Case Comment: Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2013] EWHC 1666 (“The DC Merwestone”)

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Introduction

Insurance fraud occurs when there is an element of deceit in either the application or claims stage of an insurance policy. Although there is no statutory definition for insurance fraud per se, Lord Herschell in Derry v Peek[1] held that “fraud is proved when it is shown that a false representation has been made knowingly or unknowingly, or without belief in its truth, or recklessly, without caring whether it be true or false.”[2] The law of remedies is clear in respect to wholly invented claims. If there is no loss or the loss is a result of the deliberate act of the insured, then the insured should recover nothing.[3] However, cases of fraud that involve genuine claims warrant further discussion. This comment will examine the remedial treatment of genuine claims which are supported by fraudulent means (herein referred to as ‘fraudulent devices’).

The law of fraudulent devices has been subject to very recent judicial scrutiny, and the Supreme Court in Versloot[4] has held that insurance claims supported by fraudulent devices are no longer fraudulent. This is a very interesting reversal from previous cases, and this comment will examine the historical judicial treatment of fraudulent devices before analysing the Versloot ruling in greater depth.

I. The Development of Fraudulent Devices

A fraudulent device is used in situations where there has been genuine loss, but some fraud is used to advance the claim or conceal some form of defence.[5] The use of fraudulent devices have only been examined relatively recently and its definition and law has, prior to Versloot, been recently minted in Agapitos[6] where Mance LJ set forth various classes of fraud and defines a fraudulent device as one where “…the insured believes that he has suffered the loss claimed, but seeks to improve or embellish the facts surrounding the claim, by some lie”.[7]  In Agapitos, the insured submitted a forged document that alleged that no “hot work” was done on a ship when it had in fact taken place. This requirement of notice was part of the insurance policy as the “hot work” increased the fire risk to the ship. Although the loss was genuine, this was a breach of warranty and the question was whether the use of the fraudulent device amounted to fraud. The judge at first instance, Toulson J, felt that there was no reason that a collateral lie should transmogrify the claim into a fraudulent one.

On appeal, however, Popplewell (counsel for the claimant) argued that fraud in the pursuit of a claim should attract parallel treatment with the fraudulent claim rule and therefore the whole claim should be forfeit.[8] Mance LJ took the same view, and explained that fraudulent devices were a “sub-species” of fraudulent claims,[9] which were accordingly subject to the fraudulent claim rule, with the only remedy being avoidance of the policy ab initio under s.17 of the Marine Insurance Act 1906.[10]  He did, however, consider the possibility of a “an obviously irrelevant lie” that might not attract the same sanctions.[11] To this end, Mance LJ suggested that:

the court should only apply the fraudulent claim rule to the use of fraudulent devices or means which would, if believed, have tended, objectively but prior to any final determination at trial of the parties’ rights, to yield a not insignificant improvement in the insured’s prospects — whether they be prospects of obtaining a settlement, or a better settlement, or of winning at trial”.[12]

Mance LJ therefore introduced a two-stage hybrid test of materiality which contained the subjective test of intention and the objective test of the lie’s impact – both tested at the time the lie was made. The fraud must not be “unsubstantial”, and it must be “directly” related to and intended to promote the claim. In addition, Mance LJ explained that inducement was not needed as it was “irrelevant” to the overarching legal policy to deter fraud. [13] Nevertheless, there has been some division over this view.[14]

It is important to note that although the views of Mance LJ were all made in obiter, they continued to be cited in subsequent cases, and the test was applied in the Game Boy,[15] where an insured who fabricated a valuation of a vessel was held to have made a fraudulent claim.

Interestingly, the Financial Ombudsmen Service (FOS) has taken a different view in that it looks at whether or not the document in question was used “solely to substantiate transactions that really took place, or (if) customers intend(ed) to obtain more than they were entitled to[16] This reflected a more nuanced view of the rule as the FOS takes into account the nature of the fraud in its determination.[17] Nevertheless, and although this appears to somewhat undermine[18] the general rule on fraudulent devices, this approach can mitigate the potential harshness of the fraudulent device rule . In Aviva v Brown[19], an insured, under an insurance cover for alternative accommodation, rented a property which he in fact owned. Eder J found the insured liable for one count of fraud through the usage of a fraudulent device and had no choice but to order the insured to forfeit the majority of claims that arose under the policy. This was despite the fact that the insured’s representations did not and could not affect the handling of the claim.[20]

Based on the factual situation, Eder J found that the “the conclusion was harsh”,[21] and Merkin believed that the “law had gone too far” with the fraudulent claim rule’s applicability to fraudulent devices. The insured had genuinely believed that the insurer was aware of his interest in the property and the insurer had not acted upon the notice of intention to rent, thereby leaving the insured unaware that he committed fraud. Swaby believes that this was attempted fraud at worst,[22] and that any competent insurer would have been well aware of the facts if they had read the insured’s file.[23] Accordingly, Swaby characterised the case as bringing a “sledgehammer to the proverbial nut”.

