Davis, Ian --- "Reforming the Mia ... Options & Constraints" [2000] ALRCRefJl 29; (2000) 77 Australian Law Reform Commission Reform Journal 41

Reform Issue 77 Spring 2000

This article appeared on pages 41 – 45 & 90 of the original journal.

Reforming the MIA ... options & constraints

By Ian Davis*

And down in fathoms many went the captain and the crew; Down went the owners - greedy men whom hope of gain allured: Oh, dry the starting tear, for they were heavily insured.¹

The Marine Insurance Act 1909 (Cth) (MIA) has remained virtually immune from amendment in the nine decades since its enactment. The mere fact that the MIA has escaped review for so long is reason enough for it to be reconsidered in detail now.

The terms of reference emphasise the concern of the Australian government that the effectiveness of, and competition within, the Australian marine insurance industry be maintained or enhanced, and that the Australian industry as a whole retain or enhance its competitive position in the world market. A reform proposal that is theoretically flawless and drafted with immaculate clarity serves no one if it fails in this fundamental respect.

The Australian marine insurance industry does not operate in isolation. Unilateral radical reform of marine insurance law may put the Australian market’s position with overseas co-insurers and reinsurers at risk. That is of itself no basis to recoil from the idea of change if there is good reason for it. In the ALRC’s consultations to date the response from insurers generally is not to shudder at the thought of change. Rather, there has been a mature acceptance of the fact that the world has changed since 1905 when this legislation first passed through the parliament at Westminster.

The ALRC’s task is to strike a workable and widely accepted balance between conflicting pressures:

• A desire that Australian insurance law have a streamlined and consistent statutory regime.

• A desire to retain a separate marine insurance regime for various pragmatic reasons arising out of commercial factors peculiar to marine insurance.

• An apprehension that radical unilateral reform in Australia could imperil the ability of local marine insurers to obtain reinsurance or co-insurance from overseas sources, or the prices at which they can do so.

• A recognition that, although there is apparently a broad consistency of marine insurance law and practice internationally, there are differences in areas where it has been suggested that reform should occur.

• Ultimately, however, a reformed MIA that does not balance the legitimate legal and commercial concerns of insurers and their customers alike will not serve them or Australia well.

The ALRC’s discussion paper, Review of the Marine Insurance Act 1909 (DP 63), published in July, identifies a number of areas where the available literature and preliminary consultations with lawyers, insurers, brokers and some insureds have suggested that change is required. The desired degree of change and the urgency with which it is advocated vary considerably. At one extreme there are gentle suggestions that some of the MIA’s more outmoded provisions should be either repealed or reworded. The references to bottomry and respondentia in s 16, for example, have been branded as obsolete and ripe for removal. The ALRC must ensure, however, that the removal of any apparently obsolete provision without replacement does not inadvertently leave a gap.

Most venerable of all the Act’s provisions is the suggested policy wording found in the Second Schedule. It is not warmly regarded and has been described as:

‘A strange, very peculiar, absurd, incoherent, clumsy, imperfect, obscure, incomprehensible, tortuous document, drawn up with much laxity, by a lunatic with a very private sense of humour, in a form which is past praying for.’²

However, the wholesale removal of the Second Schedule would delete definitions of various expressions that may still have some effect. These expressions range from the much-debated ‘perils of the seas’ to the more archaic ‘barratry’ and ‘arrest ... of kings, princes and people’. In the idiom of modern statutory drafting, these provisions would find themselves in a definitions section or glossary, and perhaps that is where they should be at the end of the ALRC’s review.

Diverting as they may be, these issues do not strike at the heart of the debate about the need for reform. DP 63 focuses on three principal areas where reform must be considered.

