Supreme Court rules on enforceability of exclusion clauses in insurance contracts: Texco Marketing Pvt. Ltd. vs. TATA AIG General Insurance Company Ltd. (09 November 2022)

Introduction

Date of the Judgment: 09 November 2022

Citation: Civil Appeal No. 8249 of 2022 (Arising out of SLP (Civil) No. 25457 of 2019)

Judges: Justice Surya Kant and Justice M.M. Sundresh

Can an insurance company avoid paying a claim by using an exclusion clause, even when they knew about the situation that triggered the clause when they issued the policy? The Supreme Court of India recently tackled this important question in a case involving a fire insurance claim. This case explores the principles of good faith, disclosure, and fairness in insurance contracts. The court examined whether an insurer could use an exclusion clause to deny a claim when it was fully aware of the circumstances at the time of issuing the policy.

The Supreme Court bench, comprising Justice Surya Kant and Justice M.M. Sundresh, delivered the judgment. Justice M.M. Sundresh authored the opinion for the bench.

Case Background

M/s Texco Marketing Pvt. Ltd. (the appellant) obtained a Standard Fire & Special Perils policy from TATA AIG General Insurance Company Ltd. (respondent No. 1) on 28 July 2012. The policy, effective from 28 July 2012 to 27 July 2013, was intended to cover a shop located in the basement of a building. However, the policy contained an exclusion clause that specifically stated it did not cover basements.

The insurance company conducted an inspection of the shop before issuing the policy. Notably, the shop was across the road from the insurer’s office. Another shop in a similar situation was also insured by the same company. The appellant regularly paid the premiums.

Later, the appellant made further constructions, duly informing the insurer, who again conducted an inspection. Subsequently, a fire accident occurred at the shop, leading the appellant to file a claim. The insurance company’s surveyor inspected the damage and instructed the appellant to refurnish the shop for a proper evaluation. The surveyor noted that previous inspections had been done and that the insurer was aware the shop was in a basement. Despite this, the insurance company rejected the claim, citing the exclusion clause.

The State Consumer Disputes Redressal Commission (State Commission) ruled against the insurance company, stating that there was a lack of adequate disclosure and that mandatory procedures were not followed. The State Commission held that the insurer was deficient in service and engaged in unfair trade practices. The fact that another similarly situated shop was also insured was not disputed. The State Commission ordered payment after deducting the value of goods meant for a third party.

However, the National Consumer Disputes Redressal Commission (National Commission) overturned the State Commission’s decision. Despite acknowledging that the insurance company had not followed the law and that inspections were conducted before and after the contract, the National Commission relied on the exclusion clause to set aside the State Commission’s order. The National Commission did, however, grant a sum of Rs. 7.5 lakhs to the appellant. The appellant then challenged this decision of the National Commission before the Supreme Court.

Timeline:

Arguments

The appellant argued that the National Commission did not overturn the reasoning of the State Commission on both facts and law. They contended that once a finding is made that is not in dispute, the logical consequences should follow.

The respondents argued that the existence of the exclusion clause was not in dispute, and the shop was admittedly in the basement. They further contended that the mere fact that the National Commission’s decision was accepted would not prevent the respondents from arguing that the finding of knowledge at the time of contract execution was incorrect. They submitted that this finding could not be the basis for restoring the decision of the State Commission.

The core issue before the Supreme Court was:

“Whether an exclusion clause destroying the very contract knowingly entered, can be permitted to be used by a party who introduced it, becomes a beneficiary and then to avoid its liability?”

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the following issue:

✓ Whether an exclusion clause destroying the very contract knowingly entered, can be permitted to be used by a party who introduced it, becomes a beneficiary and then to avoid its liability?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

On Exclusion Clauses:

• Shivram Chandra Jagarnath Cold Storage v. New India Assurance Co. Ltd. (2022) 4 SCC 539 – Supreme Court of India. The Court reiterated that exception clauses should be interpreted to the benefit of the insured when they are too wide and not consistent with the main purpose of the insurance policy.
• B.V. Nagaraju v. Oriental Insurance Co. Ltd. (1996) 4 SCC 647 – Supreme Court of India. The Court read down an exception clause to serve the main purpose of the policy.
• Skandia Insurance Co. Ltd. v. Kokilaben Chandravadan, (1987) 2 SCC 654 – Supreme Court of India. The Court emphasized that when there is a choice between relieving the distress of victims and reducing the insurer’s profitability, the former should be preferred.
• Glynn v. Margetson & Co. [1893 AC 351 (HL)] – House of Lords. The Court stated that when construing a contract, one must look at the whole instrument and reject provisions inconsistent with the main purpose of the contract.

