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Attempts to embellish an insurance claim can prove costly

Source: Asia Insurance Review | Apr 2015

Mr Patrick Perry and Mr Michael Maguiness, from Clyde & Co Hong Kong, advise that if an insured makes a misleading statement in the presentation of a claim without caring whether it is true or false, he risks losing all entitlement to the indemnity. Harsh as this might be to some judges, the courts have mostly adopted this rationale of deterrence against falsehood and fraud. 

It is a well-established principle of insurance law that an insured forfeits their right to claim under a policy where they make a fraudulent claim for a loss not suffered. This is a breach of an insured’s duty of good faith, and contrary to common law, and the Marine Insurance Ordinance. 
 
A long line of authority also establishes that if an insured makes a fraudulently inflated claim under a policy, he forfeits any lesser claim which he could properly have made. An owner who claims a loss of HK$10 million (US$1.29 million), knowing that the claim could not possibly be worth more than HK$9 million, recovers nothing. He is not entitled to an indemnity for that part of the insurance claim which would otherwise have been valid. 
 
The rule is recognised as being harsh, but it is considered a necessary deterrent to prevent the deception of insurers who, by the very nature of things, may have no knowledge of the incident which is said to give rise to the claim and are reliant upon the truth of what they are told by the insured.
 
Embellishment of claims can lead to whole claim being rejected
What is less well known is that an insured may forfeit an otherwise legitimate claim under a policy through making a fraudulent statement intended to enhance the prospects of the claim. 
 
The fraudulent statement need not contain any untruths regarding the legitimacy or quantum of the claim. This is known as using a “fraudulent means” or “fraudulent device”. Dishonest embellishment of a claim, even if it ends up not influencing Underwriters, can lead to the whole claim being rejected. 
 
This has been demonstrated, and confirmed as good law, in the recent English Court of Appeal case of Versloot Dredging BV v HDI Gerling Industrie Versicherung AG [2014].
 
The facts 
In Versloot, the crew of a cargo vessel used an emergency fire pump and lines to blast ice away from hatch covers in freezing conditions off the coast of Poland. 
 
However, the crew neglected to drain the water from the fire pump after use. The water froze and expanded causing a crack in the casing of the fire pump which ultimately resulted in flooding of the engine room. The pumping system in the engine room should have been able to cope with the water ingress but was defective. As a result the main engine became fully submerged and stopped working.
 
The vessel was towed to shore and the engine room was pumped out. The main engine was beyond repair and was replaced with a new engine and gearbox. The Owners of the vessel made a claim under their marine policy for losses in the sum of EUR 3,241,310.60. 
 
On presentation of the claim, Underwriters were sceptical as to how the engine room had flooded given that the leak was relatively small and must have gone unnoticed for a substantial period of time. 
 
In response to Underwriters’ queries, the Owners advised that the bilge alarm had gone off at noon on 28 January 2010 but had been ignored as it was believed to have been activated by the vessel rolling in heavy weather. The Owners stated this account of events had been confirmed by the Master of the vessel.
 
Underwriters declined to pay the loss and the Owners commenced proceedings. The grounds of Underwriters’ defence were that (i) the loss was not caused by an insured peril, (ii) the loss was caused by the unseaworthiness of the vessel to which the Owners were privy, and (iii) the presentation of the claim was supported by fraudulent statements and therefore forfeit. 
 
Rule operates too harshly for insureds?
In the High Court at first instance, the judge determined the loss resulted from a peril of the seas and was proximately caused by crew negligence both of which were insured perils under the marine policy. 
 
However, the Judge determined that the Owners had made a fraudulent statement in support of the claim. Specifically, the Owners were found to have been at least reckless as to whether the explanation for the events which they had given to Underwriters would be supported by the crew’s recollection. The Owners said that the account of events concerning the bilge pump alarm had been confirmed by the Master of the vessel, when this was not, in fact, correct at the time.
 
It was found that the Owners had put forward this story to increase the prospects of the flooding of the engine room being blamed on crew negligence (which was an Insured event) rather than on the Owners for the vessel being in a defective condition (which was not).
 
The result was that whilst the Insured had an otherwise good claim under the Policy for EUR 3,241,310.60, it forfeited the entirety of its right to indemnity because of the use of this “fraudulent device”.
 
The Judge expressed his own concerns that the rule may operate too harshly to insureds and gave leave to appeal. The Court of Appeal has now heard the case, and dismissed the Appeal, finding for Underwriters.
 
The relevant test 
The Court of Appeal confirmed the relevant test is that the whole claim is forfeit where the Insured has made an untrue statement which meets the following conditions:
 
(i) The untrue statement must be directly related to the claim;
(ii) It must have been intended by the insured to promote his prospects of success; and
(iii) If the statement was believed, it would have tended to yield a not insignificant improvement in the insured’s prospects of success. 
 
What has to be appreciated is that the threshold test is very low. The misleading statement must be relevant to the claim, and intentionally or recklessly false. 
 
However, there is no requirement that Underwriters should have been deceived by the lie, or that the lie should have played any part in Underwriter’s consideration of whether to pay the claim. 
 
It is the insured’s attempt to deceive, to gain an advantage “which is not insignificant”, that attracts the penalty. If the falsehood was designed to bolster a claim which has potential weaknesses or to try and avoid or cut short lines of inquiry or investigation by insurers, it is likely to prove sufficient to deprive the insured of any entitlement.
 
Rationale adopted was one of deterrence
The rationale adopted by the Court of Appeal was one of deterrence. “The fraudulent insured must not be allowed to think if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing”. 
 
The court rejected any test that the final result must be just and equitable, or proportionate, considering this would weaken the effect of the rule. This can be contrasted with the position in Australia, where pursuant to s.56 of the Insurance Contracts Act 1984, the Court can order Underwriters to pay if a minimal part of the claim is made fraudulently and non-payment of the remainder would be harsh and unfair. 
 
The rule has been applied by the Privy Council in Beacon Insurance Company Ltd v Maharaj Bookstore Limited [2014] and it is expected would be followed in Hong Kong. 
 
Undoubtedly, the penalty will be seen by many as potentially disproportionate to the seriousness of the misstatement in many cases. Fraud has to be established but (pursuant to Derry v Peek) this requires that there be a false representation made knowingly, or without belief in its truth, or “recklessly”. 
 
Whilst the forgetful insured will not be penalised, one who makes a misleading statement in the presentation of a claim without caring whether it is true or false, risks losing any entitlement to indemnity.
 
Mr Patrick Perry is a Partner and Mr Michael Maguiness is a Senior Associate at Clyde & Co Hong Kong.
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