The first of these is warranties and, in particular, the harsh impact of minor breaches, breaches irrelevant to the loss, and breaches remedied before loss.³ Secondly, the doctrine of utmost good faith, which finds expression most often in the insured’s obligations of full disclosure and in the penalties for misrepresentation. The third is the requirement for an insurable interest. Although this area seems to generate some heat, it may well be that the occasions where the Act appears to work unfairly are few and rather discrete. If that is so, these problems might be solved by a modest expansion of the interests that are defined to be insurable.⁴

A fourth specific area of concern is the confusion over the demarcation between contracts of insurance covered by the MIA and those covered by the Insurance Contracts Act 1984 (Cth) (ICA). This is a problem that arises in any jurisdiction which affords marine insurance a legal regime of its own, but its impact is exacerbated in Australia by the existence of the ICA and the major differences in the ways in which various areas of law are handled by the two Acts, not least the three areas highlighted above.

Warranties

In a warranty, the insured undertakes that something will be done or not done, that certain conditions will be fulfilled, or that a certain state of facts exists or does not exist.⁵ A warranty must be complied with exactly. If it is not, the insurer is automatically discharged from liability from the date of the breach although without any prejudice to any liability incurred by the insurer before that date.⁶ Furthermore, a breach of warranty cannot be remedied so that the insurer’s liability is revived when the remedial activity is complete.⁷ This statutory position may be varied by the policy or waived by the insurer.⁸ The Act goes on to imply in every policy of marine insurance, subject to any contrary express provision in the policy, two warranties: those of seaworthiness and legality.⁹

Major criticism in this area has focused on the harsh operation of warranties, especially the fact that a trivial breach, or one that is irrelevant to any claim under the policy, gives rise to an automatic discharge of the insurer’s liability irrespective of the insured’s state of mind and any attempts by it to remedy the breach. Suggested and actual reforms in this area seek to soften this harshness by introducing notions of proportionality or causation. These require a causal link between the breach and the insurer’s discharge from liability, or limit the remedies available to the insurer to a degree that reflects the prejudice actually suffered by it as a result of the breach. In either case, a trivial breach or one irrelevant to an insured loss would result in no or minimal diminution of the insurer’s liability.

An alternative would be to allow the insured to remedy the breach and thus revive the insurer’s liability under the policy, though that may be unnecessary if either or both of the elements of causation and proportionality are introduced. The policy could be treated as being suspended for the duration of the breach but reactivated when the breach is remedied. This is similar to an approach adopted by courts in Canada and the USA where the harsh impact of a breach of warranty has led to a construction of these clauses that is not necessarily in keeping with the clear wording of the statutes and the policies in question. Other approaches and options for reform are discussed in chapter 5 of DP 63.

Irrespective of the manner in which warranties generally might be reformed, there is a body of opinion that the statutorily implied warranties of seaworthiness and legality should be handled differently.

The warranty of seaworthiness is expressed differently in relation to voyage and time policies and policies on goods.¹⁰ This distinction and the concept of seaworthiness in stages are said to be out of date.¹¹ The distinction between different types of policies is certainly not essential and may have lost whatever practical utility it had with the abolition of stamp duty on marine insurance policies. The Norwegian Marine Insurance Plan does not make the distinction.

The warranty of legality is two-fold: it requires the adventure to be lawful and to be carried out in a lawful manner, so far as the insured can control it. This distinction does not, however, appear to have any practical effect and does not lead to any difference in penalty in the event of breach. One suggested change is to provide for different penalties to flow from the pursuit of an illegal voyage and from its conduct in a manner which breaches technical or other regulations. For example, a loss resulting from the ship’s use for illegal purposes discharges the insurer from liability under the Norwegian Marine Insurance Plan but a breach of a technical regulation does not.¹² One variation may be to discharge the insurer from all liability in relation to a voyage conducted for an illegal purpose but otherwise to allow the warranty to be handled in the same way as other warranties if elements of causation or proportionality are introduced generally.

As a brake on reform in this area, a number of commentators have expressed concern that the two statutorily implied warranties should be retained because they support the public interest in the observance of a multitude of safety, technical and anti-pollution conventions. Their argument is that the threat of a financial impact on the insured in the event of a breach of any of these codes provides a strong and effective incentive to observe them.

