February 2006

Material Misrepresentation: Ontario Court of Appeal Decision Departs from Established Test

When an application for insurance fails to disclose a fact that the insurer claims is material, does one assess materiality of the fact from the standpoint of the insured, or the underwriter? A recent Court of Appeal decision points us to a direction that departs from a long line of established cases that include Supreme Court of Canada decisions. Whereas the historical debate among high level decisions in Canada and the United Kingdom has centered around the subjective vs. objective test of materiality of the fact from the point of view the underwriter, we are now asked to look at materiality from two new perspectives: the insured and the loss itself.

In W.H. Stuart Mutuals Ltd. v. London Guarantee Insurance Co., 2004 CanLII 48650 (ON C.A.), London Guarantee Insurance Company provided W.H. Stuart with a fidelity insurance bond that covered losses including theft by employees carried out by means of the electronic transfer of funds and computer accounting schemes. A long-time employee of the respondent misappropriated $265,863.13. She did so by abusing her position and responsibility in the company and by producing computer generated cheques and effecting the electronic transfer of funds to separate accounts set up for her own benefit. London Guarantee denied coverage because of material misrepresentations in the application for renewal of the bond, in that W.H. Stuart had failed to disclose the true nature of its cheque issuing process.

The Court of Appeal found that W.H. Stuart represented to the insurer that it had controls in place which at least involved the participation of principals in the cheque issuing process, and that nothing had changed since 1997 when the insured first volunteered the information. This was not true. The Court concluded that W.H. Stuart was in breach of its general obligation to disclose all material facts within its knowledge relevant to determining the nature and extent of the risk, even in the absence of specific questions from the insurer.

In coming to this conclusion, the Court looked at materiality of the fact from two perspectives. From the insured's point of view:

While we do not disagree with the trial judge's view that this duty to disclose must relate to facts or risks of which the plaintiff is aware, the trial judge turned this test into a completely subjective one, which cannot be the case. There must be an objective element to the insurer's [sic - insured?] awareness of the risk.

. . . On the facts of this case it is not necessary to determine the parameters of the objective/subjective mixture to be considered in assessing the insured's awareness of the risk for purposes of the general obligation to disclose. Suffice it to say that on any analysis of the situation, in our view, the introduction of the new computerized chequing and electronic transfer system, together with the "back office" duties entrusted to the employee, created a significantly enhanced risk of theft. An insured in the position of the plaintiff respondent should have been aware of that fact. (italics added)

From a causation point of view:

Furthermore, the misrepresentation was material. It was the lack of such controls, together with the dishonest employee's authorized access to the computerized cheque generating system that facilitated the fraud in question, with respect to which the loss is claimed. (italics added)

Materiality from the Insured's Objective View

The insured's obligation to disclose a fact, according to this case, stems from his "objective" awareness of the material risk. Failing to make such a disclosure, the underwriter may treat the policy as void for material misrepresentation.

Contrast this approach to an old standard from the Supreme Court of Canada:

In policies of insurance, there is an understanding that if you know of any circumstance at all that may influence the underwriter's opinion as to the risk he is incurring, and consequently as to whether he will take it, or what premium he will charge if he does take it, you will state what you know. There is an obligation there to disclose what you know; and the concealment of a material circumstance known to you, whether you thought it material or not, avoids the policy. Ontario Metal Products Co. v. Mutual Life Ins. Co. of New York [1924] S.C.R. 35, citing Brownlie v. Campbell 5 App. Cas. 925 at 954

The test of materiality, being one that examines the influence of the risk on the underwriter, was stated to be an objective one:

[t]he test [of materiality] hinges on whether the representation is of such a nature as to influence the judgment of a prudent insurer, not on whether the representation influenced the particular insurer looking at the proposal.

. . . it is a question of fact in each case whether, if the matters concealed or misrepresented had been truly disclosed, they would, on a fair consideration of the evidence, have influenced a reasonable insurer to decline the risk or to have stipulated for a higher premium. Henwood v. Prudential Ins. Co. of America, [1967] S.C.R. 720 at 725-6 S.C.R.

