Effect of Illegality on the Contract of Insurance
An Introduction
On being confronted with disputes relating to enforceability of contracts in general,
courts start from the policy position that contracts should be enforced. The contractual
relationship is a horizontal relationship and equity will be used sparingly. However
depending upon the relationship of the contracting parties courts are willing to retreat
from . Vis-à-vis insurance contracts it is found that courts will regard “justice to an
insured party” as a relevant factor for determining enforceability of an insurance contract.
The effect of illegality on the contract of insurance varies from total nullity of the
contract to non-enforceability of a particular claim without prejudice to the validity of the
contract as regards other claims.
Illegality vis-à-vis a contract of insurance can occur at various stages and accordingly can
have varied effects upon the contract of insurance:
1.
2.
3.
4.
When making contract/Goes to the parties to the transaction
Manner of Contracting
Illegal Promises
Illegality of Purpose
1. Effect of Illegality when making Contract of Insurance
Instances of such illegality
1. Lack of Insurable Interest
A contract of insurance made by an insurer with a person who lacks the insurable interest
required by law is void.1 It can also be said to be contrary to public interest and thus
illegal.2
2. Enemy Connection
Who is an enemy?
The term “enemies” includes persons voluntarily resident or carrying on business in
enemy or enemy occupied territory. A person resident in alien occupied territory is an
enemy even if he conducts the whole of his business outside the territory.3 Similarly, a
person who is not resident in enemy territory is also an alien if he transacts business
there.4 The ‘residence’ test has met with scholarly criticism from Arnould who suggests
that the residence test is no better than the nationality test and that the most reliable test is
the business connection test.5 However Clarke submits that the double test is most
appropriate since there may be a situation where though a resident of the enemy state is
doing business in a neutral territory he is remitting the profits/benefits of this business
back to his place of residence i.e. the enemy state. Furthermore, Clarke submits that a
situation could arise where the business in the neutral territory may be used to support an
arm of that business in the enemy state itself. 6 However, I think there is more merit in
Arnould’s argument than Clarke acknowledges since the problems identified by him can
be dealt with by ‘business connection’ requirements themselves. In effect, the remittance
of business benefits and support of local arm of business could be used to establish a
business connection between the enemy state and the resident. [research definition of
business connection for this purpose].
1
Check
For example in the context of fire insurance see Spare v. Home Mutual Insurance Company, 15 F 707 (D
Or, 1883).
3
Porter v. Freudenberg [1915] 1 KB 857, 869 per Lord Reading CJ (CA); The Anglo-Mexican [1918] AC
422, 427 per Lord Parker; Sovfracht [1943] AC 203, 209 per Viscount Simon LC cited in Malcolm
A.Clarke, The Law of Insurance Contracts, Lloyds of London Press: London, 1989, p.492.
4
Sovfracht [1943] AC 203, 229 per Lord Wright cited in Malcolm A.Clarke, The Law of Insurance
Contracts, Lloyds of London Press: London, 1989, p.492.
5
Malcolm A.Clarke, The Law of Insurance Contracts, Lloyds of London Press: London, 1989, p.492.
6
Malcolm A.Clarke, The Law of Insurance Contracts, Lloyds of London Press: London, 1989, p.492.
2
Transactions with Agent of Enemy Principal
In Ingle Ltd. v. Mannheim Ins Co7 it was held that a branch in London of an insurance
company whose headquarters were in enemy territory was not in itself an enemy vis-à-vis
business transaction in England. The notion of commercial domicil prevailed over the
factum of enemy connection that might have been established. However Ingle Ltd. is not
representative of the contemporary legal position in this regard. In The Hamborn8 the
court held that the branch will be held to possess enemy character if it can be proved that
the enemy parent exercised de facto control over the branch.9
3. War time transactions
Effect of such illegality
Illegality at this stage if it gives rise to non-enforcement at all, means that the contract is
totally without effect.
In such a case the insured has no insurance. However, there is authority for the
proposition that if the insurer nonetheless pays the broker involved, the insured may
recover the money from the broker as money had and received.10
The insured is unable to recover any premiums paid to the insurer under the illegal
contract of insurance. Thus is Harse v. Pearl Life Assurance Co11 the plaintiff contracted
life insurance in which he had no interest, and was unable to recover premium paid.12 The
Harse decision was based on rules applicable to all contracts as was Vandyck v. Hewitt13
in which premium could not be recovered for cargo part owned by enemies, and for that
reason not lawfully insurable in England. This is a simple application of a general rule
against the recovery of money paid or property transferred in performance of an illegal
contract. [find out about this]
7
[1915] 1 KB 227.
[1919] AC 993 (PC).
