International risk: the evolution of the remedy of avoidance
There used to be a side-splitting “joke” amongst the barrister authors of a particular insurance law textbook that its title ought to have been “How to Avoid”. This was because twenty-five years ago telephone calls between insurance carriers and their lawyers might often have started with: “We are going to get clobbered. How can we get out of this?”.
Back then the insurance market was a very different place to what it is now. It was somewhat fragmented and there was a heady mix of under-capitalisation and LMX spiral business (a hazardous game of “pass the exploding parcel” played through mutual reinsurance). A big loss could spell doom – hence the “joke”.
The law of avoidance arguably reached its pro-insurer high-point in 1996 with the case of Marc Rich v Portman. An underwriter who wrote a demurrage liability insurance policy for a large oil trader was able to avoid that policy for non-disclosure of the trader’s demurrage history – despite not being able to explain what demurrage was during his somewhat excruciating cross-examination!
So what about the remedy of avoidance in 2020?
It is first important to understand why avoidance exists as a remedy and also that the remedy of avoidance is not unique to insurance contract law.
At the risk of stating the obvious, all contract law is based on a “meeting of minds” – because it is founded on obligations that are voluntarily assumed, as opposed to obligations imposed on us by law (such the tortious duty to take care when driving etc). To take a not unusual transaction (that may have been autobiographically inspired), such as a middle-aged man purchasing a 1980s sports car on eBay late on a Saturday night. If the seller describes the car, that is in fact full of rot and filler, as being in excellent structural condition and the purchaser, in reliance on that description, presses “buy it now” and somewhat unwisely immediately transfers the money to the seller’s bank account, he can, as a general rule, unwind the contract altogether as if it never happened and recover the purchase money. This is the remedy of rescission or avoidance – as it is called in an insurance contract law context. This remedy exists because the purchaser’s agreement to purchase the car has been obtained on a false basis, or to put it more pretentiously, their intention to enter into the contract has been “vitiated” – and so there has been no genuine meeting of minds. In those
circumstances, the law assumes the purchaser would not have proceeded with the purchase in the first place had the false representation not been made. Needless to say, this is hardly quantum theory.
The analysis is substantively the same in an insurance contract law context. However, the key difference between an ordinary contract and an insurance contract is that there is not just a duty on the insured to be accurate when it speaks, but there is also a duty on it to speak to reveal things that are objectively important to the insurer. The primary justification for this in an insurance context is that there is a presumed informational disadvantage on the part of the insurer. There is a presumption that the insurer will tend not personally to undertake an inspection of the insured subject matter to ascertain its true nature. That would substantially increase the transactional costs of providing insurance, which would in turn make insurance, which is socially and economically vital, prohibitively expensive. However, the flip-side to insurance being affordable is that the insurer requires enhanced protection beyond what is provided by ordinary contract law.
The problem with English insurance law (as it previously was) is that it arguably went too far in that it protected some fairly suspect underwriting – as well illustrated by the Marc Rich case – and it was seen to punish insureds by potentially depriving them of cover for objectively minor oversights. The law was not just used to escape the insurance equivalent of being duped into buying a rotten old sports car. Instead, it inspired fragile reconstruction of the underwriting process by rather over-zealous insurance lawyers who, working backwards from the desired outcome, might build a case founded on the non-disclosure of things which might never have crossed the underwriter’s mind. This was, of course, fuelled by the fact that it was not necessary for the underwriter to prove that they would not have written the contract at all, just that they would have done something slightly different, such as marginally increasing the premium (assuming that they also satisfied the not particularly onerous requirement of showing objective materiality – for which they may have turned to an expert underwriter who had just “retired” from the LMX spiral game). Consequently, this draconian “one size fits all” remedy was sometimes perceived as being out of all proportion to the actual “wrong” (if any) committed by the insured with potentially devastating consequences for it.
The English courts and arbitral tribunals became increasingly uncomfortable with this. More and more, judges and arbitrators were prepared to find that the non-disclosed information (or the misrepresentation) was either objectively not material or the underwriter was not induced. Consequently, the number of successful avoidance cases diminished significantly during the 2000s. This also coincided with a recognition on the part of carriers that if they kept pulling the pin on the avoidance “grenade” it would end up going off before it left their hand – because habitually declining claims is not particularly great for business.