When an event occurs that triggers a notification provision in an insurance contract, the terms should be complied with before quietly sitting back and waiting for the insurer to exercise its rights to adjust the loss or control any issues that arise, including litigation. It is clearly in the insurer’s interests to minimise the loss that it will eventually be paying. But an insurer is entitled to take some time to look into the problem, or it might make its mind up immediately to reserve all its rights, simply decline the claim or, in an extreme scenario, avoid the policy. What should an insured do in these circumstances before a settlement can be negotiated or its rights assessed by a court?
Mitigation
In most non-insurance contracts, the party suffering from the other’s breach is obliged to mitigate its loss. It might be argued that an insured is subject to this doctrine in respect of an insured event because an action on an insurance contract is one for unliquidated damages for breach of contract, rather than in debt.1 In insurance circles it is often repeated that an insured must act as though they were a prudent uninsured, which reflects any obligation of mitigation. In fact it is putting it too high to categorise this aspect as a duty. If it were a duty, an insurer would have a cause of action for its breach, which it clearly does not. It merely has a defence, which is not the same at all. However, it is true that, while the insured is completely free to act as it wishes, the insurer may not be liable for all loss suffered by the insured in consequence of so acting. In fact the claimant’s position is similar to that of one whose damages are reduced as a result of its contributory negligence. The duty is a corollary of the principle that losses that are reasonably avoidable are not recoverable.2 The contract may also specify that the insured must mitigate any loss.
Either way, in practical terms there is a duty to mitigate in the sense that a failure to discharge this obligation may impact financially on the insured.
The duty to mitigate stipulates that the insured must take all reasonable steps to avert or minimise its loss and must avoid taking unreasonable steps that might increase its loss. The test is that of a reasonable person intent on preserving its own property, as opposed to claiming on the insurer.3 The question as to what is reasonable depends on the circumstances. For example, it is unreasonable for an insured knowingly to spend more money mitigating a loss than the anticipated maximum quantum of the loss. The insured must reasonably believe that mitigation was necessary, owing to the perceived imminent danger of loss to the insured subject matter, but can only recover if the expense was properly incurred and the loss would have been caused by a risk insured against. The insurer will not be able to rely on evidence showing that the insured risk did not later materialise if the anticipatory mitigation was reasonable when effected.4
Effect of a failure to mitigate
A failure to mitigate will result in the insurer pleading a reduction of the claim in its defence for the amount of loss in monetary terms that could and should have been avoided by the insured, which could be 100%. There is, however, another anomaly of insurance law that could operate to the benefit of the insured. As a matter of ‘normal’ contract law, the injured party must mitigate to recover, but in insurance law the insurance is in place specifically to protect the insured against the effects of its own negligence and a failure to mitigate if negligent may well remain covered. A distinction between a failure to mitigate and negligence was drawn in Youell v Bland Welch & Co Ltd (No.2) [1990], where the judge commented that:
‘The significant distinction between failure to mitigate and negligence… which intervenes between wrong and loss, is that failure to mitigate bars recovery in the situation where the plaintiff deliberately acts in a manner which is unreasonable.’5
In State of Netherlands v Youell [1998] the insurers attempted to defend a claim under a shipbuilding insurance policy on the grounds that the insured was in breach of the duty to mitigate. The court applied standard rules of causation in determining the scope of the statutory duty and held that the duty to mitigate would only be breached if the insured’s conduct or inactivity was so significant that it displaced the prior insured peril as the proximate cause of the loss. The court added that a breach of the duty to mitigate was unlikely to afford a defence to insurers as the conduct or inactivity that became the proximate cause of the loss could itself amount to a separate insured peril, under the cover given for negligence in many standard forms of policy. This will be a question of the wording and the facts, but it might be thought that the liability of the insurer has to end somewhere, rather than extend to any loss and then to a line of further negligence by the insured. If such further negligence is covered, it would be in breach of any express and implied obligation, and it could be deduced that the insurer would be entitled to deduct any loss that it has suffered from a failure by the insured to comply with that express or implied term. As a matter of policy a court might treat such an exclusion as contrary to the ethos of insurance, but the doctrine of fundamental breach no longer exists so a clear wording restricting the rights of the insured should, in theory, be upheld. The short answer is that if the further negligence is causally connected to the loss and is therefore not a novus actus interveniens, and it is negligent (ie not wilful or reckless), there is a good chance that it will be covered unless it is specifically restricted by the contract.