9
See also Daimler Co Ltd. v. Continental Tyre and Rubber Co.(Great Britain) Ltd [1916] 2 AC 307.
10
Tenant v. Elliot, (1797) 1 Bos & Pul 3 (cargo insurance).
11
[1904] 1 KB 559 (CA – Life).
12
This rule was also applied in Evanson v. Crooks (1911) 106 LT 264 (Life); Goldstein v. Salvation Army
Assurance Society, [1917] 2 KB 291 (Life). See also Howard v. Refuge Friendly Society (1886) 54 LT 664
(Life).
13
1800) 1 East 96
8
2. Effect of Illegal Promises
Instances of Illegal Promises
Effect of such illegality
An illegal promise may be but a small part of the promised consideration. If the main
purpose of the contract can be carried out without the illegal part, the latter is ignored and
the contract is performed as far as possible without contravening the law. As regards the
illegal part unperformed, liability is exempted by operation of the law. If, on the other
hand, although one illegal promise among many lawful promises, is one without which a
substantial part of the rest cannot be performed, the whole contract is discharged or
dissolved.14 Insurance promises, to pay loss or to pay promises are likely to be put in the
latter category15 but in relation to claims conditions the position is likely to be different.
For example, in Watson v. Employers Liability Insurance Co16 liability insurance
contained a clause that no action could be brought against the insurer, until the liability of
the insured had been determined, a clause valid in Massachusetts, where the policy was
issued, but not in Louisiana, where the action was brought. The Supreme Court of the
United States held that the court in Louisiana could apply the insurance contract without
applying the clause.
14
The Fibrosa Case [1942] 1 KB 12 (CA) cited in Malcolm, p.520.
It is different in the United States, where the state law dictates the terms of insurance contracts. Contract
terms in breach of such rules have been disregarded and the contract enforced as if such terms had not been
included. Equitable Life Assurance Society v. Pettus, 140 US 226 (1891 – Life); America Motor Insurance
Company v. New York Seven-Up Bottling Company Inc, 238 NYS 2d 80 (1963 – motor).
16
348 US 66 (1954) cited in Malcolm, p.520.
15
3. Effect of Illegal Purpose
Instances of Illegal Purposes
Effect of such Illegal Purposes
If a contract of insurance is concluded with an illegal purpose as the main objective, the
contract is entirely unenforceable. If, as is more likely to occur, the contract is concluded
with lawful purposes in mind, but appears to covers an activity conceived later to serve
an unlawful purpose, the question arises, whether it is the entire contract which is
unenforceable from then on or just the claim or the part of the claim arising out of the
unlawful activity.
In Parkin v. Dick17 insurance was taken on goods to be subsequently specified. Goods
were shipped to a value of 10,000 pounds, of which goods to the value of 600 pounds
were naval shores shipped in breach of statute. The entire consignment was seized by an
enemy and lost. The insurer argued that, although the insurance was inoperative to cover
the naval stores, it was valid for the rest; that the policy was like a deed containing a
number of covenants, in which illegal covenants might be severed, but the rest enforced.
The court rejected the argument and held that the entire claim failed. The contract was
construed as an entire contract, so that illegality in part infected the whole.18
In the process of construction the court is influenced by the court is influenced by the
gravity of illegality, and perhaps also by other factors affecting the preliminary question,
whether and to what extent the contract should be enforced. Parkin is typical of English
marine insurance cases at that time19 and its severity may reflect the particular context,
legislations to further the wars against Napolean. It is not clear that such cases are a
reliable guide to decisions today.
17
(1809) 11 East 502. See also Bird v. Appleton (1800) 8 TR 562, 566 per Lord Kenyon CJ (hull)
Also see Keir v. Andrade (1816) 6 Taunt 498: the insured exported 300 barrels of gunpowder but was
licensed to export only 150. His insurance on the entire consignment was valid as regards 150 barrels. The
decision proceeds, it is submitted correctly, by regard to the inferences of the statute in question: as the
insured was only likely to forfeit the excess, but could keep the rest, the court inferred that insurance on the
latter was not meant to be invalid.
19
See also Wilson v. Marryat (1798) 8 TR 31, 46 per Lord Kenyon CJ (Hull and Cargo) cited in Malcolm,
p.521.
18
Illegality caused by Plaintiff Not in Pari Delicto
Instances of such illegality
Effect of such illegality
Rule
In Harse v. Pearl Life Assurance Co20 Lord Collins MR stated that relief would have
been granted, if there had been “fraud, duress, oppression, or a difference in the position
of the parties which created a fiduciary relationship to the plaintiff so as to make it
inequitable for defendants to insist on the bargain”. He was referring, although
incompletely, to the general law of contract, and to the exceptions to the rule, that money
transferred in performance of an illegal contract is irrecoverable.
