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Utmost Good Faith

Sections 12,13 and 14

Introduction

The duty of good faith is central to and regulates all aspects of the contract of insurance, from inception through to the terms of the contract, to each party’s responsibilities in the event of a claim under the contract of insurance.

Information that is of vital importance is only known to one party to the contract.To make the dealing as fair as possible, the principle of utmost good faith was developed whereby the party possessing the knowledge owes a duty to disclose the material and relevant facts to the other party of the contract so that the other party can make an accurate assessment of what they are undertaking.[1]

A Brief History

At common law a contract of insurance is based on the principle that the insurer and insured act with the utmost good faith towards each other. The principle is known as “uberrima fides”.The principle was settled by the judgement of Lord Mansfield in Carter v Boehm (1766) 3 Burr 1905; 97 ER1162.Lord Mansfield said:

“Good faith forbids either party by concealing what he privately knows, to draw the other party into a bargain from his ignorance of that fact, and his believing the contrary.”

The statements of the principles governing non disclosure by Lord Mansfield is to be considered as in the context of the inception of the contract of insurance.At common law the duty of utmost good faith applies after the inception of a contract and during its currency.

In Boulton v Holder Brothers (1904) 1 KB 784 at 791 it was held that the duty of good faith commences before a policy is made via the duty the disclosure and continues so long as the parties are in a contractual or continuing relationship with each other. Manifestations of the post-contractual duty of good faith usually arise in relation to claims - either the way the insured made the claim or the way the insurer handled the claim.

The common law operation of the duty of good faith has gone through an interesting history and development in the last 200 plus years. However, this common law development became, as a matter of common industry importance, largely irrelevant in Australia, following the enactment of the ICA and in particular, Part II, which both clarified and altered the traditional common law position.

The duty of utmost good faith is implied into all insurance contracts by Section 13. It applies to both the insurers and to insureds.

The duty covers all aspects of the insurance relationship and is additional to all other duties that the Act imposes.

The principle of utmost good faith (uberrima fides) implies into each insurance contract a requirement to act with the highest degree of integrity towards the other party, to be full and frank in disclosure and to act with fairness. There must be no intention to mislead or to deceive.

One of the aspects of the duty of good faith which remained despite this statutory intervention, was the lack of a widely settled and accepted definition of what constitutes ‘good faith’ under the ICA. The ICA contains no definition of ‘utmost good faith’. The Explanatory Memorandum to the Insurance Contracts Bill 1984 also does not contain any definition or explanation as to the meaning of ‘utmost good faith’. Rather, it is talked about as a well-accepted term, and that it is a ‘paramount duty’.6 Much has been written about the precise scope and meaning of these words7 and how they are not capable of easy definition. Yet it seems to be well accepted that its foundation imposes an obligation of fair dealing; it encompasses notions of fairness, reasonableness and community standards of decency and fair dealing.

The courts have held that while innocent errors or mere carelessness will not be sufficient to demonstrate a lack of utmost good faith, reckless conduct is likely to do so. Conduct that is fraudulent or dishonest is a breach of duty of utmost good faith.

A failure to comply with the duty of utmost good faith on the part of policyholders may result in the refusal or reduction of a claim, or in cancellation of their policies.

If insurers breach their duty of utmost good faith to policyholders they may not be able to rely on particular provisions of their insurance contracts. For example, where there is inconsistency between promotional material and policy documentation, insurers may be liable for the payment of benefits in accordance with the promotional material rather than the terms of their policy. In addition, policyholders may be able to claim damages for breach of duty from their insurer.

Insurance Contracts Act 1984 (Cth)

The duty of good faith is now an implied statutory term inserted into every general insurance contract in Australia under section 13 of the Insurance Contracts Act 1984. Section 13 requires both the insurer and the insured to act towards the other, in respect of any matter arising under or in relation to it, with the utmost good faith. Therefore, like the common law, the duty spans from the pre-contractual stage (duty of disclosure) to the post-contractual stage (the making and handling of claims). In addition, being a contractual term, damages are allowed to the innocent party in case of a breach (discussed further below).

The Insurance Contracts Act does not, however, apply to all insurance contracts. For example, the common law duty of good faith still applies to the following types of insurance contracts:

  • reinsurance contracts
  • health insurance contracts;
  • insurance contracts entered into by a friendly society;
  • marine insurance contracts; and
  • workers compensation contracts.

The duty of good faith under the ICA, however, is not vastly different than that under the common law - it is merely made more explicit as it is now in statute form. For example, section 12 states that the duty is not to be read down in any way by any other law or any other provision of the ICA. However, in practical terms, the duty under the ICA does not require a higher duty of disclosure for the insured than under the common law.

Section 14 states that if the reliance by a party on any provision of the contract would fail to be an act of good faith, then the party cannot rely on that provision. This is generally aimed at the insurer and is merely another way of saying that the insurer must have due regard to the insured's interests when the insurer is placed in a position of conflict (such as deciding whether to pay out on a claim).

The main difference between the common law duty and the duty under the ICA, however, is the nature of the remedies.

Remedies

(a) Common Law

 Under the common law, a breach allows the innocent party to avoid the contract. If the breach occurs prior to the contract's execution, then the contract is avoided from the very beginning. If the breach occurs after contract formation (e.g. during claims) then the traditional view has been that the contract may also be avoided from the very beginning of the contract. The more logical approach, however, is that the contract is avoided from the time of the breach. This avoids the situation of having earlier claims (which were made honestly) being tainted by the later act of bad faith. This was recognised by the Australian Law Reform Commission "Insurance Contracts" No 20, 1982 p 147 which stated:

"The strict application of the doctrine of utmost good faith might conceivably result in the insurer being entitled to avoid the contract ab initio [from the beginning]. If so, an insurer might be entitled to deny a prior claim untainted by fraud or to require repayment of moneys paid by it in connection with such a claim."


No damages are allowed in Australia under the common law for a breach of the duty of good faith.

ICA

The ICA expressly allows damages for post-contractual breaches of the duty of good faith. The ability to cancel the contract in all cases of a breach is also preserved.

Damages are allowed as the duty is an implied contractual term of the contract. From the insurer's point of view, however, the damages will manifest in the form of reduced claim payouts. Section 54 states:

54(1) Subject to this section, where the effect of a contract of insurance would, but for this section, be that the insurer may refuse to pay a claim, either in whole or in part, by reason of some act of the insured or some other person, being an act that occurred after the contract was entered into but not being an in respect of which sub-section (2) applies, the insurer may not refuse to pay the claim by reason only of that act but his liability in respect of the claim is reduced by the amount that fairly represents the extent to which the insurer's interests were prejudiced as a result of that act.

54(2) Subject to the succeeding provisions of this section, where the act could reasonably be regarded as being capable of causing or contributing to a loss in respect of which insurance cover is provided by the contract, the insurer may refuse to pay the claim.

Therefore, to the extent that the post-contractual breach of the duty resulted in the event causing the insured's claim, the insurer may refuse to pay the claim.

The insurer is also allowed to cancel the contract from the time of the breach under section 60(1) of the ICA.

References

The Duty of Upmost Good Faith: - Is the Duty Expanding – May 2001 – Publication – Insurance and Reinsurance – Allans Arthur Robertson

The duty of good faith: The ‘sleeper’ of insurance obligations? Publication by Freehills

Understanding the ISR Policy – Volume 2 by Allan Manning

[1] MacGillivray and Parkinson on Insurance Law, 8th Edition, Sweet & Maxwell, London, p217