Legal PRINCIPLES

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.