On Duty of Disclosure, Good Faith, and Notice:

• Manmohan Nanda v. United Insurance (2022) 4 SCC 582 – Supreme Court of India. The Court summarized the duty of an insurer and an insured to disclose all material facts, emphasizing the principle of uberrimae fidei (utmost good faith).
• Carter v. Boehm (1766) 3 Burr 1905 – The Court emphasized that insurance is a contract of speculation, and the insured must disclose all material facts.
• United India Insurance Co. Ltd. v. M.K.J. Corporation (1996) 6 SCC 428 – Supreme Court of India. The Court held that utmost good faith must be observed by both parties in an insurance contract.
• Modern Insulators Ltd. v. Oriental Insurance Co. Ltd. (2000) 2 SCC 734 – Supreme Court of India. The Court reiterated that both the insured and the insurer have a duty to disclose all material facts.
• George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd. (1983) Law Reports Q.B. 284 – The Court discussed the issue of inadequate disclosure and the need for clear communication of exemption clauses.
• Bharat Watch Company v. National Insurance Co. Ltd. 2019 (6) SCC 212 – Supreme Court of India. The Court held that the insurer must communicate the exclusionary conditions to the insured.

On Doctrine of Blue Pencil:

• Beed District Central Coop. Bank Ltd. v. State of Maharashtra, (2006) 8 SCC 514 – Supreme Court of India. The Court discussed the doctrine of “blue pencil,” which allows striking off an offending clause that is void ab initio.

On Consumer Protection:

• IREO Grace Realtech (P) Ltd. v. Abhishek Khanna, (2021) 3 SCC 241 – Supreme Court of India. The Court held that consumer forums have the power to declare contractual terms as unfair.

Legal Provisions:

• Section 2(i), Indian Contract Act, 1872 – Defines a voidable contract.
• Section 10, Indian Contract Act, 1872 – Specifies the essentials of a valid contract.
• Sections 17 and 18, Indian Contract Act, 1872 – Define “fraud” and “misrepresentation,” respectively.
• Section 19, Indian Contract Act, 1872 – Discusses the voidability of agreements without free consent.
• Section 2(1)(g), Consumer Protection Act, 1986 – Defines “deficiency” in service.
• Section 2(1)(r), Consumer Protection Act, 1986 – Defines “unfair trade practice.”
• Section 3, Consumer Protection Act, 1986 – States that the Act is in addition to other laws.
• Section 14, Consumer Protection Act, 1986 – Outlines the powers of the District Forum.
• Section 2(46), Consumer Protection Act, 2019 – Defines “unfair contract.”
• Section 2(47), Consumer Protection Act, 2019 – Defines “unfair trade practice.”
• Sections 47 and 58, Consumer Protection Act, 2019 – Define the jurisdiction of the State and National Commissions.
• Sections 49 and 59, Consumer Protection Act, 2019 – Outline the procedure applicable to State and National Commissions.
• Clause 3(ii) and (iv), IRDA Regulation, 2002 – Mandates that insurers provide all material information to the insured.
• Clause 4, IRDA Regulation, 2002 – Enjoins a duty upon the insurer to furnish a copy of the proposal form within thirty days of the acceptance, free of charge.

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

✓ Shivram Chandra Jagarnath Cold Storage v. New India Assurance Co. Ltd. (2022) 4 SCC 539*: The Court followed this precedent, reiterating that exception clauses should be interpreted in favor of the insured when they are too wide.

✓ B.V. Nagaraju v. Oriental Insurance Co. Ltd. (1996) 4 SCC 647*: The Court applied the principle of reading down an exception clause to serve the main purpose of the policy.

✓ Skandia Insurance Co. Ltd. v. Kokilaben Chandravadan, (1987) 2 SCC 654*: The Court reiterated the principle that the distress of victims should be prioritized over the insurer’s profitability.

✓ Glynn v. Margetson & Co. [1893 AC 351 (HL)]*: The Court applied the principle of looking at the whole contract and rejecting inconsistent provisions.

✓ Manmohan Nanda v. United Insurance (2022) 4 SCC 582*: The Court relied on this case to emphasize the duty of disclosure and good faith in insurance contracts.

✓ Carter v. Boehm (1766) 3 Burr 1905*: The Court reaffirmed the principle that the insured must disclose all material facts.

✓ United India Insurance Co. Ltd. v. M.K.J. Corporation (1996) 6 SCC 428*: The Court reiterated that utmost good faith must be observed by both parties.

✓ Modern Insulators Ltd. v. Oriental Insurance Co. Ltd. (2000) 2 SCC 734*: The Court reaffirmed that both the insured and insurer have a duty to disclose all material facts.

✓ George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd. (1983) Law Reports Q.B. 284*: The Court used this case to highlight the issue of inadequate disclosure.

✓ Bharat Watch Company v. National Insurance Co. Ltd. 2019 (6) SCC 212*: The Court relied on this case to emphasize that the insurer must communicate exclusionary conditions.

