Brotherton & Ors v Aseguradora Colseguros S.A. & Anor

In November 1997 the claimants subscribed to the primary and excess layers of the defendants’ reinsurance of a Banker’s Blanket Bond and Professional Indemnity insurance written in favour of a Colombian bank, Caja de Credito Agraria Industrial y Minero. The contracts of reinsurance originally ran for a period of 12 months from 7^th December 1997, but in or about November 1998 they were extended to 31^st January 1999. They covered, among other things, losses caused by dishonest or fraudulent acts of the bank’s employees, subject to certain qualifications which do not matter for present purposes.

In November 1997 the President of the bank was Mr. Benjamin Medina. The claimants say that during 1997 and 1998 allegations of serious impropriety on the part of Mr. Medina and certain other senior officials of the bank were made in the Colombian press and on national television which eventually led to investigations of a criminal and disciplinary nature. These include allegations in the press in January 1997 that the bank had made irregular loans to persons and companies connected to Mr. Medina that might cause it to sustain substantial losses, allegations that the authorities had been asked to carry out an investigation into the position, reports in the media in July 1997 that charges were to be brought against Mr. Medina and four senior directors of the bank and reports in the television news in early November that Mr. Medina had been suspended from his position for 90 days while the investigation proceeded. The claimants also rely on reports in the press in November 1997 that Mr. Medina had been arrested on suspicion of embezzling public funds and on reports in February 1998 that disciplinary proceedings were being brought against other senior officers of the bank. The claimants say that although the defendants were aware of these matters when the reinsurance was placed, they failed to disclose them and that because of that non-disclosure, and because of certain misrepresentations which were also made to them, they were entitled to avoid the contracts and have done so. They have brought this action to obtain a declaration to that effect.

To set the present application in context it is necessary to refer briefly to the history of the proceedings. The claim form was issued on 28^th August 2001. Shortly afterwards the claimants obtained permission to serve the defendants out of the jurisdiction, although an order was subsequently made to allow service on the brokers Butcher Robinson & Staples International Ltd through whom the reinsurance had been placed. The proceedings were served shortly thereafter. The defendants sought to set aside service but that application was dismissed in December 2001 and the defendants then set about pleading a defence.

In paragraphs 6 and 7 of their original particulars of claim served on 24^th September 2001 the reinsurers referred to a number of reports in the newspaper El Tiempo dealing with the alleged involvement of Mr. Medina and his colleagues in irregular loans made by the bank to some of their acquaintances. In paragraph 12 they alleged that the allegations were material, partly because some of the losses suffered by the bank which the defendants had notified to the reinsurers had arisen out of the transactions in question, but also because they are relevant to moral hazard, and in paragraph 13 they asserted that they would not have entered into the contract on the same terms, if at all, if the existence of those reports had been disclosed.

In their defence which they served on 11^th February 2002 the defendants admitted the existence of the reports in El Tiempo, but they did not admit the truth of the allegations. On the contrary, in response to paragraph 7 of the particulars of claim they denied that any proper basis existed for the investigations into the activities of Mr. Medina, for his arrest or for the charges being brought against him which were part of a political campaign against the government. The defendants went on to plead that nearly all of the investigations had already been concluded in his favour, although a few were still pending. In paragraph 11 of the defence they denied that the allegations against Mr. Medina were material, without saying why, although they did admit that some of the losses in respect of which they were making claims were related to transactions that were the subject of those allegations. Having regard to the pleading as a whole, I think it is fair to say that the legal relevance of the allegation in paragraph 5 that there was no proper basis for the charges against Mr. Medina is not clearly spelled out.

In their reply served on 14^th March 2002 the claimants joined issue with the defendants on their case that there was no proper basis for the allegations against Mr. Medina. They also made it clear that it was not a necessary part of their case that the allegations were true, simply that they had been made.

This was how the case stood when the matter came before Toulson J. at a case management conference on 26^th July 2002. Whatever criticisms may be made of the defence, it seems that it had by then become apparent to all concerned that the defendants intended to adduce evidence at the trial to show that the allegations against Mr. Medina were unfounded in order to argue that they were therefore not material. The judge gave directions covering the usual steps in preparation for trial, including an order for the exchange of witness statements by 20^th December 2002. He directed that the trial be fixed for a date not before 1^st April 2003 with an estimated duration of 8 days.

