Balancing the Scales: The Abolition of “Basis of Contract” Clauses

Introduction

A recurring theme in insurance law is the power imbalance between the insurer and the insured. The Law Reform Commission in its ‘Consumer Insurance Contracts’ Report (LRC 113 - 2015) recognised that many rules in the area have not changed since the 18^th and 19^th centuries and a time when insurance was often arranged between shipping traders and small insurers (paras. 3–4). Providing stronger legal protections for insurers simply made sense at that time. However, the modern-day insurance industry revolves around the average consumer contracting with powerful insurance companies which avail of extreme wealth and resources.

Until very recently, “basis of contract” clauses were an active example of this power imbalance which has consistently been criticised and denounced by the judiciary and in the academic literature alike, with the former describing them as “traps for the insured” (Zurich General Insurance Company v. Morrison [1942] 2 K.B. 53, 58) and the latter castigating the insurance industry as “preying on the unprotected consumer” (Austin J. Buckley, ‘Insurers’ self-regulation does not work’ (2005) 12(1) C.L.P. 10, 12).

 What are “Basis of Contract” Clauses?

These clauses involve insurance companies requiring individuals seeking insurance to answer questions on a form which then constitute the basis of the resulting contract and are converted into warranties. Their draconian nature stems from the fact that insurers are not required to justify whether the answer provided is material to the risk in question. Thus, if an individual answers a question incorrectly or inaccurately, the “basis of contract” clause permits insurers to avoid the policy in its entirety, regardless of whether the inaccuracy is material to the loss. As a result, it is a type of clause which permits insurers to get around the entire issue of identifying a material non-disclosure which is a fundamental principle of insurance law.

The Infamous Case of Keenan v. Shield Insurance Co. Ltd.

The issues posed in Keenan v. Shield Insurance Co. Ltd. [1987] 1 I.R. 113 (HC) encapsulate the problems with basis of contract clauses. The Applicant applied for insurance cover in respect of his private residence and its contents. A fire took place there and he claimed to be entitled to be indemnified by the insurers for the destruction of the residence. The insurers disputed their liability on the basis that there was a misrepresentation of fact and a non-disclosure of relevant information.

The case turned on a question on the proposal form which asked whether the insured had “ever sustained loss or damage by any of the risks or liabilities” he wished to insure against. He answered no, being unaware that the £53 in compensation he had received earlier that year in respect of damage to a fire pump was relevant. Blayney J. found “with considerable regret” against the insured, holding that the answer was false and as a result the insurer could avoid all liability. The Court at p. 118 was clear that:

even if I were to conclude that the inaccuracy in the reply to [the question] was trivial, that would be no obstacle to the defendant repudiating the policy in view of the accuracy of the answers in the proposal form having been warranted by the plaintiff.

This is a classic example of a legally sound yet regrettably unfair judgment. In a just world, the insurer would have paid out compensation simply reduced in proportion to the incorrect answer provided. For context, the insurance policy amounted to £14,000 in respect of the private residence and £2,000 for its contents. In contrast, the insured had paid a measly £53 in respect of the claim for fire damage to a pump.

Of course, there is a reason for this insurance practice: every piece of information is crucial to understanding the full scope of the situation and calculating the correct premium. Insurers require a guarantee that questions will be answered correctly and truthfully in order to rely upon this information. This is especially true in respect of preventing the insured from attempting to inflate their risk assessment to attain a better deal; or even in deterring those who wish to exploit this relaxed standard to instigate fraud. Although it has been acknowledged that insurers should maintain a strict application of their clauses, this does not justify the excessively harsh application that occurred in practice.

It is clear that basis of contract clauses are inherently unfair, being construed in a fashion which profits from the most minute of inaccuracies and often with no material connection to the damages that actually occur. This was evident in Dawsons Ltd. v. Bonnin and Ors. [1922] 2 A.C. 413 where the House of Lords found that the inaccuracy in question was immaterial, yet still held that the insurer need not pay out any compensation.

The last remnants of the concept can be viewed in the recent decision of the High Court in Billane and Anor. v. Financial Services and Pensions Ombusman and Anor. [2021] IEHC 726, where Barrett J denied an appeal against the Ombudsman’s decision in November 2017 to affirm a basis of contract clause which deemed the home insurance claim in question void.

Better Late Than Never

Against this background, the recommendations contained in the LRC’s 2015 ‘Consumer Insurance Contracts’ Report were celebrated as “the most radical change in insurance law for over 100 years” (Brian Hutchinson, ‘Editorial’ (2015) 22(9) C.L.P. 214). It proposed, among other things, the abolition of basis of contract clauses (para. 4.35).

The Oireachtas subsequently enacted the Consumer Insurance Contracts Act 2019, with s.19(3) of which expressly declaring basis of contract clauses to be invalid. Coming into effect on the 1^st September 2020, it brought an end to this unjust practice and, though late in the day, has added a weight to the insured’s side of the scales.