This and the next Chapter will concern principles of
law, but the Notes will not provide a comprehensive survey of some very complex
issues. The purpose of the Notes, as with the overall study, is to give an
insight into the important aspects of an insurance intermediary's professional
activities.
THE LAW OF CONTRACT
This is an area of law which affects every one of us,
whether in our personal or business lives. As we shall see, contract is an
essential element in civilised societies, therefore it is important to have some
appreciation of this important subject.
Definition
The simplest definition for ‘contract’ is probably: a legally
enforceable agreement. There are a large variety of agreements, but not all
are intended to have legal consequences. A social arrangement between
two persons, such as a lunch appointment for example, is an agreement, but
where either of them unilaterally cancels the appointment, there is no
suggestion that the disappointed party should be able to take legal action
against the other party, because the agreement is not legally recognised as
valid.
Contracts comprise
promises or undertakings, usually given in exchange for a promise or
undertaking from the other side. In legal terminology, contracts are something
intangible. Therefore, an insurance policy in itself is not a contract; instead
it is the most commonly used evidence of an insurance contract. An insured who
has been affected by a fire will not expect the insurer to deny his insurance
claim on the grounds that the insurance contract no longer exists after the
insurance policy has been destroyed in the fire. Contracts may concern
relatively trivial (such as buying a newspaper or taking a tram ride) or
very important matters (such as a major building project or employment).
In any event, the contracting parties expect promises to be honoured, and can
demand compensation or enforced performance if they are not honoured.
Types of Contracts
For our purposes, we may consider that there are two
major types of contract, as follows:
(a) Simple contracts: Although these are described
as ‘simple’, this does not mean that they only deal with uncomplicated matters
and are easy to understand. Rather, it means that they are simple or easy to
form. A simple contract is one created verbally, or by writing not under seal.
It can also be inferred from conduct. In short, the validity of simple
contracts does not depend on special formalities.
[An example of a contract inferred from conduct is
where someone picks up a newspaper from a street vendor and where their body
language clearly indicates a purchase. Technically, a contract is formed
between the seller and buyer, with the acts of handing over and accepting the
money for the newspaper: no words or writing are needed.]
In fact, the great majority of insurance contracts are
‘simple’ contracts. Technically, insurance contracts, to be valid, do not have
to be evidenced in writing; but in practice, they almost always are.
Nevertheless, as we shall see later, insurance contracts of a certain type are
legally required to be evidenced by insurance policies.
(b) Contracts by deeds: A deed is a written
instrument signed, sealed and delivered. (Delivery is no longer required to be
physical delivery; an intention to be unconditionally bound by the deed
suffices.) It must be used with certain transactions such as a transfer of
land. Besides, suretyship is always issued in the form of a deed; otherwise,
when a claim arises, the obligee may possibly face a defence put up by the
surety that he has not the right to sue because he has provided no
consideration (see 2.1.3 (c) below for the doctrine of consideration).
Elements or Essentials of a Contract
For the purposes of this section, we shall be talking
only of simple contracts (see 2.1.2(a) above), since these
constitute the great majority of contracts that are met in insurance
transactions. To be a valid contract, an agreement must meet certain criteria
called ‘elements of contract’ in the course of its formation. Should any of
these elements be absent, the proposed contract either does not exist or is
defective in another sense. There are three types of defective contracts,
as follows:
1 Void (or invalid) contracts: This means that
the proposed contract does not exist in law; it is entirely without legal
effect. In the context of insurance, the implication is that generally all
premiums which have already been paid under a void contract (or invalid
agreement) are returnable; so are claims paid.
Voidable contracts: A voidable
contract is one that is apparently of legal effect and that remains to be
legally effective unless and until an aggrieved party to the contract treats it
as void as from contract conclusion within a reasonable time after acquiring knowledge
of the availability of such a right of election. In insurance, it could arise,
for instance, with a breach of some types of policy provision, or the discovery
that important information was omitted or wrongly given at the proposal stage
(see 3.2 below);
3 Unenforceable contracts: This means what it
says, an unenforceable contract cannot be enforced (or sued on) in a court of
law. However, this is not because it is void, but because some required action
has not been taken (e.g. stamp duty not paid on a lease of land, marine insurance
policy not issued, etc.). This defect can be remedied by carrying out the
required action, so that the contract becomes enforceable (e.g. by issuing a
marine policy even after a loss has realised).
Turning to the elements of contract themselves,
legal textbooks are not always agreed just exactly how many elements should be
found with any one valid contract, but we shall consider six criteria
here, as follows (remembering that we eed not go into great detail):
(a) Offer: if no offer is made, obviously there can
be no agreement between the two or more parties. In insurance, the offeror may
be the intending insured (perhaps by completing and submitting to the insurer a
proposal form (or application form)), or the insurer (perhaps as a counter-offer
or in connection with a policy renewal); all depends on intention as
evidenced by facts. Therefore, although it is widely accepted that an act of
completing an insurance proposal form is normally an act of offer, it is
technically incorrect to say that it is a settled law that completing an
insurance proposal form is an act of offer to the insurer.
(b) Acceptance: the proposed contract cannot come
into being unless the offer is accepted by the other party (the offeree).
All terms of the offer must be accepted before a contract is concluded. If that
other party intends to vary the terms of the proposed contract (requiring
increased premium or policy restrictions, for example), this, upon its
communication, constitutes a counter-offer, which will have the effect
of nullifying the original offer. A counter-offer is subject to acceptance by
the original offeror (who becomes the offeree with the counter
offer).
(c) Consideration: this is the price (monetary or
otherwise) a contracting party pays for the promise the other party
(‘promisor’) makes to him. In the case of a simple contract, consideration must
be given by both parties; otherwise it is void. On the other hand, a
promise contained in a deed, even if it has been given not for consideration,
is enforceable at common law by the promisee. In other words, a unilateral
promise not made by a deed is invalid. In insurance, the consideration is: the promise
by the insured to pay premium; and (ii) the promise by the insurer
to pay or compensate as per policy terms.
Note: 1 Where an
insured event occurs before the premium promised is paid, the insured will
still be entitled to insurance payment in accordance with the terms of the
contract and the insurer will have a separate claim against him for the unpaid
premium. However, some policies require actual payment of premium as
consideration, which requirement will have the effect of overriding the said
legal rule.
2 The insurer's consideration is the promise to
pay, etc., rather than the actual payment. In many cases, no claim arises under
the policy, but when the insured period ends the insurer is treated as having
provided consideration, and therefore there will not be a question of the
contract being void for lack of consideration leading to an entitlement to
return premiums.
(d) Capacity to contract: it means the legal ability
to enter into a contract. With individuals, if they are mentally disordered,
or are minors, the contracts they make are generally voidable at
their option. With companies, they must not act in a way that exceeds their
legal powers.
(e) Legality: the subject of the agreement must
be legal. A contract to kill or to commit any other crimes, for example, is not
valid. Likewise, insurance on smuggled goods would also not be legally
recognised. However, exceptions do exist. For instance, the courts may enforce
an insurance claim in favour of an insured under an insurance contract that is
illegal because the insurer was not authorised to transact the kind of
insurance business in question.
(f) Intention to create legal relation: to make a
valid contract, each party to it must clearly have the intention that it is to
have legal consequences. This seldom gives rise to any problem with insurance
contracts because, unlike social or domestic agreements, commercial agreements
are presumed to have been made with an intention to create legal relation.