Publications
A Matter of Circumstance
London & Bermuda Newsletter
The Court of Appeal has shone a bright light on claims made policy trouble spots which are almost certain to loom large in the credit crunch fallout.
Two dichotomies about ‘circumstances’
For insureds, failure to make proper notification may have catastrophic results. Warranties on renewal or a change in insurers may deprive the insured of future cover for claims arising out of a known error. If the error is notified as a circumstance, the current policy should respond to claims to which the error gives rise. On the other hand, insureds may be reluctant to raise alarm bells over matters that prove insignificant and impair their risk profile unnecessarily. Worse, if the insured just has a nagging concern that something may have gone wrong, but as yet no one else has adverted to it, must they still notify? Will they lose future cover if they don’t? The sense of credit crunch-related storm clouds brewing raises the stakes in getting the answer right.
Conversely, insurers will want to reject notices where they cannot determine what is being notified or where they are unconvinced there really is any “circumstance” to be notified at all. But they will also want to take insureds to task for failing to notify properly, and to rely on policy defences for default.
Kidsons is a fascinating object lesson about a firm of accountants caught between this particular rock and hard place. Kajima illustrates the difficulties insureds can encounter, and the rights of insurers, where the critical circumstance is difficult to identify. These decisions add extremely useful detail to our understanding of the legal landscape.
When is a circumstance notifiable?
How do you distinguish circumstances which are “likely to give rise to a claim”, and thereby notifiable, from those which are not? The issue is important: insurers can reject notifications of circumstances which are not likely to give rise to claims; equally, insureds don’t have to notify them. Moreover, is the right test what a reasonable insured would think, or what the insured actually thought?
The circumstance in Kidsons
Kidsons owned a business selling tax shelter schemes. A tax manager employee expressed strongly worded, broad concerns that the schemes were inherently flawed (“inherent flaws”) and had not been put in place properly (“implementation”).
Kidsons’ Professional Indemnity Insurance policy obliged them to notify insurers “as soon as practicable” of circumstances which “may give rise to a claim” of which Kidsons were aware. Claims subsequently arising from circumstances so notified were deemed covered under the policy in place at time of notification.
The problem for Kidsons as a firm was that they were not convinced there really was anything to notify. Accordingly, their presentations to insurers soft-pedaled the implementation concerns and omitted all reference to concerns about inherent flaws.
Third parties subsequently claimed against Kidsons in relation to inherent flaws in the schemes. Kidsons argued the policy covered these claims as the presentations triggered the deeming clause.
Court of Appeal’s decision – insured has the benefit of the doubt in marginal cases
Notifiability is a matter of judgment and involves “crystal ball-gazing”. The problem for the insured is everything rides on this difficult question. For this reason, the test has to give the insured the benefit of the doubt. The right approach therefore is a hybrid of what the insured actually believes about a circumstance, and what the reasonable insured would believe:
- Circumstances which are too vague or remote to be reasonably capable of being regarded as matters that may give rise to a claim are not notifiable. Insurers can reject notices thereof.
- Circumstances any reasonable person in the insured’s position would recognise as carrying a real risk of a claim are notifiable; failure to notify amounts to breach.
- In the middle of the continuum is a range of circumstances the potential for which to give rise to claims is a matter for reasonable debate. Whether these are notifiable depends on the insured’s subjective view. The insurer cannot reject notices, but nor can it defend future claims on the basis of failure to notify. In this middle region, the insured can do no wrong.
Kidsons failed to notify the inherent flaw concerns. That did not mean it was in breach: the potential for claims was in the more debatable region of the continuum, so the subjective test applied.
How thorough or clear must the notice be?
As with notifiability, the standard of clarity must reflect the inherent element of judgment involved, combined with the high stakes for the insured. Where the policy is unspecific about the form of the notice (as it was in Kidsons), it is wrong to be too prescriptive. Otherwise, it is too easy for the insured to get caught out.
The notice just needs to be “fair, comprehensive and comprehensible” or a “fair, if summary, presentation”. Failure to meet that standard amounts to breach. It seems if the insured holds something back, and fails to give a fair presentation, the notice may be rejected. A notice which is deliberately misleading is almost certain to fail the test, entitling insurers to reject.
Here, Kidsons’ notice of implementation concerns toned down what the tax manager said, but did not fail the “fair presentation” test.
Distinguishing claims that ‘arise from’ circumstances from those that do not
Kajima explored a different aspect of notification. Whereas Kidsons concerned a dispute over what constituted notification, the issue in Kajima was whether defects and damage arising after notification and expiry of the policy were covered by the original notification.
Kajima had designed and built a block of flats. It notified insurers of certain defects it had discovered. The notification also referred to other possible damage and stated that an investigation was underway. During subsequent investigations, further defects were discovered which had not been known at the time of notification.
It was held the notified circumstances could not be expanded by the later discovery of unrelated defects or damage which were not the subject matter of notification. A claim must be “sufficiently causally related to the fact, event, happening or condition which comprises the notified circumstance, that it can be fairly said to have arisen out of it”.
If the notice is ambiguous, who gets the benefit of the doubt?
If the notice is open to more than one interpretation – one broad, one narrow – what determines which is the right one? In answering this question, do you consider what the insured actually had in mind in drafting the notice, or how a reasonable onlooker would read it?
Kidsons didn’t believe there were inherent flaws. So if actual beliefs and intentions were decisive, the notice could not encompass them. But if the meaning were what a reasonable onlooker would read the notice as saying, then Kidsons potentially stood to benefit, and insurers to suffer, from a drafting “accident”.
The Court did not have to grasp this particular nettle directly. But it seems scope is a matter of what a reasonable onlooker would treat the notice as covering, and that actual beliefs may be irrelevant. That may allow insureds to benefit from accidents of construction. Lack of knowledge does not make the circumstance necessarily unnotifiable. However, if the notice is deliberately ambiguous, the insured may not benefit from a potential broad reading.
Are internal concerns a circumstance?
The court hazarded that a “circumstance” is more typically something “external”, for example, an outside party adverting to a mistake. Internal, personal opinions are less obvious candidates. Strictly speaking, all the insured has to do is give a fair presentation of all material information. It needn’t then express its own view about the risk the facts represent; that is for the underwriter.
Unfortunately, because the point wasn't fully argued, these comments do not provide legal guidance; they just kick up this particular dust. But it is interesting dust, nonetheless.
HLB Kidsons v. Lloyd’s Underwriters et al (31 October 2008 - [2008] EWCA Civ 1206)
Kajima UK Engineering Limited v. The Underwriter Insurance Company Limited ([2008] Lloyd’s Rep IR 391)
|