Exceptions
The exceptions can be explained as cases in which parties to the contract are not in pari
delicto and, where appropriate, this principal will be applied to illegal insurance
contracts, as shown below:
1) Innocence
Obviously, the parties are not in pari delicto, if one party, not being implicated in the
illegality at all, is innocent. He may be able to enforce the contract or obtain restitution
with two qualifications. First, no remedy will be granted, however innocent the
supplicant, if that is required by the public policy in issue. Second, his innocence must be
justifiable. It is justifiable, if he is unaware of facts,21 for example the vehicle lacked the
required certificate22 but not perhaps if he knew or should have known the facts but was
ignorant of the existence, content or true meaning of the relevant rule of law being
infringed: ignorantia juris haud excusat.23
2) Relative Turpitude
The parties are not in pari delicto, if, although both are implicated in the illegality, the
behaviour of one, the defendant, is significantly worse than that of the party seeking
[1904] 1 KB 559, 563 (CA – Life).
Pearce v. Brooks (1866) LR 1 Exch 213; Fielding and Platt Ltd. v. Najjar [1969] 1 WLR 357 (CA);
Motel Manager Training School Inc. v. Merryfield, 347 F 2d 27 (9 Cir, 1965) cited in Malcolm, p.522.
22
Wilson v. Rankin (1865) LR 1 QB 162, 164 per Erle CJ (freight); see also Dudgeon v. Pembroke (1874)
LR 9 QB 581 (hull); Further, premium has been recovered, when the insured paid premium in ignorance of
the outbreak of war, which rendered performance illegal: Oom v. Bruce (1810) 12 East 225 (Cargo); or, if
the war breaks out between the time of payment and the time that cover begins, as the consideration has
totally failed: Fibrosa case [1943] AC 32.
20
21
relief24, notably where the defendant has been guilty of fraud, 25 duress or oppression
against the plaintiff. An example would be the fraud of an agent of an insurer who,
seeking greater commission, misrepresented facts concerning the possibility that the
company had enemy status.
3) Class Protection
The parties are not in pari delicto if one belongs to a class, which the law seeks to protect
from the other, whether by statute26 or rules of common law. If an insurance contract
should be vitiated by infringement of statute, it is submitted that in many cases a remedy
should be available to the “insured” under this exception.27 More generally, equity may
afford remedy in case of “an advantage taken by a clever man over an ignorant one”.28
In Cunliffe29 the plaintiff, a collier, took insurance on the life of his brother-in-law,
induced by the fraudulent misstatement by the insurer’s agent that such insurance was
valid. The court allowed his action, because the statement had been made by a person
skilled in insurance to one who was not. The decision was affirmed by the Court of
Appeal.30
4) Repudiation
A person implicated in the illegality may recover, if he repudiates the venture in time.31
Repudiation is in time if it occurs before the illegal conduct has begun.32 Although
repudiation is sometimes called repentance, with the implication that the parties are not in
pari delicto, a safer basis for the right of recovery in such cases is pragmatism: the
existence of the right may encourage parties to pull back from an illegal design,33
whether the motive be moral regeneration or fear of apprehension.
23
Research this from 22-2B3.
Saugers v. Edwards [1987] 2 All ER 651 (CA).
25
Hughes v. Liverpool Victoria Friendly Society Sy [1916] 2 KB 482 (Life).
26
Browning v. Morris (1778) 2 Cowp 790, 792 per Lord Mansfield; Kiriri Cotton Co Ltd v. Dewani [1960]
AC 192 (PC) cited in Malcolm, p.522.
27
Re Cavalier Ins Co Ltd, 23 May 1989 cited in Malcolm, p.522.
28
Harse v. Pearl Life Assurance Co [1904] 1 KB 559, 564 per Romer LJ (CA – Life).
29
British Workman’s & General Assurance Co. Ltd. v. Cunliffe (1902) 18 TLR 425, cited with approval in
Harse.
30
(1902) 18 TLR 502. The court was at pains to find that the misstatement was one of fact rather than of
law.
31
Morck v. Abel (1802) 3 Bos & P 35, 39 per Chambre J (cargo); Palyart v. Leckie (1817) 6 M & S 290,
293 per Lord Ellenborough CJ (cargo): the main reason given was that the insured has given no notice of
the renunciation of the insurer, until he started the action; a modern court might prefer the reason that he
had lost the opportunity to carry out the illegal venture, and therefore the reason for allowing the recovery
(to encourage second thoughts) did not arise: Bigos v. Bousted [1951] 1 All ER 92.
32
Check Merkin, 97 LQR 920 (1981).
33
Provision for locus poenitentiae if person withdrew from conduct before purpose was achieved.
24