English High Court considers duties of an insurance broker and whether breaches caused the insureds’ loss
A serious fire destroys a number of commercial buildings on one site. The insurers of the destroyed buildings and the destroyed plant/machinery under two separate policies elect to avoid the policies for non-disclosure/misrepresentation.
Without contesting the insurers’ decisions and determining the legal position under the policies, either by way of a settlement or a judgment, the insureds sue the insurance broker in negligence.
There are a number of defences open to an insurance broker in this situation:
- The insurers’ avoidance was legally incorrect,
- Even if it was correct, the insurance broker did not breach any of his or her duties to the insured,
- Even if the insurance broker did breach his or her duties, that breach did not cause the insureds’ financial loss (because some other breach by the insured would still have resulted in a correct declinature of the claim).
In Dalamd Limited v Butterworth Spengler Commercial Limited  EWHC 2558 (Comm), the English High Court had to consider all these defences.
In negligence cases, the facts are usually critical in determining whether a party has been negligent.
Briefly, the insureds operated a waste recycling business trading as ‘Ecocycle’. Through a firm of insurance brokers (Butterworth), they arranged property insurance covering the buildings and property owner’s liability insurance covering liability risks with Novae (a Lloyd’s syndicate), and contractor’s all risks insurance covering the plant and machinery with XL (another Lloyd’s syndicate).
They subsequently discussed with Butterworth purchasing business interruption insurance. Butterworth obtained quotes, but due to financial constraints, the insureds only purchased cover from Novae for:
- Increased cost of working
- Additional increased cost of working
- Stock debris removal
The insureds chose not to purchase cover for gross profits.
About a year later, a storm caused damage to the insureds’ premises. XL indemnified the insureds for damage to its plant and machinery and Novae paid the insureds’ claim for increased cost of working.
The storm caused a build-up of waste stored outside the insureds’ buildings. A regulatory authority inspected the build-up and determined it was a breach of the insureds’ licence. Learning of this, Novae cancelled its policies with the insureds.
Butterworth obtained a quote from Aviva to replace the covers cancelled by Novae. Aviva agreed to cover the insureds subject to a condition that the insureds always stored the outside waste a specified distance from its buildings and from its site boundaries (External Storage Condition). Aviva subsequently surveyed the site and discovered that the insureds were in breach of the External Storage Condition. Both Butterworth and the insureds were advised of this.
The insureds’ financial position deteriorated and they eventually became insolvent. They ceased trading.
The insureds incorporated another company (JLS) with a view to it carrying on the waste recycling business instead. One of the insureds, which owned the premises, gave JLS a licence to operate from its premises. A company set up in these circumstances is sometimes called a ‘phoenix company’.
Butterworth was advised of the insolvency and was instructed to ‘transfer’ the insureds’ policies to JLS to cover it for conducting the waste recycling business.
Butterworth contacted Aviva and asked it to:
… note change of name following Ecocycle going into administration.
Later Butterworth told Aviva:
… of a change of trading name. All risks, process and materials remain the same.
The cover with XL was simply allowed to renew.
Some months later there was a serious fire at the premises, destroying all the buildings and plant/machinery. Both Aviva and XL avoided their policies for misrepresentations/non-disclosure and Aviva also relied on the breach of the External Storage Condition.
Claim against insurance broker
The insureds did not contest the avoidance/declinature by Aviva and XL. Instead, they issued court proceedings against Butterworth alleging it:
- Failed to disclose properly to Aviva the insureds’ insolvency,
- Failed to give adequate advice to the insureds about the meaning and effect of the External Storage Condition imposed by Aviva,
- Failed to give adequate advice in relation to gross profits cover,
- Failed to give advice about the availability of loss or rents cover (one insured rented the building to the other insured),
- Failed to give proper disclosure of what they knew to XL or give inadequate advice about the matters that should have been disclosed to XL.
Duties of an insurance broker
The Court said the duties of an insurance broker to his or her client include the following:
- The broker must identify the type and scope of cover which the client needs, and advise the client accordingly.
- The broker must take reasonable steps to arrange insurance cover which the client has instructed him to obtain, and which is suitable for and clearly meets the client’s requirements.
- In placing the insurance, the broker must have regard to the obligations of disclosure owed to the insurer. In particular, the broker must:
- Once cover has been placed, the broker must consider and explain to the client what cover has been arranged,
- At renewal, the broker must go through the same exercise that was carried out at inception of the policy.
i. Advise his or her client of the duty to disclose all material facts,
ii. Explain the consequences of failing to do so,
iii. Indicate the sort of matters that ought to be disclosed as being material, or arguably so,
iv. Take reasonable steps to elicit matters that ought to be disclosed, but which the client might not think it is necessary to mention,
The Court found that Butterworth had breached its duty of care in 3 respects:
- Butterworth had breached its duty to disclose the insureds’ insolvency to Aviva properly. The information passed on was to its own agent, not Aviva’s agent. In any event, the information passed on was inaccurate – it merely mentioned the business had changed name. The reality was different to this.
- Butterworth had breached its duty by not raising the availability of loss of rents cover and discussing this with its clients when one of the insureds relied solely on rental income.
- Butterworth breached its duty when it didn’t advise XL of the breach of the insured’s licence and the imposition of the External Storage Condition by Aviva.
However, before any of these breaches entitled the insureds to damages, the insureds had to prove that the breaches caused them financial loss. In relation to this issue, the Court found as follows in the same order:
- While the breach of the duty to disclose the insolvency to Aviva entitled Aviva to avoid the policy, Aviva would have been able to decline the claim anyway because of the insureds’ breach of the External Storage Condition. Therefore, Butterworth’s breach did not cause the insureds’ financial loss.
- While Butterworth breached its duty to advise about loss of rents cover, by this point the insureds were insolvent and would not have been able to pay for it anyway. Therefore, this breach did not cause any financial loss to the insureds.
- If Butterworth had advised the missing material facts to XL, XL would not have been able to avoid its policy. Therefore, this breach did cause financial loss to the insureds.
In order to come to these decisions, the Court had to decide whether the insurers’ avoidance of the policies was legally valid, and what impact compliance with all duties would have had on coverage. The insureds argued this should be assessed on a loss of chance basis. However, the Court rejected this and said it should be assessed by a conventional yes/no decision about what the coverage position would have been based on the information available to the Court.
In the end, Butterworth was only liable for one breach of its duty of care. This resulted in the declinature of the insureds’ claim against XL for the damage to its plant and machinery.
This case is a good example of how Courts have to consider not only if there has been a breach of duty, but also whether any breach has caused the insureds’ financial loss sued for. The Courts must grapple with counter factual questions about what would have happened if the broker had fulfilled its duties.
The decision to sue the broker without determining the legality of the insurers’ avoidance first (or together in the same proceeding) was unusual. This required the Court to predict whether the insurers’ avoidance was legally correct based on the limited information available. It also led to the argument about whether the test to apply in this situation was the lower threshold of a loss of chance, or the higher threshold of a yes/no decision on what the coverage position would have been.
Brokers must take care when providing information to insurers about material events. As this case shows, where the insured is insolvent, the broker must give precise information about what is really happening and ensure his or her client is properly advised. Characterising a change of insured due to an insolvency event as a change of name is not good enough.
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