Pre-loss mitigation
An insured should also be aware that there is a distinction between money spent in advance to avert a loss that has become reasonably foreseeable and a loss that is entirely fortuitous. One might assume that an insured would be entitled to recover any costs spent in avoiding a loss from its insurer, that would otherwise occur and be paid as a claim by the insurer. Common sense would agree, but on balance the courts have not; partly because, even where the contract expressly provides that the insured must take all reasonable measures to avert a loss, there is apparently no implied term that it would be reimbursed by its insurer, but also partly because any duty to mitigate arises after a breach, not before it.6 More technically, for the purposes of insurance law, the breach of a contract of indemnity is not the occurrence of the insured peril but the fact that the insured has suffered loss. There is also the view that a breach that could be averted is not sufficiently fortuitous to merit cover. On the other hand there are obvious public policy reasons for enabling an insured to recover such costs, not least that the insurer suffers a diminished loss and that it makes little sense to allow an insured to recover if it does nothing, but not if it takes positive action. Nevertheless, insureds would be well advised expressly to include clauses for such recovery in their policies, as the absence of such clauses mean that recovery may not be allowed. The cost incurred in de-risking the mythological Millenium Bug is one example.
This duty to ‘sue and labour’, as it is known in marine circles, was limited in Davey Offshore Ltd v National Oilwell (UK) Ltd [1993] to the insured taking ‘such obvious steps to avert or minimise the loss that any prudent assured could be expected to take’ and in principle would, for example, include a ransom payment.7 It is entirely open to an insurer to include a clause expressly requiring the insured to take steps to minimise a loss once it has occurred, and to preserve and exercise all rights that accrue as a result of any loss, ie against third parties.
Subrogation
Until 2008, a waiver of all the insurer’s rights of subrogation was automatically implied against any joint or co-insured, or to any party entitled to the benefit of the insurance, to the extent of that party’s interest unless that party has acted in a morally culpable manner (ie involving dishonesty or recklessness).8 Thus, where a bank is a co-insured with a borrower, there need be no separate waiver of a subrogation clause. However, in Tyco Fire & Integrated Solutions (UK) Ltd v Rolls-Royce Motor Cars Ltd [2008] the suggestion was that this rule was a ‘rule of law’ or an overriding rule was removed in favour of the doctrine of construction of the contract. Rix LJ commented in Tyco that he could see that a provision for joint names insurance might strongly influence the construction of the contract and might lead to a carve-out liability, but that:
‘If the underlying contract envisages that one co-assured may be liable to another for negligence even within the sphere of the cover provided by the policy, I am inclined to think that there is nothing in the doctrine of subrogation to prevent the insurer suing in the name of the employer to recover the insurance proceeds which the insurer has paid in the absence of any express ouster of the right of subrogation, either generally or at least in cases where the joint names insurance is really a bundle of composite insurance policies that insure each insured for his respective interest. Most co-insurances are of such a composite kind.’9
The lesson is if a contracting party wishes to remain free of liability, it should expressly say so, particularly where there are many possible insureds, eg a construction project where one party takes out a policy that includes insurance for sub-contractors.
Clear terms
Although many terms in respect of subrogation are implied, it is invariably better to use clear and unambiguous wording setting out the purpose of the insurer’s right to subrogate, when it is to apply (eg before payment has been made), the right of the insurer to sue in the insured’s name (including a formal assignment of rights of action should this be required), the right of the insurer to control any negotiations and settlement, and a commitment by the insured to take all steps necessary to allow the insurer to take full advantage of rights and remedies in respect of sums paid out under the policy, including executing any documents.10 The issue of costs should also be considered if it is possible that the insured could suffer an uninsured loss. Finally, unless a court specifically allocates damages to each section of any claim, it will be very difficult to establish which part of the recovery applies to each type of damage. This is particularly true with regard to payments into court or offers made by the defendant on a global basis. In the light of recent case law it would be prudent for an insured or reinsured to ensure that any discrete elements are clearly identified.
Application of Subrogated Recoveries
Inadequate funds
One other aspect that should be clarified is the allocation of any recoveries made. The insured is treated as a co-insurer for the purposes of allocating money recovered through subrogation, so that its retention has the same status as the sums paid by insurers. It is effectively a payment by itself to itself as part of the loss. Any money recovered from a third party is applied ‘from the top down’. Thus, the money available should first be paid to the insured against the uninsured portion of its loss and secondly to the insurers against their payments under their policies. Only when both the insured’s uninsured losses and the insurers have been paid would any balance be applied against the insured’s deductible. If the insured wishes to minimise the risk that its payout will be limited owing to the absence of funds, it will have to agree an express clause either at the outset or prior to any recovery.
Excess funds
Although the insured is entitled to an indemnity from the insurer, the insurer is only entitled to recover what it has paid the insured in respect of the insured loss or liability, together with interest. Any sum recovered by the insured in excess of the sum paid by the insurer may be retained by the insured, save for the amount of interest due to the insurer from the date of settlement. The insured can retain interest payable from the date of loss (or shortly afterwards) until the date of payment by the insurer. Equally, the insurer is obliged to pay interest on any surplus funds owed to the insured.
