Judgment on Fraudulent Device – Beware the Insured

February 2015

Ballast Water

In Versloot Dredging v HDI Gerling [2014] EWCA Civ 1349 the Court of Appeal (Christopher Clarke - who gave the leading judgment – Vos, L.J., Sir Timothy Lloyd) has dismissed the appeal of an insured whose legitimate claim was held forfeit, as it was proven that the insured’s general manager had made a fraudulent statement in support of the claim.  This decision clarifies an area of uncertainty in English law.

The claimants were the Owners of a dredging vessel insured under a marine policy. The vessel took on water, the source of which was not located for some time, causing the engine room to flood. The Owners brought a substantial claim including the cost to repair the engine.

At first instance, although Popplewell, J. decided the claim was a good claim as the loss was caused by an insured peril of the sea, namely the fortuitous entry of seawater caused by crew negligence; Popplewell, J. also found that the general manager of the management company had made false claims.

In a letter responding to initial enquiries posed by the underwriters’ solicitors during the investigative stage, the general manager stated that: (i) the bilge alarm had gone off at about noon on 28 January 2010; (ii) it had been ignored because its sounding was attributed to the rolling of the vessel in heavy weather; and (iii) he had been told both of these things by the master and the crew. Not only did the evidence disclosed by the owners cast doubt on this statement, but Popplewell, J. considered that an alleged conversation between the general manager and the master was an invention.

He concluded that the statement was an untruth told recklessly and the letter was a fraudulent device. Popplewell, J. felt bound to follow the Court of Appeal’s decision on the “Aegeon” [2002] 2 Lloyd's Rep. 42 (see below) and consequently the whole claim was forfeited.  However, he conceded that he made his decision regrettably because “In a scale of culpability which may attach to fraudulent conduct relating to the making of claims, this was at the low end”.  Nevertheless he was bound by the materiality test in Agapitos v Agnew [2003] QB 556 (i.e. a “not insignificant improvement”) where an insured gives a false statement to improve (not insignificantly) the facts of a genuine claim.

Leave to appeal was granted. 

It is well understood that as a matter of English law, and often by express terms in insurance contracts, that fraudulent claims, i.e. deliberately self-inflicted or pretended losses, or claims which are knowingly or recklessly exaggerated, are forfeited in their entirety including both the fraudulent part of the claim and the good part.

The question considered here was whether a fraudulent “device”, being a statement which was known by the insured to be untrue or which was made recklessly, not caring whether it was true or false, in support of a claim honestly believed by him to be good both as to liability and amount, would also result in forfeiture of the whole claim.

The Court of Appeal’s decision on the “Aegeon” provides guidance on this concept.  In his judgment in that case, Mance, L.J. had suggested that a fraudulent device was to be treated as a sub-species of fraudulent claims, attracting the same sanction, subject to three provisos: -

  • The device must be directly related to the claim as opposed to a dispute with a third party.
  • The device must have been intended by the insured to promote his prospect of success.
  • To yield a not insignificant improvement in the insured’s prospects - whether they be prospects of obtaining a settlement, a better settlement, or of winning at trial (referred to as the “limited objective element”).

However, this part of Mance, L.J.’s judgment was not necessary for the decision in that case, as the fraudulent device had arisen in the context of the claimants’ statement of case and not prior to the commencement of legal proceedings. A key issue, therefore, was whether the comments of Mance, L.J. in the “Aegeon” correctly reflected the law.

In Versloot, the owners maintained that the consequence of forfeiture was a disproportionately harsh sanction.  They also submitted that the general manager’s statement, i.e. that the crew had given that account, did not in any event satisfy the materiality test; it did not directly relate to the claim, and it would not satisfy the limited objective element.

The Court of Appeal had little difficulty in coming to the conclusion that Popplewell, J. was correct to find that the letter was a fraudulent device.  Clarke, L.J. also decided there had been no error in the application of the materiality test where Popplewell, J. found on the facts that “The false statement was directly related to the claim and intended to promote the claim”. The Court of Appeal affirmed the decision in the “Aegeon”, and on the grounds of public policy confirmed that there was no proportionality requirement.  Clarke, L.J. said, “On the contrary the drastic effect of the forfeiture rule is what gives its deterrent effect and its justification rests on that basis”.  On the premise that the sanction was proportional, the Court of Appeal also found that the decision did not fall foul of the Human Rights Act 1998.

What are the consequences of this decision?

This is a decision that will be welcomed by insurers.  However, for the benefit of the insured, it was emphasised, “The rule is only applicable in the case of fraud, from which no insured should have any difficulty in abstaining.  The careless or forgetful insured is not affected, nor is the insured who tells some irrelevant lie or whose lie is not told in order to induce payment” (Clarke, L.J.).

The above said, this decision acts as a timely warning to Owners or Charterers and/or their agents and/or their alter ego managing companies to ensure that the statements or the evidence that they put forward with an insurance claim are true, and that a completely accurate picture of the claim is presented.  This decision proves it will not avail an insured to say, as was tried here, that the statement in the letter was simply an attempt by the general manager to explain what had happened i.e. that the alarm must have sounded.  Indeed, to the contrary, it was considered that a factual account supported by the crew’s recollection would be markedly more significant than one based on a theory and not so supported.

A final and important point is that once a fraudulent device has been used in support of a claim, the forfeiture sanction bites, even if at a later stage the insured seeks to correct his wrongdoing or wishes to resile from that position.

The Insurance Act 2015 received Royal Assent on 12 February 2015, introducing the most significant changes to English insurance contract law since the Marine Insurance Act 1906. This legislation will come into force in August 2016. The Insurance Act 2015 provides that an insurer is not liable to pay a fraudulent claim, but the concept of a fraudulent claim is deliberately not defined.  The explanatory note to the Insurance Bill before it received Royal Assent shows the legislative intention to include fraudulent devices: “if a claim is tainted by fraud, the policyholder forfeits the whole claim.”  This position should, therefore, remain good law when the Insurance Act 2015 comes into force.

We are grateful to Sarah Allan, senior solicitor of Bentleys, Stokes and Lowless for this article.