RSA v Tughans - Does a claim for the recovery of fees paid to a firm constitute an insured loss?

The Court of Appeal, in Royal and Sun Alliance Insurance Ltd v Tughans (A Firm) [2023] EWCA Civ 999, has upheld the first instance decision ([2022] EWHC 2589 (Comm)), finding that Tughans’ professional indemnity insurers could not decline cover for a liability which included the firm’s fees.

It is reasonably common for claims against an insured professional to include a component seeking a return of the fees paid by the claimant. This case provides useful clarification in an area of law where that has long been lacking, and affords some welcome practical guidance. Unfortunately, some difficult edge cases remain, chiefly concerning restitution claims and the impact of set-off defences on coverage.

The facts concerned a solicitors’ firm, but the decision is equally applicable across the range of professions.

Background

The underlying proceedings are yet to come to trial so the coverage dispute proceeded on an assumed facts basis. 

Briefly, Mr Coulter, a former partner at Tughans, had been engaged by Brown Rudnick LLP (BR) to perform professional services in relation to a sale of loans. He did not open a file number and the other partners were unaware of his involvement at the time. 

When a buyer was found, BR sent an engagement letter to them which provided that BR would be entitled to a success fee of £15m upon successful completion (which was to be shared with Tughans). As part of the engagement, various representations and warranties had been given by BR and, in turn, Mr Coulter.

The sale completed and £9m (£7.5m + VAT) was transferred by BR to an account Mr Coulter had specified. At this point Mr Coulter told his partners he had generated a fee of £1.5m and then transferred £7.2m (£6m + VAT) to a company in his name. Mr Coulter later revealed the full position to his partners and returned the money. 

Tughans notified its insurers and, later, BR started proceedings against Tughans for damages claiming, amongst other things, that misrepresentations were given. Insurers declined the claim on the basis that the claim did not arise from the provision of professional services (so was outside the insuring clause) and that, in any event, no “loss” had been suffered. Tughans arbitrated for declarations as to cover, with the arbitrator finding in their favour. Insurers appealed under s.69 Arbitration Act 1996 on a point of law to the High Court, which also found against insurers but it granted permission to appeal its finding as to what counts as an insured loss. 

The policy wording and the indemnity principle

The insuring clause provided: "The Insurers will indemnify the Insured in respect of claims or alleged claims made against the Insured…..in respect of any civil liability (including liability for claimant's costs and expenses) incurred in connection with the Practice…provided that no indemnity will be given (a) to any individual committing or condoning any dishonest fraudulent criminal or malicious act….."

The Court noted that the insuring clause was expressed in very wide terms – any civil liability – drawing no distinction between liability for damages in respect of fees and any other form of liability. Whilst some policies address the question of cover for fees head on, this policy was silent and provided broad cover. The Court also noted that the insurers were not advancing any argument that the other partners condoned so the exception in the insuring clause did not apply. 

Turning to the appeal issue, insurers’ argument was summarised by the Court of Appeal as follows:

“Because the fee was procured by misrepresentation, Tughans had no right to retain it; and if it was obliged to return it, as part of a damages claim, it had not lost something to which as a matter of substance it was entitled, just as much as if the contract were avoided and it was obliged to return it or its value in a restitutionary claim… Tughans had not suffered a loss in the amount of the fee, and cover for that element of a damages claim would violate the indemnity principle.”

Identifying that the “indemnity principle” was at the heart of the insurers’ submissions, the Court found that the principle did not assist insurers for the following reasons:

• Entitlement to the fee

The ordinary position is that, where a professional has accrued a contractual right to a fee, an award of damages in the amount of the fee payable would constitute a loss for the purposes of a professional indemnity policy. This is because the fee has been earned by the performance of services. If that fee needs to be paid out to satisfy a liability claim, the firm has been deprived of the remuneration it received for the services it provided and equates to a loss for the firm. Insurers argued that because the fee was procured by a misrepresentation, it should not have been received by the firm in the first place and therefore was not covered by the insurance policy. The Court rejected this. Once the fee has been earned, the professional is entitled to it unless and until the contract is rescinded (which BR had not done). Further, one could not treat an earned fee whose payment is procured by a misrepresentation as equivalent “in substance”, as insurers had argued, to an unearned fee to which the professional is never entitled. 

• Purpose and function of PII 

The insurers’ indemnity principle argument ran contrary to the public interest purpose of PII – to protect clients – and the commercial and regulatory function of PII - to protect partners from their own and others’ negligent mistakes and from fraud of those others. 

• Composite nature of PII

PII is written on a composite basis, meaning that it is treated as if separate insurance contracts have been entered into with each individual insured. As such, if one partner is accused of fraud or dishonesty, for example, cover for the other partners should not automatically be impacted (subject to express terms to the contrary) unless they were parties to those breaches or condoned the breaches. If insurers’ argument were correct, then that would leave the innocent partners substantially uninsured, which is contrary to the protection intended by composite PII cover.

• Restitution

The insurers also argued that the indemnity principle precluded cover for liability for fees framed as a restitutionary claim and, therefore, for liability for fees as part of a damages claim. The claim from BR was clearly framed as a damages claim and not a restitutionary claim, so the point did not fall to be decided, but the Court did make some observations. Where the fee had been earned, as in this case, the indemnity principle would not necessarily preclude cover for a restitutionary claim, subject to clear language to that effect in the policy: “Being deprived of such fee is a loss to the solicitor for the reasons I have explained, and none the less so when the deprivation arises from a liability for a claim framed in restitution, following rescission, as for a claim framed in damages.”

