In dealing with contracts, you likely will have encountered terms which require contracting parties to deal with each other in ‘good faith’. This means that you have a general obligation to deal with the other party honestly and fairly. The duty is sometimes provided for expressly and often implied into a contract. Insurance contracts, however, are in a special category. Due to specific legislation regulating insurance contracts, a duty of ‘utmost good faith’ is implied into every insurance contract made after 1 January 1986 and must be complied with by both parties to the insurance contract. However, what ‘utmost good faith’ actually involves is far from clear.
What does ‘utmost good faith’ involve?
The exact parameters of the duty of utmost good faith are not entirely clear, as the legislation provides no definition and courts have been reluctant to provide more than some nebulous guidelines. It has been noted that the word ‘utmost’ undoubtedly reaches a higher threshold than simply ‘good faith’. Therefore, although it still requires parties to act honestly and fairly towards each other, a breach of the duty can be caused by behaviour which falls short actual dishonesty or impropriety. A common formulation of the duty is that it involves notions of fairness, reasonableness and community standards of fair dealing.
It is perhaps easier to get an idea of the duty of utmost good faith by considering some examples of where insurers and insured’s might be required to act in accordance with duty of utmost good faith.
- Policy construction - ensuring policies are unambiguous and easily understood by insureds. This could require bringing unusual terms to the attention of the insured.
- Disclosure – insurers should disclose all material facts the insurers consider regarding the nature of the risk the insured seeks to cover. This will assist the insured in complying with their duty of disclosure.
- Determinations of claims – claims must be assessed in a proper and timely fashion. They should not be delayed or refused without proper cause, especially when this would adversely affect the insured.
- Assuming and managing conduct of third party claims – matters should be conducted with insured’s interests in mind.
- Raising defences – only genuine defences to be raised. The insurer should not act opportunistically by relying on strict definitions where unreasonable.
For the insured:
- Notifications – ensuring duty of disclosure is complied with and all other relevant information is disclosed to insurer during the policy period.
- Making claims – not to make false or exaggerated claims and to cooperate with insurer when claims are being investigated.
- Handling claims made by third parties – to involve and cooperate with insurer when dealing with demands by third parties.
However, it is important to note that these are only a few examples and that the duty of utmost good faith extends to all facets of the insurance relationship. This means that neither party will be permitted to rely on any condition in the insurance contract if to do so would breach the duty of utmost good faith. The only aspect of the insurance contract that the duty of utmost good faith will not affect is the insured’s duty of disclosure which is provided for in separate section. Please see our article on the duty of disclosure for further information
Arguably, it can even extend to conduct which occurred before the contract was entered into, such as the way in which the policy was explained to a customer or whether any important information was withheld. However, the status of pre-contractual conduct in relation to the duty of utmost good faith is still uncertain.
What happens if I breach the duty of utmost good faith?
A breach of this duty by either party will give the other a right to contractual damages.
If the insurer has been guilty of a breach, the insured will have the right to terminate the contract. Insurers however, will only have a right to termination in compliance with strict requirements of the Act. The contract can only be terminated prospectively and not avoided from its beginning. Thus, all rights accrued prior to the termination will stand.
Although the legislation doesn’t provide a provision for judicial review or any statutory remedies, ASIC is empowered to discipline insurers if they breach the duty of utmost good faith in the handling or settlement of a claim or potential claim. This could include suspension, banning or cancellation of an insurer’s financial licence.
Please be aware the law may have changed since this article was written in October 2014. If you have any questions regarding the duty of utmost good faith or your rights under an insurance contract, please don’t hesitate to contact us.