A HISTORY OF THE DUTY OF UTMOST GOOD FAITH

“The precise definition of the term [utmost] ‘good faith’ depends on the legal context in which it is used.” While this quote does not appear particularly enlightening or conclusive, it is a surprisingly accurate description of the duty. As such, the duty has aptly been described as “a curious animal: arising from an indefinite source, with an undetermined content” of “considerable flexibility and versatility”. Its application is guided by the “legal context in which it is used” and its scope and its operation are still largely unsettled. 

At its core, the duty of utmost good faith imposes a standard for both insureds and insurers to uphold in their dealings with each other. It is closely connected to the ideals of “fair dealing, reasonableness and community standards of decency and fair dealing”. However, the exact meaning of the duty is unknown, as it has not been provided an explicit definition in the ICA or in the common law. Its scope is consequently moulded by the precedents set in case law, with each case being determined on a case-by-case basis with regard to what the actions of a “reasonable person in the circumstances” would be. There has been much academic discussion in journals about the duty and its operation, but there is a tendency to “throw up a plethora of terms which can be regarded as synonyms with utmost good faith but which do not really tell us much more about it”.

While the duty of utmost good faith is in force from the pre-contractual to post-contractual interactions between insureds and insurers, the focus of this discussion will be on the post-contractual dealings, which include claims lodgement and administration. 

The uncertainty in the area of post-contractual breaches of the duty is in part due to the lack of litigation. This is because prior to the introduction of the ICA, a breach only allowed for avoidance of the contract from inception. This remedy was particularly redundant for the insured, as it would have the practical effect of denying indemnity. As a result, insured parties had no incentive to litigate and thus most litigation was brought forth by insurers for matters of disclosure. Since the introduction of the ICA, the duty has become an implied term in every general insurance contract in Australia. As such, a breach of the duty would allow for the innocent party to sue for damages, avoid the contract or prevent the other party from acting in a certain way.

RECENT REFORMS OF THE ICA

The recent reforms of the ICA do not alter the meaning of the duty of utmost good faith. Rather, the scope of the duty now extends to third-party beneficiaries. In addition, a breach of the duty of utmost good faith is now also a breach of the ICA. Greater powers provided for the Australian Securities and Investments Commission (ASIC) in the reforms means that ASIC can pursue action against an insurer under the Corporations Act for a breach or breaches of the duty of utmost good faith. Under this provision, ASIC has the power to suspend or cancel an insurer’s Australian Financial Services Licence (AFSL). The implication for insurers is that there is uncertainty surrounding ASIC’s discretion as to when they will intervene. This, in combination with the existing lack of clarity about the specifics of the duty, has created a commercial environment devoid of certainty for insurers, in particular. While the purpose of the amendment was to “ensure that the regulatory framework adequately addresses claims handling service”, this has not been without cost. The Treasury has recognised that due to the increased powers of ASIC, there are potential extra litigation costs to both the government and insurers.

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