“Basis of contract” clause – the danger is in the detail

June 30th, 2014, Published in Articles: Vector

 

The United Kingdom (UK) Court of Appeal recently upheld a decision which confirmed that the “basis of contract” clause in a proposal form for insurance cover constitutes a warranty, even where the insurance policy makes no reference to the form.

The Technology and Construction Court’s decision in Genesis Housing Association versus Liberty Syndicate Management held that the insured housing association could not recover under an insurance policy providing cover in the event of insolvency of a building contractor due to:

  • An incorrect statement as to the identity of the builder in the proposal form.
  • A basis of contract clause in the declaration to that form, providing that the statements made therein would form the basis of the contract between the insured and the insurer.

The facts

Genesis engaged Time and Tide Bedford (TT Bedford) to construct 51 residential units at a building in Bedford. Genesis submitted a proposal form for coverage, via its agent, for insurance from Liberty Syndicate 4472 at Lloyds which included an optional extra for cover against the risk of the building contractor becoming insolvent during the construction period.
The proposal form submitted by Genesis contained one incorrect statement – the name of the builder was shown as Time and Tide Construction (TT Construction) when the building contractor was to be TT Bedford.

On the insolvency of TT Bedford, Genesis lodged a claim with the insurers under the policy. The insurers denied liability and averred that the misstated name of the builder in the proposal form constituted a breach of warranty, with the effect of the policy being void from inception.

The court of appeal

The central issues before the court were:

  • Whether an incorrect statement in a proposal form, which concerned the identity of the builder, enables an insurer to escape liability.
  • What effect a declaration in the proposal form, that statements contained therein would form the basis of the contract of insurance (“basis of contract” clause), would have.

The appeal court confirmed that earlier authorities had established the principle that, where a proposal form contains a basis of contract clause, such a form has contractual effect, even if the policy contains no reference to it. Accordingly, all statements in the form constitute warranties on which the insurance contract is based.

However, the court stated clearly that the fact that the policy contained an express “no misrepresentation” clause did not dilute the effect of the basis of contract clause in the proposal. If it is the intention of the parties to the insurance contract to exclude the contractual effect of a basis of contract clause, the parties must do so in clear and unequivocal language. The court rightly held that the policy in the present case contained no exclusionary words and that the signed proposal form was of contractual effect.

The court held further that the insurer’s rights to avoid misstatements cannot only be limited to circumstances where there was intention to defraud as such provisions confer additional express rights to the insurers rather than to curtail their existing rights.

Where an insured signs a declaration that the contents of the proposal form are true “to the best of his knowledge and belief”, a later basis of contract clause is not to be interpreted to mean that a misstatement has no effect if the proposer is unaware of the error. As the insurers were providing cover against the risks of insolvency of an identified builder, only that builder’s insolvency was covered. The court also found that it was within Genesis’ knowledge and belief that the statement was incorrect and that the misstatement in relation to the identity of the builder on the proposal form was sufficient to void the policy.

Implications and conclusion

The decision illuminates the harsh impact of a breach of warranty created by the basis of contract clause, and provides a useful reminder to both insurers and those insured of the consequences of providing inaccurate information in a proposal form, where that information forms the basis of the contract.

It must be mentioned that in the UK the new Consumer Insurance (Disclosure and Representations) Act excludes the operation of the basis of contract clause in ens-user contracts. However, it remains relevant in commercial construction and both insurer and the insured should be mindful of its importance.

Lucas Bowles, regional director, South, East Cape

 

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