Kolokythas & Anor. v. The Federation Insurance Limited¹

2.1 In this case the owners of four shops in a Sydney suburb applied to an insurance company for fire insurance. The owners completed a proposal seeking cover for four individual lock-up shops contained in one building. The proposal was dated 18 May, 1978. On 14 May, 1978 planning consents, given five years earlier by the local planning authority in relation to two of the shops, expired. This meant that four days before the date of the proposal, it became unlawful to carry on the businesses that were being carried on in those two shops. The proposal did not refer to the expiry of planning consents. Nor had the insurer asked questions in the proposal form about planning consent The proposal was accepted and an insurance policy was issued. During the currency of the policy on 5 October, 1978 the premises caught fire and were substantially damaged. The owners claimed under the policy the full amount of the cover of $50,000 together with an amount of $6,600 in respect of loss of rental (the policy including a loss of rent cover).

2.2 The insurance company refused to pay the claim and the owners sued for recovery under the policy. The proposal contained the following provision:

I hereby declare that the Answers given above are in every respect true, and that I have not withheld any information likely to affect the acceptance of this Proposal; . . . and I agree that the Proposal and Declaration shall be the Basis of the Contract between the Company and myself and shall be taken as part of the Policy ...

2.3 The court held that:

• the common law duty on the part of the person proposing insurance “to disclose all material facts” is separate from the provisions and requirements of both the proposal and the consequent insurance contract or policy. This is so even if the declaration in the proposal is made part of the contract of insurance. The duty cannot be described as, or as arising out of, a “term or condition of the contract of insurance”;
• section 18 of the Insurance Act, 1902 applies only when “a term or condition of the contract of insurance” is not observed or performed. The section neither refers to nor applies to the common law duty of disclosure and therefore has no application to a failure to discharge that duty. The result is that the court has no power to give relief against such a failure;
• it was a “material fact” that two of the shops in this case were used on the date of the insurance proposal for purposes which conflicted with local government planning laws and were, in the words of the judge, “ impermissible” under that law. The judge concluded that the fact was “material” after hearing evidence that the absence of town planning permission could provide a strong temptation to some people to bring about a loss deliberately, for example, by fire, so as to acquire benefits under the policy. He pointed out that this temptation could be even stronger where (as in this case) the policy provided cover against loss of rent The insurer was entitled to full disclosure of facts which could lead to a loss of this kind;
• the owners had breached their common law duty by not disclosing that material fact when making the proposal. The insurer was therefore entitled to avoid the policy and section 18 could not be applied to excuse the breach by the insured as it was only concerned with non-observance or non-performance of terms or conditions of the contract of insurance. Consequently, the claim by the insured failed.

Bazouni v. Sun Alliance Insurance Limited²

2.4 This case also involved fire damage to a shop. The owner was a middle-aged Lebanese lady who had lived in Australia for twelve years at the time of the hearing in March 1981. In 1973 she bought a shop with an adjacent dwelling in a Sydney suburb. In 1977 a burglary occurred at the premises and the insurer paid under the relevant policy a sum of $500. In the same year that insurer decided to discontinue the insurance and advised the owner accordingly. The owner was unable at any time, including the time of the hearing, to speak or read English to any extent. After withdrawal of the insurance in 1977 the owner and her daughter went to the office of another insurance company and completed a proposal for fire insurance. At the foot of the proposal form was a form of declaration in the following terms:

No insurer has declined to insure me, refused renewal or cancelled any policy of insurance.

2.5 The owner signed and made the declaration. The insurance policy was duly issued and contained a provision stating that

the insured has made to the company named above... a written proposal which it is agreed shall be the basis of this contract and be considered as incorporated herein ...

2.6 The owner, did not make any disclosure to the new insurer at any stage of the withdrawal of cover by the previous insurer. A fire occurred on the premises almost two years later. The owner made a claim upon the insurance company and some months later, after making inquiries, the insurance company discovered that the former insurer had cancelled the earlier policy. The new insurer thereupon avoided the policy and refused to pay the claim of the owner for damage caused by the fire.

2.7 In the Supreme Court Mr. Justice Yeldham held that the insurance company “must succeed by reason of the plaintiff’s non-disclosure of the act of the prior insurer in declining to continue the insurance cover...”. That refusal was a “material matter”. The judge expressed agreement with the decision in Kolokythas to the effect that section 18(1) of the Insurance Act 1902 does not apply to breach of the common law duty of disclosure and held that there had been a breach on the part of the owner of her common law duty to disclose material facts.

