The limits of contractual discretion: UK Acorn Finance Limited v Markel (UK) Limited  EWHC 922 (Comm)
In UK Acorn Finance Limited v Markel (UK) Limited, HHJ Pelling QC applied the Supreme Court’s decision in Braganza v BP Shipping Limited  UKSC 17 in the context of an insurance dispute. The Judge found that an insurer had acted irrationally in concluding that misrepresentations made by the insured in risk profile documents were fraudulent. In particular, when exercising its contractual decision-making power, the insurer had failed to give due weight to the maxim that it was inherently more probable that any misrepresentation had been made negligently rather than dishonestly.
The Claimant brought a claim against the Defendant insurers under sections 1(1) and (1)(4) of the Third Party (Rights Against Insurers) Act 1930 (the “Act”).
The Claimant sought to recover an indemnity with respect to two judgments it had obtained against Westoe 19 Limited (formerly Colin Lilley Surveying Limited) (“CLS”), a limited company whose business was property valuation.
The underlying claim concerned a number of valuations undertaken by CLS for the Claimant between 11 June 2010 and 30 March 2012, which the Claimant alleged had been negligent. Letters of claim were sent to CLS in 2013.
CLS was insured under professional indemnity policies underwritten by the Defendant in 2013 and 2014 (“the Policies”). However, by a letter dated 8 February 2016, the Defendant purported to avoid the Policies. Soon after, default judgment was entered against CLS in each of the claims brought against it.
The Defendant maintained that it was entitled to avoid the Policies as a result of misrepresentations and non-disclosures contained in or evidenced by risk profile documents generated by the Defendant prior to the renewal of each of the Policies and approved on behalf of CLS. In particular, CLS had failed to inform the Defendant that it had carried out work for subprime lenders (defined by the Defendant as institutions which were not high street lenders or building societies). Prior to the renewal of the policy in 2014, CLS notified the Defendant of a claim made against it by Waterman Capital, which was not a high street lender or building society, with respect to valuation work carried by CLS.
Under the Policies, CLS’s representations took effect as warranties. Further, the Policies were each subject to an unintentional non-disclosure clause (“the UND”), and it was common ground between the parties that, therefore, the Defendant could avoid the Policies only if the misrepresentations were not innocent and free from any fraudulent conduct or intent to deceive.
THE TERMS OF THE POLICIES
The terms of the Policies were broadly the same in 2013 and 2014. Each policy contained a preamble that included the following statement:
“Underwriters having received a Proposal which shall form the basis of and be incorporated in this contract and in consideration of the Premium having been paid to Underwriters, We agree to pay or indemnify to the extent and in the manner herein provided subject to the terms, limitations, exclusions and conditions of this Certificate.”
The Policies contained the following definitions:
““Assured/You/Your/Yours” shall (for the purpose of the General Exclusions, Claims Conditions, General Conditions and all other General Definitions) have the same meaning as that given in the applicable Insuring Clause under which payment or indemnity is being sought.
“ Claim” shall mean
(i) any claim form, writ or summons or other application of any description whatsoever or counter claim issued against or served upon You, or
(ii) any communication or allegation communicated to You which might result in a Loss
“Our / Us We” shall mean the Underwriters
“Proposal” shall mean all information supplied to Us (whether by written, electronic or any other means) for the purpose of effecting this contract of insurance.”
Under the Policies, an insuring clause provided: “We agree to indemnify You against Loss, arising from any Claim made against You during the Period of Insurance in respect of a Wrongful Act in or about the conduct of the Professional Services.”
The UND provided as follows:
“(a) In the event of non-disclosure or misrepresentation of information to Us, We will waive Our rights to avoid this Insuring Clause provided that
(i) You are able to establish to Our satisfaction that such non-disclosure or misrepresentation was innocent and free from any fraudulent conduct or intent to deceive
(ii) the Premium and terms shall be adjusted at Our discretion to those which would have applied had such circumstances been disclosed
(iii) where You should have notified a Claim during a preceding Period of Insurance and the indemnity or cover to which You would have been entitled was in any way more restricted than that provided at the date of notification We shall be liable only to the extent applicable during such preceding Period of Insurance
(b) We shall not deny payment or indemnity on the grounds of Your non-compliance with Claims Condition 1 (Notifications of Claims) or 2 (General Handling of Claims) applicable to the Certificate as a whole subject to proviso (a)(iii) of this clause but where You have prejudiced the handling or settlement of any Loss the amount payable in respect of such Loss (including Costs and Expenses) shall be reduced to such sum as in Our opinion would have been payable in the absence of such prejudice.
