Are you being served?

Identifying the party for whom the broker acts in placing insurance has always been a difficult exercise. The legal position has always been that the broker acts for their client, the insured. The English courts have, therefore, been very strict about not requiring the broker to 'serve two masters'. There has been considerable reluctance to recognise the broker as owing any duties to the insurer, without having expressly agreed to do so. This reluctance is quite apparent from many previous cases, including most recently the seminal case on insurers' rights of access to brokers' records in the Lloyd's market, Goshawk v Tyser.

Many market participants find this strict legal view at odds with the reality of the market. Representatives of brokers and insurers often have very close, ongoing working relationships. Some brokers are also commercially, if not legally, 'tied' to particular insurers.

The legal consequences of a broker being deemed to act for the insured has also often presented some very unpalatable consequences. A recent example is the decision last year in the Court of Appeal in Limit v Axa. In that case, an entirely innocent reinsured had its reinsurance treaty avoided due to a misrepresentation made on placement - without the reinsured's knowledge - by the broker.

The Law Commissions for England & Wales and Scotland have been consulting on the reform of insurance law. They have recognised the existing difficulties with the law of the agency of brokers. Three proposals for reform have already been made which, if implemented, would radically change the position of the broker.

Business insurance

For business insurance, the Law Commissions proposed that a broker should be regarded as acting for the insurer if it deals with only one or a small number of insurers and does not search the market. The consequences of any failure by the broker to pass on pre-contract information in that situation would, therefore, not be visited upon the insured and the insurer would still have to pay the insured's claim.

This reform was intended by the Law Commissions to impact only small to medium-sized businesses obtaining insurance. Responses to the Law Commissions' consultation indicated that larger businesses would also be impacted. The Law Commissions have, therefore, dropped adopting such a 'bright-line' test for business insurance for the time being.

The Law Commissions have also proposed reform of the remedies that apply to a broker's breach of duty. The remedy for a breach of section 19(a) of the Marine Insurance Act 1906 by the broker is that the insurer may avoid the policy. The obvious consequence is that the insured - sometimes through no fault of their own - is penalised by avoidance of their insurance policy.

Streamlined resolution

Consequently, the Law Commissions proposed that in this situation the insurer should no longer be able to avoid but should have a direct right to claim damages from the broker.

This reform, if implemented, would have the benefit of an entirely innocent insured not losing its policy due to a breach of duty by the broker. This promises to streamline the resolution of disputes and avoid the significantly increased costs that accompany two-way disputes between insurers and brokers being unnecessarily elevated into three-way litigation. This problem is also exacerbated if the insurance policy contains an arbitration clause, meaning that the same facts may have to be considered in both arbitration and court proceedings, either simultaneously or sequentially.

Although this reform appears to suggest greater exposure for brokers, in practice it could provide enhanced certainty and protection to innocent brokers. The broker may be less likely to be 'targeted' for a contribution to achieve a discounted settlement of the insured's claim.

Consumer insurance

For consumer insurance, the Law Commissions have just issued a new policy statement dealing with the agency of brokers for providing pre-contract information.

They recommend four principles be enshrined in new legislation in relation to consumer insurance. These principles include that a broker acts for the insurer if it is the insurer's appointed representative. Another proposed principle is that the broker should act for the consumer unless there is a close relationship between the broker and the insurer so as to indicate that the insurer has granted the broker authority to act on its behalf. This latter question would need to be determined by weighing up the various factors in the case. The Law Commissions have helpfully included in their policy statement an indicative and non-exhaustive list of the factors indicating either that the broker acts for the consumer or for the insurer. In the absence of any such factors, the broker will be taken to act for the consumer.

The Law Commissions' policy statement suggests that if the courts find the proposed legislative framework useful for consumer insurance, then they may find the same principles helpful in other areas. This is clearly the Law Commissions signalling that if the proposed principles work in the 'test arena' of consumer insurance, then the courts ought to consider extending them to business insurance.

Reforms on track?

The Law Commissions may be succeeding in redressing the perceived failings of the outright common law presumption that the broker acts for the insured. A process of incremental development through the courts - rather than direct legislative reform - will allow a body of experience to be built up. The courts may, therefore, be in a position to evaluate whether an alternative test to determine a broker's agency - focusing upon the closeness of the relationship between the insurer and broker - will yield more satisfactory consequences in business insurance.

In the meantime, if insurers are granted a direct right of action against brokers - as proposed - this reform should assist the market by simplifying the resolution of disputes that can arise between all parties involved in insurance contracts.

- David McCarthy is an associate director, and Andrew Simpson an associate, in the insurance and reinsurance group of Berwin Leighton Paisner.