An Unilateral Exclusion Clause in Insurance Contract is Void since inception

Texco Marketing Pvt. LtdVs. TATA AIG General Insurance Company Ltd. &Others
CIVIL APPEAL NO. 8249 OF 2022 [Arising out of SLP (Civil) No. 25457 of 2019]
Supreme Court of India

THE APEX COURT HELD THAT HELD THAT

Non-compliance of Clauses (3) and (4) of the IRDA Regulation, 2002 precededby unilateral inclusion, and thereafter followed by the execution of the contract,receiving benefits, and repudiation after knowing that it was entered into for aknown fact to the insurance company, would certainly be an act of unfair trade practice. This view isfortified by the finding that the exclusion clause is an unfair term, going againstthe very object of the contract, making it otherwise un-executable from its inception.

BRIF FACTS

1. The appellant secured a Standard Fire & Special Perils policy from therespondent on 28.07.2012.

2. The policy was effective from 28.07.2012 to27.07.2013. It was meant to cover a shop situated in the basement of thebuilding. However, the exclusion clause of the contract specifies that it does notcover the basement.

3. Due inspection of the shop was made which was actuallysituated on the other side of the road from the office of respondent No. 1. Notonly this shop of the appellant, but yet another shop similarly situated, was alsoinsured by respondent No. 1. The appellant continued to pay the premiumpromptly.

4. The appellant put up further construction, for which due notice was given anddue inspection was also made.

5. The shop met with a fire accident for which theappellant raised a claim. The surveyor of respondent No. 1 also made aninspection, on the basis of which the appellant was instructed to refurnish itsshop for the purpose of due evaluation.

6. While arriving at the sum payable, thesurveyor did notice the fact that the earlier inspections were made and that thefact that the shop was in a basement was to the knowledge of the insurer.

7. Theclaim made was repudiated by respondent No. 1, taking umbrage under theexclusion clause.

8. The State Consumer Disputes Redressal Commission (hereinafter referred to as'the State Commission') rejected the contention of respondent No. 1 on thepremise that there was no adequate disclosure, the mandatory provisions havenot been followed, as such the insurer was deficient in service and indulged inunfair trade practice. The fact that a similarly placed shop was also covered, wasnot in dispute. The amount payable is only after due deduction of the goodsmeant for the third party.

9. The aforesaid decision was overturned by the National Consumer DisputesRedressal Commission (hereinafter referred to as 'the National Commission'),mandate of the law and inspection was indeed done prior to the execution of thecontract, and even thereafter. Having found a deficiency in service, it placedreliance upon the exclusion clause in setting aside the decision of the State Commission while granting a sum of Rs.7.5 lakhs. It is this decision of theNational Commission which is under challenge before us.

ISSUE

Sub-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?

THE SUPREME COURT OF INDIA.
The Apex Court consider and has decided the case on the basis of various principles'
ADHESION CONTRACT.

Black's Law Dictionary defines “Adhesion Contract” as:

“A standard-form contract prepared by one party, to be signed by the party in aweaker position, usually a consumer, who has little choice about the terms. Alsotermed Contract of adhesion; adhesory contract; adhesionary contract; take it or
leave it contract; leonire contract.”

Adhesion contracts are otherwise called Standard-Form Contracts. Contracts ofInsurance are one such category of contracts. These contracts are prepared bythe insurer having a standard format upon which a consumer is made to sign.

The Consumer has very little option or choice to negotiate the terms of the contract, exceptto sign on the dotted lines. The insurer who, being the dominant party dictates itsown terms, leaving it upon the consumer, either to take it or leave it. Suchcontracts are obviously one sided, grossly in favour of the insurer due to theweak bargaining power of the consumer.

The concept of freedom of contract loses some significance in a contract ofinsurance. Such contracts demand a very high degree of prudence, good faith,disclosure and notice on the part of the insurer, being different facets of thedoctrine of fairness. Though, a contract of insurance is a voluntary act on thepart of the consumer, the obvious intendment is to cover any contingency thatmight happen in future. A premium is paid obviously for that purpose, as there isa legitimate expectation of reimbursement when an act of God happens.

Therefore, an insurer is expected to keep that objective in mind, and that toofrom the point of view of the consumer, to cover the risk, as against a plausiblerepudiation.

