A recent Court of Appeal decision highlights the consequences which flow from an insured providing dishonest information in support of an insurance claim.(1) It is the first appellate-level consideration of the fraudulent claims rule in New Zealand and confirms both that the duty of utmost good faith is an implied contractual term and that the legislative framework in the Contract and Commercial Law Act (CCLA) 2017 governs remedies for breach.
Mr Taylor, a self-employed insurance broker, took out an income protection policy with Asteron Life in 1994. The policy provided:
- total disability benefit cover, which provided ongoing monthly income payments if the insured could not work more than 10 hours a week due to sickness or injury; or
- a partial disability benefit if the insured's income was reduced to less than 75% due to illness.
In 2010 Taylor made a claim under the policy (citing bone cancer and related chronic pain) and began receiving total disability benefit payments. Payments continued through to September 2014, at which point Asteron suspended them owing to Taylor's failure to provide requested information regarding his working hours and income, citing concerns that both Taylor's working hours and income exceeded the policy's eligibility thresholds.
Taylor commenced High Court proceedings, seeking a declaration that he was entitled to ongoing benefits under the policy, along with recovery of payments in arrears. For its part, Asteron counterclaimed, seeking repayment of all sums paid to Taylor on the basis that he had breached his utmost duty of good faith by making materially false statements regarding his working hours and income. Asteron initially suspended payments rather than cancelling the policy, though later asserted that its counterclaim constituted cancellation.
The High Court rejected Taylor's claim but upheld Asteron's counterclaim and awarded it NZ$371,286.70 plus interest and costs (which represented all payments made to Taylor under the policy). Justice Cooke found that Taylor had remained actively involved in his insurance broking business and that both his hours worked and income received exceeded the eligibility thresholds for both total and partial disability benefits. In addition, the court found that Taylor had deliberately misrepresented the amount of time that he had spent working, which constituted a breach of his obligation of utmost good faith.
While some of the information in Taylor's original claim form from July 2010 was inaccurate, there was insufficient evidence for a finding that he had made deliberately false statements at that time. However, subsequent information submitted by Taylor was found to contain deliberately false statements regarding the amount of work in which he was engaged.
Asteron advanced its claim based on (principally UK) common law principles addressing the duty of good faith. However, the court held that the legislative framework provided by the CCLA governs an insurer's ability to cancel or avoid liability under an insurance contract for misrepresentation, repudiation or breach. In reaching this decision, the High Court noted uncertainty about the underlying source of the duty of utmost good faith, but concluded that the duty of good faith was an implied term of the insurance contract and therefore subject to a contractual analysis.
To obtain relief pursuant to Section 43 of the CCLA, Asteron must have cancelled the contract following Taylor's provision of dishonest information. While Asteron's correspondence suspending payments (or any subsequent communication) did not say that it was cancelling the policy, the court was satisfied that Asteron's intention to cancel the policy had been clearly communicated by a brief of evidence served by its in-house lawyer stating that Asteron's position was that it had cancelled the policy. Even if Asteron had not cancelled the policy, the court considered that Asteron would have been entitled to full recovery based on principles of restitution, as Taylor's income levels were such that he was never entitled to receive any benefit payments under the policy.
Taylor appealed the High Court's factual finding that he was not entitled to total disability benefits and that he had made misrepresentations, as well as its finding that Asteron had been entitled to cancel the policy and recover all amounts paid. In addition, Taylor argued that the High Court should not have held that he had acted dishonestly as dishonesty was not pleaded by Asteron so was not properly in issue. As a result, the Court of Appeal addressed:
- the nature of an insured's obligation of utmost good faith (in particular, whether it is an implied term or a freestanding common law obligation);
- whether Asteron had properly pleaded a claim based on dishonest breach of contract and cancellation under the CCLA; and
- whether, on the facts, Asteron had cancelled the policy.