Accordingly, the owner is case failed. Although the court’s decision was that breach of the common law duty was sufficient to determine the matter, the judge also said that even if section 18(1) could be invoked he “would not be prepared to hold that the insurer was not prejudiced by the relevant non-disclosure”. As well as the common law duty of disclosure, this case presented a question arising from the incorporation into the insurance contract of the provisions of the proposal, but the court did not need to deal with that question its decision resting solely on the non-disclosure point.

Later Decisions

2.8 We have been advised that an appeal from the judgment of the Supreme Court in Kolokythas was abandoned. After the decision in Bazouni and another case³ following Kolokythas, Mr. Justice Rogers announced that the judges normally sitting in the commercial list proposed to follow the principle established by Kolokythas unless and until that decision was overruled by the Court of Appeal or other superior court.⁴ To date there has been no such contrary decision.

Comment

2.9 These decisions have had the effect of exposing possible areas where liability might be avoided by insurers upon technical grounds that are beyond the reach of section 18 of the Insurance Act 1902. Two aspects need to be considered. The first is that the section has no application to the common law duty to disclose material facts and therefore gives no power to the courts to inquire whether the failure of an insured person to fulfil that duty ought to be excused.

2.10 Secondly, both Kolokythas and Bazouni involved a written provision of a kind that has come to be described as a “basis of contract” clause. In Kolokythas the provision appeared in the proposal and in Bazouni in the policy. A “basis of contract” clause provides that the proponent warrants the truth of his or her answers; or agrees that the truth of those answers will be a condition precedent to the validity of the contract; or acknowledges that should any answer not be true the insurer will be entitled to deny a claim or cancel the policy. Such a clause is effective only if contained in the policy, it is insufficient for it to appear in the proposal alone, unless the proposal itself is incorporated in the contract.⁵ If, however, the clause is effective, the consequence is that any inaccuracy in the proposal relieves the insurer from liability under the policy, even though the answer given by the insured is innocent, worthy of excuse, not “material” and unrelated both to the risks insured against and to the loss giving rise to the dispute.⁶ In other words, the insurer need not establish materiality, or even knowledge of the inaccuracy on the part of the insured, to rely on an incorrect answer in order to resist the insured’s claim. Thus, in the leading case of Dawsons Ltd. v. Bonnin,⁷ there had been an unimportant misstatement by the insured relating to the place where a motor vehicle would be garaged. The House of Lords found that the misstatement was not material, but because of the basis of contract clause the insurer could avoid liability under the policy.

2.11 It would seem that the power of the court under section 18 to excuse a failure by the insured “to observe or perform a term or condition of the contract of insurance” does not extend to a “basis of contract clause”. This is because an incorrect answer in a proposal which is subject to a basis of contract clause, probably cannot be described as constituting a failure by the insured “to observe or perform” a term or condition of the contract.⁸ The error is more accurately regarded as a failure by the insured correctly to complete a proposal, which is made the basis of the contract than a breach of a term or condition. The error may more properly be categorised as a failure on the part of the insured correctly to complete a proposal which is made the basis of the contract, than a breach of a term or condition.

2.12 The harsh effects that can flow from the common law rules relating to non-disclosure and misrepresentation and from the use of basis of contract clauses, have been criticised.⁹ In our view legislation is required to overcome the problems exposed by the judgments in Kolokythas and Bazouni. As we explain later, we think the most appropriate course of action is to extend provisions in the Consumer Credit Act, 1981, which apply to certain insurance transactions, to insurance generally. This extension should be subject to certain exceptions discussed in Appendix II.

FOOTNOTES

1. [1980] 2 N.S.W.L.R 663.

2. 17 March 1981, Supreme Court of New South Wales (Yeldham J.),

3. Chapman v. Greater Midwest Insurance Pty. Ltd. [1981] 1 N.S.W.L.R. 479, in which Yeldham J. again stated that he agreed with the decision and reasoning of Rogers J. In Kolokythas, in relation to the common law duty of disclosure and the terms of s.18 of the Insurance Act, 1902.

4. Sarina v. G.R.E. Insurance Ltd., 29 April 1981, Supreme Court of New South Wales (Rogers J.).

5. Deaves v. C.M.L Fire & General Insurance Co. Ltd. (1979) 143 C.L.R. 24.

6. Thomson v. Weems (1884) 9 App.Cas. 671; Condogianis v. Guardian Assurance Co. Ltd. [1921] 2 A.C. 125; Deaves v. C.M.L Fire and General Insurance Co. Ltd. (1979) 143 C.L.R. 24.

7. [1922] 2 A.C. 413.

8. See the doubts expressed in R. Else-Mitchell and R Parsons, Hire-Purchase Law (4th ed. 1968), p.143, in relation to s.21 of the Hire-Purchase Act, 1960:

It is straining words to say that an insured has failed to “observe or perform” a condition that his statements are true if it should prove that in some particular they are untrue.