Utmost good faith

Section 23 of the MIA states that a contract of marine insurance is ‘based upon the utmost good faith’. This concept manifests itself in a number of duties visited on both parties. The most obvious manifestations fall on the insured and are the insured’s duty of full disclosure before the contract is concluded and its duty to refrain from misrepresentation. The remedy available to the underwriter is the avoidance of the contract from its outset with the return of premium (except in the case of fraud).¹³ The Act provides for no intermediate position. This can lead to harsh outcomes where the breach was relatively minor.

Much of the modern debate in this area has centred on the test of materiality. A misrepresentation or non-disclosure must be material to give the insurer the right to avoid the contract. Until the 1990s the accepted test was objective: the standard of materiality was determined by reference to a notional prudent insurer and without reference to the state of mind of the actual insurer. This allowed inept insurers to avoid all liability under their contract, even in relation to claims that were otherwise valid and had no connection with the misrepresentation or non-disclosure.

The House of Lords in Pan Atlantic Insurance Co Ltd v Pine Top Insurance Co Ltd¹⁴ added a second element to the test: the House of Lords now requires the court to determine whether the non-disclosure or misrepresentation in fact induced the actual underwriter to issue the policy.

The second aspect of materiality is the extent to which the material circumstance influenced or would have influenced the prudent or actual underwriter. There is dispute as to whether the misrepresentation or non-disclosure must have influenced the insurer’s mind to some extent or whether that influence must have been decisive. The House of Lords rejected the decisive influence test in Pan Atlantic though a somewhat different test was applied by the English Court of Appeal in St Paul Fire and Marine Insurance Co (UK) v McConnell Dowell Constructors Ltd.¹⁵ That test was rejected by Justice Byrne in the Victorian Supreme Court in Akedian Co Ltd v Royal Insurance Australia Ltd.¹⁶ Justice Byrne followed the test formulated by Justice Samuels in the NSW Supreme Court in Mayne Nickless v Pegler.¹⁷ Justice Samuels determined that a fact is material ‘if it would have reasonably affected the mind of the prudent insurer in determining whether he will accept the insurance, and if so, at what premium and at what conditions’.

The ICA has altered the law in this area for non-marine general insurance in a number of ways. Section 13 of the ICA implies into the contract a provision requiring each party to act towards the other with the utmost good faith in respect of any matter arising under or in relation to the contract. This is expanded in s 14: the parties cannot rely on the provisions of the policy if to do so would be to fail to act with the utmost good faith. The characterisation of the duty as a contractual term presumably makes damages and other contractual remedies available to the parties (at least to the extent permitted by the ICA), which of itself offers more flexibility than the current regime under the MIA.

The original formulation of the duty of disclosure in s 21 of the ICA when it was first enacted was amended in 1998 by the introduction of s 21A. Section 21 required the insured to disclose every matter:

(a) known to it that it knew to be a matter relevant to the decision of the insurer whether to accept the risk and, if so, on what terms; or

(b) that a reasonable person in the circumstances could be expected to know to be relevant in that way.

Although regarded by some as a compromise between an objective and a subjective test, it nonetheless placed a burden on the insured to determine what might be relevant to an insurer’s (that is, someone else’s) decision. Section 21A now requires an insurer to put to an insured specific questions that the insurer feels are relevant to the risk and to request expressly that the insured disclose each ‘exceptional circumstance’ that the insured knows or could be expected to know to be relevant to the insurer’s decision. Proper replies to these questions discharge the duty of disclosure.

The Law Commission of New Zealand reviewed this issue in 1998.¹⁸ It declined to adopt s 21 of the ICA but it considered abolishing the duty of disclosure and replacing it with an obligation to answer questions correctly.¹⁹ However, it concluded that this was inappropriate because it would interfere unduly with existing commercial practices that make it impractical for insurers always to obtain answers to questions before they take on a risk.

Finally in relation to the doctrine of good faith, there is uncertainty as to the extent that the doctrine imposes duties on the parties after the formation of the contract and, if it does, to what point.

