THE DUTY OF UTMOST GOOD FAITH

THE DUTY OF UTMOST GOOD FAITH

Kelly Godfrey Employment Lawyers

Increasingly Courts are implying a common law duty of good faith into commercial contracts. Requiring parties to act honestly and reasonably in exercising their contractual rights, absent of capricious or unconscionable behaviour. 1Whilst the nature of the duty of utmost good faith implied by s.13 of the Insurance Contracts Act

7984 (Cth) ('the ICA') is different in

nature to that imposed by the common law, it too is receiving renewed interest.2The doctrine of utmost good faith in comparison with other provisions of the ICA remains somewhat of a mystery. Whilst it is an area of insurance law which has remained relatively underutilised, the doctrine's potential use makes it the great unknown of modern insurance law.3

The Scope of the Duty of Utmost Good Faith

It is imperative that both the insurer and insured participate in all contractual negotiations,4 as the duty of utmost good faith is a reciprocal duty which relates to every aspect of the parties relationship.5 The duty endures until all obligations underthe contract of insurance have been discharged. However, if the contract is terminated by a release, the subsequent behaviour of the parties may be relevant. 6lf a further legitimate loss was discovered after execution of the release, the duty of utmost good faith would prevent the release being pleaded as a bar to the claim. 7 ln Australia, if litigation is commenced in relation to the policy, the duty continues until judgement and perhaps beyond.8

Defining the Duty of Utmost Good Faith

The duty of utmost good faith, (alternatively known as the duty of uberrima fides 9) is better described than defined. With the ICA providing no definition, guidance must be derived from an examination of the parties' relationship on a case by case basis. 10 Wh ilst the duty

requires an 'essential element of honesty'll and 'good faith', arguably the inclusion of the word 'utmost' elevates the duty to a higher status,12 requiring the parties to act fairly and reasonably in accordance with community standards of decency and fair dealing. 13 It may also require candour,14 utmost fidelity, 15 the absence of recklessness16 and perhaps at its highest, sacrificing a discretionary economic advantage in circumstances where its misuse will be detrimental to the other party.17 It is not however, a fiduciary duty, requiring one party to place the needs of the other above its own. 18 A party to an insurance contract will be prevented from relying upon any provision in the contract where to do so would constitute a breach of utmost good faith. 19

An objective test, applied to the subjective facts of the particular case, is used to ascertain whether the duty of utmost good faith has been breached. That is, would a reasonable person with the subjective knowledge of the insurer (orthe insured as the case may be) take such action?20

Breach of the Duty of Utmost Good Faith by the Insurer

Whilst not an exhaustive list and obviously based on the particular factual circumstances pertaining to the case at hand, the duty of utmost good faith has been found to have been breached where the insurer has:

? failed to explain the important provisions of the policy to the insured;21

? failed to notify the insured of the serious consequences of breaching a condition of the policy;22

? failed to inform the insured of any conditions which are precedent to the insurer's liability to pay the claim;23

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The duty requires the insurer in certain circumstances to discLose materiaL which may be adverse to their case , as weLL as provide the insured with the opportunity to address any matters upon which the insurer has reLied in making their determination.

? failed to observe the strict terms of the insurance contract;24

? relied on a term which had been included in the policy in error;25

? failed to advise the insured that the policy they had obtained did not afford the protection they had explicitly req uested ;26

? failed to progress a claim and to make a decision on liabilitywithin a reasonable period of time;27

? failed to provide an adequate explanation for denying the claim within a reasonable period of time;28

? failed to make a settlement payment on a legitimate claim within a reasonable time;29

? failed to investigate a claim prior to denying it;30

? failed to act reasonably and to carefully assess the interests of both the insured and insurerwhen making the decision to defend rather than settle the claim ;31

? failed to consult with and to make proper disclosu re to the insu red where there was a conflict of interest between the parties;32

? failed to be candid and failed to make clearto the insured at an early stage the limits of any obligations arising under the policy. The insurer also failed to advise the insured of differential liability, as well as the risks the insured faced and forwhich they may require independent legal advice;33

? failed to act properly and reasonably in assessing claims.

This obligation becomes more onerous in circumstances where the insurer is making a determination in its own interests. The duty requires the insurer in certain circumstances to disclose material which may be adverse to their case, as well as provide the insured with the opportunityto address any matters upon which the insurer has relied in making their determination.34

? failed to consult with the insured in settling the claim and to explain the consequences of the settlement.