Toulson J. was clearly alive to the fact that the hearing might well be significantly affected by the need to determine whether there had been any foundation for the allegations against Mr. Medina, but at that stage it was not clear what the ambit of the evidence might be. He therefore directed that the case management conference be restored in January this year to enable the court to consider the position afresh in the light of the witness statements that should by then have been served. The matter now comes before me on the restored case management conference.

In preparation for this hearing the claimants issued an application notice on 22^nd January seeking an order

“that the defendants be debarred from adducing or relying on evidence of, or relating to, any matters that occurred after the contract of reinsurance had been written or evidence that was not available to them at that time, with a view to proving that the allegations against Mr. Medina were without foundation”.

The basis of the application is that evidence of that kind is irrelevant to the issues in the action and that to allow it to be called would only prolong the trial and lead to a pointless waste of costs. In my view, however, the form of the application masks its true nature. As the pleadings stand at present there is an issue between the parties as to whether there was any foundation for the allegations against Mr. Medina and while that remains the case I do not think that the defendants can properly be prevented from calling evidence in relation to it. The real question that divides the parties, as was recognised in the course of argument, is whether the allegations made against Mr. Medina are no longer to be regarded as material (assuming they ever were) if the defendants can show at trial that they were without foundation. To put it another way, the question is whether the allegation in paragraph 5(1) of the defence is legally relevant, or whether it is irrelevant and embarrassing because it gives rise to a factual dispute of some complexity that can ultimately have no bearing on the outcome of the litigation. If the allegation is irrelevant and embarrassing, the right course in my view is to strike it out rather than debar the defendants from calling evidence in support of it, although the effect of doing so will be much the same.

Mr. Swainston Q.C. submitted that the materiality of any circumstances can only be judged by reference to the position as it existed at the time of placing the risk. Circumstances that are material at the time of placing cannot be treated as immaterial by reference to additional information that was not, and in this case could not have been, before the underwriter when he accepted the risk. He therefore submitted that the defendants should not be allowed to pursue this part of their case since it would only lead to the postponement of the trial and to both parties incurring a considerable amount of costs that were bound to be wasted. Mr. Millett reminded me, however, that Toulson J. did not order that this question be tried as a preliminary issue; he simply directed that the case management conference be restored after the exchange of witness statements to enable the court to consider the position again. He submitted that materiality is a question of fact (see section 18(4) of the Marine Insurance Act 1906) and that the issue should therefore be left for determination at trial when the court will have had the benefit of hearing evidence from underwriters familiar with writing risks of this kind. In relation to the issue of substance he relied principally on the decision of Forbes J. in Reynolds v Phoenix Assurance Co. Ltd [1978] 2 Lloyd’s Rep. 440 and of Fisher J. in Gate v Sun Alliance Insurance Ltd [1995] L.R.L.R. 385 (N.Z. High Ct.) in support of the proposition that allegations that can subsequently be shown to have been untrue are not to be regarded as material and that a failure to disclose such an allegation does not entitle the insurer to avoid the contract.

It is right to say that a decision on this question will not finally determine the outcome of the action. The claimants also seek to establish their right to avoid the contracts by reference to certain misrepresentations which they say were made by or on behalf of the defendants. For their part the defendants say that even if the allegations against Mr. Medina were material, there are other reasons why the reinsurers were not entitled to avoid the contract when they purported to do so. In these circumstances I do not think that the court ought to determine this issue in advance of the trial unless it is clear that to do so would relieve the parties of a significant burden in terms of preparing and presenting evidence that could not ultimately affect the outcome of the action. Provided the court can be satisfied of that, however, to deal with the matter now would in my view be consistent with the overriding objective.

The trial of this action is due to begin at the end of June. I was told by counsel that the estimate of 8 days given when the matter was before Toulson J., and on the basis of which the trial has been listed, did not allow for the issues relating to the truth or otherwise of the allegations against Mr. Medina, the scope of which was then still uncertain. Mr. Swainston submitted that it would be impossible in the time available for the reinsurers to make proper enquiries in Colombia and obtain the evidence necessary to deal adequately with these issues and that they would be likely to give rise to a substantial increase in the length of the trial. He submitted, therefore, that the existing trial date could not be maintained if the defendants were allowed to pursue this part of their case.

