Exercise of discretion in insurance contracts

David Hadfield discusses the exercise of discretion in insurance contracts.


It is common for the terms of commercial contract to permit one of the parties to withhold consent for the other party to do something or to provide that a party to the contract has the power to make a decision that affects the other party’s rights under the contract. Insurance contracts are no exception to this practice and it is generally the insurer who has the benefit of this right or power.

Unsurprisingly, the exercise of this type of power is fertile ground for disputes between the parties as to how or on what basis it should be exercised; for example, do phrases such as ‘sole discretion’ or ‘absolute discretion’ or ‘establish to our satisfaction’ mean that the party that has the benefit of the power can act as they wish? The answer is ‘No’, again unsurprisingly, but that does not answer the question, which recently came under scrutiny in an insurance context in the case of UK Acorn Finance Ltd v Merkel (UK) Ltd [2020] EWHC 922 (Comm).

This case confirms that the discretion must be exercised in a way that meets the test used in public law cases as to whether the decision of a public authority should be set aside. Further, it also suggests that those responsible for reaching this type of decision for an insurer need to be given appropriate training so they can apply the test properly.

Examining how a decision has been made is a two-stage exercise:

  • First the court looks to see whether, when reaching the decision, the body or individual concerned
  • took into account factors that ought not to have been taken into account, or
  • failed to take into account factors that ought to have been taken into account, and
  • Secondly, even if those tests were satisfied, was the decision so unreasonable or irrational that no reasonable body or person could have made it.

This test comes from the case of Associated Provincial Picture Houses Limited v. Wednesbury Corporation [1948 1 KB 223, and lawyers speak of the ‘Wednesbury test’ or of ‘Wednesbury unreasonableness’. It (not unreasonably) imposes quite a high standard on public authorities and bodies, and historically, for that reason alone the courts have been reluctant to impose the standard on parties to commercial contracts, preferring to apply a test of reasonableness. There were cases where the more stringent test was suggested as applying, notably Gan Insurance Co Ltd v Tai Ping Insurance (Nos 2 & 3)[1], but it was the Supreme Court decision in Braganza v BP Shipping Ltd[2]that made it clear that was the case.

Mrs Braganza’s husband was a senior engineer on a BP vessel who went missing at sea. Mrs Braganza was challenging a decision by BP that her husband was likely to have committed suicide and so was not entitled to death benefits provided for in his employment contract. The court was being asked to examine and reverse BP’s decision. It was split as to the final outcome of the appeal but united on the approach to be adopted.

The Supreme Court considered the authorities and, in concluded the stricter public law test applied, but there are qualifications to this:

  • It is very rare if at all that a contract will expressly incorporate the Wednesbury test or something similar. Consequently, in virtually all cases the court will have to imply a term to that effect into the contract, and in order to do that the usual test for implication of terms will have to be satisfied. These are:
    1. The term to be implied must be reasonable and equitable.
    2. It must be necessary to give business efficacy to the contract so that no term will be implied if the contract is effective without it, orthe term must be so obvious that it goes without saying.
    3. The term must be capable of clear expression; and
    4. It must not contradict any express term of the contract.
  • The Supreme Court was reluctant to suggest that in a commercial context the standard required of a decision maker would be the same as that applied to someone in government or a public authority.
  • The court in considering this type of case was not the decision maker, and could not substitute its own decision for the one made. The court’s sole purpose was to review the process by which the decision was reached to see if could stand.

As regards the need to imply a term into the contract, an earlier decision had described the term in these terms: In essence . . . it is that the relevant party will not exercise its discretion in an arbitrary, capricious or irrational manner. Such a term is extremely difficult to exclude, although I would not say it is utterly impossible to do so. (Mid Essex Hospital Services NHS Trust v. Compass Group UK [2013] EWCA Civ 200) This is essentially what the Supreme Court also held.

