Professional indemnity insurance and the issue of condoning fraud or dishonesty

Last month, an important decision was made in the context of solicitors professional indemnity insurance (PII).

The Commercial Court in Discovery Land Company LLC & Ors v Axis Specialty Europe SE¹ provided guidance on the circumstances in which a partner in a law firm will be held to have condoned the dishonest conduct of another partner.

As this article discusses, the question of condoning in this context will be key in terms of coverage for solicitors PII. As the dust settles on the judgment, we consider its implications both for solicitors’ PII and the insurance of other professions.

Background

The background to the proceedings in Discovery Land Company LLC v AXIS Specialty Europe SE [2023]  comprised claims (by the Claimants) against Jirehouse Partners LLP, a limited liability partnership, and two private limited companies, Jirehouse and Jirehouse Trustees Ltd (together, the Jirehouse Entities) relating to the fraudulent actions of one of the principals, Mr Jones.  As part of these proceedings, it was determined that the Jirehouse Entities had the same two members/directors, Mr Jones and Mr Prentice.

In earlier proceedings, the Claimants had obtained judgments against the Jirehouse Entities relating to dishonest dealings by Mr Jones in respect of client monies in two separate transactions.

The Defendant, Axis (the Insurers) provided the primary layer of the Jirehouse Entities’ solicitors PII (in summary, £3 million per claim less the excess). The question before the Court was whether the Claimants’ successful claims were covered by that PII policy.

The Policy

Primary cover for solicitors’ indemnity insurance must comply with the SRA Minimum Terms and Conditions of Professional Indemnity Insurance (the MTC).  Few exclusions are permitted but insurers may exclude liability to indemnify :

“any particular person to the extent that any civil liability or related defence costs arise from dishonesty or a fraudulent act or omission committed or condoned by that person” (paragraph 6.8)².  

This MTC provision was closely followed in the wording of clause 2.8 of the Jirehouse Entities’ policy (the Policy) meaning that the decision in this case will be relevant to many other policies.  Clause 2.8 provided as follows:

“EXCLUSIONS
The insurer shall have no liability under the policy for……..

8 FRAUD OR DISHONESTY

Any claims directly or indirectly arising out of or in any way involving dishonest or fraudulent acts, errors or omissions committed or condoned by the insured, provided that:

(a) the policy shall nonetheless cover the civil liability of any innocent insured; and

(b) no dishonest or fraudulent act, error or omission shall be imputed to a body corporate unless it was committed or condoned by, in the case of a company, all directors of that company or, in the case of a Limited Liability Partnership, all members of that Limited Liability Partnership.”

Therefore, in order to establish that the claim was not covered by the Policy, Insurers needed to establish that all the members/directors of the Jirehouse Entities either committed or condoned dishonesty or a fraudulent act or omission.  In this case, the question for the Court was whether Mr Prentice had condoned the fraudulent acts of Mr Jones – and the burden of proof lay with the Insurers.

The meaning of condone

The Judge concluded that the word “condone” is an ordinary word and should be applied as such.  He did not wish to supply different or additional words by way of elaboration but he agreed with the Claimants’ argument that, used in ordinary language, to “condone” conveys acceptance or approval.  

In some situations, to “condone” would not require “an overt act”.  Further, the Judge accepted the Insurers’ submission that it is “enough to know and condone a pattern of dishonest behaviour of which the particular fraudulent act forms part”.  The key question will then be exactly what (if anything) was condoned, which will require careful factual analysis.

On the facts, the Court found that Mr Prentice failed to meet the standards required in his profession as a solicitor and that he was at times untrustworthy and willing to behave dishonestly.  The Judge even accepted that Mr Prentice realised that Mr Jones was “prepared to do things that he should not have been prepared to do” and that Mr Prentice was prepared to turn a blind eye to some of Mr Jones’ actions. In summary, Mr Prentice “lacked the necessary sense of professional responsibility and an appreciation of the importance of the regulatory requirements of his profession”.