Finally, in the context of mitigation and subrogation, it should be noted that although the Unfair Contract Terms Act 1977 does not apply to insurance contracts, an express term which is onerous or removes substantive rights on breach by a consumer may be capable of adverse review by the Insurance Ombudsman, who will apply the spirit of the Act (and the Financial Service Authority’s Insurance Conduct of Business Sourcebook 2.5.1 achieves much the same result), and it may also fall foul of the Unfair Terms in Consumer Contracts Regulations 1999, which protects consumers by rendering unenforceable any unfair term contained in a pre-formulated standard form contract.11
Reservation of Rights
While considering their options after a claim, insurers will often reserve their rights. Although a knee-jerk reservation of rights or rejection of a claim reaction has been judicially described as undesirable, the reality is that an insurer’s best position is to reserve its rights as soon as it is aware of any breach of the policy or of the duty of good faith.12 Even so, insurers must still take care not to convey the impression that they have elected to handle the claim rather than rely on a breach of a term to reject liability. Insurers will also face time constraints on becoming aware that the term had been breached. As Rix LJ states:
‘I would certainly not like to give the impression that insurers can equivocate for long while giving the plain impression that they are treating a claim as covered by their policy, especially at a time when a decision might be required, without running at least the risk that they will be treated as having waived some requirement of their contract or their right to avoid it. Moreover, there may well be express options given to insurers under their policy, the unguarded exercise of which is simply inconsistent with the right to decline cover.’13
In Syndicate 512 at Lloyd’s v Imperio [1993] the Court of Appeal considered that every professional knows how to reserve their rights, that a reservation of rights did not amount to aggressive conduct and that that the reinsurer would have to reserve its position if it intended to take any step that would otherwise constitute affirmation of the contract.
In Scottish Coal Company Ltd & ors v Royal and Sun Alliance plc & ors [2000] the underwriters were fully aware of the existence of a non-disclosure and its implications, but reserved their position primarily on a material change of risk. They then agreed an extension of the policy period for a pro rata share of increased premium without any further reservation of rights, which the court found to be an unequivocal election to affirm the contract. The lesson to be learned by insurers is that a reservation should be clear and repeated if any action is taken that might prejudice its effect. The lesson for insureds is that the initial exercise of reserving its rights may well be of limited value and can be superceded by any action taken by insurers that is effectively an affirmation of the contract.
Notes
- Edmunds v Lloyd Italico [1986] 2 All ER 249.
- Yorkshire Water Services Ltd v Sun Alliance plc [1997] Lloyd’s Rep 21, 32.
- Integrated Container Service Inc v British Traders Insurance Co Ltd [1984] 1 Lloyd’s Rep 154, 158.
- Ibid 163.
- Youell v Bland Welch & Co Ltd (No 2) [1990] 2 Lloyd’s Rep 431.
- Notably in Yorkshire Water, although in respect of a liability policy rather than a property policy.
- The phrase ‘sue and labour’ is effected by s78(4) of the Marine Insurance Act 1906, which states that it is the duty of the assured and their agents, in all cases, to take such measures as may be reasonable for the purpose of averting or minimising a loss.
- As exemplified in Co-operative Retail Services Ltd v Taylor Young Partnership Ltd [2000] EWCA Civ 207, which also dispensed with the rule of circuity of action and the doctrine of an implied term.
- Tyco Fire & Integrated Solutions (UK) Ltd v Rolls-Royce Motor Cars Ltd [2008]. Para 77.
- Terms of subrogation are implied by the principle of indemnity – that the insured can only recover no more than 100% – which must give rise to the concept that any sum recovered exceeding 100% must revert to the insurer. The right of the insurer to sue in the insured’s name is implied by English law (see Mason v Sainsbury (1782) 3 Doug KB 61).
- The Financial Service Authority’s Insurance Conduct of Business Sourcebook 2.5.1 states: ‘Principle 6 (Customers’ interests) requires a firm to pay due regard to the interests its customers and treat them fairly. A firm may not exclude the duties it owes or the liabilities it has to a customer under the regulatory system. It may exclude other duties and liabilities only if it is reasonable for it to do so.’
- See Kosmar Villa Holidays plc v The Trustees of Syndicate 1243 [2008] 2 All ER (Comm) 14, paras 82-83. In 2008 the Association of Insurance and Risk Managers published its ‘Statement of Principles’, applicable on notification of a potential loss or series of potential losses reasonably anticipated to exceed £2.5m from the date of the first notification of a potential loss for a period of 90 days. It is voluntary and requires that the insurer will not pre-emptively initiate any formal dispute resolution proceedings of any sort or issue any form of reservation of rights. The parties will then discuss, on a without prejudice basis, the manner in which the insurer might respond to the potential loss, the supporting information required and the appropriate timetable for the resolution of any potential issues regarding coverage, extending the time as agreed. The purpose is to avoid legal costs by allowing direct discussion to take place for the purpose of an amicable resolution of the claim.
- Paras 82-83, Kosmar.