A vessel is incapacitated by an ingress of water which floods the engine by way of a faulty sea-water inlet valve in the bow thruster space. It is unsurprising that sceptical underwriters mount an investigation. The witnesses are proffered for interview and a theory developed to explain the steps required for the water to reach the levels it did without the crew being able to stop it.  The story is embellished perhaps out of frustration but in a way that is more than simply “gilding the lily”.  A statement is made which crosses the line between speculation and dishonest embellishment.

That dishonest or reckless statement is what the law refers to as a “fraudulent device” but which has been recast as a “collateral lie” following the recent decision by the Supreme Court in the DC Merwestone (Versloot Dregding BV and another v HDI Gerling Industrie Versicherung AG and others [2016] UKSC 45). In that case the vessel’s managers’ theory was that a bilge alarm had sounded some hours before the flooding but that heavy seas had prevented the crew from reacting to it. This was not the crew’s story. It was (the Court found) a reckless or dishonest untruth.

 In the first instance judgement the court found that the claim was good. The water had entered via a faulty valve and there was no suggestion of unseaworthiness, so the claim did not fall foul of Section 39(5) of the Marine Insurance Act 1906.  The owners had a valid claim of Eur 3.241 million but this was lost because of the fraudulent device. The Judge, who clearly had misgivings, stated that the outcome was “disproportionately harsh”, but was a decision that he was bound by the law to reach.

It is well established that no one can or should benefit when a claim is dishonestly exaggerated, but with the fraudulent claim principle extended to “collateral lies” the underwriters had what they believed to be a powerful deterrent. Their position was reinforced by the subsequent decision of the Court of Appeal which found for underwriters. However, there is a fundamental difference between a fraudulently exaggerated claim, where the insured is trying to get something that he is not entitled to and a claim where the lie is dishonest, but the claim itself is not.

The Supreme Court overturned the Court of Appeal decision and removed collateral lies from the fraudulent claims rule, which it accepted was there to prevent fraud but was not based on any sound authority. Importantly, the application of the fraudulent claims rule to collateral lies led to a remedy that was disproportionate to the breach, an outcome that the Supreme Court strove to avoid.

In summary; for a claim to be lost, a lie :

“….must at least go to the recoverability of the claim on the true facts. By that test the fraudulent claims rule applies to a wholly fabricated claim. It applies to an exaggerated claim. It applies even to the genuine part of an exaggerated claim if the whole is to be regarded as a single claim, as it must be. But it does not apply to a lie which the true facts, once admitted or ascertained, show to have been immaterial to the insured’s right to recover.” (per Lord Sumption, para 36)

Lord Mance in his dissenting judgement suggested that this conclusion would in effect create a cheats charter. It is understandable that insurers will be concerned by what they will see as a softening of the law. What is and is not a fraudulent device is still very subjective (even the new Insurance Act 2015 makes no attempt to define what it is) and accordingly no assured should risk presenting a claim based on dishonest statements particularly where that evidence is not supported by the crew themselves.