Importantly however, the Judge decided that this conduct, though open to criticism, did not confirm that Mr Prentice knew or suspected that Mr Jones was involved in a multi-million pound fraud.  The reason Mr Prentice had not made enquiries (which would have uncovered the misuse of client monies) was because he lacked an appreciation of the requirement to do so, not because he did not want to confirm any suspicions he had about Mr Jones.  On that basis, the Judge concluded that Mr Prentice could not be said to have condoned (generally or specifically) Mr Jones’ actions in the two relevant transactions.  

Once again, we are reminded that determining coverage issues such as this is a fact-specific exercise.  The Court considered in detail the underlying facts and noted that despite various investigations over the years, the SRA had not decided that the conduct of Mr Jones required further action. The SRA’s outcomes would have reassured Mr Prentice about Mr Jones’ actions, and perhaps persuaded Mr Prentice that those actions were not sufficiently serious to warrant his attention.   Further, even if Mr Prentice had looked more closely at these transactions at the time, the Court could not be confident that he would have encountered matters that would mean that his further involvement (in terms of working with Mr Jones) would amount to condoning the dishonesty/fraud on the part of Mr Jones that would give rise to the Claimants’ claims.

The judgment both highlights the challenges facing such insurers when seeking to establish that the dishonesty exclusion applies, and that the key question in this context is likely to be what exactly was condoned?  The partner in question needs to have condoned the specific fraudulent acts or omissions out of which the claims arise, rather than just condoning a general pattern or series of dishonest or fraudulent conduct.

Is this decision relevant for other professions?

In the UK, extensive regulation is also in place for chartered surveyors, chartered accountants and chartered architects. All are required to have PII in place and both chartered surveyors and chartered accountants have PII minimum approved policy wording that will be applicable in most cases.

Chartered accountants

Under the Institute of Chartered Accountants’ minimum approved policy wording (effective from 1 September 2021), Section E sets out permitted exclusions from cover. These include at E8 any claim “if the Insured seeking indemnity for such Claim has committed or condoned any dishonest or fraudulent act or omission that is material to the amounts payable as a result of such Claim”.  There are provisos to this exclusion, notably that the exclusion only applies where either the insured has admitted the commission or condonation or there is an unappealable judgment or adjudication that establishes this.

This wording includes the concept of the insured condoning a dishonest or fraudulent act or omission and so the Discovery judgment is likely to be relevant to coverage disputes arising out of this exclusion.

Chartered surveyors

The 2023 Royal Institute of Chartered Surveyors (RICS) approved minimum wording excludes claims (in summary) arising out of any dishonesty or fraud of any insured save where this causes loss to any client of the insured – the wording does not however include a reference to condoning any dishonest or fraudulent act or omission.

Other professions

For professions where there is no PII minimum wording, including architects, engineers and brokers, the policy terms actually agreed in practice nonetheless may (and often do) include wording akin to the clause under consideration in Discovery. In such cases, the extent to which the dishonesty/fraud was condoned by those beyond the direct perpetrator, and exactly what was condoned, may well be a central issue for those dealing with coverage.

Discussion

Interestingly, the Discovery judgment ends with an observation by the Judge that clients of solicitors (and potential clients) are likely to be unaware of and surprised by the fact that the insurance in place for a firm would not respond if insurers can demonstrate that all partners were dishonest or condoned dishonesty. The Judge observed that “the question of sufficient transparency” in relation to the limits of the insurance in this scenario might be suitable for a joint review by the Law Society and the Solicitors Regulation Authority.  

We will wait to see if this suggestion is taken up by either entity.  In the meantime, we are left with this decision which confirms that the hurdle for solicitors professional indemnity insurers to overcome in order to rely on the dishonesty exclusion remains high. 

^{1 [2023] EWHC 779 (Comm)}

^{2 SRA | Indemnity Insurance Rules | Solicitors Regulation Authority}