Expert Commentary

The Birth of the Covenant of Good Faith and Fair Dealing

In 1766, before the idea of the United States of America was conceived, the British House of Lords recognized the existence of the covenant of good faith and fair dealing in Carter v. Boehm, S.C. 1 Bl. 593, 3 Burr 1906 (1766).


Claims Practices
July 2013

This was an insurance case involving a policy underwritten by Charles Boehm. The 1-year policy covered the governor of Fort Marlborough, George Carter, against the loss of Fort Marlborough in the island of Sumatra in the East Indies by its being taken by a foreign enemy. The fort indeed was taken, by Count D'Estaigne, within the policy year.

The insurer objected, claiming fraud by concealment of circumstances that ought to have been disclosed, particularly the weakness of the fort and the probability of its being attacked by the French. The governor had 20,000 £ in effects but only insured 10,000 £, and he was guilty of not defending the fort.

Evidence showed that the property was not a fort proper or designed to resist European enemies. It was only calculated for defense against the natives of the island of Sumatra. The governor's office was not military, but only mercantile, and Fort Marlborough was only a subordinate factory to Fort St. George.

There was no evidence to the contrary, and a verdict was found for the plaintiff by a special jury. The case was heard by the House of Lords on appeal for a new trial by the defendant, Boehm.

Analysis

As a defense, the plaintiff noted that the weakness of the fort and the probability of the attack were universally known to every merchant on the exchange of London. All these circumstances were fully considered by a special jury of merchants, who were the proper authority to judge them.

The underwriter insisted that the insurer has a right to know as much as the insured himself knows. The defendant alleged that the broker was the sole agent of the insured and that situations that increase the risk of loss need to be disclosed. Discussing the particulars that had been concealed, the defendant insisted strongly that the plaintiff ought to have discovered the weakness and absolute indefensibility of the fort.

Insurance Is a Contract upon Speculation

The underwriter trusts the insured's representation and expects him to be forthright and not to hold back any circumstance in his knowledge, mislead the underwriter into a belief that the circumstance does not exist, and induce him to estimate the risk as if it did not exist. The keeping back of such circumstance is a fraud, and therefore the policy is void. The policy would equally be void against the underwriter if he concealed material facts from the insured. Good faith forbids either party from concealing what he privately knows and drawing the other into a bargain from the other's ignorance of that fact and his believing the contrary.

The ruling said that the insured may be innocently silent on many matters—he need not mention what the underwriter knows. An underwriter cannot insist that the policy is void because the insured did not tell him what he actually knew.

The reason for the rule that obliges parties to disclose what they know of the risk is to prevent fraud and to encourage good faith. The question therefore must always be whether there was, under all the circumstances at the time the policy was underwritten, a fair representation or a material concealment regarding the insured risk.

The underwriter knew at the time he agreed to the insurance that the policy was to indemnify George Carter, the governor of Fort Marlborough, in case the event insured against should happen. The defendants knew of a letter written to the East India Company that the insured location, though called a fort, was really nothing but a factory or settlement for trade. Although the insured was called a governor, he was, in fact, a merchant. The fort was only intended and built with an intent to keep the natives at bay. The only security against European ships of war consisted in the difficulty of the entrance and navigation of the river for want of proper pilots.

Evidence also established that the general state and condition of the fort was well known by most persons conversant or acquainted with Indian affairs. Lord Mansfield noted that the underwriter at London, in May 1760, could judge much better of the probability of the contingency than Governor Carter could at Fort Marlborough in September 1759. He knew the success of the operations of the war in Europe. He knew what naval force the English and French had sent to the East Indies. He knew or might know everything that was known at Fort Marlborough in September 1759 of the general state of affairs in the East Indies or the particular condition of Fort Marlborough by the ship that brought the orders for the insurance.

There was no evidence that the governor had any intention to perpetrate a fraud. He wrote to the company everything he knew or suspected. His subsequent conduct revealed that he thought the danger very improbable.

Preventing Fraud and Encouraging Good Faith

If the defendant's objections were to prevail in this case, the court's ruling would be turned into an instrument of fraud. The underwriter, knowing the governor to be acquainted with the state of the place, knowing that he apprehended danger and must have some ground for his apprehension, being told nothing of either, signed the insurance policy without asking a question. The court held that the objection "that he was not told" was insufficient to vacate the policy after he took the premium.

Conclusion

The decision of Lord Mansfield 253 years ago is as relevant today as it was then. An insured or an insurer cannot conceal material facts from an insurer, or a policy will be declared void as a result. The insured and the insurer must treat each other with absolute good faith. When, as here, the insurer knew, or should have known, all of the facts he claimed were concealed from him, the claim of fraud by the governor was, in itself, fraud.

Insurers, potential insureds, and their agents and brokers should work to deal with each other with the utmost good faith and should neither misrepresent nor conceal material facts from the other.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week, including links to free articles from industry experts. Discover practical risk management tips, insight on important case law and be the first to receive important news regarding IRMI products and events.

Learn More