EXCLUSION CLAUSE

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 madeon such a clause. This is for the reason that insurance contracts are special contracts premised on the notion of good faith. It is not a leverage or a safeguard
for the insurer but is meant to be pressed into service on a contingency, being acontract of speculation. An insurance contract by its very nature mandatesdisclosure of all material facts by both parties.

An exclusion clause has to be understood on the touchstone of the doctrine ofreading down in the light of the underlining object and intendment of thecontract. It can never be understood to mean to be in conflict with the mainpurpose for which the contract is entered.

A party, who relies upon it, shall notbe the one who committed an act of fraud, coercion or misrepresentation,particularly when the contract along with the exclusion clause is introduced byit. Such a clause has to be understood on the prism of the main contract. Themain contract once signed would eclipse the offending exclusion clause when itwould otherwise be impossible to execute it.

A clause or a term is a limb, whichhas got no existence outside, as such, it exists and vanishes along with thecontract, having no independent life of its own. It has got no ability to destroy itsown creator, i.e., the main contract. When it is destructive to the main contract,right at its inception, it has to be severed, being a conscious exclusion, thoughbrought either inadvertently or consciously by the party who introduced it. Thedoctrine of waiver, acquiescence, approbate and reprobate, and estoppel wouldcertainly come into operation as considered by this court in various cases.

THE INDIAN CONTRACT ACT, 1872

“2.Interpretation-clause.- In this Act the following words andexpressions are used in the following senses, unless a contraryintention appears from the context:-
xxx xxx

(i) An agreement which is enforceable by law at the option ofone or more of the parties thereto, but not at the option ofthe other or others, is a voidable contract.

xxx xxx xxx

SECTION 10.WHAT AGREEMENTS ARE CONTRACTS

All agreements arecontracts if they are made by the free consent of parties competent tocontract, for a lawful consideration and with a lawful object, and arenot hereby expressly declared to be void.

Nothing herein contained shall affect any law in force in India,and not hereby expressly repealed, by which any contract is requiredto be made in writing or in the presence of witnesses, or any lawrelating to the registration of documents.
xxx xxx xxx

SECTION 17.'FRAUD'

'Fraud' means and includes any of thefollowing acts committed by a party to a contract, or with hisconnivance, or by his agent, with intent to deceive another partythereto or his agent, or to induce him to enter into the contract:-

1) the suggestion, as a fact, of that which is not true, by onewho does not believe it to be true.
2) the active concealment of a fact by one having knowledgebelief of the fact:
3) a promise made without any intention of performing it.
4) any other act fitted to deceive.
5) any such act or omission as the law specially declares to befraudulent.

Explanation.-Mere silence as to facts likely to affect thewillingness of a person to enter into a contract is not fraud, unless thecircumstances of the case are such that, regard being had to them, it isthe duty of the person keeping silence to speak, or unless his silence,is, in itself, equivalent to speech.

Section 18 “MISREPRESENTATION”- “Misrepresentation” means and includes

(1) the positive assertion, in a manner not warranted by theinformation of the person making it, of that which is nottrue, though he believes it to be true'
(2) any breach of duty which, without an intent to deceive,gains an advantage of the person committing it, or anyoneclaiming under him, by misleading another to his prejudice,or to the prejudice of anyone claiming under him.
(3) causing, however innocently, a party to an agreement, tomake a mistake as to the substance of the thing which is thesubject of the agreement.

SECTION 19.VOIDABILITY OF AGREEMENTS WITHOUT FREE CONSENT

When consent to an agreement is caused by coercion, [***] fraud ormisrepresentation, the agreement is a contract voidable at the option ofthe party whose consent was so caused.

A party to contract, whose consent was caused by fraud ormisrepresentation, may, if he thinks fit, insist that the contract shall beperformed, and that he shall be put in the position in which he wouldhave been if the representations made had been true.

Exception.- If such consent was caused by misrepresentation orby silence, fraudulent within the meaning of section 17, the contract,nevertheless, is not voidable, if the party whose consent was so causedhad the means of discovering the truth with ordinary diligence.

Explanation.- A fraud or misrepresentation which did not causethe consent to a contract of the party on whom such fraud waspractised, or to whom such misrepresentation was made, does notrender a contract voidable.

Illustrations

A fraudulently informs B that A's estate is free from incumbrance.B thereupon buys the estate. The estate is subject to mortgage. B mayeither avoid the contract or may insist on its being carried out andmortgage-debt redeemed.”