Further, whilst a claim for restitution or unjust enrichment relating to sums to which the Insured never had any legal entitlement is, prima facie, not an indemnifiable loss, there may be situations where money is received but not earned as a fee which may still be an indemnifiable loss. The Court gave the example of a payment on account made to a firm for fees and an employee steals this from the client account before the work is done to earn the fee. A subsequent claim by the client for the money, advanced as a restitutionary claim, could give rise to a liability which constitutes a loss, which would fall within the scope of PII cover. However, the Court was not inclined to give concluded views on this point given that the issue did not arise on the facts of this case.

• Set-off

Insurers also sought to argue that if the declaration of cover was granted that that would have the effect of treating the PII as first party cover for unpaid fees. Using an example of BR having not paid the fee, Counsel for insurers posited that Tughans would then have sued for it and they would then have been met with the BR damages claim which would include the fee amount. It was submitted that in this hypothetical an equitable set-off would have been applied so that Tughans’ claim for the fee would have failed and BR’s damages claim would not have included any element of the fee. Thus, there would be no loss for the PII to respond to. 

The Court rejected this argument for two reasons:

1. It ignores the composite nature of PII – the innocent partners are not in the same position they were before; they are worse off by reason of the fee having been paid as they are each responsible for the whole liability whilst only having a beneficial interest in a small percentage of the fee received.
2. The example given by Counsel for the insurers would constitute no “loss” but that was because there would be no ascertained civil liability for it, and it would not fall within the insuring clause of the policy wording: “where the fee is unpaid in the posited example the Policy does not respond; whereas, where there is a liability which includes the fee element, the Policy does respond because there is a liability and a loss, which is exactly what professional indemnity insurance is designed to cover.”

Therefore, the form of the claim is more important here than assertions about the substance of it. If the fee is not paid and is set-off, there is no liability and no cover. If the fee is paid and is returned, there is a liability and therefore cover.

What are the takeaways? 

Whilst this case was a loss for insurers, the judgment provides some clarity to insurers when they are faced with claims from professional firms which involve similar issues and they need to make decisions on cover. The Court has now made clear that, for insurance purposes, being deprived of an earned fee for professional services does constitute a loss if the firm is deprived of it, as part of the liability established to the client. Unearned fees, however, may not constitute a loss – this would depend on the facts of the case in question so these should be interrogated by insurers – and it is also important for insurers to carefully look at how the underlying claim has been framed. 

Two points are of note here:

1. The Court made passing comments suggesting that restitutionary payments including returning fees might in some cases be capable of constituting a loss under PII. Nevertheless, where the claim is clearly framed by the client as restitutionary, it is more likely that cover is not available. There are some difficult distinctions here about when a fee is “earned” or “unearned” in a restitutionary situation. This broader issue would benefit from a thorough examination by the Supreme Court in due course.
2. The BR claim is based on contractual misrepresentations – it is not a standard negligence claim – and had BR rescinded the contract, rather than seeking damages, the “loss” might not have fallen within the PII, as it might then have been a restitutionary claim based on an “unearned” fee. This illustrates the remaining complexity when insurers are examining the underlying facts.

Further, the point about set-off is interesting. Situations of set-off (between client liability and an unpaid but earned fee) have been the subject of differing views, with no clear case available to provide specific guidance. Tughans appears to emphasise that what counts is whether there is a net liability of the firm established to the client – if that liability is reduced by the amount of the unpaid fee, then insurers benefit through a lower insured liability. Nevertheless, this was not the actual situation in Tughans, and there may be a variety of set-off situations that will yet need to be distinguished and analysed more subtly. For example, what if the firm chooses not to use its unpaid fee as a set-off but rather to pursue the fee claim independently? Then the liability would be established on a “gross” basis and the insurer would, on the face of it, be liable on a gross basis.

The purpose and function of professional indemnity insurance - to provide protection to the public, a firm’s clients and the partners of a firm who are honest was strongly emphasised by the Court. The Court’s comments stress that arguments that it considers run contrary to the purpose and function of PII will rarely succeed.

As to the scope of cover, the insuring clause is the starting point and this may vary depending on the nature of the insured firm’s business. Here, the case concerned solicitors’ insurance requirements in Northern Ireland and the insuring clause was very broad – covering any civil liability. It is doubtful that the minimum regulatory terms of solicitors and other professionals in England and Wales materially differ. Where possible (which is likely to be outside the scope of regulated terms), it is always worth considering express provisions addressing topics such as fees, because that provides a more certain and explicit regime. 

As the nature of professional services continues to evolve, there is also value in considering fees from a much broader perspective. Typical engagement terms are evolving to meet the requirements of clients whose own businesses are undergoing often dramatic change; the risk allocation achieved through terms such as contractual warranties or performance bonds can impact both the level of fee and the extent of insurers’ liability, but without the connection being explicitly addressed. As ever, an holistic approach can yield opportunities in terms of striking a balance that better meets the requirements of both insurers and insureds, and also affords clarity up front rather than through the facts of particular coverage disputes.