On the basis of the material before me it is difficult to form a very clear view on either of these questions. Mr. Millett pointed out quite properly that the issue has been on the pleadings since February last year and that the claimants have therefore had a good deal of time in which to carry out whatever investigations they thought appropriate. That is true as far as it goes, but the application now before me was first foreshadowed at the case management conference in July last year and was deferred until after exchange of witness statements. I do not think that the claimants can be criticised for failing to carry out investigations in Colombia at a time when the position still remained uncertain. Quite how quickly the necessary investigations could be completed is difficult to say. In effect the claimants would in each case be seeking to obtain access to the information available to the relevant prosecuting or supervising authorities. It may well be that they would not seek to contest every case in which the investigations had resulted in the exoneration of Mr. Medina or whichever of the other senior officers was concerned, but in some cases they might well wish to do so depending on the manner and circumstances in which it was concluded. More importantly, perhaps, it is accepted that there are two matters still outstanding against Mr. Medina, one of which has apparently resulted in his suspension from office. It is likely that each of these would call for full investigation and it is unclear to what extent the claimants could expect to obtain assistance from the authorities.

The allegations relate to a large number of transactions. Both the underlying documents and the documents relating to the investigations themselves are mainly, if not entirely, in Spanish and some assistance from local lawyers would no doubt be needed in understanding the nature and implications of the steps taken by the different investigating authorities. I am doubtful whether the steps needed to obtain satisfactory evidence in relation to the substance of the allegations could be completed in time for a trial in June, but even if that were possible the cost of obtaining and preparing the evidence would be substantial for both parties. It is equally difficult to assess how long it might take to deal with these issues at trial, but given their nature they could not be disposed of without a thorough investigation, so the time required would probably be substantial and that would add considerably to the costs. Mr. Millett submitted that if the court were ultimately to hold that the truth of the allegations was irrelevant to their materiality the defendants could be ordered to bear the costs incurred in this way, but the fact is that some of the costs are likely to be irrecoverable in any event and is neither in the interests of the parties nor in accordance with wider considerations of the administration of justice for time and money to be spent in that way to no ultimate purpose.

All this suggests that it would be sensible to decide whether the defendants’ case is sound in law before any further expense is incurred. The only argument against doing so is that whichever way the decision goes the losing party will wish to take the matter further and that the existing arrangements for trial will inevitably be disrupted. I accept that this is a factor to be taken into account, but I do not think that great weight should be attached to it. The trial date is already under threat as things stand, so although an appeal would delay matters, it would probably only add to a delay which is likely to occur in any event. Any avoidable delay in resolving the dispute is unwelcome, of course, but it has not been suggested that it would give rise to any prejudice that could not be adequately remedied by a suitable award of interest at the end of the day.

Mr. Swainston submitted that whether any given fact is or is not material for the purposes of the insured’s duty to make full disclosure is to be determined at the time of making the contract and is not affected by information acquired at a later date. By its nature the question arises mainly, if not exclusively, in relation to reports or allegations the truth of which is uncertain at the time the risk is placed. As the authorities show, this is not a novel problem. In Seaman v Fonnereau (1743) 2 Str. 1813 the Davy had been insured for a voyage from Carolina to Holland. Two days before the insurance was placed the owner’s agent had received a letter informing him that the ship had been lost sight of suddenly some days earlier and that the master had said only the day before that she was leaky. It subsequently became known that the ship had in fact continued her voyage for some days until she had been lost by capture. It was held that the materiality of the report was to be judged at the time the contract was made and not by subsequent events and that it should have been disclosed to the insurer even though the ship had not been lost and notwithstanding that her eventual loss had not been caused by unseaworthiness.

In Lynch v Hamilton (1810) 3 Taunt. 37 the plaintiff had insured goods on a voyage from the Canary Islands to London on vessels to be declared. He shipped goods on three named vessels, one of which, the President, was subsequently lost by capture. At the time of making the contract he had failed to disclose to the underwriters the fact that the goods had been shipped on board the President nor did he draw to his attention the fact that a report had been received that the President had been observed apparently “labouring much and to be very leaky and deep laden”. At the trial the master of the President gave evidence that at the time in question she was in good order and neither leaky nor deeply laden. The court held that the plaintiff could not recover for the loss of his goods because

“[he] did not communicate this rumour, so prejudicial to the safety of the vessel, when he himself knew it, at the same time understanding, as we do, that the rumour was groundless.”