Thus, the nuanced approach of the FOS was designed precisely to mitigate[24] the effect of stringent rulings that were disproportionately harsh on the insured, such as the subsequent case of Sharon’s Bakery v Axa.[25] In this case, the insured had forged an invoice for a piece of destroyed machinery as the original invoice was missing. The judge found the insured liable for fraud and all benefits under the policy were forfeited. It is also worthy to note that the law does not allow for the insured to claim consequential losses from a genuine claim, and there is no recourse against insurers who unfairly delay payment. This results in insureds taking drastic measures to advance a claim.

The fraudulent device rule was discussed during the consultation session for the Law Commission’s second paper. Several commercial judges,[26] including Popplewell (who had previously been counsel for the insurer in Agapitos), considered that the general rule might have been stretched too far.[27] In particular, the judges compared the fraudulent claim rule’s application to fraudulent devices with that of personal injury claims where it was commonplace for claimants to exaggerate their injuries. This deceit is not punished with the avoidance of damages, rather, the exaggerated portion of the claim would be disregarded. By extension, there is no reason “why an assured whose house burns down loses his buildings and contents entitlement to hundreds of thousands of pounds because he falsely claims for extra laptops”.[28]

This position was also explored in Summers v Fairclough Homes,[29] where it was held that only the fraudulent portion of an exaggerated personal injury claim would be forfeited.

II. An Analysis of the Versloot Rulings

Facts of the Case and First Instance Ruling

In Versloot,[30] the insured wanted to claim for the loss of a ship and fabricated a crew report in order to show he met the requirements of due diligence under the insurance policy, even though such requirements had not been met. The claim of €3.2 million for the loss of a ship itself was completely genuine. Popplewell J presided over the court of first instance.

Popplewell J     cites a large portion of Mance LJ’s decision in the Agapitos,[31] and observed that although the fraudulent claim rule has been settled as a fundamental principle of insurance contract law, [32] the fraudulent device rule had only originated in the Agapitos; as the decision itself was made in obiter, he was not bound to follow it.

Popplewell J also went on to explain that the rationale behind the fraudulent claims rule does not apply to fraudulent devices because the insured is not seeking to gain any more than what they were entitled to.[33] This defeats any argument that the rule acted to deter potential fraudsters who were claimed for self-gain. Moreover, he believed that the “the condemnation (of fraud) must take… colour from the differing circumstances of each case.[34] Accordingly, he recognised that the forfeiture of a genuine claim worth €3.2 million was a “disproportionately harsh sanction[35] which was borne of a reckless untruth and not a carefully planned deceit. He instead considers “a materiality test which permitted the court to look at whether it was just and proportionate to deprive the assured of his substantive rights, taking into account all the circumstances of the case[36] Despite this, Popplewell with ‘manifest reluctance[37] opted to apply Mance LJ’s dicta as he had felt that the issue needed further judicial treatment, and he was unable to provide the same level of analysis as a full Court of Appeal.[38]

Court of Appeal Ruling

The case was subsequently appealed, and the Court of Appeal felt similarly bound to apply earlier case law. Clarke LJ was of the view that the extension of the fraudulent claim rule to fraudulent devices had been approved by the Supreme Court in Summers v Fairclough Homes. He also considered various other cases where Mance LJ’s dicta had been endorsed, [39]  before reiterating the underlying public policy interest of fraud deterrence as the principal justification of the fraudulent claim rule’s application to fraudulent device.[40] Accordingly, he chose not to endorse Popplewell’s proportionality test on this principle of deterrence as he felt that the calculation of fraud was still unclear, and there was a possibility of encouraging fraud if parties felt that they could recover even a small part of a fraudulent claim. Clarke LJ believed that the critical issue at hand was whether or not the fraud claim rule’s application to fraudulent devices was proportionate to the policy of deterrence, rather than whether or not it was proportionate to the relevant fault.