CONSUMER PROTECTION ACT, 2019

SECTION 2(46). Definitions. – In this Act, unless the context otherwise requires,-"unfair contract" means a contract between a manufacturer ortrader or service provider on one hand, and a consumer on the other,having such terms which cause significant change in the rights ofsuch consumer, including the following, namely:

(i) requiring manifestly excessive security deposits tobe given by a consumer for the performance ofcontractual obligations; or

(ii) imposing any penalty on the consumer, for thebreach of contract thereof which is whollydisproportionate to the loss occurred due to suchbreach to the other party to the contract; or

(iii) refusing to accept early repayment of debts onpayment of applicable penalty; or

(iv) entitling a party to the contract to terminate suchcontract unilaterally, without reasonable cause; or

(v) permitting or has the effect of permitting one partyto assign the contract to the detriment of the otherparty who is a consumer, without his consent: or

(vi) imposing on the consumer any unreasonable charge,obligation or condition which puts such consumerto disadvantage;”

SECTION 2(47) "unfair trade practice" means a trade practice which, for thepurpose of promoting the sale, use or supply of any goods or for theprovision of any service, adopts any unfair method or unfair ordeceptive practice including any of the following practices, namely:--

(i) making any statement, whether orally or in writing or byvisible representation including by means of electronicrecord, which--

(a) falsely represents that the goods are of a particularstandard, quality, quantity, grade, composition, styleor model.
(b) falsely represents that the services are of a particularstandard, quality or grade.
(c) falsely represents any re-built, second-hand,renovated, reconditioned or old goods as new goods.
(d) represents that the goods or services havesponsorship, approval, performance, characteristics,accessories, uses or benefits which such goods or
services do not have.
(e) represents that the seller or the supplier has asponsorship or approval or affiliation which suchseller or supplier does not have.
(f) makes a false or misleading representationconcerning the need for, or the usefulness of, anygoods or services.
(g) gives to the public any warranty or guarantee of theperformance, efficacy or length of life of a product or of any goods that is not based on an adequate orproper test thereof:”

DOCTRINE OF BLUE PENCIL

In such a situation, the doctrine of “blue pencil” which strikes off the offendingclause being void ab initio, has to be pressed into service. The said clause beingrepugnant to the main contract, and thus destroying it without even a need foradjudication, certainly has to be eschewed by the Court. The very existence ofsuch a clause having found to be totally illegal and detrimental to the executionof the main contract along with its objective, requires an effacement in the formof declaration of its non-existence, warranting a decision by the Courtaccordingly.

The aforesaid principle evolved by the English and AmericanCourts has been duly taken note of by this Court in Beed District Central Coop.Bank Ltd. v. State of Maharashtra, (2006) 8 SCC 514,

“10. The “doctrine of blue pencil” was evolved by the English andAmerican courts. In Halsbury's Laws of England, (4th Edn., Vol. 9), p. 297,para 430, it is stated:

“430. Severance of illegal and void provisions.—A contract will rarely betotally illegal or void and certain parts of it may be entirely lawful inthemselves. The question therefore arises whether the illegal or void partsmay be separated or 'severed' from the contract and the rest of the contractenforced without them.

Nearly all the cases arise in the context of restraintof trade, but the following principles are applicable to contracts in general.”

11. In P. Ramanatha Aiyar's Advanced Law Lexicon, 3rd Edn. 2005, Vol. 1, pp. 553-54, it is stated:

“Blue pencil doctrine (test).—A judicial standard for decidingwhether to invalidate the whole contract or only the offending words.

Under this standard, only the offending words are invalidated if itwould be possible to delete them simply by running a blue pencilthrough them, as opposed to changing, adding, or rearranging words.(Black, 7th Edn., 1999)

This doctrine holds that if courts can render an unreasonablerestraint reasonable by scratching out the offensive portions of thecovenant, they should do so and then enforce the remainder.

Traditionally, the doctrine is applicable only if the covenant inquestion is applicable, so that the unreasonable portions may beseparated. E.P.I. of Cleveland, Inc. v. Basler [12 Ohio App 2d 16 :230 NE 2d 552, 556].

Blue pencil rule/test.—Legal theory that permits a judge to limitunreasonable aspects of a covenant not to compete.

