In Versloot Dredging BV v HDI Gerling Industrie Versicherung AG and others (The DC Merwestone)1 the Supreme Court abolished the doctrine of fraudulent devices, holding by a majority of four to one that a collateral lie - an untruth told to support an otherwise valid claim - does not provide insurers with a defence to the claim.
The vessel suffered main engine damage following water ingress to the engine room. To support a claim on owners’ hull and machinery insurance, the vessel’s general manager, K, gave evidence that the master had reported a bilge alarm being triggered several hours before the casualty, but which was not investigated by the crew because the vessel was rolling in heavy weather. K subsequently admitted this was untrue. The underwriters argued that owners had made a fraudulent statement when presenting their claim, so that the claim was void.
At first instance2, Popplewell J found that K’s false statement was a “reckless untruth” told to support owners’ allegation of crew negligence, to head off any defence based on want of due diligence, and to improve the chances of a prompt settlement. Whilst K had genuinely believed at the time of his statement that it was a reasonable explanation of events, he was reckless as to whether he had in fact been told by the master that the bilge alarm had sounded.
Under the law as it then stood, an insured who made use of a fraudulent device such as a false document or statement in support of an otherwise genuine claim forfeited that claim. Following the obiter remarks of Mance LJ (as he then was) in The Aegon3, the lie would deny the insured of its claim where the lie was “material” in that it directly related to the claim and, if believed, would objectively yield a “not insignificant” improvement in the chances of winning at trial or obtaining a better settlement or quicker payment.
With some reluctance Popplewell J therefore dismissed the claim, which he found otherwise valid. He observed that to deprive owners of their €3.2 million claim as a result of K’s reckless untruth was a “disproportionately harsh sanction.”
The owners’ appeal to the Court of Appeal was dismissed, and the matter then came before the Supreme Court.
What is a collateral lie?
Lord Sumption (with whom Lords Clarke, Hughes and Toulson agreed) observed that there are three types of fraudulent claim4:
- where the entire claim is fabricated - in which case the insurer is under no obligation to pay the claim;
- where the claim is genuine but dishonestly exaggerated - again the insurer is not liable;
- where the claim is genuine but the insured gives dishonest information to support the claim, whether to improve its strength or with the aim of obtaining faster payment. This is a fraudulent device or a “collateral lie” - a lie which “turns out when the facts are found to have no relevance to the insured’s right to recover”. Such a lie might, the Supreme Court felt, be described in the vernacular as the insured “gilding the lily”5.
The Supreme Court’s judgment focused on the third category.
Collateral lies do not preclude recovery
Lord Sumption drew a distinction between claims which are fraudulently exaggerated, where “the insured’s dishonesty is calculated to get him something to which he is not entitled”, and a collateral lie, where “the insured is trying to obtain no more than the law regards as his entitlement and the lie is irrelevant to the existence or amount of that entitlement.”
In distinguishing between a fraudulent claim and a collateral lie, the question is whether, on the true facts, the lie goes to the recoverability of the claim. An insurer’s liability to pay a claim arises as soon as the insured suffers a loss covered under the policy. If the lie is told to support an otherwise unrecoverable claim, or to exaggerate the sum payable beyond what is due to the insured, it is fraudulent and the claim is forfeit. If, however, the lie is one which on the true facts is “immaterial” to the insured’s right to recover, because the insured is seeking to recover no more than what the law regards as the insured’s entitlement in any event, the insured’s claim will stand.
One justification for the remedy of forfeiture for a fraudulent claim is that the insured should not be permitted to make a “one way bet6”. However, that justification does not, in the majority’s view, apply to claims supported by a collateral lie, where “the insured gains nothing from the lie which he was not entitled to have anyway. Conversely the underwriter loses nothing if he meets a liability that he had anyway.”
Delivering a dissenting judgment, Lord Mance argued that to find that a lie told in support of a claim is “immaterial” simply because it later transpires that the claim was valid without it “seems a charter for untruth,” which leaves insureds to “tell lies with virtual impunity.” In his view, where collateral lies are deployed by an insured, it is almost always because the insured fears it has a questionable claim. Judging the validity or otherwise of the claim with the benefit of hindsight does not reflect that reality7.
The materiality of a collateral lie is to be judged with the benefit of hindsight8. The difficulty, from an insurer’s perspective, is that it may not be obvious when a lie is discovered whether it is “material”, so that the claim is forfeit, or collateral. That may not be known until the facts are found at trial.
The Supreme Court acknowledged that the insured’s mistruth might cause insurers to pursue irrelevant investigations or to decide not to make enquiries which had the truth been known would have been relevant. However, it was held that to permit insurers to decline an otherwise valid claim on that basis “would be a wholly disproportionate response9.” Instead, an insured who supports its valid claim with a collateral lie will face other sanctions10 including costs penalties. Lord Mance, however, was sceptical that the possibility of costs sanctions would, from the insured’s perspective, outweigh the perceived benefits of telling the lie at the time it was told11.
The Supreme Court recognised that fraudulent insurance claims remain a serious problem for the London market and beyond. Research by the ABI12 suggests that the value of detected fraudulent claims exceeded £1 billion in 2014 and that undetected fraudulent claims cost the UK economy £2 billion that year. Against this background, the loss of the remedy of forfeiture for the use of a fraudulent device is perhaps surprising. However, the Court found that the policy of deterring fraudulent claims did not justify the loss of a valid claim supported by a collateral lie. For Lord Hughes, there is “plainly a difference of quality between the insured who deals fraudulently with his insurer in an attempt to gain something to which he is not entitled, and the insured who dishonestly gilds the lily with a lie or falsified evidence, but stands thereby to obtain nothing more than was his legal due.” The remedy of forfeiture in the latter situation “is simply too large a sledgehammer for the nut involved.”
As Lord Mance noted, insurers may respond to the abolition of the fraudulent devices rule by introducing clauses giving an express right to decline a claim supported by a collateral lie. It is understood that draft clauses to this effect are under consideration by the market. Whether insurers will be able to insist on the inclusion of such clauses in the current market remains to be seen.