Supreme Court finds fraudulent device rule does not apply to "collateral lies"

We previously reported the Court of Appeal's judgment in Versloot Dredging BV v HDI Gerling, which confirmed that, under English law, an insured who employs a fraudulent device to advance an otherwise good claim will forfeit its right to the entire claim.

On 20 July 2016 the Supreme Court allowed Versloot Dredging's appeal by a majority of 4 to 1, holding that the so-called fraudulent device rule does not apply to "collateral lies" which are immaterial to the policyholder's right to be indemnified under the policy.

Background

The case concerned a ship the DC Merwestone which was incapacitated by a flood in her engine room. An insurance claim was made and the ship's owner informed the insurer that crew had stated that the bilge alarm had sounded at noon on the day of the flood, but could not be investigated because the vessel was rolling in heavy weather. That turned out to be a lie, told by the owner to expedite the insurance claim. The Court of Appeal held that where a policyholder employs such a fraudulent device to support an otherwise valid claim it will forfeit its claim entirely.

What is a collateral lie?

The Supreme Court has now confirmed that the fraudulent device rule does not apply to a "collateral lie". Lord Sumption defined this as:

"… a lie which turns out when the facts are found to have no relevance to the insured's right to recover."

Essentially, the court held that the decisive question was whether the claim would have been equally recoverable whether the statement was true or false. If it would, then the statement and its veracity is irrelevant and the insurer cannot repudiate the claim. In Versloot the lie was found to be irrelevant because the loss was caused by a peril of the sea.

Comment

The judgment confirms that, in addition to claims which are entirely fabricated, where a policyholder dishonestly exaggerates the amount of its loss, the insurer is not liable even for that part of the claim which may otherwise have been justified. It is only where the claim has been "embellished" in some irrelevant way, for example to obtain payment faster and/or with less hassle, that the insurer will not be entitled to repudiate the claim.

The judgment is consistent with the move towards a more policyholder-friendly regime in the UK, with the Insurance Act 2015 coming into force in August this year. The scope of the fraudulent device rule is not specifically dealt with in the new legislation and it was contemplated that the courts would have to resolve this issue in due course.

Lord Hughes noted in the judgment that the conclusion reached is in step with the general approach adopted in the Act. For example, the Court of Appeal had been influenced by the fact that parties to an insurance contract have a "special relationship" governed by the duty of utmost good faith. Lord Hughes noted that one consequence of the Insurance Act 2015 and the Consumer Insurance (Disclosure and Representations) Act 2012 was to "separate the duty of good faith from the law relating to fraudulent claims."  

For more information please contact Harriet Stokes, Associate at harriet.stokes@michelmores.com or Garbhan Shanks, Partner at garbhan.shanks@michelmores.com.