managed by Kappa Maritime Ltd., the directors of which were members of the Kollakis family and Mr. Nicholaidis. The registered managers were a Greek company whose directors were Captain Kollakis and Mr. Faraklas. The latter was the sole director of the claimant, Manifest Shipping. A year before this insurance policy was renewed, there was a fire in the engine room of the Centaurus. The engine room could not be effectively sealed and the Korean crew did not use the CO² system to extinguish the fire. The ship became a CTL. Within two months from the first incident, the Kastora ship became also a CTL due to an engine room fire, which was not put out by her Korean crew. This time the crew used the CO² system but it was not effective because the funnel dampers were not closed. A surveyor appointed by the managers of the vessel, Kappa Maritime, found the dampers in poor condition. The directors of the claimants and of both managing companies were aware of these facts. As they were not happy with the Korean crews in the fleet, they changed over to having entirely Greek officered vessels. The captain appointed to the Star Sea was experienced and competent. However, no steps were taken by the relevant directors to check his knowledge of the right way to use the CO² system. Furthermore, no special steps were taken to ensure the maintenance of the engine room equipment and to instruct the superintendents to check the state of the dampers.

Deficiencies in the Star Sea’s emergency fire pump were found in January 1990, when a Belgian port authority surveyor inspected her after her arrest by cargo claimants. During repairs of the fire pump, which were eventually completed, the chief engineer cut a suction pipe passing through the forepeak ballast tank to a non-return valve in the ship’s side. This pipe was never repaired and, as it transpired later, this affected the ship’s seaworthiness. On May 27^th 1990, the Star Sea sailed from Nicaragua bound for Zeebrugge with a full cargo of bananas, mangoes and coffee. Two days later, as she was approaching the Panama Canal, a fire started in the engine-room. The fire spread and was not put out for several days. It caused extensive damage to the vessel, so as to render her a CTL.

The assured shipowners, Manifest Shipping Ltd., claimed under the insurance policy against the underwriters, who pleaded - in reliance on section 39(5) of the Marine Insurance Act of 1906 - that the ship was sent to sea in an unseaworthy condition with the privity of the assured and/or that the assured was in breach of its duty of utmost good faith under section 17 of the Act.

Part of the underwriters’ case was that the ship was unseaworthy by reason of a) the cut suction pipe, because it could not draw when the ballast tank was empty while the ship was laden, thus rendering the emergency fire pump useless; b) the ineffective sealing of the engine room; c) the fact that the master was incompetent in that he was unaware of the right use of the CO² system. On the issue of "privity" of the assured, the insurers’ case was based upon what had happened to the Centaurus and the Kastora ships in the previous year and what the assured ought to have learned from the previous fires. The underwriters accepted that the occurrence of the fire was not attributable to unseawortiness, but alleged that the spread of the fire and the failure to extinguish it was attributable to unseawortiness. On this analysis, they were prepared to pay a small partial loss, in respect of the damage that would have been caused in any event by the outbreak of fire, but not a CTL resulting from the failure to extinguish the fire.

The underwriters’ case with regard to breach of section 17 related to a) what the assured did not disclose in witness statements - exchanged before trial – about facts concerning defects in the dampers of the Kastora, which were reported in the expert’s second report; b) the fact that they did not disclose the expert’s reports concerning the Kastora casualty, - the allegation being that the assured’s solicitors consciously decided to treat them as ‘privileged’ having appreciated that disclosure of these reports would weaken their clients’case in this litigation; and c) misleading information given by the assured’ brokers about the Kastora casualty. There was no allegation, at any stage, that the claim was put forward fraudulently, namely without an honest belief that it was a claim the assured was entitled to make.

Judgment
1. The section 39(5) defence
The House of Lords held- agreeing with the Court of Appeal - that the defence under section 39(5) of the Act failed. There was, in the court’s view, no evidence of privity on the part of those, namely the relevant directors, whose state of mind could be attributed to the assured. The managers and the other relevant persons believed that the captain they had appointed to the Star Sea was competent and experienced. As the Court of Appeal pointed out, correctly, the judge had not made a finding that any of the relevant individuals had suspected or believed that the Star Sea might be unseaworthy because of any deficiency. The evidence did not, on the correct view of the law, sustain the finding of "privity" because"an allegation that they [the relevant directors] ought to have known is not an allegation that they suspected or realised but did not make further enquiries", as Leggatt L.J. had pointed out. A finding of negligence, the House of Lords held, even to a very high degree, did not suffice for a finding of "privity".

2. The section 17 defence
The Court held: 
a) the section 17 defence failed because the underwriters had to show that the claim was made fraudulently (which they had failed to do);
b) before litigation starts, the parties’ relationship is purely contractual, subject to the application of the general law. When a writ is issued, the rights of the parties are crystallised and new remedies are available. The disclosure of documents and facts are provided for with appropriate sanctions and the court’s orders are discretionary. Certain immunities from disclosure are conferred under the rules of privilege. Therefore, once the parties are in litigation, it is the procedural rules which govern the extent of disclosure which should be given in the litigation, not section 17 as such, although s. 17 might influence the Court in the exercise of its discretion;
c) as regards the obligation in law of an insured at the stage of a disputed claim, Lord Clyde took the view that there is no duty upon the insured to make full disclosure of his own case to the other side in a litigation. He saw no practical justification for such an obligation at that stage.

