Staying on the hook - Court of Appeal finds against Insurer on condonation and aggregation in solicitors Scottish castle fraud case

Guest article written by Phil Murrin and Jenny Eacott of DAC Beachcroft

Overview

AXIS Specialty Europe SE -v- Discovery Land Company LLC (1) Taymouth Castle DLC LLC (2) The River Tay Castle LLP (3)  [2024] EWCA Civ 7

Issues as to whether a partner or director condoned dishonesty of another partner or director, and  whether large claims which have some connections may be aggregated for insurance purposes, have troubled the UK solicitors' professional indemnity market for many years.

In a decision arising from a substantial fraud carried out by a dishonest solicitor, the Court of Appeal has ruled that a member / director did not condone the dishonest conduct of a co-member / director, and therefore the dishonesty exclusion to cover permitted by the SRA's Minimum Terms & Conditions ("MTC") did not apply. The Court also rejected the Insurer's appeal  on aggregation of the two claims. This was notwithstanding findings made at first instance questioning the honesty and  integrity of the less involved member / director.

The insurance wording

AXIS Speciality Europe SE ("Axis") provided primary layer solicitors’ professional indemnity insurance (£3m per claim subject to a £250,000 excess) for Jirehouse Partners LLP and two private companies, Jirehouse (an unlimited company) and Jirehouse Trustees Ltd ("JLT”) (together, the “Jirehouse Entities”). The policy was written pursuant  and subject to the MTC and contained the following standard and permitted exclusion to cover:

The policy also included the following aggregation clause (matching the standard and permitted MTC wording):

Background

The Claimants, three affiliated entities, brought proceedings against the Jirehouse Entities in relation to a transaction in  which Mr Jones (a member and director of the Jirehouse Entities) acted for the first clamant in the purchase of Taymouth  Castle, in Scotland, where Queen Victoria and Prince Albert are said to have stayed shortly after their wedding. The Claimants made two claims:

1. “The Surplus Funds Claim”, where the Claimants accused Mr Jones of dishonestly removing purchase monies totalling $14,050,000 from JLT’s client account; and
2. “The Dragonfly Loan Claim”, where Mr Jones was accused of dishonestly and without authority using the castle as security for a loan of £4,980,470 from Dragonfly Finance SARL and then removing that sum from the firm’s client account.

The Claimants obtained judgment in default against the Jirehouse Entities. As the Jirehouse Entities were insolvent, Axis was potentially liable to indemnify the claimants under the Third Parties (Rights against Insurers) Act 2010. Separately, Mr Jones received a custodial sentence.

Axis declined cover relying on the dishonesty exclusion in the Policy. Axis contended that the only other member and director of the Jirehouse Entities, a Mr Vieoence Prentice, had condoned the dishonest behaviour of Mr Jones which gave rise to the claims, such that the dishonesty could be attributed to the Jirehouse Entities.

Axis did not claim that Mr Prentice had actual knowledge of Mr Jones’ dishonest behaviour in respect of the Surplus Funds Claim and the Dragonfly Loan, but that he had “blind eye knowledge" of Mr Jones’ wrongdoing. Axis argued that Mr Prentice had a firm suspicion that Mr Jones was misappropriating client funds, and that he deliberately failed to follow up that suspicion, because he feared it would be confirmed.

Axis also sought to rely on the aggregation clause in the policy in order to treat the claims as a single claim, in the event that the fraud / dishonesty exclusion was found not to apply.

The trial judge found in favour of the Claimants on both the condonation and aggregation issues. It was found that Mr Prentice had acted unprofessionally and in a "not honest" manner in respect of separate winding up petitions against Jirehouse Entities, was untrustworthy and prepared to act dishonestly, but that this was not enough. It was found that Mr Prentice had been motivated by distancing himself from areas of personal risk, rather than condoning the frauds. Axis appealed.

Decision of the Court of Appeal

Condonation issue

The Court of Appeal recognised that the difficulty facing Axis on appeal concerned the nature of attacking factual findings at appellate level. This has been the subject of numerous cases in recent years. In short, the party challenging such findings needs to establish that they were "plainly wrong", identifying a clear flaw in the judge's reasoning. In particular, it is not for the appellate court to reach an independent conclusion by consideration of all of the evidence. Nor can the appealing party apply a selective, "island hopping" approach. The Court recognised that this is "a high hurdle to overcome."

The Court held that the conclusions reached by the trial judge were based upon a perfectly proper evaluation of all the relevant evidence. The judge had been entitled to take the view that there was a plausible alternative explanation (distancing) to that alleged by Axis for Mr Prentice's motive for lying (condonation).

The judge's findings about Mr Prentice’s state of mind, the reasons why he failed to make proper enquiries, and why he lied were on this basis not “rationally unsupportable.” His decision that there was no condonation by Mr Prentice of Mr Jones’s wrongdoing was not “plainly wrong” and the appeal on the condonation issue was therefore dismissed.

Accordingly, Axis was liable to indemnify. The next question concerned how much indemnity was available.

Aggregation issue

The Court of Appeal agreed with the judge's assessment that the aggregation clause in the Policy did not apply to the claims to limit liability and the appeal on the aggregation issue was also dismissed.

It recognised that whether the Surplus Funds Claim and the Dragonfly Loan Claim arose from “similar acts or omissions in a series of related matters or transactions” involved an exercise of judgement based on a fact-sensitive evaluation.