Being an objective test, it has been observed that the imprudence or negligence of the insurer and its agent which may have assisted the insured in obtaining the insurance do not relieve or excuse the plaintiff from the consequences of his failure to disclose material circumstances. Ford v. Dominion of Canada (1988), 34 C.C.L.I. 224 (Man. Q.B.) at 235 (trial judge's reasons).

The entrenchment of this test for materiality has been highlighted by Prof. Rendall. He commented that ever since Ontario Metal Products Co. v. Mutual Life Insurance Co. of New York (1924), [1925] 1W.W.R. 362, [1925] A.C. 344, [1925] 1 D.L.R. 583 (P.C.), above, there has been no serious question that the test for materiality is that which would influence the reasonable underwriter in deciding whether to accept the risk and what premium to fix. The test is not what the underwriter for the insurer now alleging a material misrepresentation would have done if informed of the matter now in dispute, though such insurers would always like to rely on their own standard of materiality - a standard, of course, which they would assert ex post facto.

The current view in England takes a different perspective from the principles laid out in Ontario Metal Products. Unlike the pure objective test followed in that case and in Henwood, the House of Lords in Pan Atlantic Insurance. v. Pine Top Ltd., [1995] 1 A.C. 501 preferred a combination objective and subjective test. The House of Lords read into the equivalent section of the Marine Insurance Act, 1906 an additional requirement that there be inducement of the actual underwriter. Lord Mustill summarized the majority's position on p. 550:

(1) A circumstance may be material even though a full and accurate disclosure of it would not in itself have had a decisive influence on the prudent underwriter's decision whether to accept the risk and if so at what premium. But, (2) if the misrepresentation or non-disclosure of a material fact did not in fact induce the making of the contract (in the sense in which that expression is used in the general law of misrepresentation) the underwriter is not entitled to rely on it as a ground for avoiding the contract.

As far as this writer is aware, this approach has not been adopted by any court case in Canada. One trial court judge expressly declined to follow Pine Top in the context of marine insurance:

In my view, the Pine Top decision does not reflect the law of this province and is contrary to the provisions of the Marine Insurance Act. Lord Mustill's definition of materiality flies in the face of the statutory definition. See Nuvo Electronics Inc. v. London Assurance (2000), 49 O.R. (3d) 374

The Causation Element of Materiality

To take matters even further away from established precedent, the Court of Appeal in W.H. Stuart Mutuals considered the causation element of materiality in a totally different light. As things stood before W.H. Stuart Mutuals, the misrepresented or undisclosed fact must be such that it would "have influenced a reasonable insurer to decline the risk or to have stipulated for a higher premium". After all, one important element in negligent misrepresentation cases is whether the person to whom the representation was made acted on it to his detriment. In the case of an underwriter, that would be accepting a risk he would have declined or charged a greater premium for, had the misrepresentation not been made. Under these circumstances, the underwriter is entitled to void the policy ab initio, whether or not the misrepresented fact caused or contributed to the insured's loss.

What the Court of Appeal in W.H. Stuart Mutuals seems to be saying is that a "misrepresentation" is material if the misrepresented fact was a cause of the loss. It is best to treat that part of the judgment as obiter or an afterthought, since it appeared that the Court had already concluded that there was a material misrepresentation from the objective standpoint of the insured's awareness of the risk. It should not be read as adding a new element in determining materiality for the purpose of voiding the policy. Otherwise, the insurer can never void the policy until after a loss has occurred. Indeed, if the material fact comes to the underwriter's knowledge before any loss takes place, that would be the best time to void the policy, so as to give the insured other insurance options before he suffers a loss.

Conclusion

With the greatest of respect, it is difficult to reconcile the Court of Appeal's test of materiality in W.H. Stuart Mutuals with any established test that preceded it. There was no reference in that decision to the accepted test. There was no evidence of a prudent underwriter that would have been essential had the Court followed this test. The Court also looked at causation in terms of the loss, instead of the effect on the prudent underwriter. It can only add uncertainty to both the underwriter's and the insured's position.

© Ramon Andal, 2006