Insurable interests

The distinction between insurance and gambling has long been seen as a rather fine one. Prior to the Marine Insurance Act 1745 (UK) there was no legal requirement that the insured have any connection to the insured adventure and, therefore, the distinction effectively did not exist. Since then, however, insurable interests have been the defining factor between these two forms of speculation. An insurable interest, or an expectation of acquiring one, is necessary for the contract to be valid.²⁰ Section 11(2) of the MIA specifies that an insurable interest exists when the insured has a legal or equitable relationship to the insured adventure such that the insured will benefit from its safe arrival or suffer from its loss, damage or detention or may incur a liability to a third party as a result of its loss, damage or detention. It is not necessary to be an owner to have an equitable interest. Mortgagees, lessees, trustees, the lenders of money on bottomry or respondentia bonds, mortgagors and a number of others have an insurable interest as determined either by the courts or the statute. The definition nonetheless has two elements, both of which must be satisfied. There must be a legal or equitable connection and the insured must suffer or lose a benefit as a result of the insured incident. The mere suffering of financial loss is insufficient.

Contrast this with the position under s 16 and s 17 of the ICA. Under s 16, an insurable interest is not required when the contract is entered into: it is sufficient that the insured suffers a pecuniary or economic loss because of the damage to or destruction of the subject matter of the contract.²¹ Accordingly, by virtue of these differences, there are cases where insureds may recover under the ICA but not under the MIA.

This position may be remedied by the inclusion in the policy of a ‘lost or not lost’ clause, which is specifically permitted by the MIA,²² or by the inclusion of ‘warehouse-to-warehouse’, ‘free on board’ or ‘cost and freight’ pre-shipment clauses in the policy. It has been argued that the nature of commerce involving goods carried by sea makes the strict requirement for insurable interest necessary in marine insurance. For example, the repeated on-sale of goods and the assignment of the policy while the goods are in transit necessitate its retention to ensure that only appropriate insureds who both suffer loss and have the appropriate interest when the loss occurs recover under the policy.

Conclusion

The issue is one of balance. Few have argued that there should be no change to the MIA. However, there has been a strong statement that the MIA should not be transformed into an alien creature that none of us recognise. Rather, it is suggested that it should be morphed into a finer version of its familiar self. It is clear that the international marine insurance market already tolerates a fair margin of divergence from a standard marine insurance contract and there is no need to shy away from change simply on the basis of an attachment to a presumed English norm.

The ALRC intends to canvass the spectrum of possible changes to ensure that broad public debate is encouraged and that its recommendations will take into account as a wide a range of opinion as possible. Where appropriate, Australia should not be afraid to take a lead on reform of marine insurance law where that change is seen to be right. The question for judgment is to assess the extent to which Australia should move ahead of, or away from, an international norm, to the extent that any such creature can be identified.

*Ian Davis is a full-time Commissioner of the ALRC with responsibility for the Marine Insurance inquiry.

Endnotes

1. WS Gilbert ‘Etiquette’ from The ‘Bab’ Ballads 1866-1871.

2. D O’May Marine Insurance – Law and Policy Sweet & Maxwell London 1993, 8, amalgamating epithets drawn from English case law.

3. ALRC DP 63, ch 5.

4. ALRC DP 63, ch 7.

5. MIA, s 39(1).

6. MIA, s 39(3).

7. MIA, s 40(2).

8. MIA, s 39(3) and 40(3).

9. MIA, s 45 and 47 respectively.

10. See MIA, s 45(1), 45(5) and 46(2).

11. ALRC DP 63, para 5.68, 5.77, Draft Proposal 5.

12. ALRC DP 63, para 5.84–5.86, Draft Proposals 6–8.

13. MIA, s 90.

14. [1995] 1 AC 501.

15. [1995] 2 Lloyd’s Rep 116, 112-4.

16. (1997) 148 ALR 480.

17. [1974] 1 NSWLR 228, 239.

18. Law Commission Some Insurance Problems (Report 46) Wellington 1998, 1–18.

19. The Law Commission of NZ did not consider s 21A of the Australian ICA, which had apparently not yet been enacted when the Law Commission was preparing its report.

20. MIA, s 10(1) and (2).

21. Section 17.

22. Section 12(1). On this basis the insured ultimately succeeded on appeal in NSW Leather Co v Vanguard Insurance Co Ltd (1991) 25 NSWLR 699.