Why is «the good faith principle» so important in insurance contracts?

The good faith principle in insurance contracts

An insurance contract has a specific condition to become effective: the parties’ good faith. This is confirmed by article 8 of the Mexican Insurance Contract Act (“ICA”) that sets forth the insured’s obligation to disclose in writing all the important facts for the insurance company to conduct a risk assessment that may influence the conditions of the insurance.

If the contract is executed by an insured’s representative, it shall disclose to the insurance company all the important facts that are known or should be known by the representative and the insured (article 9 of the ICA).

When a third party offers to execute an insurance contract on behalf of the insured, the offeror shall disclose all the important facts that are known or should be known by itself or the insured (article 10 of the ICA).

The failure to reveal or disclose information by the insured or its agent or representative will entitle the insurance company to cancel the insurance contract without liability, even if such non-disclosed information does not relate to the occurrence of the loss (article 47 of the ICA).

The good faith principle inherent to insurance contracts was confirmed by the first chamber of the Mexican supreme court.

As proposed by justice José Ramón Cossío Díaz on a meeting held on January 10, 2018, the first chamber of the supreme court decided the direct constitutional trial in review (amparo directo en revision) 5256/2015.

The subject matter of the court’s decision was to determine the constitutionality of article 70 of the ICA, and more particularly to confirm whether such an article breaches (i) the constitutional principle of certainty in the rule of law, (ii) the principle of equality, and (iii) the freedom to contract on consumer relations.

An English translation of article 70 of the ICA is as follows:

“The obligations of the [insurance] company will be extinguished if it proves that the insured, the loss payee or their representatives conceal or misrepresent the facts that would exclude or might limit such obligations, with the purpose of misleading the insurance company. The same principle shall apply in the case that, with the same purpose, the insurance company is not provided on a timely basis with the documents referred to in the previous article.”

Article 69 of the ICA provides that the insurance company shall be entitled to request from the insured or loss payee all kind of information on the facts relating to the loss and by which the circumstances for its occurrence and the consequences of the same may be determined.

Facts of the matter

An insured entity brought an action before a court of law to enforce an auto insurance contract, because of a car theft. The trial court and the appealing court decided the case in favor of the plaintiff.

The defendant filed a constitutional trial (amparo action) and the court granted constitutional protection to the insurance company for the lower court to regard as admissible the exception established in article 70 of the ICA. That is, the insurance company was released from its obligations because of the insured’s concealment and misrepresentation on the facts of the car theft.

Afterwards, the plaintiff filed a motion for review where it claimed the unconstitutionality of article 70. The motion was denied on a constitutional appeal.

The supreme court did not find any unconstitutionality of article 70 of the ICA, and confirmed the protection granted to the insurance company.

Reasoning of the first chamber of the supreme court of justice.

The supreme court decided the case in favor of the insurance company on the following grounds:

a) Article 70 of the ICA does not infringe the principle of certainty in the rule of law, given that it states clearly the behavior leading to the extinction of the insurance company’s obligations. It is not necessary that such article provides a list of cases that might constitute concealments or misrepresentations leading to the release of the insurance company’s obligations. Such cases will depend on the terms and conditions of each insurance contract and are behaviors determined by an ex post investigation of the loss performed by the insurance company.

b) Article 70 of the ICA does not infringe the principle of equality, and the freedom to contract on consumer relations, because the insurance company, when performing an investigation that follows a loss notice, must conduct it professionally and in good faith. In addition, the insurance company shall guarantee the information right to the insured on a clearly and accurate manner, by formulating questionnaires pertaining to the important facts of an event. This will lead to know the circumstances and consequences of the loss.

Final remarks

The supreme court decision will very likely apply by extension to other types of insurance contracts where the insured, loss payee or their representatives conceal information or make misrepresentations aiming at misleading the insurance company.

The principle of good faith in contract law becomes even more important as to insurance agreements. Insurance companies should know all relevant information and important facts revealed by the insured to conduct their risk assessment, or, an ex post event investigation.

If insureds, loss payees, or their representatives, hide information, make misrepresentations or dishonest statements; and the insurance companies prove so, they will be released from all their obligations assumed in the insurance contracts.

Source