Severance of contract; 'severance can be effected when the partsevered can be removed by running a blue pencil through it withoutaffording the remaining part'. Attwood v. Lamont [(1920) 3 KB 571 :1920 All ER Rep 55 (CA)] . (Banking)

A rule in contracts a court may strike parts of a covenant not tocompete inorder to make the covenant reasonable. (MerriamWebster)

Phrase referring to severance (q.v.) of contract. 'Severance can beeffected when the part severed can be removed by running a bluepencil through it' without affording the remainingpart. Attwood v. Lamont [(1920) 3 KB 571 : 1920 All ER Rep 55(CA)] . (Banking)”

ANALYSIS & DECISION

1. Both the forums have held concurrently that respondent No. 1 was conscious ofthe fact that the contract was entered into for ensuring a shop situated in thebasement. The aforesaid position is not only a factual one but also accepted bythe respondents as no challenge has been laid against the impugned order.Similarly, there was no specific denial on the non-compliance of adequatenotice. The National Commission has not given any finding on this aspect,though it was dealt with in extenso by the State Commission.

2. On a reading ofSection 21(A) of the Consumer Protection Act, 1986, it is clear that it is not akinto Section 96 of the Code of Civil Procedure, 1908. Even otherwise, theimpugned order has not considered all the relevant materials which were dulytaken note of by the State Commission.

3. Once it is proved that there is a deficiency in service and that respondent No. 1knowingly entered into a contract, notwithstanding the exclusion clause, theconsequence would flow out of it. We have already discussed the scope andambit of the provisions under the Indian Contract Act, 1872. Even as per thecommon law principle of acquiescence and estoppel, respondent No. 1 cannot beallowed to take advantage of its own wrong, if any. It is a conscious waiver ofthe exclusion clause by respondent No. 1.

4. Under the impugned order, we have already taken note of and discussed, the findings of the State Commission, which are indeed approved by the NationalCommission. These findings are sufficient enough to come to the conclusion thatthe terms of the contract are unfair, particularly the exclusion clause, and thatrespondent No. 1 has indulged in unfair trade practice. In such view of thematter, the decision of the National Commission cannot be sustained as theappellant cannot be non-suited only on the ground of mere deficiency in servicewithout taking note of the fact that it is the duty of the Forum to grant theconsequential relief by exercising the power under Section 14(d) and 14(f) of theConsumer Protection Act, 1986 which mandates the payment of adequatecompensation by way of an award. The said provision makes it consequential ingranting adequate compensation once it finds deficiency, the existence of unfairterms in the contract and unfair trade practice on the part of the other party. Inother words, a party is entitled for the relief which the law provides.

5. Non-compliance of Clauses (3) and (4) of the IRDA Regulation, 2002 preceded by unilateral inclusion, and thereafter followed by the execution of the contract,receiving benefits, and repudiation after knowing that it was entered into for abasement, would certainly be an act of unfair trade practice. This view isfortified by the finding that the exclusion clause is an unfair term, going againstthe very object of the contract, making it otherwise un-executable from itsinception.

6. Therefore, we have no hesitation in setting aside the order passed by theNational Commission. However, we are in agreement with the submission madeby the counsel appearing for the respondents that the State Commission withoutany basis granted a sum of Rs.2.5 lakhs towards harassment and mental agony.

7. We are of the view that no case for awarding amount under that head has beenmade out as the respondents merely took a legal stand.

8. In light of the aforesaid, the order impugned passed by the National Commissionin F.A. No. 275 of 2016 stands set aside except to the extent of declining a sumof Rs.2.5 lakhs towards harassment and mental agony. The appeal standsallowed in part.

CONCLUSION

This is a landmark decision on rights of the insured where insurance companies illegally withhold claim settlement. Moreover, this judgement will also be useful in dealing with Adhesion contracts in cases like Real estate companies entering into contract for sale of properties.

In this case the Apex Court said that “ before we part with this case, we would like to extend a word of caution to allthe insurance companies on the mandatory compliance of Clause (3) and (4) ofthe IRDA Regulation, 2002. Any non-compliance on the part of the insurancecompanies would take away their right to plead repudiation of contract byplacing reliance upon any of the terms and conditions included thereunder.”

