UK Acorn Finance (UKAF) was a bridging finance lender. It had obtained judgments worth over £13m against CLS, an insolvent firm of surveyors, in relation to negligent valuations. Markel was CLS’ professional indemnity insurer but it had sought to avoid the relevant policies on the basis of misrepresentation and/or non-disclosure. In short, CLS had stated that it hadn’t undertaken any valuation work for sub-prime lenders, but that statement was incorrect; in fact, UKAF was a sub-prime lender.
The policies in question pre-dated the Insolvency Act 2015, so principles of fair presentation and proportionate remedies were of no relevance. Since the policy documentation contained a basis of contract clause, CLS’ representations amounted to a breach of warranty and, on the face of it, Markel was therefore automatically discharged from all liability under the policies. However, the policies contained an unintentional non-disclosure (UND) clause which provided:
“In the event of non-disclosure or misrepresentation of information to Us, We will waive Our rights to avoid this Insuring Clause provided that . . . You are able to establish to Our satisfaction that such non-disclosure or misrepresentation was innocent and free from any fraudulent conduct or intent to deceive”
Whilst the judgment also deals with other issues, the fundamental question which the court was asked to determine was whether, in light of the UND clause, Markel was entitled to avoid the policies in circumstances where the policy wording gave Markel a discretion to waive its strict rights. Was Markel able to exercise its discretion however it wished, or were there limits on that discretion?
In reaching a decision, the court said that it was first necessary to look at the construction of the UND clause, the relevant phrase being “You are able to establish to Our satisfaction . . .” The effect of that wording was (1) that the burden was on CLS to establish that any misrepresentation or non-disclosure was “innocent and free from any fraudulent conduct or intent to deceive”; and (2) importantly, that it was for Markel to decide whether CLS had discharged that burden to its satisfaction. On its face, the contract therefore appeared to confer an unqualified decision-making power on Markel in circumstances where its decision would impact the rights of both parties, and where there was a clear conflict of interest.
The Courts have however held that such clauses are subject to a so called “Braganza duty”, or duty of rationality. A Braganza duty was said by the Supreme Court to concern the activity of a “contractual decision maker” where the contract term being considered was one by which “one party to the contract is given the power to exercise a discretion, or to form an opinion as to relevant facts…” The Supreme Court noted that “the party who is charged with making decisions which affect the rights of both parties to the contract has a clear conflict of interest” and that therefore the courts will ensure that such powers are not abused, for example by making arbitrary, capricious or irrational decisions.
The Court in Acorn found that Markel’s discretion was subject to a Braganza duty that required Markel to:
- take relevant considerations into account, including the fact that the conduct of the individual at CLS who had completed the risk profile was consistent with his position that he believed the reference to sub-prime lending only applied to residential lenders
- disregard any irrelevant matters, such as the late notification of a separate unrelated claim and
- not come to a conclusion that no reasonable decision maker could ever have reached
The Judge acknowledged that parties to a commercial contract (including insurers) cannot be expected to adopt the same high standards of decision-making as the state or the courts. However, he confirmed that a UND clause is “a classic example of a clause to which the [Braganza principles] should be applied”; and that the starting point, at the very least, should be that it is inherently more probable that a misrepresentation has been made innocently or negligently rather than dishonestly.
In the circumstances, the court found that Markel was not entitled to avoid the policies.
The case is important because it is the first English decision which confirms that the duty of rationality (as expressed in Braganza) applies to unintentional or innocent non-disclosure clauses. It therefore provides guidance as to the sorts of issues that insurers need to consider when exercising their discretion in relation to such clauses. Crucially, when fraud or dishonesty is alleged, insurers should make a fair and balanced assessment based on all of the available facts.
Finally, it is worth noting that the court drew specific attention to the fact that, whilst Markel’s overall decision making process was flawed, the individual decision-maker could not be criticised because he had not been trained in how to approach the situation. The judgment should therefore prompt insurers to review their claims handling manuals and other guidance to ensure that any clauses that might be caught by this decision are flagged and that any relevant decision-making processes are clearly documented.