The question that arose concerned at what level did similarity have to be examined, in terms of the granularity of the acts or omissions. The Court found that to argue that there was substantial similarity between the acts generating the two claims as both claims were for stealing money from a client account where the clients in question were closely connected entities was to consider the question at too high a level. It ignored the substantive differences between the acts.

Rather, the act in the Surplus Funds Claim was a straightforward misappropriation of monies, whereas the acts giving rise to the Dragonfly Loan Claim consisted of the wrongful arrangement of a facility and charge, drawdown under the facility, and then release of the monies from the client account. Viewed objectively, the complaints were considered very different, even though on both occasions the dishonest behaviour of Mr Jones culminated in the theft of client monies. Further, although the victims of the fraud were affiliated, they were separate entities.

Even had the acts been sufficiently similar, the Court held that they did not arise from "a series of related matters or transactions". Applying the requirement that the transactions "fitted together" from AIG v Woodman [2016] EWHC 2398, the Court held that the Surplus Funds Claim arose from the purchase of the castle which was completed before the loan was made and was not dependent upon the loan. The only connection between the purchase and the Dragonfly Loan was that the same property was involved and the victims of the frauds were clients who were closely-related entities. Those factors were insufficient to provide the necessary link between the two transactions.

Comment

The decision will no doubt attract substantial interest, as most professional indemnity insurance policies contain arbitration provisions and there are accordingly few reported decisions on the interpretation of the solicitors' minimum terms. However, whilst it may not be a decision that pleases the insurance community, the decision does not represent any change in approach or add greatly to the limited body of authority.

It is relevant to note that the Court of Appeal expressly stated that the policy must be interpreted in line with the principal purpose of professional liability insurance cover, namely, "the protection of that section of the public that makes use of the services of solicitors". The dismissal of the appeal ensured that the Claimants would recover their losses on both claims up to the limit of indemnity.

On condonation, the Court of Appeal simply confirmed that the judge's decisions were not ones that no reasonable judge could reach. In appealing the trial judge's decision that Mr Prentice had not condoned the dishonest conduct, Axis was in effect challenging a finding of fact. This will always be an uphill struggle, as the appellant will need to establish that the finding is "plainly wrong". Axis had to persuade the Court of Appeal that the judge’s finding of fact that Mr Prentice did not have “blind eye knowledge” of Mr Jones’ dishonest behaviour was rationally insupportable - a high hurdle to overcome.

Many Insurers might wonder how this came to be decided against Axis in view of the findings made against Mr Prentice's professionalism, honesty, integrity and trustworthiness generally. Axis relied on the judge's findings that Mr Prentice was dishonest, deeply unprofessional, and lacking in integrity in a number of respects.

Although the Court of Appeal accepted that another judge, making the same adverse findings about Mr Prentice might have drawn less benign conclusions, it held the judge was entitled to conclude that Mr Prentice's reason for not making proper enquiries was not because this would confirm that Mr Jones was misappropriating client monies. The judge's finding that there was no "blind eye knowledge" and therefore no condonation of Mr Jones's dishonest conduct was not “rationally unsupportable.” The problem for Axis therefore arose from the findings at first instance.

Previous cases on condonation, namely Zurich v Karim [2006] EWHC 3355 and Goldsmith Williams v Travelers [2010] EWHC 26, involved similar questions as to the extent of knowledge required for condonation. Insurers had succeeded in both of those cases, but the facts were distinguished.

The Court of Appeal did, in its first consideration of the meaning of condonation in this context, provide some helpful guidance on what is required for condonation of a dishonest act or omission. To “condone” conveys acceptance or approval and does not require an overt act. The condoner does not need to know of the dishonest act before or at the time it was committed and may condone another’s dishonest behaviour after the event. There has to be a causal nexus between the dishonest behaviour said to have been condoned, and the claim against the insured for which an indemnity was sought.

Helpfully, the Court of Appeal confirmed that the language of the dishonesty clause was wide enough to embrace a situation in which someone condones a pattern of dishonest behaviour which is of the same type as the dishonest behaviour that directly gives rise to the claim, and of which the latter forms part. Accordingly, where a partner is aware of an established practice of misappropriating client monies by another partner, they cannot argue that they did not condone the dishonest act as they were unaware of a specific instance of such behaviour where, for example, they were on holiday at the time of the misappropriation.

Again, the aggregation appeal was a difficult battle to win as Axis was challenging an exercise of judgement based on a fact-sensitive evaluation. The requirement to demonstrate similarity of acts and omissions at a relatively granular level, and the demanding approach adopted in relation to the connection between the transactions, is consistent in broad terms with recent case law, and will no doubt bring attention once again to the MTC aggregation wording.

Finally, it is also notable that notwithstanding the findings, Mr Prentice remains on the solicitors' roll.

Authors from DAC Beachcroft

Re-published with kind permission from DAC Beachcroft. First published 18-Jan-2024: https://www.dacbeachcroft.com/en/What-we-think/staying-on-the-hook-court-of-appeal-finds-against-insurer-on-condonation-and-aggregation

This article has been written by Phil Murrin and Jenny Eacott of DAC Beachcroft and the opinions and views stated in this article are those of Phil Murrin and Jenny Eacott and not Howden Insurance Brokers Limited (“Howden”). Howden is an insurance broker and is not authorised or regulated to advise on the interpretation of Court of Appeal findings in respect of condonation and aggregation. Howden shall not (i) owe or accept any duty, responsibility or liability to you or any other person; and (ii) be liable in respect of any loss, damage or expense caused by your or any other party’s reliance on this article.