Marine Insurance: Current Good Faith Rules Continue To Cause Blot On The Landscape?
We have less than twelve months until insurance contracts written under English law will be subject to the new provisions of the English Insurance Act 2015.
Once the Act takes effect in August 2016 the rules for good faith (non-disclosure and misrepresentation) and for warranties - unless contracted out - will be very different. For some members of the insurance market, the new regime cannot come soon enough. It would appear that some members of the English judiciary agree.
In the recent English Commercial Court decision of Involnert Management Inc v. Aprilgrange Ltd & Others (The "Galatea")  EWHC 2225 (Comm), Leggatt J held that yacht insurers were entitled to avoid a property insurance on a yacht – and decline liability for a total loss claim - in view of an innocent material non-disclosure by the assured as to the market value of the yacht at the time of placing. But Leggatt J lamented the fact that (as he saw it) until the new law comes into use, current English insurance law puts an insurer in a better position due to an innocent non-disclosure (i.e. no liability at all) than the insurer would have been had full disclosure been made (i.e. reduced level of cover).
In December 2011 the yacht Galatea caught fire alongside at her marina in Athens, Greece. She became a constructive total loss. At the time the yacht was insured by the same hull insurers for both Hull & Machinery risks (section A) and Increased Value Risks (section B). The total agreed insured value for both sections was €13 million - €9.75 million of cover on "all risks" H&M terms and €3.25 million of cover on "total loss only" Increased Value terms. (The 25% upper tier of TLO Increased Value has been in use for some time across a number of marine hull markets - including the yacht market - as a means of reducing the total hull premium).
The yacht was purchased by the assured in 2007 and, in prior policy years, had always been insured at her original purchase price of €13 million. 18 months before the April 2011 hull placing, the yacht managers obtained a professional valuation of the market value of the yacht at €7 million. About a month before placing the policy, the owner received an email from the yacht managers recording the managers' view that the yacht's market value was €7 million.
Insurers rejected liability for the total loss claim under both sections of the hull cover on several grounds. The bulk of Leggatt J's judgment focussed on (i) whether the non-disclosure of the earlier valuation at €7 million was material; and (ii) if it was material, whether insurers had waived materiality. The judge held that the non-disclosure was material and that materiality was not waived by insurers. Although the non-disclosure was innocent (i.e. it was an inadvertent and unintentional error by the assured/yacht managers) it was nevertheless a material non-disclosure. Insurers had not waived materiality and so they were entitled to avoid the policy as a whole.
Avoidance for material over-valuation is not new. Property that is insured for amounts way in excess of its true market value presents a clear moral hazard and is therefore material. English law has long recognised that, for a marine hull insurance, a ship owner is entitled to insure his property for in excess of market value provided that the owner "genuinely and reasonably believes that a commercial vessel ought to be insured for a particular value which is in excess of the market value and the proposed value is consistent with reasonably prudent ship management" (see North Star Shipping v. Sphere Drake ). The difficulty for this yacht owner, however, is that the Court found that, in view of the clear valuation at only €7 million, the owner could not reasonably have believed that his vessel ought to be insured for €13 million.
It is easy to view this decision as perhaps the death throes of the (soon to be) old non-disclosure rules and yet another example of judicial frustration with those rules. But even under the (soon to be) new non-disclosure rules, the failure to disclose the earlier yacht valuation would still be viewed by Leggatt J as a failure by the assured to make a "fair presentation of the risk" and would be considered a "qualifying breach" under the new Insurance Act 2015. On the yacht underwriters' evidence, application of the new rules would therefore have reduced the level of cover (and the level of the total loss claim) by almost 40% to €8 million. That is quite a drop in cover.
Over-valuation cases are not new. But the Galatea judgment is of interest as it is the first time in recent years that English judges have addressed the issue of valuation against a split "tower" of marine hull cover. For many years the agreed vessel value at the time of placing lay in the agreed value under the H&M policy. The Increased Value cover was, originally, utilised as a way of insuring against both an increase in a vessel's market value during the policy period as well as the additional costs which an owner is likely to incur when his vessel becomes a total loss (and which are irrecoverable under the H&M policy). Against that original use of Increased Value cover, one could argue that there was no material over-insurance because the agreed H&M value was €9.75 million against a market value of €7 million - perhaps not so much of a jump as to trigger moral hazard (although on his evidence it looks like the actual underwriter would still have thought that reduced gap to be material).
However, as both the parties and the judge recognised in the Galatea, the global yacht/superyacht hull market has for some time adopted the 75/25 split of cover between H&M and TLO Increased Value sections as being representative of the combined insured value of the yacht and therefore a way to obtain the top 25% of that cover at a much lower premium, and the CTL trigger at only 75% of the combined insured value. Whether a similar approach can be said for the global blue water hull market - where H&M and Increased Value covers can often be placed in different markets with different insurers - is unclear.
Finally, it is worth remembering that, despite the focus on non-disclosure and waiver of materiality, the yacht owners' claim also failed completely on the grounds that it had not complied with a pretty innocuous condition precedent – namely an obligation to provide insurers with a sworn proof of loss within 90 days of the loss (in circumstances where insurers knew – and no-one disputed – that the total loss had occurred). But the condition precedent was clear and unambiguous and it was not complied with. The law on conditions precedent will not be affected by the Insurance Act 2015 (unless you try to "dress" any of them up as warranties). So be careful what conditions precedent you agree to!