Whilst there is a 'quality of confidence' between the parties there is no disparity in the parties' bargaining power35

? declined the claim without credible and genuine reasons.

Mere suspicion is not sufficient to reject the claim. Nor is the insured permitted to unmeritoriouslytest the claim by putting the insured to proof. 36

A breach of the duty may arise where the insurer:

? fails to notify the insured of an entitlement they have under a policy of which the insured lacks knowledge;37

? engages in 'horse trading', something which is prevalent in claims negotiations;38

? fails to draft the policy of insurance in clear and unambiguous language, so that the insured clearly understands the policy;39

? fails to disclose to the insured pertinent information which would have a substantive effect upon the insured's decision to insure against the risk;40

? without a valid reason, offers the insured uncommercial conditions on the renewal of a policy attempting to dissuade the holder to discontinue coverage;41

? delays payment of a claim to secure an investment benefit;42

? makes an unreasonable and unnecessary request for i n f o r m a t i o n . 43

The Courts have held that the duty has not been breached, in the factual circumstances of the particular case, where the insurer:

? accepted an increased premium with the knowledge that an exclusion clause in the policywas

20 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #87 DECEMBER 2002

likely to apply, in circumstances where it had explained the exclusion and given the insured the chance to overcome it;44

? unreasonably refused to follow a certain course of action;45

? maintained a bona fide defence which ultimately failed ;46

? cancelled the insurance policy on the basis of fraud after it had paid the claim.47

A breach will not necessarily be found where the insurer refuses to accept an attractive settlement offer in an attempt to avoid adverse publicity or to attempt to have the insured share the liability.48

To a large extent these decisions replicate the 'Ten Commandments of Good Faith' which insurers in a number of States in the United States of America are required to observe. Many States in the United States have enshrined these duties in statute.49 These Commandments require insurers to:

1. judiciously investigate claims;

2. efficiently evaluate claims;

3. inform the insured of all settlement negotiations;

4. notify the insured of the likely outcome of litigation;

5. forewarn the insured of the

possibility of a decision exceeding the policy and counsel the insured in relation to any action they could take to avoid that occurrence;

6. conduct themselves having

regard to the interests of the insured;

7. reasonably consider any

equitable offer of settlement and to accept that offerwhere it would be reasonably prudent to do so, given the possibility of paying the total indemnity;

8. furnish a legitimate defence and to appeal any adverse decision where good faith requires such action be taken;

9. exercise care when providing a legal defence;

10. use due skill and care when

adjusting claims. 50

The duty of utmost good faith may restrain an insurer's ability to rely on information obtained by its agents, where those agents:

? prior to an indemnity being obtained, gather information without first warning the insured that they are conducting investigations without prejudice to the insurer's rights; or

? without informing the insured that such information may be relied upon by the insurer in assessing the claim. 51

Breach of the Duty of Utmost Good Faith by the Insured

Again, whilst not a definitive guide and obviously based on the particular factual circumstances pertaining to the case at hand, the duty of utmost good faith has been held to have been breached where the insured:

? deliberately provided a false answer in a claims form;52

? in the case of a legal indemnity policy, failed to advise the insurer that proceedings had been initiated against it and hence failed to provide the insurerwith the opportunity to assume conduct of the matter;53

? intentionally withheld information in making a claim, intending to deceive the insurer;54

? failed to act reasonably so as to reduce or minimise the insurer's liability;55

? failed to provide information required by the insured and required by the terms of the policy;56

? knowingly made a fraudulent claim. 57

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Other circumstances in which a breach of the duty may be found include:

? failure to notify the insurer of circumstances which may effect the insurer's future conduct with respect to the policy,58 in circumstances where there is an enduring contractual obligation to do SO;59

? recklessly completing a claims form ;60

? an exaggeration of the circumstances pertaining to a claim;61

? engaging in 'horse trading' to settle a cla im ;62

? failure to provide information to enable the insurer to make a decision on indemnity.63

It is unlikely that a breach of the duty will be found where the insured:

? fails to disclose their precarious fin an cia l posit ion;64

? provides information which does not fully disclose all necessary issues, in circumstances where the insurer neglects to request additional material.65

Courts have held that the duty has not been breached on the specific factual circumstances of the case, where the insured:

? in accordance with legal advice, withheld information in an effort to secu re assista nce from the reinsured's underwriting agent;66

