Insurance Contract Law Reform - Proposed Amendments to the Duty of Good Faith

The Law Commission continues to make great strides in proposing insurance contract law reform. Its latest offerings are two papers which consider the duty of good faith: Issues Paper 6, Damages for Late Payment and the Insurer's Duty of Good Faith; and Issues Paper 7, The Insured's Post-Contract Duty of Good Faith. We touched briefly on both these topics in our December 2009 issue of Insurance and Reinsurance Review.

Issues Paper 6 – Damages for Late Payment and the Insurer's Duty of Good Faith

This Issues Paper was published on 24 March 2010. In it, the Law Commission considers whether a policyholder should be entitled to damages where the insurer has refused to pay a valid insurance claim, or has paid only after considerable delay. Failure by insurers to provide a prompt indemnity, for example, following a fire at commercial premises, can lead to disastrous financial consequences on the part of the insured, which can include a total loss of the business. Under English law, there is no recompense, save for the discretionary award of interest which will often not reflect the policyholder's true loss.

In American jurisdictions of course, the position is very different. Under the law of most states, insurance companies owe a duty of good faith and fair dealing to the persons they insure. This duty is often referred to as the "implied covenant of good faith and fair dealing" which automatically exists by operation of law in every insurance contract. If an insurance company violates that covenant, the policyholder may sue the company on a tort claim in addition to a standard breach of contract claim. The contract-tort distinction is significant because as a matter of public policy, punitive or exemplary damages are unavailable for contract claims, but are available for tort claims. The end result is that a plaintiff in an insurance bad faith case may be able to recover an amount larger than the original face value of the policy, if the insurance company's conduct was particularly egregious.

The Problem with Sprung

Under English insurance law it is established law that a claim under an insurance policy is a claim for damages and there is no right to damages for late payment of claim/indemnity, as held in President of India Lips Maritime Corporation (The Lips) [1988] AC 395 and followed reluctantly by the Court of Appeal in the key case of Sprung v Royal Insurance (UK) Limited [1997] CLC 70.

The Law Commission considers that Sprung is out of line with the principles of ordinary contract law. The general position is that a defendant is required to compensate the claimant for any loss flowing naturally from the breach of contract or any special loss which he ought to have known would flow from the breach. Insurance law is the exception because the sums due under the insurance policy are in the form of damages for breach of the insurers' undertaking to "hold the insured harmless" by way of indemnity and therefore payable on the occurrence of the insured peril. As the Law Commission points out, this is a pure fiction as it means that insurers are automatically in breach of contract if the assured suffers a loss.

The Law Commission also has the following objections to the decision of Sprung:

the law is unfairly weighted in favour of insurers because the...

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