(c) in the event of any dispute between You and Us regarding the application of (a) and (b) above, such dispute or disagreement shall be referred by either party for arbitration to any person nominated by the President for the time being of The Royal Institution of Chartered Surveyors.”
THE CENTRAL ISSUES
HHJ Pelling QC found that in the 2013 and 2014 risk profiles, CLS had confirmed that it had not undertaken any work for sub-prime lenders, and that these statements were misrepresentations (paragraph ). These misrepresentations took effect as warranties (paragraph ). HHJ Pelling QC went on to consider:
(1) whether, by its letter of 8 February 2016, the Defendant had waived its right to rely on CLS’s breach of warranty; and
(2) the effect of the UND clause.
As noted above, the policy documentation included a provision to the effect that “… Underwriters having received a Proposal which shall form the basis of and be incorporated in this contract …”.
HHJ Pelling QC held that the effect of this provision was that the representations on which the Defendant relied were warranties and CLS unconditionally guaranteed the accuracy of those warranties. The effect of a breach of such warranties (subject to the UND) was that the Defendant was “automatically discharge[ed]…from the time of the breach” without the need to prove materiality or reliance on the misrepresentation (paragraph ).
As HHJ Pelling QC noted, the Policies pre-dated the Insurance Act 2015, with the effect that the Act was not relevant to the dispute (paragraph ).
The Defendant’s letter of 8 February 2016, by which it purported to avoid the Policies, read:
“Having considered the matter carefully, we regret to inform you that Markel has formally avoided the Policies as a result of CLS’s deliberate and dishonest misrepresentations and on-disclosure…CLSL has not established to Markel’s satisfaction that the non-disclosure or misrepresentation of CLSL’s clients was innocent and free from any fraudulent conduct or intent to deceive. Indeed, Markel believes that the non-disclosure and/or misrepresentations were deliberate and dishonest. Merkel is not therefore obliged to waive its rights to avoid the Policy” (paragraph ).
The letter also set out what were described as being the “Relevant Policy Terms” and included the provision which made the Proposal the basis of the contract between the parties (paragraph ).
The Claimant argued that, by this letter, the Defendant had waived the right to rely on the breach of warranty.
HHJ Pelling QC rejected this argument, holding that there was nothing in the letter which was inconsistent with reliance by the Defendant on its right to avoid the Policy for breach of warranty. In HHJ Pelling QC’s judgment, “it [was] difficult to see why the author of the letter would have included the provision that made the Proposal the basis of the contract between the parties if the intention had been to waive reliance on that provision” (paragraph ).
Further, the only waiver available in this context was waiver by estoppel; it was necessary to both plead and prove the essential elements of such a waiver, including:
“a clear and unequivocal representation that the reinsurer (or insurer) will not stand on its right to treat the cover as having been discharged on which the [reinsured] (or insured) has relied in circumstances in which it would be inequitable to allow the reinsurer (or insurer) to resile from its representation” (paragraph , citing from the first instance decision in HIH Casualty & General insurance Limited v. Axa Corporate Solutions  Lloyd’s Rep. I.R. 325).
HHJ Pelling QC held that the Claimant had not pleaded the necessary elements of waiver by estoppel and had not established those elements by reference to the contents of the letter of 8 February 2016 (paragraph ).
THE EFFECT OF THE UND CLAUSE
Having established that the Defendant was entitled to rely on breach of warranty in order to decline cover under the Policies, HHJ Pelling QC considered the operation and effect of the UND clause. HHJ Pelling QC set out and applied case law on the approach to be taken to contractual terms which confer an absolute discretion on one party.
Step 1: construing the UND clause
According to HHJ Pelling QC, the first step was to construe the clause in question, in accordance with established principles of construction, to determine whether it did indeed confer an absolute contractual right on one party (paragraphs  – ).
HHJ Pelling QC construed the UND clause and held that it conferred an unqualified decision-making power on the Defendant:
“In my judgment the only relevant phrase is “ … You are able to establish to Our satisfaction that such non-disclosure or misrepresentation was innocent and free from any fraudulent conduct or intent to deceive …” Within that phrase, the only part that matters for present purposes are the words “ … to Our satisfaction …”. In my judgment the effect of that language is twofold. First, it makes clear that the burden is placed on CLS to establish that any misrepresentation of non-disclosure was “ … innocent and free from any fraudulent conduct or intent to deceive …”. This is the effect of the words “ … You are able to establish …”. Secondly, the language used clearly states that the decision maker is the defendant. That is the effect of the words “ … to Our satisfaction …”… The contract confers the decision making power on the defendant… That being so, unless the unqualified terms of the agreement are qualified by implication, the parties are bound by the decision of the defendant” (paragraph ).