✓ Beed District Central Coop. Bank Ltd. v. State of Maharashtra, (2006) 8 SCC 514*: The Court applied the doctrine of “blue pencil” to strike off the offending exclusion clause.

✓ IREO Grace Realtech (P) Ltd. v. Abhishek Khanna, (2021) 3 SCC 241*: The Court used this case to support the power of consumer forums to declare contractual terms as unfair.

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the principles of fairness, good faith, and the duty of disclosure in insurance contracts. The Court emphasized that an insurance company cannot rely on an exclusion clause to deny a claim when it was aware of the circumstances that triggered the exclusion at the time of contract formation. The Court also highlighted the importance of protecting the interests of consumers, especially in standard-form contracts where they have little bargaining power. The Court noted the insurer’s knowledge of the shop’s location in the basement, the inspections conducted, and the non-compliance with disclosure norms as key factors.

The court found that the insurer knowingly entered into the contract despite the exclusion clause, and therefore, it could not use that clause to avoid liability. The court also emphasized the need for insurance companies to comply with regulatory norms, particularly regarding the provision of all material information to the insured. The court also noted that the exclusion clause was unfair and against the very object of the contract.

Fact:Law Ratio

Logical Reasoning

Judgment Analysis

The Supreme Court’s reasoning was based on the principles of good faith, fairness, and the duty of disclosure in insurance contracts. The Court held that the insurance company was aware of the fact that the shop was in the basement, and therefore, it could not rely on the exclusion clause to deny the claim. The Court emphasized that insurance contracts are special contracts that require a high degree of good faith and disclosure from both parties.

The Court interpreted the exclusion clause in the context of the main purpose of the contract, stating that an exclusion clause cannot be used to destroy the very purpose of the contract. The Court also applied the doctrine of “blue pencil” to strike off the offending exclusion clause, as it was found to be against the very object of the contract.

The Court also noted that the insurance company had not complied with the mandatory provisions of the IRDA Regulation, 2002, which requires insurers to provide all material information to the insured. This non-compliance further weakened the insurer’s case.

The Supreme Court’s decision has significant implications for future cases involving insurance contracts. It clarifies that insurers cannot rely on exclusion clauses to deny claims when they were aware of the circumstances that triggered the exclusion at the time of contract formation. It also reinforces the importance of good faith, disclosure, and fairness in insurance contracts.

The Court’s reasoning is supported by several key quotes from the judgment:

✓ “An exclusion clause in a contract of insurance has to be interpreted differently. Not only the onus but also the burden lies with the insurer when reliance is made on such a clause.”

✓ “A party, who relies upon it, shall not be the one who committed an act of fraud, coercion or mis-representation, particularly when the contract along with the exclusion clause is introduced by it.”

✓ “When an exclusion clause is introduced making the contract unenforceable on the date on which it is executed, much to the knowledge of the insurer, non-disclosure and a failure to furnish a copy of the said contract by following the procedure required by statute, would make the said clause redundant and non-existent.”

There was no minority opinion in this case.

Key Takeaways

✓ Insurance companies must act in good faith and disclose all material information to the insured.

✓ Insurers cannot rely on exclusion clauses to deny claims when they were aware of the circumstances at the time of contract formation.

✓ Exclusion clauses should be interpreted in the context of the main purpose of the contract and cannot be used to defeat the contract’s objective.

✓ The doctrine of “blue pencil” can be used to strike off offending clauses that are void ab initio.

✓ Consumer forums have the power to declare contractual terms as unfair.

✓ Insurance companies must comply with the mandatory provisions of the IRDA Regulation, 2002.

Directions

The Supreme Court cautioned all insurance companies on the mandatory compliance of Clause (3) and (4) of the IRDA Regulation, 2002. Any non-compliance on the part of the insurance companies would take away their right to plead repudiation of contract by placing reliance upon any of the terms and conditions included thereunder.

Development of Law

The ratio decidendi of this case is that an insurance company cannot rely on an exclusion clause to deny a claim when it was aware of the circumstances that triggered the exclusion at the time of contract formation. This decision reinforces the principles of good faith, disclosure, and fairness in insurance contracts. The Supreme Court has clarified that exclusion clauses cannot be used to destroy the very purpose of the insurance contract, especially when the insurer was aware of the relevant facts. This decision clarifies the legal position that the insurer cannot take advantage of its own wrong.

Conclusion

The Supreme Court ruled in favor of the appellant, M/s Texco Marketing Pvt. Ltd., setting aside the National Commission’s order. The Court held that TATA AIG General Insurance Company Ltd. could not rely on the exclusion clause to deny the claim, as the insurer was aware that the shop was in the basement at the time of issuing the policy. The Court emphasized the principles of good faith, disclosure, and fairness in insurance contracts, and cautioned insurance companies to comply with the IRDA regulations.