Does Fraud Pay?
By Roger Miles of Elborne MitchellFirst published: Shipping & Trade Law - Vol 2, No 5 [1st September 2002]

The simple answer is possibly "yes" if you can get away with it but definitely "no" if you are found out. There is perhaps no better illustration of this than the recent Judgment of Mr Justice Moore-Bick in Agapitos & Another -v- Agnew & Others (the "AEGEON") and the Order on Judgment made by Mr Justice Morison in the same case.

In February 1996 the Claimants' vessel "AEGEON" was moored undergoing conversion from a roll-on roll-off car ferry to a passenger cruise ship. On the 19th February sparks from hot work set fire to upholstered seating which was stored nearby and the Port Authority ordered the vessel to be towed from her berth and beached. Whilst that manoeuvre was being carried out, the "AEGEON" struck a wreck and subsequently capsized and sank. The vessel was insured by the Defendants and it was common ground that the vessel was lost by an insured peril. However, Underwriters declined liability on the grounds that the Owners were in breach of one or more of the policy warranties.

When the insurance was initially placed, the terms of cover included:
"Warranted London Salvage Association approval of location, fire fighting and mooring arrangements and all recommendations complied with."

"Warranted no hot work".

When they were advised that the vessel was to be moved to a new location, Underwriters required the Salvage Association Certificate to be up-dated and on the 12th January 1996 Underwriters were informed that hot works would commence soon. On the same day, Underwriters scratched an endorsement wherein they agreed to cover such hot work on condition that it was warranted that the Salvage Association Certificate was updated and all recommendations complied with prior to the commencement of hot work. When they were requested to extend the period of cover on the 6th February 1996, Underwriters agreed but the endorsement scratched on that day read "Warranted London Salvage Association Certificate updated".

In their defence to the claim brought by the Owners of the "AEGEON" Underwriters pleaded several breaches of warranty including breach of the warranty of 6th February 1996. It was Owners' case that they had spoken on the telephone with the Salvage Association surveyor who they said told them that provided the fire extinguishers were overhauled and bilge alarms were fitted, then they could commence hot work. They further claimed that the hot work did not commence until 12th February 1996 by which time the requirements of the Salvage Association surveyor had been carried out. However, two sworn statements taken from workmen immediately after the casualty, averred that hot works of a substantial nature had been carried out from the 1st February. At this stage, Underwriters sought to amend their Defence to allege fraud.

The matter came before a Judge who refused leave to amend the Defence on the grounds that if the Defence of breach of warranty was good then any continuing duty on the Claimants not to deceive Underwriters was discharged by the breach and that anyway a plea of breach of such continuing duty would be superfluous. If Underwriters could not make out the Defence a breach of warranty then any alleged lies by the Claimants would only be material where the truth would have provided Underwriters with a Defence. In the circumstances of this case, the Judge held that the lies could not be material. The Judge also refused to equate lying to promote an otherwise valid claim with fraudulently pursuing an exaggerated claim and tender to the view that the duty of good faith is superseded by the rules governing litigation once litigation has commenced.

The Court of Appeal dismissed Underwriters' Appeal but, in doing so, conducted an exhaustive and interesting review of the relationship with the common law rule on fraudulent claims and Section 17 of the Marine Insurance Act 1906.

The common law rule, which is applicable even where there is no express clause in the Policy, is that an Assured who has made a fraudulent claim forfeits any lesser claim that he could have properly have made. Thus an insured will be unable to recover if he has in fact suffered no loss, if he has wilfully caused the loss, if he has exaggerated the amount of the loss by a significant degree or if he knowingly seeks to suppress evidence which would provide the defence to the claim. Lord Hobhouse, in The Star Sea, summarised the effect of the common law rule when saying "The fraudulent insured must not be allowed to think that if the fraud is successful, then I will gain, but if it is unsuccessful, I will lose nothing". So, if for example, the Assured has a valid claim for, say, US$100,000 but fraudulently presents his claim in the sum of, say, US$200,000 and the fraud is discovered, the Assured will recover nothing. This would also be true if, when making his claim, the Assured genuinely believed he had a valid claim for US$200,000 but fraudulently continued to pursue a claim in that amount after he had discovered that his true loss was in fact only US$100,000.

Section 17 of the Marine Insurance Act 1906 provides:
"A contract of marine insurance is a contract based upon the utmost good faith, and, if the utmost good faith be not observed by either party, the contract may be avoided by the other party".

The Courts have long considered Section 17 to be draconian and have sought ways to limit its applicability whilst not diminishing the effect of the common law rule. In The Star Sea in which it was alleged that the Assured had deliberately withheld from disclosure two experts' reports which Underwriters considered might have assisted them in defending the claim, the House of Lords held that once litigation commences the rules of Court replace the rules of contract of which Section 17 is one. However, The Star Sea did not involve alleged fraud or the use of a fraudulent device by the Assured in pursuing the litigation. The Agapitos case did, and Underwriters argued that even if the Section 17 duty only applied to the pre-litigation stage, the common law rule should continue to apply during the litigation stage. The Court of Appeal, however, could see no reason for there to be a different duration of impact for the Section 17 duty and the common law fraud rule.

So does this mean an Assured can pursue his claim in litigation with impunity if his claim is based on fraudulent evidence? The answer is clearly no. If the fraud is discovered, then the Assured's evidence as a whole is likely to be viewed with the utmost suspicion, and in all probability the Assured will lose his case and be ordered to pay costs on an indemnity basis.

The trial of the main action lasted for some 10 days. Amongst those giving evidence at the trial were the Owner, one of his managers and the surveyor appointed by the Salvage Association.

There was an obvious conflict of evidence as to the conversations which took place between the Owner and his staff and the Salvage Association surveyor. The Judge considered the Salvage Association surveyor to be an excellent witness who listened carefully to the questions put to him, answered them fairly and intelligently and who was quite willing to give ground where it was appropriate to do so. He preferred the surveyor's evidence to that from Owners' side. He found that it would be very unusual and quite out of character for the surveyor to have given any kind of approval for hot work to commence without first having visited the vessel to satisfy himself that everything was in order and to consider what ongoing recommendations were required. The Judge held that there had been five breaches of warranty by Owners although it was only necessary to find one breach of warranty for Owners' claim to fail.

The question of costs came before Mr Justice Morison and in his Order on Judgment he ordered that the Claimants' claims be dismissed and Judgment entered for the Defendants, that the First and Second Claimants should be jointly and severally liable for the costs of the Defendants, that they should pay interest on any costs already paid by the Defendants and that the Defendants' costs should be paid on an indemnity basis. Further, he ordered that the First and Second Claimants should make a payment on account of the Defendants' costs in the sum of £600,000 within 14 days. The Claimants' Application for Leave to Appeal was refused.

As can be seen, the Award on Costs was quite draconian, the reason for this being the manner in which the Claimants had pursued their claim. Ordinarily, the success of the Defendant Underwriters in the main action may well have turned out to be a pyrrhic victory. The Claimants in this type of case are generally a single ship owning company and Underwriters would find it difficult, if not impossible, to enforce any Costs Order in their favour. However, in this case, the Second Claimant was the mortgagee bank and, as can be seen above, both the Owner and the bank were made jointly and severally liable for Underwriters' costs. As no bank could afford to fail to honour a Judgment against them, Underwriters' recovery was assured. Had the Claimants not pursued their claim fraudulently, then probably, whilst they would still have been ordered to pay the Defendants' costs, they would only have been ordered to pay these on the standard basis and the Order on Judgment would have been far less draconian.