Although the defence under section 17 raised many questions, the court dealt generally with the following important issues (but on the facts of the case, it did not have to decide them):
(a) whether the duty of utmost good faith is a duty that continues after the contract is made, and
(b) the consequences of fraudulent claims.

a) Is the duty of good faith continuous?
Unlike sections 18-21 of the Marine Insurance Act, which specifically refer to the pre-contractual duty of disclosure and the making of true representations, applying the broad provisions of section 17 gave rise to difficulty. Section 17 provides:
"Insurance is uberrimae fidei. A contract of marine insurance is a contract based upon the utmost good faith and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party". 
The question was: whether the intention of section 17 (which does not refer to a time limitation as to the duration of the duty) was that the broad duty of good faith to which it refers differs from the time-specific provisions of the subsequent sections, in that it continues after the contract is concluded?

Lord Clyde concluded that the concept of good faith in insurance contracts reflects the degree of openness required of the parties in the various stages of their relationship. It is not an absolute. The substance of the obligation which it entails, can vary according to the context in which the matter comes to be judged. For example, a high degree of openness is required at the formation of contract stage, but there is no justification for requiring that degree necessarily to continue once the contract has been made.

Lord Hobhouse was concerned about the drastic sanction for breach of the section 17 obligation. The sole remedy for breach is avoidance of the contract; the section did not give a remedy in damages, unlike the tort of deceit or the breach of a contractual term. He added that the concept of avoidance most appropriately applies to the making of the contract and derives, as old authorities have established, from application of a rule of law, not from the parties’ agreement. Later developments applied the requirement of disclosure to matters occurring after the making of the contract, in particular to the making of fraudulent claims.

There are many judicial statements, he said, that the duty of good faith can continue after the contract has been entered into. However, the content of the obligation to observe good faith has a different application in different situations.

Having a contractual obligation of good faith in the performance of the contract presents no conceptual difficulty. The remedy may be in damages, or if the breach is serious, it may entitle the other party to terminate the contract. But any such relief would apply prospectively and would not affect rights that had already accrued.

The right to avoid referred to in s.17, on the other hand, is different; it applies retrospectively. Thus, where the want of good faith occurs after the making of the contract, the sanction of avoidance becomes anomalous and disproportionate. According to Lord Hobhouse, no principle of this breadth is supported by any authority.

Thus, Lord Hobhouse proposed that a coherent scheme can be achieved by distinguishing:
(i) a lack of good faith which is material to the making of the contract itself (or some variation of it), which derives from the rule of law and its remedy is the right to elect to avoid the contract;
(ii) a lack of good faith during the performance of the contract, which derives from express or implied terms of the contract and the remedies for which are the contractual remedies provided by the law of contract.

b) Fraudulent claims
Lord Hobhouse said that where the assured is found to have made a fraudulent claim upon the insurer, the insurer is obviously not liable for the fraudulent claim and he may not be liable for a lesser claim, which could have been honestly made. This is the result of a rule of law and it is not dependent upon inclusion of a term in the contract.

Although confusion arose from some modern cases as to whether the remedy was based on breach of good faith or on contract, Lord Hobhouse was of the view – relying on academic texts and on older authorities - that the sanction for fraudulent claims is forfeiture of all benefit under the policy or all claims upon it, not avoidance ab initio [from inception]. Thus, claims already paid would not be affected.

Lord Scott similarly concluded that:
"The presentation of a dishonest or fraudulent claim constitutes a breach of duty that entitles the insurer to repudiate any liability for the claim and, prospectively at least, avoid any liability under the policy. Whether the presentation of such a claim should be regarded as a breach of a continuing duty under s.17 that entitles the insurer to avoid the policy with retrospective effect, enabling any payments made in satisfaction of previous unimpeachable claims to be recovered by the insurer, is more debatable. It is not necessary in the present case to decide the point….I would, however, limit the duty owed by an insured in relation to a claim to a duty of honesty."

The meaning of this statement is that the duty of the assured at the stage of making a claim should not be based on section 17 which would have the effect of entitling the insurer to claim back money already paid in relation to other claims honestly made. Such duty should be just limited to making honest claims.

Comment
The decision develops and clarifies the law. Although Lord Clyde’s statement seems to be open-ended and may be misinterpreted, it nevertheless provides the broader principle. Lord Hobhouse’s analysis provides particular details of that broader principle. It elaborates the concept that the requirement of good faith means different things at different stages in the life of the contract, according to the context in which the matter comes to be judged as follows:

(a) the stage of pre-contractual good faith (applicable also when there is a renewal or variation of the contract of insurance), which is based on a rule of law. Only at this stage may the breach of the obligation be met with avoidance of the particular contract to which the breach was material (namely, the original policy or the renewed one, or a variation). No positive answer was given to the question whether – if the breach occurred in relation to the variation of the policy, only the variation itself would be avoidable or the policy as a whole. But Lord Hobhouse cited with approval what Blackburn J. had said in an old decision that: "if the alteration of the policy was such as to make the contract more burdensome to the insurer and a material fact to the alteration known to the assured at the time was concealed, the policy would be vitiated".

(b) the stage of post-contractual good faith is based on express or implied terms of the contract. Instances of this may be a held covered clause, or a requirement to give information or notice to the insurer in certain circumstances specified by the contract; the remedies for breach will derive from contract law but in most cases are likely to be set out in the relevant clause of the contract. Culpable non-disclosure during the currency of the policy was considered to be insufficient to attract the drastic consequences of avoidance under s.17.

(c) At the stage of presenting claims, the substance of the obligation is not to make fraudulent claims. In the event of a fraudulent claim, the sanction is forfeiture of the claim as provided by the common law rule.

(d) The litigation stage is governed by the procedural rules of court but the concept of good faith will be relevant when the judge exercises his discretion as to whether or not to enforce a particular procedural rule.