KEY TAKEAWAYS

i) The court interpreting Adhesion Contracts which are standard form of contracts where the insurance company dominates the contract with very little option on the party but to sign on the dotted lines, are one sided contract grossly in favour of the insurer.

ii) Such contracts therefore demand very high level of fairness. The court thereafter discussed the importance of exclusion clause, principles of Uberrimae fidei and doctrine of blue pencil held that the insurance company knowingly entered into a contract, notwithstanding the exclusion clause, the consequence would flow out of it.

iii) Further the court also cautioned all insurance companies that they should strictly follow Clause 3 and 4 of the IRDA Regulations,2002 which dealt with explaining the insurance clauses to the insured and furnish a copy of the proposal form within 30 days.

DISCLAIMER: The case law presented here is only for sharing knowledge and information with the readers. The views are personal ,shall not be taken as professional advice. In case of necessity do consult with professionals for more clarity and understanding of subject matter.

Footnotes:

CLAUSE 8 OF IRDAI( PPHI) REGULATIONS 2017
PROPOSAL FOR INSURANCE:

1. Except in case of a marine insurance cover, or such other covers approved by the Authority exempting usage of proposal form, a proposal for grant of insurance cover, either for life insurance business or for general insurance business or for health insurance business, must be evidenced by a document in written or electronic or any other format as approved by the Authority. It is the duty of the insurer tofurnish to the insured, free of charge, within 30 days of the acceptance of a proposal, a copy of the proposal submitted by the Insured.

2. In case of marine insurance cover or other insurance covers where a proposal form is not used, the insurer shall record the information obtained orally or in writing or electronically and confirm it within a period of 15 days thereof with the prospect and incorporate the information in its cover note or policy. Where the insurer claims that the prospect suppressed any material information or provided misleading or false information on any matter material to the grant of a cover, then the onus of proof rests with the insurer only in respect of any information not so recorded.

3. Any proposal form seeking information for grant of life cover shall prominently state therein the requirements of Section 45 of the Act.

4. While answering the questions in the proposal form for obtaining life insurance cover, the prospect is to be guided by the provisions of Section 45 of the Act.

5. Wherever the benefit of nomination is available to the proposer, in terms of the Act or the conditions of policy, the insurer or the distribution channel shall draw the attention of the proposer to it and encourage the proposer to avail the facility and inform him of the provisions of section 39 of the Act.

6. Insurer shall process the proposals with speed and efficiency and the decision on the proposal thereof, shall be communicated in writing to the proposer within a reasonable period but not exceeding 15 days from the date of receipt of proposals or any requirements called for by the insurer.

7. Where a proposal deposit is refundable to a prospect under any circumstances, the same shall be refunded within 15 days from the date of underwriting decision on the proposal.

CLAUSE 9 MATTERS TO BE STATED IN GENERAL INSURANCE POLICY

1. A general insurance policy shall clearly state:

(i) the name(s) and address(s) of the insured and of any bank(s) or any other person having financial interest in the subject matter of insurance, UIN of the product, name, code number, contact details of the person involved in sales process.
(ii) full description of the property or interest insured.
(iii) the location or locations of the property or interest insured under the policy and, where appropriate, with respective insured values.
(iv) period of Insurance.
(v) sums insured.
(vi) perils covered and not covered.
(vii) any franchise or deductible applicable.
(viii) premium payable and where the premium is provisional subject to adjustment, the basis of adjustment of premium be stated.
(ix) policy terms, conditions and warranties, Exclusions, if any.
(x) action to be taken by the insured upon occurrence of a contingency likely to give rise to a claim under the policy.
(xi) the obligations of the insured in relation to the subject matter of insurance upon occurrence of an event giving rise to a claim and the rights of the insurer in the circumstances.
(xii) any special conditions attaching to the policy.
(xiii) the grounds for cancellation of the policy which in the case of a retail policy, for the insurer, can be only on the grounds of mis – representation, non-disclosure of material facts, fraud or non-co-operation of the insured

Explanation: Products approved as retail policies under File and Use guidelines notified by the Authority from time to time fall within the purview of retail policy referred above.

Provided that in the case of Commercial policies alone, other circumstances under which the policy may be cancelled be given, along with the manner of calculation of refund and notice period for cancellation.

(xiv) the address of the insurer to which all communications in respect of the insurance contract should be sent.
(xv) the details of the endorsements, add-on covers attaching to the main policy.
(xvi) that, on renewal, the benefits provided under the policy and/or terms and conditions of the policy including premium rate may be subject to change; and
(xvii) details of insurer's internal grievance redressal mechanism along with address and contact details of Insurance Ombudsman within whose territorial jurisdiction the branch or office of the insurer or the residential address or place of residence of the policyholder is located.