By: Neil Thomson, Sedgwick Chudleigh, Bermuda
The UK Supreme Court has ruled that “collateral lies” made in the context of an insurance claim will not necessarily void coverage. Previously English courts had held that an insurer could avoid paying a claim in its entirety where the insured had acted dishonestly in connection with the making of the claim. This “fraudulent claims rule” was applied to discourage insureds from dishonesty, fraud, and embellishment in making claims.
Versloot Dredging BV and anr (Appellants) v HDI Gerling Industrie Versicherung AG and ors (Respondents)  UKSC 45 involved a loss arising from flood damage to the engine room of a cargo ship during a storm. In submitting their claim to insurers, the owners lied, claiming the crew could not respond to a flood alarm due to the weather conditions. The judge at first instance held that, although the insured’s lie was irrelevant (as the loss was otherwise covered), because the lie was a “fraudulent device” the entire claim was invalidated. This decision subsequently was upheld by the Court of Appeal.
By a majority, the Supreme Court found in favor of the insured on the basis that its fraud was, on the facts, immaterial to its right to recover. The Supreme Court ruled that “collateral lies” are an exception to the fraudulent claims rule and should not preclude the insured from an indemnity to the extent that it suffered a true, insured loss, but not of course for any fabricated loss. In other words, the claim would have been payable regardless of whether the insured lied, and accordingly neither party has gained or lost anything as a result.
Lord Sumption set out the test as follows:
… although a lie uttered in support of a claim need not have any adverse impact on the insurer, I consider that it must at least go to the recoverability of the claim on the true facts. By that test, the fraudulent claims rule applies to a wholly fabricated claim. It applies to an exaggerated claim. It applies even to the genuine part of an exaggerated claim if the whole is to be regarded as a single claim, as it must be. But it does not apply to a lie which the true facts, once admitted or ascertained, show to have been immaterial to the insured’s right to recover. [emphasis added]
The Court was careful to distinguish between fraud occurring during the formation of the policy and fraud occurring during the claims process. In the former setting, dishonest disclosure will directly affect the insurer’s ability to properly underwrite the risk, and will allow an insurer to completely avoid the contract (but note the imminent changes to this principle under the UK Insurance Act 2015). In the latter setting, however, the insurer already has assumed the risk and, if that risk eventuates (even with some embellishment), it is in no worse position than if the embellishment had not occurred.
Section 12 of the Insurance Act 2015 (which comes into force on 12 August 2016) provides that an insurer is not required to pay a fraudulent claim. However, “fraudulent claim” is not defined, and there is no distinction between a completely fraudulent claim and a collateral lie. Versloot, accordingly, has provided guidance on this issue and has made it clear that there must be proportionality in the remedies available to an insurer in response to collateral lies. This approach is generally consistent with the approach found elsewhere in the Insurance Act 2015, in particular the proportionate remedies for non-disclosure (in contrast to the current position where even minimal non-disclosure may allow an insurer to completely avoid a contract).