Continental European Legislative and Judicial Trends: Supreme Court of Spain Rules on Policyholder’s Duty of Disclosure Prior to Conclusion of Contract
In a decision dated May 10, 2011 ( JUR 2011/194346), the Supreme Court of Spain ruled that a policyholder breached the duty of disclosure prior to the conclusion of a contract, even though the insurer did not submit to the policyholder any questionnaire at the time the policy was initiated. Whether this decision fits into the legal framework of the Spanish Insurance Contract Act is the subject of this article.
Section 10 of the Spanish Insurance Contract Act 1980 (ICA) deals with disclosure or declaration of risk, misrepresentation and its consequences.
Under Section 10 of the ICA, prior to the conclusion of the contract, the policyholder (buyer of cover) is subject to a duty to disclose to the insurer, pursuant to the questionnaire submitted by the insurer, all the circumstances known by the policyholder that may be relevant for the evaluation of the risk. The policyholder may be relieved of this if the insurer does not submit a questionnaire or if there are circumstances that may be relevant for the evaluation of the risk that are not covered in the questionnaire submitted by the insurer.
Therefore, the policyholder does not have a proactive duty to disclose all material facts that may have a bearing on the evaluation of the risk, but only those facts asked by the insurer. The declaration is confined to the questions raised in the questionnaire, which are prohibited from being too broad or general. Under this system, knowledge of information that would be sensitive and even prejudicial to the insurer is not necessarily subject to disclosure to the extent the relevant questions are not asked in the questionnaire.
The declaration of risk made by a policyholder is the basis for the contract and binds the policyholder as party to the contract. Insureds are also bound by the declaration whether they have signed the application or not because the duty of disclosure lies with the policyholder who acts on behalf of the insureds.
When there are “inaccuracies” (misrepresentations) or “reservations” (concealment or non-disclosure) in the information provided in the completed questionnaire or proposal form, the remedies available depend on when the insurer becomes aware of them.
If the insurer knows about them before the loss takes place, the insurer is entitled to rescind the contract within one month of learning about the misrepresentation or reservation. In this event, the insurer may keep the premium for the period in progress, unless it acted in bad faith or with gross negligence. If the loss occurs before the rescission is notified, or if the misrepresentation or non-disclosure is discovered after the loss takes place, the insurer is no longer entitled to rescind the contract but may only reduce the indemnity. The amount of the reduction is based on the amount that is the proportion of the premium actually collected to the premium that would have been collected had the true risk been disclosed to the insurer. If the policyholder acted in bad faith or with gross negligence though, which would be proved by the insurer, the insurer is released from its obligation to indemnify.
The declaration of risk is intended to give the insurer a clear picture of the risk it is assuming. It needs to determine if the coverage should be granted, the type/scope of coverage and its price.
But the declaration is based on questions submitted by the insurer. These should be specific and relevant, and the insurer is responsible for drafting them adequately for the type of risk it is considering covering. If it is found that the questions were not answered truthfully later on, the insurer has the burden to prove that the untruthful answers affected its perception of the risk in such a way that it would have charged a higher premium or would not have covered the risk at all.
Background of the Supreme Court Judgment
On March 2, 2001, a landslide caused material damages to a residential building under construction. The insured builder (Arcade Park) made a claim for both material and third party damages under an all risk construction and assembly works policy.
The insurer declined the claim for alleged willful misconduct of the policyholder. The insurer alleged that, at the time of taking out the policy, the policyholder had concealed the fact that in February 2000 a landslide took place in the plot where the construction was being done. At that time, the property developer was the current claimant, Arcade Park, and the builder was Necso Entrecanales y Cubiertas, which took an all risk construction policy with the insurer. There is no indication that Necso Entrecanales y Cubiertas reported the claim to the insurer at the time. Discrepancies between Necso Entrecanales y Cubiertas and Arcade Park led the former to terminate its contract with Arcade Park, which from that moment took over the direct execution of the construction.
On November 24, 2000, Arcade Park took out, as policyholder-insured, the all risk construction and assembly works policy to cover the building under construction. T he insurer did not submit to Arcade Park any questionnaire at the time of application for the policy. The policy contract contained a condition, the tenth, under the heading “Commenced Work,” that stated “the insured declares that at the time of the entry into force of this insurance, there are no circumstances that could give rise to a claim under this policy.”
The court of first instance dismissed the claim, holding that Arcade Park had concealed the landslide that occurred in February 2000, which affected the insurer’s appropriate evaluation of the risk. The court also held that the concealment of the landslide infringed the tenth particular condition of the policy and breached the policyholder’s duty of disclosure established in Section 10 of the ICA, even though the insurer did not submit a questionnaire to the policyholder.
The court took the view that the lack of a questionnaire did not mean that the insurer had adopted a passive stance regarding acquiring information about the risk to be covered. The lack of a questionnaire had been balanced with the declaration of the insured contained in the tenth particular condition of the policy. The court held that the insurer was aware that the construction had already begun before Arcade Park took out the new policy. The insurer expressed, through the declaration required under the aforementioned condition, an active interest in obtaining the relevant circumstances for the evaluation of the risk from the policyholder.
Therefore, the court ruled that Arcade Park’s omission to disclose the February 2000 landslide breached the duty of good faith that ought to preside over the relations between insurer and insured. This breach, continued the court, amounted to a fraud (dolus), understood as “reticence in the expression of circumstances known by the policyholder that may influence the evaluation of the risk which, had they been known by the insurer would have influenced decisively the insurer’s will to conclude the contract” (Decision of the Supreme Court of December 31, 1998 [RJ 1998\9775]).
The claimant appealed. The Court of Appeal dismissed Arcade Park’s appeal and confirmed the first instance judgment, although it concluded that there was gross negligence on the part of the policyholder, instead of fraud.
Arcade Park then appealed to the Supreme Court, which also confirmed the Court of Appeal’s judgment, releasing the insurer from any obligation to bear the risk and pay the indemnity requested by Arcade Park. The Supreme Court first made an interesting and comprehensive summary of the existing case law on the interpretation of Section 10 of the ICA on terms similar to those set forth under the legal framework of this commentary.
In line with the earlier decisions of the lower courts, the Supreme Court held that in the case at issue, it had been proved that the policyholder breached the pre-contractual disclosure duty established in section 10 of the ICA, even though the insurer did not submit to the policyholder any questionnaire. The aim pursued by the questionnaire had been met by the tenth particular condition. The Supreme Court, therefore, equated the pre-contractual disclosure duty of the policyholder to the “contractual” declaration of the risk contained in the tenth particular condition of the policy.
The decision of the Supreme Court leaves some ground for discussion and doubt because it is not entirely consistent with the regime set forth in Section 10 of the IC A. It may convey the wrong signal to the market in that the questionnaire may be replaced by a statement in the particular conditions of the policy. Section 10 requires that a questionnaire be submitted to the policyholder prior to the conclusion of the contract if the insurer wishes to have information on the risk.
The Policyholder is Not Required to Volunteer Information
The purpose of the questionnaire is to allow the insurer to evaluate the risk prior to entering into the contract. If no questionnaire is presented to the policyholder, then the insurer may not rescind the policy, reduce the indemnity or even deny coverage in the event of bad faith on the part of the policyholder who withheld information on the risk.
To say that the statement made in the particular conditions of the policy equates to a submission of a questionnaire may be an exaggeration. It is assumed the Court understood that such a statement presupposed a previous discussion and request for information similar to a questionnaire. Nonetheless, for the avoidance of doubt, it is advisable that insurers present the questionnaire to potential policyholders for all events covering all the issues they might find relevant in order to have a comprehensive knowledge of the risk at hand.