Whilst the UND clause also provided, at subsection (c), that any dispute between the parties was to be referred to arbitration, this had no bearing on the question of whether the clause conferred on the Defendant an absolute contractual decision-making power. HHJ Pelling QC said: “Although the claimant places some reliance on the arbitration clause in paragraph (c) as impacting on the true construction of the UND Clause, I do not agree that it has any impact on the construction issue that arise in this case. The arbitration agreement within the UND Clause was a contractually agreed means by which a dispute was to be resolved. It says nothing about the question that the tribunal charged with resolving the dispute had to ask itself when resolving a dispute. In principle the question should be the same whether the parties use the agreed dispute resolution mechanism or (as in fact is the case here) they chose not to do so but instead to litigate the dispute” (paragraph ).
Step 2: the implication of a term
The next stage was to consider whether the seemingly absolute contractual right was to be qualified by virtue of an implied term. The Court considered the Supreme Court’s decision in Braganza v BP Shipping Limited  UKSC 17, the leading authority on this topic. HHJ Pelling QC said: “In my judgment, it is clear that there is to be implied into the agreement between these parties a term to the effect identified in that case” (paragraph ).
In Braganza, the Supreme Court had considered a contractual term by which “ … one party to the contract is given the power to exercise a discretion, or to form an opinion as to relevant facts …” (paragraph  –Baroness Hale, with whom Lord Kerr agreed). By a majority, the Court held that such clauses were subject to an implied term stipulating that the decision maker must (1) take into account relevant matters and omit from consideration irrelevant matters and (2) must not come to a conclusion that no reasonable decision maker could ever have reached (“the Wednesbury test”) (paragraph  – Baroness Hale, with whom Lord Kerr agreed, and paragraph  – Lord Neuberger, who spoke in more cautious terms, considering that both limbs of the Wednesbury test should be applied in reviewing “at least some contractual discretions”).
Whilst the Court could not substitute itself as decision maker in place of the original decision maker, it could carry out a reviewing exercise to determine whether the decision maker had complied with the Wednesbury test (paragraphs  – Baroness Hale, with whom Lord Kerr agreed and paragraph  – Lord Neuberger).
Baroness Hale also said: “It may very well be that the same high standards of decision-making ought not to be expected of most contractual decision-makers as are expected of the modern state” (paragraph ).
Baroness Hale noted that a principle of rational decision-making was that: “The more unlikely something is, the more cogent must be the evidence required to persuade the decision-maker that it has indeed happened” (paragraph ).
Applying Braganza, HHJ Pelling QC held that “Neither party can be treated sensibly as having intended to permit the defendant to make decisions that were arbitrary, capricious or irrational. Thus it is necessary to imply a term in order to eliminate the possibility of such decision making since it is only by implying such a term that the UND Clause can be given business efficacy or because the necessity for the implication of such a term is so obvious that it goes without saying. There is no question of such an implied term contradicting the agreement of the parties. On the contrary it is giving effect to that which both are to be treated as having intended” (paragraph ).
It was not for the Court to substitute its own judgment for that of the contractual decision maker, and, therefore, the Court was not entitled to consider whether the whether the misrepresentations relied on by the Defendant were free from any fraudulent conduct or intent to deceive. Instead, the Court was tasked with considering whether the decision made by the Defendant had been arbitrary, capricious or irrational under the Wednesbury test (paragraphs , ,  and ).
HHJ Pelling QC went on to hold that in applying the Wednesbury test: “… it is necessary to bear in mind the often quoted direction in Re H (Minors) (Sexual Abuse: Standard of Proof) (ibid.) that “ … the more serious the allegation the less likely it is that the event occurred and, hence, the stronger should be the evidence before the court concludes that the allegation is established on the balance of probabilities …” – see Braganza (ibid.) per Lady Hale at paragraph 36. In a case such as this, where contractually the onus has been placed on the insured to prove the misrepresentation or non-disclosure “ … was innocent and free from any fraudulent conduct or intent to deceive …” this principle requires the decision maker to bear in mind that it is inherently more probable that a misrepresentation has been made innocently or negligently rather than dishonestly in arriving at an evaluative conclusion based on the whole of the material that the decision maker ought to take into account” (paragraph ).