The decision in Braganza was applied in UK Acorn Finance. This was a claim against an insurer (Markel) under the Third Parties (Rights Against Insurers) Act 1930. The claimant had successfully sued a former Markel insured for negligent valuations but Markel claimed to be entitled to avoid the policy because their insured was guilty of fraudulent or dishonest misrepresentation and non-disclosure.

The policy, however contained an ‘Unintentional Non-Disclosure’ clause, which as relevant read:

(a) In the event of non-disclosure or misrepresentation of information to Us, We will waive Our rights to avoid this Insuring Clause provided that

(i) You are able to establish to Our satisfaction that such nondisclosure or misrepresentation was innocent and free from any fraudulent conduct or intent to deceive

It was common ground that this clause gave Markel the power to decide whether the insured had ‘satisfied’ Markel that the insured had not been dishonest; the issue was how the power should be exercised.

The judge reviewed the case law and stressed that the clause gave the insurer the right to make the necessary decision and that it was not open to the court to substitute its own decision for that of Markel; what the court was doing was addressing how the insurer should be required to approach reaching its decision and whether it had complied with those requirements.

As regards whether it was open to him to imply a term into the contract the judge held it was, and he did so in a way that suggests it would be rare for the court not to imply such a term in similar circumstances. He said:

Applying those principles, the implication of such a term plainly satisfies the necessity requirement since without such a term, it would be open to the defendant to make decisions that were arbitrary, capricious or irrational. As Lady Hale stated in Braganza at paragraph 18:

“ … the party who is charged with making decisions which affect the rights of both parties to the contract has a clear conflict of interest. That conflict is heightened where there is a significant imbalance of power between the contracting parties as there often will be in an employment contract.

The same might equally be said for an insurance contract, where the insurer is generally in a stronger position than the insured, and the judge expressly referred to the Wednesbury case.

However, the judge also endorsed what Lady Hale had said in Braganza that one should not expect from a decision maker in a commercial context the same high standards expected of a modern sate, and added: it would be a mistake to expect an insurance company in the position of the defendant to adopt “… the same expert, professional and almost microscopic investigation of the problems both factual and legal, that is demanded of a suit in a Court of Law.

Having dealt with all these legal issued the judge went on to examine the actual decision-making process within the insurer and found them sadly lacking. The judge emphasised what had been said in Braganza and other cases, namely that the more unlikely something is, the more cogent must be the evidence required to persuade the decision-maker that it has indeed happened. In this case, innocent non-disclosure was more likely than dishonesty. He also emphasised that evidence supporting innocence had not been given sufficient weight. The result was that the judge held that Markel was not entitled to avoid the policy because of its flawed decision-making process, and that had proper process been adopted it was very difficult to conceive that a decision to avoid would have been made.

The judgment concluded with remarks that although he had been critical of the Markel decision making, he was not making a personal criticism of the employee responsible for reaching decision because: “as far as I can see he was not trained in how to approach decision making of this sort nor was there any guidance for him to follow in the defendant’s claims handling manual as to how issues of this sort ought to be approached. Once it is accepted that clauses such as the UND clause in this case are qualified by a Braganza duty, the decision making to be applied will need to be much more focussed than has perhaps been the case in the past.”

The message from these cases is that, when making a discretionary decision, insurers need to have proper procedures in place to ensure that whoever is responsible for making the decision knows how to approach the exercise and evidence. For this they need to be given appropriate training so they are aware of what they can and cannot take into account. As to that, it is not possible to give a definitive list but the decision cannot, for example, be governed of influenced by an insurer’s unconnected commercial considerations. Nor can questions like dishonesty of the insured be decided by ‘gut feeling’ or suspicion; there needs to be a proper evaluation of the evidence. This might sound like an invitation to pass it over to your lawyers but as we have seen, the courts have not said it is a lawyer’s job, and there is no good reason to do so if proper procedures and training are in place.

[1] [2001] EWCA Civ 1047

[2] [2015] UKSC 17

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