A human rights argument against the rule was also considered; under s.6 of the Human Rights Act 1998, the state could not impair the right of persons with regard to their entitlement to enjoy their possessions. It was argued that under the fraudulent claim rule, the avoidance of what was otherwise a genuine entitlement to property was in breach of this right. On this point, Clarke LJ decided that there was no breach as s.6 was overridden by public policy; the fraudulent claim rule was proportionate to the objective sought, and the sanction was not penal in nature.[41]

As such, Clarke LJ seems to approach the Versloot issue from a public policy standpoint, as opposed to Popplewell and Swaby, who are predominately focused on its disproportionate treatment of (presumably) consumer insureds in an asymmetric bargaining position.

Supreme Court Ruling

By a majority of four to one, the Supreme Court reversed the Court of Appeal and ruled in favour on the insured; it was held that the fraudulent claim rule was not applicable to valid insurance claims that were supported by fraudulent devices. According to Soyer, this has hit the insurance market like a “bombshell”[42] and will have implications across all sectors of the industry.[43]

In giving the leading judgment, Lord Sumption held that in claims involving fraudulent devices the “the lie is dishonest, the claim is not”.[44] There was no convincing nexus between a lie told at inception and a lie told at claims stage because the insurer is bound to pay genuine claim anyway.[45] Moreover, he felt that it was illogical for the fraudulent devices rule to cease applying on the commencement of litigation as it was when most insureds were tempted to “gild the lily” and submit falsified documents for procedural expediency.[46] On the other hand, Lord Hughes opted to step back and ground his decision within the historical development of the law. He considered how the MA 1906 was originally intended to protect a fledging insurance industry, and moreover, notes that Parliament had left s.12 of the 2015 Act open for the judicial interpretation of fraudulent claims.[47] This meant that it was acceptable for the fraudulent claims rule to be reformed.

On the other hand, Mance LJ grounded his dissenting judgement in the public policy of deterrence, and argued that “abolishing the fraudulent devices rule means that claimants pursuing a bad, exaggerated or questionable claim can tell lies with virtual impunity[48] He also went on to criticise the approach of both Sumption and Hughes as being a non-sequitur,[49] and argued that they failed to understand that the insurance industry was an institution based on the assessment of risk and the settlement of claims.

III. Conclusion

The Versloot ruling highlights a major change in the judicial approach toward fraudulent claims. Under the new law, insureds who embellish a genuine claim with fraudulent evidence cannot be penalised under the fraudulent claims rule. The Supreme Court did consider the issue of deterring insurance fraud, but concluded that there were sufficient protections in place. In particular, the contempt of court rules (involving false evidence) and the insurer’s pre-litigation right to terminate cover prospectively were deemed sufficient to deter would-be fraudsters. Moreover, insureds who submit false evidence would be stigmatised as any finding of prior fraud would remain disclosable.[50]

Of course, the efficacy of this decision has yet to be seen. It is prudent to note that insurers are still free to simply design express clauses that penalise the use of fraudulent devices. This will warrant further judicial treatment, and it will be interesting to examine the approach of the courts. The author believes that it would not be logical for express terms to defeat the Versloot ruling in its entirety, and that courts will have to carefully balance the freedom to contract with consumer protection, perhaps by assessing the element of reasonableness within the contract.[51]

The author believes that the ruling has improved remedial flexibility and mitigates the harshness of the previous law. However, the criticism of the decision to reverse the rule of fraudulent devices and the diversion of opinion within the judiciary belies the concern that it may lead to an uptake of fraudulently evidenced claims. The author also believes that the law is still unclear, and the impact of the new rules may instead serve to further complicate instead of clarify remedies.

[1] Derry v Peek [1889] UKHL 1

[2] Ibid 373

[3] Bugra A and Merkin R, “Fraud” and fraudulent claims” (British Insurance Law Association journal, No 125, October 2012) 6

[4] Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2013] EWHC 1666

[5] For example, a breach of warranty: US Trading Ltd v Axa Insurance Co Ltd [2010] Lloyd’s Rep. I.R. 505

[6] Agapitos v Agnew (The Aegeon) (No.1) [2003] Q.B. 556

[7] Ibid para 30

[8] Agapitos v Agnew (The Aegeon) (No.1) [2003] Q.B. 556 2

[9] Ibid 45

[10] A codification of the pervasive uberrimae fidei doctrine (the principle of good faith in insurance contracts)