Having said this, HHJ Pelling QC recognised that, in accordance with Baroness Hale’s judgment in Braganza, there was a distinction to be drawn between the standard of decision making expected from a commercial party and that employed by the courts: “As Lady Hale observed at paragraph 31 of her judgment: “… It may very well be that the same high standards of decision-making ought not to be expected of most contractual decision-makers as are expected of the modern state…” How in practice this qualification is to be applied is not developed. However, I accept Mr Pooles’ submission that it would be a mistake to expect an insurance company in the position of the defendant to adopt “… the same expert, professional and almost microscopic investigation of the problems both factual and legal, that is demanded of a suit in a Court of Law” – see CVG Siderurgicia del Orinoco SA v London Steamship Owners Mutual Insurance Association Ltd  1 Lloyds Rep 557” (paragraph ).
Further, even when a contracting party has failed to take into account a relevant consideration or has considered an irrelevant factor, a court should not interfere with the decision where “it appears to a court to be highly likely that the outcome would not have been substantially different even taking account of the error” (paragraph ).
Turning to the facts of the case before him, HHJ Pelling QC summarised the issues to be decided as follows:
“(i) did Mr McKechnie (a) fail to take into account any facts and matters that he ought to have taken into account or (b) take into account any facts and matters that he ought not to have taken into account, (ii) would the decision have been the same even if any such errors had not occurred and (iii) was the decision one that no reasonable decision maker could have arrived at on the material that ought properly to have been considered” (paragraph ).
HHJ Pelling QC then said: “Whilst the issue in (iii) above has to be examined even if issue (i) or (ii) are resolved in favour of the defendant, it is difficult to see how the test referred to in (iii) above could be satisfied if the issues I refer to in (i) and (ii) were resolved in favour of the claimant” (paragraph ).
The limits of the implied term
HHJ Pelling QC refused to consider process-related issues, such as whether the Defendant ought to have arranged a meeting with CLS before making its decision:
“In the public law context challenges to the process by which decisions are arrived at are legally distinct from Wednesbury challenges. There is nothing in Braganza (ibid.) that incorporates into private law any public law concepts other than two distinct elements to the Wednesbury test summarised above. Secondly, any such challenge if permitted in principle would have to be approached with caution since it would be equally if not more of a mistake in such a context to expect of a commercial decision maker the same standards that are expected of the state or a process that is similar to that adopted by a state court or tribunal or an arbitrator” (paragraph ).
Burden of proof
With respect to the burden of proof, HHJ Pelling QC considered that it was for the Defendant to satisfy the Court that its decision had been made rationally. However, the Defendant was not obliged to prove that CLS had committed a fraud given that: “The contract between the parties placed the burden of satisfying the decision maker on CLS as insured” (paragraph ).
THE DECISION ON THE FACTS
The Court considered that it was apparent, from a number of responses given in cross-examination, that the Defendant had “failed to approach the dishonesty issue with an open mind or bearing in mind that it was more probable that a misrepresentation has been made innocently or negligently rather than dishonestly” (paragraph ).
The Defendant had also failed to take into account relevant considerations such as the fact that CLS had not sought to conceal the Waterman claim even though it had failed to mention, in the risk profiles, that work had been carried out for Waterman, a sub-prime lender. The Defendant ought to have considered whether this indicated that the omission in the risk profile was innocent (paragraphs  and ).
HHJ Pelling QC held that it was not possible to conclude that the outcome would have been the same had this issue been approached correctly:
“The errors to which I have referred (and in particular those concerning approach referred to at paragraph 95 and following) permeate the whole of the decision making exercise, which on analysis consisted of little more than a reference to the falsity of the representations coupled with the fact that at the time they were made, CLS was carrying out commercial valuation work for lenders other than clearing banks and building societies…As I explained earlier it is difficult to see how a decision could be one that a decision maker was entitled to arrive at if in arriving at that decision, the decision maker has taken account of factors that should not have been considered or failed to take account of factors that ought to have been considered” (paragraphs  and ).
HHJ Pelling QC then invited the parties to make submissions as to the form of the order to be made in light of his conclusions. However, the judgment does not indicate the terms of the order ultimately made.
The decision in UK Acorn Finance Limited v Markel (UK) Limited confirms that the law governing contractual discretion, as set out in Braganza, applies in the insurance context (contrary to submissions made by the Claimant). Whilst it is clear that contractual decision makers will not be held to the same standard as public bodies, it is equally clear that they will be expected to apply some of the principles of reasoning routinely applied by courts – such as the maxim that negligence is inherently more probable than dishonesty. The precise standard of decision-making expected of commercial parties is no doubt an issue which will require further consideration in subsequent decisions.