The report in question had been posted in Lloyd’s and might therefore have been read by the underwriters but the decision was upheld on appeal under the name of Lynch v Dunsford (1811) 14 East 494. Lord Ellenborough said

“The question is, whether the assured’s agent was bound to communicate to the underwriters a material fact within his own knowledge, as coupled with the report made relating to the supposed risk they were about to insure, which report turned out not to be true. Now the duty of the assured or his agent in making such communications of material circumstances within their knowledge must attach at the time of effecting the insurances, and cannot depend upon the subsequent event.”

In both cases the report was in fact untrue, and in the latter case, it seems, known by the insured to be untrue, but in neither case was that considered to prevent its being material so as to require disclosure by the insured. The learned editors of Arnould’s Law of Marine Insurance and Average (16^th ed.) treat these decisions as authority for the proposition that the duty of disclosure is to be determined by reference to its immediate influence on the judgment of the underwriter at the time he accepts the risk and does not depend on what may subsequently be discovered.

Each of these cases was concerned with rumours or reports that directly concerned the likelihood of a loss of the subject matter of the insurance. In the context of moral hazard, however, different views have been expressed about the materiality of allegations that can subsequently be shown to have been unfounded. In March Cabaret Club & Casino Ltd v The London Assurance [1975] 1 Lloyd’s Rep. 169 May J. expressed the view, albeit obiter, that an insured is bound to disclose the fact that he has been charged with a criminal offence, even though he is in fact innocent. In Reynolds v Phoenix Assurance Co. Ltd [1978] 2 Lloyd’s Rep. 440 Forbes J. took the contrary view. He considered that the most relevant circumstance from the insurer’s view is whether the insured has actually committed an offence of a kind that would influence his judgment. If he has, he is bound to disclose the circumstances of the offence itself, not simply the fact that he has been charged with having committed it. Accordingly, he concluded that if the insured was obliged to disclose allegations of impropriety, he was only obliged to do so when they were unfounded. The learned judge was unwilling to accept that conclusion and so rejected the argument.

In Inversiones Manria S.A. v Sphere Drake Insurance Co. Plc (The ‘Dora’) [1989] 1 Lloyd’s Rep. 69 Phillips J. considered whether an insured was bound to disclose charges of smuggling on the assumption (contrary to his actual finding) that they were unfounded. Having considered the judgments in March Cabaret Club v The London Assurance and Reynolds v Phoenix he preferred the reasoning of May J. in March Cabaret and concluded that such allegations must be disclosed. He pointed out that when deciding whether to accept a risk underwriters are influenced not merely by facts which, with hindsight, can be shown to have affected the risk but also by facts that raise doubts as to the risk. He accepted expert evidence that the charges should have been disclosed whether well-founded or not.

In Gate v Sun Alliance Insurance Ltd [1995] L.R.L.R. 385 (N.Z. High Ct.) Fisher J. preferred the view of Forbes J. in Reynolds v Phoenix. He held that whether any fact is material is to be decided by the court objectively, with the benefit of hindsight, and in the light of all the evidence currently before it. Although he recognised that at the time of writing the risk the underwriter would want to know about allegations in order to consider whether they were well-founded or at least could not be discounted, he concluded that his interest in the allegations as allegations would evaporate if he were made aware of what the actual facts were. Accordingly he concluded that allegations that can be shown at trial to be unfounded are not material.

Finally I must refer to the decision of Colman J. in Strive Shipping Corporation v Hellenic Mutual War Risks Association (The ‘Grecia Express’) [2002] EWHC 203 (Comm); [2002] 2 Lloyd’s Rep. 88. The judge was concerned in that case not with specific allegations of impropriety but with circumstances which were said to raise doubts about the probity of the insured and thus to be relevant to moral hazard. Having considered the judgments in March Cabaret Club v The London Assurance, Reynolds v Phoenix and The Dora, he concluded that it was quite clear from the terms of s.18 of the Marine Insurance Act 1906 that the materiality of a particular circumstance has to be judged at the time of the placing of the risk and by reference to the impact that it would then have on the mind of a prudent insurer. He therefore held in agreement with May J. and Phillips J. that unfounded allegations of criminal conduct may be material and, if so, must be disclosed. He also held, by parity of reasoning, that facts which, viewed objectively, suggest that the insured is dishonest may likewise be material and therefore must be disclosed. Moreover, he made it quite clear that in his view such facts do not cease to be material because it can later be shown that the inferences that might be drawn from them were false, nor do allegations cease to be material simply because they can subsequently be shown to have been ill-founded.