[11] Agapitos v Agnew (The Aegeon) (No.1) [2003] Q.B. 556 38

[12] Ibid 38

[13] Ibid 35

[14] Lowry J and Rawlings P, “Insurance Fraud: ‘the convoluted and confused’ state of the law” (Law Quarterly Review (2016) Jan 132)

[15] Eagle Star Insurance Co Ltd v Games Video Co (GVC) SA [2004] EWHC 15 (Comm)

[16] Ombudsman News, Issue 21 (October 2002) <available at http://www.financial ombudsman.org.uk/news/2012.html> Last accessed 1/3/2017

[17] Ombudsman News, Issues 42/3 and 42/4 (December 2004/January 2005), <available at

http://www.financial-ombudsman.org.uk/publications/ombudsman-news/42/42.pdf> Last accessed 1/3/2017

[18] Lowry J and Rawlings P, “Insurance Fraud: ‘the convoluted and confused’ state of the law” (Law Quarterly Review (2016) Jan 132) 5

[19] Aviva Insurance Ltd v Brown [2011] EWHC 362 (QB)

[20] Bugra A and Merkin R, “Fraud” and fraudulent claims” (British Insurance Law Association journal, No 125, October 2012) 6

[21] Aviva Insurance Ltd v Brown [2011] EWHC 362 (QB) 127

[22] Swaby G, “The price of a lie: discretionary flexibility in insurance fraud” (Journal of Business Law 2013, 1, 77-102) 90

[23] Ibid 91

[24] Financial Ombudsman Service, “Ombudsman News” (Issue 41, November 2004 at Page 8)

[25] Sharon’s Bakery (Europe) Ltd v AXA Insurance UK Plc [2011] EWHC 210 (Comm)

[26] Notably Mrs Justice Gloster DBE, Mr Justice Burton, Mr Justice Beatson, Mr Justice Christopher

Clarke, Mr Justice Flaux and Mr Justice Popplewell

[27] Law Commission, Insurance Contract Law: Business Disclosure; Warranties; Insurers’ Remedies for Fraudulent Claims; and Late Payment  (No. 353, 2014)  22.22

[28] Ibid 22.16

[29] Summer J, “Insurance Law and The Financial Ombudsman Service” (2010, Informa Publishing: London)

[30] Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2013] EWHC 1666

[31] Agapitos v Agnew (The Aegeon) (No.1) [2003] Q.B. 556

[32] Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2013] EWHC 1666 146

[33] Ibid 161

[34] Ibid 165

[35] Ibid 225

[36] Ibid 166

[37] As described by Clarke L.J. on appeal: see Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2015] Q.B.608 at 2.

[38] Versloot Dredging BV v HDI Gerling Industrie Versicherung AG  [2013] EWHC 1666 181

[39] Eagle Star Insurance Co Ltd v Games Video Co (GVC) SA [2004] EWHC 15 (Comm); Savash v CIS General Insurance Ltd [2014] EWHC 375 (TCC)

[40] Lowry J and Rawlings P, “Insurance Fraud: ‘the convoluted and confused’ state of the law” (Law Quarterly Review (2016) Jan 132) 9

[41] Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2015] Q.B.608 162

[42] Soyer B, ‘Case Comment: Versloot Dredging BV & Anor v HDI Gerling Industrie Versicherung AG & Ors [2016] UKSC 45’ (UKSC Blog 15 Aug 2016)  <http://ukscblog.com/case-comment-versloot-dredging-bv-anor-v-hdi-gerling-industrie-versicherung-ag-ors-2016-uksc-45/? Last accessed 1/3/2017

[43] Baird G, ‘What is a fraudulent claim?’ (Kennedys 25 July 2016) <http://www.kennedyslaw.com/casereview/what-is-a-fraudulent-claim/> Last accessed 1/3/2017

[44] Versloot Dredging BV and another (Appellants) v HDI Gerling Industrie Versicherung AG and others (Respondents) [2016] UKSC 45 at 26

[45] Ibid 91

[46] Ibid 36

[47] Ibid 102

[48] Ibid 182

[49] Ibid 111

[50] Baird G, ‘What is a fraudulent claim?’ (Kennedys 25 July 2016) <http://www.kennedyslaw.com/casereview/what-is-a-fraudulent-claim/> Last accessed 1/3/2017

[51] Hooley R , “Controlling contractual discretion” (C.L.J. 2013, 72(1), 65-90 at 65)

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