? failed to disclose that they had double insurance;67

? failed to declare property covered by the policy in a declaration of value clause;68

? made a bona fide claim and instituted court proceedings when the claim was denied by the insurer;69

? elected in accordance with legal advice, not to notify the insurer of circumstances which may give rise

to a claim, due to the likely effect on future premiums;70

? failed to notify the insurer of information which was discovered only after the claim had been settled and the contract terminated, in circumstances where there was no continuing obligation to do SO;71

? had increased the potential liability of the insurer, by acting in accordance with legal advice and electing to rescind an earlier settlement agreement and enter into a new one which provided for the assignment of the insurance contract for an additional year;72

? made an innocent error in completing a claim form;73

? used the formula provided in the policy to calculate the amount payable, in circumstances where the method produced an inane resu It.74

Insurance brokers do not themselves owe the insurer a duty of utmost good faith. However, as the insured's agent, they must be extremely careful not to breach the insu red's duty by thei r actions. 75

REMEDIES FOR BREACH OF THE DUTY OF UTMOST GOOD FAITH Bad Faith Claims and Punitive Damages

Bad faith claims are prevalent in the United States. It is based on the premise that insurance is obtained for peace of mind, which has seen a flurry of litigation and an expansion of the concept beyond Australian standards. 76 This covenant of good faith and fair dealing obliges the parties to avoid any action which may harm the rights of the other to secure the benefits of the contractual bargain. 77 ln the United States, a breach of the duty may give rise to both contractual and tortious liability, resulting in not only compensatory and punitive damages but also damages for hurt feelings and emotional distress.78

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Whilst some US courts have indicated that there should be a reasonable relationship between the award of punitive and compensatory damages, there are no prescribed limits. In determining the quantum of the award some US cou rts have gone to the extreme of allowing evidence of the insurer's financial position to be tendered. The State of California has consistently made the highest awards, with punitive damages

sometimes 200 times the

compensatory damages award. Some US courts have also indicated a willingness to award punitive damages in cases where compensatory awards are denied.79

The evolution of bad faith damages in New Zealand has been short lived with the New Zealand Court of Appeal overturning the High Court's decision to award bad faith damages in Cedenco Foods Ltdv State Insurance Ltd.8o The High Court in making the award indicated that whilst the payment of interest went some way toward providing appropriate compensation, the 'outrageous' failure of the insurer to promptly pay the valid claim justified sanction byway of punitive damages, intended to punish the insurer. 81

Whilst the Australian Law Reform Commission ('theALRC') has declined to introduce a tort of bad faith into the ICA, asserting that contractual remedies are sufficient,82 the courts have at least, in circumstances where the insurance contract is not subject to the ICA, indicated the potential for the existence of a tortious duty.83 Whilst awards of punitive or exemplary damages are rare, often confined to intentional torts such as defamation and trespass,84 it appears that Australian courts are becoming less conservative in their approach. 85

Theoretically damages exceeding the limits of the insurance policy are possible. If an insurer

unreasonably declines to settle a

matterwithin the limits of the

policy, resulting in a determination

exceeding policy limits, ordinary

contractual principles should

permit a compensable award of

damages, which may exceed policy limits.86 It is possible that punitive

damages may also be imposed

where an insurer demonstrates a

callous disregard forthe interests

of the insured or systemically

breaches the policy. Whilst s.13 is

likely to play an ancillary role in

such circumstances, (the action

likely to involve a breach of other

terms and conditions of the policy),

the very existence of the duty of

utmost good faith may increase the

likelihood

of

such

an

a

w

ar

d.

8

?

In Gibson v The Parkes District Hospita{88 Badgery-Parker J

examined the duty of good faith in the context of a workers compensation policy, not subject to the ICA. However, His Honour's reasoning could equally be applied in the context of claims arising under the ICA. His Honour held that the insurer had breached its duty of good faith in failing to process and pay the claim within a reasonable period of time and that this breach attracted liability for damages in tort, given the proximate relationship between the parties, characterised by 'dependence and vulnerability' .89 His Honour indicated that the damage suffered by the insured went well beyond that which the workers compensation scheme could remedy. He indicated that the insurer's conduct had the potential to cause not only 'temporary hardship, anxiety and distress, but also in some cases ongoing economic loss; as where during the period of delay the worker is unable to maintain mortgage or hire purchase payments and suffers forfeiture or is forced to sell assets' .90 For this the worker must receive adequate compensation.

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