The Court of Appeal upheld the first-instance decision on both Taylor's claim and Asteron's counterclaim, although it held that Asteron was entitled to recover only payments made after Taylor had dishonestly provided false information to Asteron. In doing so, it canvassed at length the conceptual debate as to whether the fraudulent claims rule is best seen as an implied term in an insurance contract or a standalone common law rule applicable to insurance policies. The conceptual distinction has practical significance, as the remedies available for breach of an implied term are those provided by the CCLA rather than common law, and a breach of an implied term would enable an insurer only to decline (or recover payments for) the dishonest claim, rather than avoid all obligations under the policy from its inception. An implied term is also subject to modification by the express terms of the particular insurance contract.
The Court of Appeal held as follows:
- The common law fraudulent claims rule is best seen as an implied term within all insurance contracts (subject to any extension, modification or restriction by the express terms of the contract).
- An insurer's right to cancel an insurance policy and seek damages following a fraudulent claim is governed by the CCLA. There are no special rules governing cancellation of insurance contracts that operate in parallel to this act.
- The implied term requiring an insured to act honestly is an essential term to the insurer, such that a breach entitles the insurer to cancel the policy. It would be obvious to both insurer and insured that no insurer would wish to continue providing cover to an insured who has made a dishonest claim.
- Where an insurer cancels a policy following a fraudulent claim, the policy is terminated from the date of cancellation. Accordingly, while the insurer is not obligated to pay the fraudulent claim, cancellation does not affect either parties' rights and obligations which accrued before the date of cancellation. For this reason, cancellation does not disentitle an insured to receive or retain payment for an earlier claim that was raised prior to cancellation and was not dishonest.
The court rejected the contention that Asteron did not plead dishonesty properly, noting that Asteron had pleaded that Taylor owed and had breached a duty of good faith, which was consistent with the language used in case law describing and applying the fraudulent claims rule. It was also satisfied that Asteron's pleading constituted valid cancellation as it was a clear indication that Asteron was treating the contract as at an end.
It followed from the court's conclusion summarised in the final bullet above that Asteron was not entitled to recover the initial benefit payments that were made to Taylor prior to his dishonest provision of false information. These payments were not impugned by either Taylor's subsequent dishonesty in respect of later periods or Asteron's cancellation of the contract. The Court of Appeal acknowledged that the High Court had found, as a matter of fact, that owing to his earning level, Taylor was never entitled to receive benefit payments, and therefore all payments by Asteron were in error and so could have been recovered through a restitution claim. However, Asteron had not chosen to pursue a claim in restitution, despite becoming aware of the extent of Taylor's earnings during the period prior to his dishonesty a few months prior to trial. Accordingly, the Court of Appeal reduced the damages payable to Asteron by NZ$55,000 to account for benefit payments made prior to Taylor's dishonesty.
This is the first time that an NZ appellate court has substantively addressed the conceptual underpinnings of the common law fraudulent claims rule. In doing so, the Court of Appeal thoroughly addressed divergent UK authority and confirmed (at least for New Zealand) that the duty of utmost good faith arises from an implied contractual term rather than a manifestation of a wider common law duty of good faith. The significance of this conceptual clarification is two-fold:
- It confirms that the threshold required for breach of the implied duty of utmost good faith in respect of claims is dishonesty, not some lesser standard (eg, non-disclosure).
- It clarifies that the relevant legal framework governing the remedies available for breach is the legislative framework provided by the CCLA rather than common law principles.
Earlier first-instance NZ decisions applied a dishonesty threshold to the fraudulent claims rule, although none addressed the conceptual underpinnings of the rule. This case is also the first time that the CCLA has been applied to address a breach of the duty of utmost good faith rather than principles of common law.
While the Court of Appeal's conclusion that Asteron was not entitled to recover benefit payments made to Taylor during the period prior to his dishonesty may appear harsh, in view of the finding that Taylor was not entitled to receive the payments as they were made under influence of a mistake and could have been recovered by Asteron through a restitution claim, the court's decision reflects the pleadings on which the parties went to trial. On learning that payments had exceeded the policy entitlement, it was for Asteron to amend its pleadings to add a restitution claim. This should serve as a timely reminder to always keep pleadings under review as additional information is uncovered during the trial preparation process, even at a late stage where the court's leave is required to make amendments.
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