UK: Basis Of Contract Clauses: Are Insurers Ready For Reform?

The Law Commission has proposed further reforms to the proposal process.

What are basis of contract clauses?

Basis clauses apply to statements made during the presentation of risks. They convert statements from representations into warranties.

In the ordinary course, false representations do not affect coverage unless they are material to the risk and influence the judgement of the underwriter involved.

If the policy contains a basis clause, a false representation of any type will allow underwriters to decline indemnity for breach of warranty.

Why are basis clauses controversial?

Because basis clauses apply to pre-contractual statements, the breach of warranty occurs at inception. The requirement of strict compliance means that even a trivial, irrelevant or non-causative breach can result in the insurer being discharged from liability. Insureds can be left without any cover even if they are unaware that they have done anything wrong.

There is a widely held view that basis clauses tip the balance too far in the insurer's favour.

What is the experience in other jurisdictions?

The use of basis clauses is already restricted in other jurisdictions.

In Australia the Insurance Contract Act 1984 (Cth), (which expressly set out to strike a fair balance between the insurer and the insured) contains provisions which render basis clauses ineffective. s24 of the Act provides that all statements of existing fact are to be treated as representations, and not as warranties.

In New Zealand, the Insurance Law Reform Act 1977 prevents insurers from relying on statements made in proposal forms or other documents "on the faith of which the contract was entered into" to avoid liability unless the statement is both 'substantially incorrect' and material.

What is being done in the UK?

Legislation was passed in 2012 which abolished the use of basis clauses in consumer insurance contracts. The Law Commission is now considering similar restrictions for commercial insurance contracts. AIRMIC, the LMA and several leading insurers have given their support to the proposed reforms.

Reform is inevitable. It is not yet clear precisely what shape the reforms will take, although a final report containing draft legislation is expected from the Law Commission later this year.

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