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Originally the duty of utmost good faith was a common law concept which applied directly to contracts of insurance. The introduction of the Insurance Contracts Act 1984 (the Act) brought about a fundamental change to this duty - the Act states 'a contract of insurance is based on the utmost good faith and there is implied in such a contract a provision requiring each party to it to act towards the other party, in respect of any matter arising under or in relation to it, with the utmost good faith.' Today the duty of the utmost good faith must be looked at from both the common law and statutory perspectives with respect to obligations owed by insurers to insureds once a claim has been lodged under an insurance policy. Insurance contracts are subject to the duty of utmost good faith because each party to the contract must act with the utmost good faith with respect to their dealings with one another. This duty is not to be confused with the duty of disclosure which deals with the pre-contractual obligations of the parties and is otherwise dealt with under the Act.

Effectively the duty of utmost good faith is now implied in contracts of insurance which previously was not the case at common law. At common law the strict application of the duty might have resulted in an insurer entitled to avoid a contract of insurance ad initio (from inception). The difference now is that as an implied term in a contract of insurance a breach of the duty by the insurer can now give rise to a claim for damages in contract in relation to the settlement of a claim. As the meaning of 'utmost good faith' is not defined in the Act reference must be had to some of the cases in this area. What is important to keep in mind is that duty focuses on the word 'utmost' and that this is the measure of good faith relied upon with fairness and honesty being part of it. Of course the duty has to be viewed objectively and it applies globally to all aspects of the relationship between an insurer and insured encompassing the payment and settlement of claims. There is an argument that the duty may have some precontractual force although this does not have much currency. Given that we are talking about an insured being able to sue under the Act for damages for breach of an implied term of the duty of utmost good faith, this begs the question: whether or not an insurer could be held liable in damages where they have exhibited bad faith? Suffice to say, in the USA bad faith claims have been around for many years and perhaps this area of the law may develop in Australia in future although the courts have expressed otherwise.

One of the vexing questions which remains to be asked is whether in certain circumstances an insured's duty to act with good faith extends to third parties along with the utmost good faith. Recent cases suggest that there can be a breach of a duty of utmost good faith even where the insurer has not acted dishonestly and where third party interests are involved. As matters currently stand there is no tort of bad faith and a breach of the duty can only result in a liability for damages for breach of contract. In a recent case the New South Wales Court of Appeal ruled that an insurer has a duty of good faith and fair dealing not only to an insured but to those who benefit under a policy. The court said that the duty of good faith applies where the policy is at least for the indirect benefit of the insured. Despite this there remains considerable doubt as to whether the duty of utmost good faith extends to third parties as the duty that the court is talking about here is one of good faith and fair dealing.