Versloot Dredging BV & Anor v HDI Gerling Industrie Versicherung AG & Ors [2016] UKSC 45

The insured ship owners made a valid €3.2m marine insurance claim after engine room flooding, but recklessly lied about a bilge alarm to speed up payment. The Supreme Court held that such collateral lies, irrelevant to the claim's validity, do not forfeit recovery.

Facts

On the night of 28/29 January 2010, the cargo vessel ‘DC MERWESTONE’ suffered an ingress of seawater into the engine room shortly after departing Klaipeda, Lithuania. The flooding resulted from a combination of crew negligence (failure to close the sea inlet valve of the emergency fire pump after using it to clear ice), frost damage to the pump casing, negligently unsealed engine room bulkheads following earlier contractor works, and defective engine room pumps. The main engine was damaged beyond repair.

When the insurers, through Ince & Co, investigated, Mr Chris Kornet of the vessel’s managers told them in an email of 21 April 2010 that the bilge alarm had sounded at around noon on 28 January and that the crew had attributed it to heavy weather. Popplewell J found this to be a ‘reckless untruth’: Mr Kornet had not been told this by the crew. He made the false statement because he was frustrated by delay in payment and feared the insurers would focus on unseaworthiness and owners’ privity.

Crucially, the lie was irrelevant to recoverability. The judge held the loss was proximately caused by perils of the sea, the Inchmaree clause afforded no defence, and the owners had not breached the section 39(5) Marine Insurance Act 1906 warranty. The claim of approximately €3.241m was good on the true facts, but Popplewell J nonetheless held it forfeit on account of the ‘fraudulent device’, describing this as a ‘disproportionately harsh sanction’.

Issues

The central issue was whether the common law fraudulent claims rule applies to a valid insurance claim that is supported by a ‘collateral lie’ – i.e. a dishonest statement which, on the facts as ultimately found, turns out to have been irrelevant to the insured’s right to recover.

Arguments

Insurers

The insurers contended that the fraudulent claims rule extends to fraudulent devices used to promote a claim, relying on Mance LJ’s analysis in Agapitos v Agnew (The ‘AEGEON’). They argued the necessary connection between the lie and the claim was supplied by a test of materiality assessed at the time the lie was told, by reference to how it would have appeared to a hypothetical insurer when the full facts were not yet known. Deterrence of insurance fraud justified the rule.

Insured

The insured argued that where the claim is in truth wholly valid, a lie which is irrelevant to recoverability should not forfeit the claim. Forfeiture in such circumstances would be disproportionate, would punish without any commercial justification, and would be inconsistent with general principles of contract law requiring causation or inducement. Reliance was also placed on Article 1 of the First Protocol to the ECHR.

Judgment

The Supreme Court (Lord Sumption, with Lord Clarke, Lord Hughes and Lord Toulson agreeing; Lord Mance dissenting) allowed the appeal and entered judgment for the insured in the sum of €3,241,310.60 plus interest.

Lord Sumption’s reasoning

Lord Sumption distinguished three situations: wholly fabricated claims, dishonestly exaggerated claims, and valid claims supported by collateral lies. The fraudulent claims rule is well established for the first two but its extension to the third is a more recent and controversial development.

He held that the rationale of the rule is the deterrence of fraud, reflecting informational asymmetry in insurance. However, in the case of a collateral lie supporting a valid claim, the insured ‘is trying to obtain no more than the law regards as his entitlement and the lie is irrelevant to the existence or amount of that entitlement. In this case the lie is dishonest, but the claim is not.’ The insurer loses nothing if he meets a liability he had anyway, and the insured gains nothing from the lie he was not entitled to.

Lord Sumption rejected the test of materiality proposed by Mance LJ in The ‘AEGEON’ (and adopted by the Court of Appeal below), which assessed materiality at the time the lie was told. He held that, because the insurer has no discretion in evaluating an existing claim (unlike the pre-contract stage where he can choose whether to accept the risk), the only rational test of materiality is whether the lie goes to recoverability on the true facts. A collateral lie which is shown to have been unnecessary is not material in the relevant sense.

Lord Hughes’ supporting reasoning

Lord Hughes emphasised proportionality. While the fraudulent claims rule remains essential and is preserved by section 12 of the Insurance Act 2015, extending it to collateral lies would be ‘too large a sledgehammer for the nut involved.’ He identified a qualitative difference between fraud aimed at gaining something to which one is not entitled, and ‘gilding the lily’ to obtain only what one is already due. Other sanctions (loss of credibility, costs, future insurance difficulties, potential prosecution) suffice for collateral lies.

Lord Clarke and Lord Toulson

Lord Clarke emphasised that policy did not require so harsh a result, and pointed to the anomaly that fraud committed after litigation begins falls outside the rule. Lord Toulson agreed, noting that experienced advocates know lying to bolster a true case is not ‘smart’ because it damages credibility.

Lord Mance (dissenting)

Lord Mance, who had authored the leading judgment in The ‘AEGEON’, maintained that the fraudulent claims rule should extend to fraudulent devices. He argued the majority’s hindsight-based approach overlooked the reality that lies are typically told when the insured doubts the strength of his claim, distorts the claims process, and rewards undetected fraud while imposing no real penalty on detected fraud. He would have heightened the materiality threshold to ‘significant’ improvement of prospects but otherwise upheld the rule.

Implications

The decision narrows the common law fraudulent claims rule. The rule continues to apply with full force to wholly fabricated claims and to dishonestly exaggerated claims (including the genuine element of an exaggerated claim), but it does not apply to a lie which, on the facts as ultimately found, turns out to have been irrelevant to the insured’s entitlement to indemnity.

The Court overruled the obiter analysis in Agapitos v Agnew (The ‘AEGEON’) and the Privy Council’s application of it in Stemson v AMP General Insurance (NZ) Ltd, to the extent they treated collateral lies as forfeiting valid claims.

Section 12 of the Insurance Act 2015, applicable to contracts concluded after 12 August 2016, restates the fraudulent claims rule but, as both the majority and minority recognised, deliberately left open the position on collateral lies. The decision therefore informs the construction of that statute as well as the common law for earlier contracts.

The decision matters particularly to insurers and insured parties in commercial and marine insurance, and to practitioners advising on claims handling. Insurers retain robust protection against fabricated and exaggerated claims, but cannot use a peripheral untruth to escape liability for a claim that is, on analysis, wholly justified. The Court noted that insurers may now wish expressly to provide in their policy wording for the consequences of fraudulent devices if they desire greater protection.

Limits of the decision: the rule against forfeiture of valid claims does not licence dishonesty. Other consequences follow from telling lies in the claims process – damage to credibility, adverse costs orders, potential criminal liability, prospective termination of cover, and difficulty obtaining future insurance. The decision is also confined to the common law rule; express policy terms may produce different results. Article 1 Protocol 1 ECHR arguments were not decided as they did not arise on the majority’s view of the common law.

In the wider legal context, the case reflects a principled limit on the role of an insured’s immorality in defeating otherwise valid civil claims, consistent with the general law of contract’s emphasis on causation and inducement, and resists disproportionate forfeiture remedies in the law of insurance.

Verdict: The appeal was allowed. The Supreme Court (by a 4:1 majority, Lord Mance dissenting) held that the fraudulent claims rule does not apply to a valid insurance claim supported by a collateral lie which, on the true facts, is irrelevant to the insured’s entitlement to recover. Judgment was entered against the insurers for €3,241,310.60 plus interest.

Source: Versloot Dredging BV & Anor v HDI Gerling Industrie Versicherung AG & Ors [2016] UKSC 45