Fraud pay-outs can be recovered

What happens when a domestic policyholder with a genuine claim tries to turn it into a 'nice little earner' by embellishing it with expenses that were never incurred?

Can the insurer void the entire claim, even when the fraud was committed after legitimate parts of the claim had actually been paid? And what happens to other claims under the policy?

The Appeal Court recently cleared up two important grey areas, helping to answer these questions. Although the insurer did not have it all its own way, it is fair to say that the industry will be more reassured by the outcome than not.

The judges made it clear that members of the public who regard insurance companies as "fair game" run the risk of being hit where it hurts - in the wallet.

AXA General Insurance Ltd v Gottlieb and Another [2005] considered four claims relating to water damage under a buildings policy.

While two of these were entirely legitimate, the others were a bit like the curate's egg - good in parts, but also fraudulent in parts.

The first claim related to dry rot following a water leak. Initially, it was for the cost of repairs and was genuine. After that, however, the policyholders added the cost of alternative accommodation, which they had never used. AXA made interim payments both before and after the commission of the fraud.

The second claim was also tainted by fraud in the shape of a forged repair invoice.

Unlike the first one, however, AXA did not make any payment after the fraud had been committed. The other two claims, which had occurred earlier, were genuine and had already been settled at the time the frauds came to light.

There were two issues at stake in respect of the claims. The assureds argued that they should be allowed to keep the insurance moneys paid out prior to the addition of a fraudulent element in respect of each claim.

Test cas
Lower courts, both in this and other disputes, had favoured the insurers. This was, however, the first time that the question had become before the Court of Appeal, making it an important test case.

AXA opposed the appeal on the grounds that the frauds negated the claims in their entirety, but it also went further. It cross-appealed that it should be allowed to recover the payments already made under the two genuine claims, even though those incidents were unrelated.

Both the insured's appeal and AXA's cross-appeal were dismissed.

In its judgment, the Court of Appeal lent its authority to the proposition that under common law insurers are entitled to recover all payments made in a fraudulent claim.

This applies even when some of the loss is entirely genuine and when compensation is paid before the fraud itself is committed.

Given that it was already settled law that a later fraud forfeits a genuine claim which has already accrued but not been paid, the court reasoned that the fact that sums had already been advanced should not prevent their recovery.

The court took into account the difficulties that insurers often face in proving precisely when a fraud has occurred. In reaching its decision, it also had in mind the practical consideration that insurers will be discouraged from making interim payments if, upon the discovery of fraud at a later date, those payments cannot be recovered.

In that sense the decision was good news for genuine claimants, who might otherwise have found insurers more reluctant to make interim payments in the future.

At the heart of the court's decision was the well-established maxim of public policy that "the fraudulent assured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing".

Deterrent fashio
As Lord Justice Mance said in the AXA case, there is no reason to "reduce the severity of a rule which is deliberately designed to operate in a draconian and deterrent fashion".

To put it another way, insureds caught fiddling insurance claims cannot expect to have their cake and eat it.

The law on fraudulent claims will continue to act as a deterrent by exposing fraudulent insureds to the risk that they will forfeit the genuine, as well as the fraudulent, parts of their claims.

When it came to AXA's cross-appeal, the court held that there was no basis or reason for giving the common law rule on fraudulent claims retrospective effect on prior, separate unrelated claims that have already been settled before any fraud occurs.

The court did not rule on what would have happened if those separate claims had yet to be paid at the time of fraud.

Contractual principle
But it noted that there was "some force in the argument that the common law rule relating to fraudulent claims should be confined to the particular claim to which the fraud relates."

This may not be the last word on the matter, however, as there remains the possibility that such payments would be voided under general contractual principles, for example avoidance for breach of the continuing duty of good faith. The court was not required to rule on this question, which may have to await some future judgment.

In football parlance, you could say that the insurer played out a one-all draw. It was, however, an outcome that most would have settled for at the start of the game. IT

' Jonathan Steer is a trainee solicitor at Elborne Mitchell