Newsletter > March 2001
HOUSE OF LORDS: “THE STAR SEA”
In a recent decision handed down in the case of Manifest Shipping Co. Ltd. v. Uni-Polaris Insurance Co. Ltd. [the “STAR SEA”]  H. L. J. No. 2 the House of Lords considered whether the requirement of “utmost good faith” in contracts of marine insurance extends past the initial negotiations (the acceptance of the risk by the insurer and the fixing of a premium) to apply later in time when a claim is made by the insured. This case provided an opportunity for the House of Lords in fact to comment on the extent of the duty of utmost good faith after the conclusion of a policy, and in particular, the context of the claim.
Courts have in the past confirmed that the duty of utmost good faith goes past the formation of the contract, applying, for instance: – where an insured is obliged to give notice to an insurer under an existing policy of entry into a war zone; – where an insured wishes to give notice to an insurer seeking to take advantage of a “held covered” clause in an existing policy; – where there are rights of inspection under reinsurance treaties. Courts have held in the past that the duty of good faith remains upon an insured to not make a dishonest claim or a claim amounting to fraud against an insurer. If a dishonest claim is made, then the insurer has been entitled to avoid the claim. This case involves an interesting situation and the potential for the “utmost good faith” obligation to be stretched well beyond the mere duty on the part of the insured to make an honest claim.
In this case, a time policy of insurance was placed insuring the vessel “STAR SEA” in 1989. In May 1990, “STAR SEA” encountered serious fire damage while at sea, rendering her a constructive total loss. A claim was filed by the vessel owner with the defendant hull insurer. The insured denied the claim, alleging a breach of a statutory warranty, specifically, that with the privity of the insured that the vessel was sent to sea in an unseaworthy state which directly lead to the fire loss in question. The claim being denied, the matter went to litigation on the policy. Through the course of the adjudication at trial, it emerged that the insured opted not to make full disclosure of certain expert reports bearing on the question of seaworthiness. In hindsight this simply seems to have been a matter of litigation strategy and the insured availing itself of normal rules of “privilege”; that is, the decision when to withhold production and disclosure of certain documents used in litigation. Underwriters complained at the end of the trial that this failure to make full disclosure of relevant facts, combined with certain misstatements of fact, amounted to a breach of the “utmost good faith” duty placed on the insured. Underwriters argued that this by itself allowed them not only to avoid payment of the claim, but to avoid the entire policy ab initio. The underwriters alleged that the insured was under a continuing duty of utmost good faith to disclose to them any information material to the claim and which might affect their decision to pay or defend the claim. On a technical level the underwriter had an appealing argument as the “utmost good faith” requirement in the Marine Insurance Acts is generally stated and is not limited to any particular point in time only (and therefore it should apply even in the course of a trial involving a dispute on the policy). On the other hand, this was a difficult case from the perspective of the insured because as had been held throughout, the so-called litigation strategy and the non-disclosure of certain facts was not in any way fraudulent or seen as dishonest. At trial, the judge ruled that there had been a breach of a warranty of seaworthiness, specifically, there having been a privity on the part of the shipowner in effectively ignoring or willfully ignoring the seaworthiness problem, but that the insurer could not avoid the contract on the basis of a breach of good faith by the insured during the course of litigation. Both sides appealed to the Court of Appeal. The insured successfully set aside the finding that there was a breach of warranty (the facts not supporting a finding of privity) and the insurer was again unsuccessful in its argument that there was a breach of good faith allowing it to avoid the policy given the insured’s conduct during the trial.
On appeal to the House of Lords, the House of Lords ruled as follows:
1. The court again concluded that there was no evidence of fraud on the part of the insured in the making of the claim or in the presentation of its case at trial; 2. The Court of Appeal correctly upheld the insured’s claim, there being no evidence of “privity” with the seaworthiness problem; 3. On the material point of “utmost good faith”, the court unanimously ruled that that once parties are in litigation, it is the procedural rules that govern the extent of the disclosure which should be given in the litigation, and not the more general “utmost good faith” requirement in the Marine Insurance Acts; 4. The court unanimously ruled that it is accepted that the duty of utmost good faith continues to apply after the conclusion of the insurance contract, but that it does not necessarily follow that the content of the duty is the same as that existing prior to or at the time of the making of the contract. The duty of good faith after the making of the contract must be considered as a new and different type of duty than that beforehand, which should not be coloured by the extent of the duty owed pre-contractually by the insured. The court confirmed that the duty of good faith owed after the contract is not the same as in the pre-contractual stages. At a minimum, an insured presenting a claim after the making of a contract of insurance has an obligation to act honestly in the presentation of the claim.
The House of Lords noted, in support of its findings, that it is now well established in law that while the relationship between parties to a contract is framed by that contract priorto litigation, that once litigation commences, the rights of the parties are “crystallized”. The lawsuit is to then determine the rights enjoyed by each of the parties, and the appropriate remedies. Accordingly, the disclosure of documents and facts is now governed by rules of procedure in court orders. New remedies are available to the parties under that framework, and it is therefore unnecessary that the draconian “ab initio” remedy be available to an insurer in those circumstances. Indeed, the court found it highly prejudicial and out of proportion that an insurer should be able to point to the conduct of an insured in litigation (especially where the litigation is precipitated by the insurer denying coverage) as a basis to avoid the policy altogether especially in circumstances such as those present, where the initial basis for the denial of payment was ultimately seen to be without merit.
It is therefore clear that this case is another example of the court considering the extent of the duty of post-contractual good faith on the part of an insured, with the court insisting that there be some reasonable connection between the conduct in question and the remedy available. The court also noted the inevitable result that, by not making a clear distinction between pre-contractual dealings and any duty of disclosure on the part of an insured after the contract is made that the remedy of avoidance of contract would almost be wholly one-sided in favour of the insurer. In effect, absent fraud or dishonesty on the part of the insured, if the insured is seen to have reasonably conducted itself within the rules of court, with an honest belief in the merits of its case, then an insurer will have difficulty now arguing that certain steps taken or decisions made in the insured’s litigation strategy amount to a breach of the overriding good faith obligations thereby allowing the insurer to avoid the claim.
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