In Versloot Dredging the Supreme Court had to consider whether the rule against fraudulent claims was engaged where an insured had told lies to support a bona fide claim. The Supreme Court’s decision is considered by Fiona Sinclair QC, Amanda Savage and Joshua Folkard.
The case concerned a €3.2 million claim under a marine insurance policy for seawater flood damage to a ship’s engine room. The Claimant was the ship owner. The Defendant was its hull and machinery insurer.
The Claimant made a claim under the policy, and it was common ground that this was an honest and legitimate claim. The reason for the flood was initially a puzzle because there was no breach in the hull near the engine room, but the Claimant’s ship manager worked out what had happened. The water had entered through a faulty pump at the other end of the ship and travelled unseen through the bilges to emerge some hours later in the engine room. If that was right, the bilge alarm probably sounded some hours before the flood and the crew probably ignored the alarm because it was often triggered by rough seas. Frustrated that insurers were not paying up and hoping to prevent a lengthy investigation into whether the ship was seaworthy (there was no cover if it was not), the manager told the Defendant that the ship’s master had confirmed to him that the alarm had sounded and been ignored. That wasn’t true, although the manager’s theory about how the flood happened was correct, and the ship was seaworthy. . So his lie made no difference to the merits of the insurance claim.
THE DECISIONS BELOW
Popplewell J found that the manager’s lie was a reckless untruth, not a carefully planned deceit. But it was a fraudulent device, so the Claimant forfeited the claim. Popplewell J reached his decision with regret, because in the circumstances he thought this “a disproportionately harsh sanction” ( EWHC 1666 (Comm) at ).
Popplewell J’s decision was affirmed with less reluctance by the Court of Appeal  EWCA Civ 1349. The Court adopted Mance LJ’s obiter view in The Aegeon that the fraudulent claim rule extends to fraudulent devices. It also rejected the Claimant’s argument that this extension was a disproportionate infringement of the Claimant’s rights under Article 1 Protocol 1 of the European Convention on Human Rights.
THE SUPREME COURT’S DECISION
The majority distinguished between (i) fraud which fabricates a claim; (ii) fraud which exaggerates an otherwise genuine claim; and (iii) rejecting “fraudulent device” as an archaic term, “collateral lies”. A collateral lie is “a lie which turns out when the facts are found to have no relevance to the insured’s right to recover” (, , ).
Fraud in categories (i) and (ii) will continue to lead to forfeiture of the whole claim. The ‘fraudulent claims rule’ was resoundingly upheld ().
However fraud in category (iii) will no longer impeach a claim (, , ).
The majority gave five main reasons for this decision:
- In the case of a collateral lie, the fraud is irrelevant to the insured’s entitlement to recover. In Lord Sumption’s words, “the lie is dishonest, but the claim is not” . There was no convincing analogy between a lie told before inception of the policy and a lie told at the claims stage, because at the claims stage the insurer is already bound to pay any genuine claim (, ).
- The ‘fraudulent devices rule’ is a disproportionate response to the only relevant detriment suffered by an insurer as a result of a collateral lie, namely, being put off relevant inquiries or embarking on irrelevant ones. Lord Hughes described it as “simply too large a sledgehammer for the nut involved” .
- The argument that the insured should not be able to make a ‘one-way’ bet was a non sequitur in the context of a collateral lie. The argument is that unless the fraudulent claims rule applies to deter a collateral lie, a dishonest insured has nothing to lose. If his lie is not found out, it may hasten settlement of the claim. If it is found out, he still has his genuine claim. But, as the majority pointed out, “the insured gains nothing from the lie which he was not entitled to have anyway [and] the underwriter loses nothing if he meets a liability which he had anyway” (, ).
- It would be disproportionate and contrary to public policy if a lie told in the course of litigation were to give an insurer an additional defence to a claim. There was no difference in principle between that case and a lie told before proceedings were issued (, ).
- There were numerous other disincentives to prevent an insured lying to its insurer, not least (i) the threat of a criminal prosecution for fraud; (ii) the possibility of being penalised in costs; (iii) the possibility of prospective termination of the policy and/or the refusal of future insurance; and (iv) the loss of any credibility in the trial of a claim . Lord Toulson observed that a collateral lie would have “a boomerang effect” through loss of the insured’s credibility .
Scope of the decision
Versloot Dredging was a marine insurance case, but Lord Hughes stressed that the “the law in question applies in exactly the same way to any commercial or domestic insurance policy” . The decision is therefore applicable to all kinds of insurance.
The ‘fraudulent claims rule’ and court proceedings
The fraudulent claims rule no longer applies once litigation has commenced. Thereafter, the obligations on the insurer and the insured are governed by the rules of the Court, such as disclosure and privilege (). This confirms views expressed by Lord Hobhouse in The Sea Star  1 AC 469 at  and by Mance LJ in The Aegeon at .
The decision in Versloot Dredging is important, not least because of its impact on the reforms in the Insurance Act 2015. Section 12 codifies the common law rules relating to fraudulent claims, but the Act does not define “fraudulent claim”. As Lord Hughes noted at , the Supreme Court’s decision defines the scope of the new section 12. The Act comes into force on 16 August 2016.
In one sense, the decision provides a clear, certain rule. The Court declined to adopt a solution which would allow a trial court to tailor the sanction to the level of dishonesty of the insured. In particular, the Court rejected the proportionality approach offered by Article 1, Protocol 1 of the ECHR. The decision also aligns the response to fraudulent insurance claims more closely with the courts’ response to other types of fraudulent claims: in Summers v Fairclough Homes  UKSC 26, the court confirmed that fraudulently exaggerated claims in litigation will be struck out only in exceptional circumstances.
However a lie is only ‘collateral’ if it is irrelevant to the existence or amount of the insured’s entitlement under the policy ‘when the facts are found’. There must be some doubt about whether insurers and insureds engaged in the claim process will be able to tell easily or quickly whether a lie is collateral in that sense. While Versloot Dredging looks at the issue from the trial end of the telescope, most insurance claims do not get that far. Lord Mance highlighted this point in his dissenting judgment (, -).
It remains to be seen whether insurers will amend their policy wordings to reintroduce the fraudulent devices rule by contract. Lord Mance’s parting comment was that insurers will “no doubt be advised about whatever may be the potential merits of making express whatever understanding they have, or action they may wish to take, regarding the effect of fraudulent devices” . Subject to the inclusion of appropriate wording, the ‘fraudulent devices rule’ may yet survive in practice.