As I have made clear, I am not concerned in the present case with whether any of the allegations made against Mr. Medina or his colleagues were material when judged at the time of the placing. That is a matter that can only be determined at trial in the light of the evidence that will no doubt be given by experienced underwriters familiar with this market. The only question that I am asked to consider is whether, if any of those allegations would be considered material if judged at the time of placing, they can now be regarded as immaterial if the insured is able to establish at trial that they were untrue. In my view both principle and the weight of authority support the conclusion that they cannot.

The foundation of the insured’s duty of disclosure lies in an insistence that the insurer must be given a fair opportunity to assess the risk and a recognition of the fact that he is unlikely to have that opportunity unless the insured discloses all material circumstances of which he is aware at the time the contract is made. A material circumstance is one which would influence the judgment of a prudent insurer in fixing the premium or determining whether he will take the risk and it follows, therefore, that the concept of materiality is directed to the exercise of underwriting judgment. Information that only comes to light after the contract has been made cannot affect the insurer’s underwriting judgment and for that reason cannot, in my view, have any bearing on the materiality of information that was available (though not in fact disclosed to the underwriter) when the contract was made. This is the foundation of the views expressed by May J. in March Cabaret v The London Assurance, Phillips J. in The Dora and Colman J. in The Grecia Express with all of whom I respectfully agree. It was also the basis of the decisions in Seaman v Fonnereau, Lynch v Hamilton and Lynch v Dunsford. It follows that if reports, rumours or allegations which were in circulation at the time the contract was made are material (this being a matter of fact for decision in the light of the evidence), they do not cease to be material on subsequently being shown to have been false.

Mr. Millett submitted that if an underwriter called to give evidence on the issue of materiality were asked whether the judgment of a prudent insurer would be influenced by an allegation of dishonesty, he would say that it would depend on whether it was true or not. I doubt whether he would give that answer, but even if he did it would not in my view carry the matter any farther. In order to judge whether the circumstance in question would have been likely to influence the judgment of a prudent underwriter it is necessary to assume that he knew as much as, but no more than, the underwriter to whom the risk was actually offered. If one does not make that assumption, any assessment of the materiality of an undisclosed circumstance is liable to be distorted because the context in which it would have been evaluated by the underwriter will be distorted by the introduction of information that was not available to him. It is precisely for this reason that I am unable to agree with the conclusion of Fisher J. in Gate v Sun Alliance which is based on the proposition that a circumstance is only material if it would have influenced the judgment of a prudent insurer “armed with actual knowledge of the full facts”. In effect this involves reviewing the underwriting exercise on a basis fundamentally different from that on which it was originally conducted. I can see no reason for this purpose to draw a distinction between reports that relate to the likelihood of loss and allegations that relate only to moral hazard (though it should be said that in the present case the allegations straddle both considerations). In either case the insurer can only act on the information available at the time he exercises his underwriting judgment and where the circumstances in question are reports or allegations, he is entitled to evaluate them for himself in the light of whatever other information is available to him. In either case, therefore, the materiality of the circumstance in question must be judged at that time. In the present case, therefore, proof that the allegations against Mr. Medina and his colleagues were in fact unfounded cannot render them immaterial.

In his skeleton argument Mr. Millett put forward an alternative submission to the effect that even if subsequent proof that the allegations were unfounded would not render them immaterial, it would deprive the reinsurers of the right to treat the contract as avoided. In support of that argument he relied on another passage in the judgment of Colman J. in The Grecia Express at page 132-133. In the event, however, Mr. Millett did not pursue that point in argument and for the reasons I gave in Drake Insurance Plc v Provident Insurance Plc [2003] EWHC 109 (Comm) (unreported, 3^rd February 2003) I am unable to accept that it is sound.

It follows that in my view the case pleaded in paragraph 5(1) of the amended defence is irrelevant as a matter of law and that no purpose would be served by calling evidence to establish that the allegations and charges made against Mr. Medina and the bank’s other officers were unfounded. In these circumstances I think the right course is to strike out that paragraph with the consequence that there will no longer be any issue to which such evidence will be relevant.