The Court of Appeal considers for the purpose of the solicitors’ Minimum Terms of Cover what it means to ‘condone’ a fraud and whether two dishonest acts by a solicitor fall to be aggregated (Discovery Land v Axis)

Insurance & Reinsurance analysis: A dishonest solicitor, Mr Jones, misappropriated substantial sums from his client (DLC). He also used DLC’s property, without its authority, as security for a loan to a company under his control. The solicitor’s firm (Jirehouse) was insolvent, and so DLC sued its insurers (Axis) under the Third Parties (Rights against Insurers) Act 2010 (the 2010 Act). Axis defended the claim on two grounds. First, it relied upon a policy exclusion for fraudulent acts that were ‘condoned’ by the firm’s other partners, members or directors (in fact there was only one, Mr Prentice). Second, it argued that the two claims in question were ‘similar acts or omissions in a series of related matters or transactions’. At trial before Robin Knowles J (the Judge) Axis lost on both issues. The Court of Appeal dismissed Axis’ appeal. On the condonation issue, it held that the Judge’s conclusion, though generous to DLC, was not perverse and so could not be overturned. On the aggregation issue, it agreed with the Judge that the two acts in question were neither ‘similar’ nor ‘in a series of related matters or transactions’.

What are the practical implication of this case?

Condonation

This is believed to be the first occasion where the Court of Appeal has considered the meaning of the condonation provision in the SRA’s Minimum Terms of Cover (MTCs). While the case ultimately turned on its own facts, the Court of Appeal nevertheless made some general observations:

• to ‘condone’ something does not require an overt act. Passive acceptance or approval of another’s wrongdoing is enough
• the condonation provision in the MTCs refers to 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. The court explained that there therefore needed to be a causal nexus between the condoned behaviour in question and the claim against the insured
• however, the inclusion of the words ʻor in any way involvingʼ means that the causal link is potentially a loose one. If the act of dishonesty that was condoned ʻformed an essential part of the chain of events leading to the claimʼ (para [41]), then the causation requirement is met
• likewise, the clause was wide enough for a situation where someone condones ʻa 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 partʼ (para [43])
• it is a question of fact and degree whether the dishonest behaviour giving rise to the claim does in fact form part of a wider pattern of dishonest behaviour that has been condoned

Aggregation

The particular aggregation clause relied upon had two cumulative elements. First, the two (or more) claims had to arise from ‘similar acts or omissions’. Second, they must fall within a ‘series of related matters or transactions’.

On the similarity issue, the court emphasised the fact-sensitive nature of the inquiry. Just because acts giving rise to claims are of a ‘similar nature’ does not necessarily mean that there is, as there needs to be, a ‘real or substantial’ similarity between them. Likewise, distinctions on ‘points of finer detail’ does not prevent there being a ‘sufficient substantive similarity’ between the acts or omissions complained of (para [84]).

So far as the second element is concerned, the court adopted the phrase used by Lord Toulson in AIG Europe Ltd v Woodman, which is to ask whether the acts giving rise to the two claims ‘fitted together’. On the facts of the case, the court agreed with the Judge’s conclusion that the acts in question did not fit together, ie did not form part of a series of ‘transactions that were related’.

Perhaps the main point to take away from the decision is that the question of whether a solicitors professional indemnity insurers are entitled to decline cover on the ground of fraud is highly fact-sensitive. Even if the third-party claim arises out of conduct by a solicitor that was clearly fraudulent, it may nevertheless be difficult for insurers to prove that all the remaining partners or directors ‘condoned’ the fraud. Likewise, the fact that a solicitor is prepared to carry out dishonest acts does not, by itself, mean that the acts he does carry out are for aggregation purposes ‘similar’ or part of a related series of transactions.

What was the background?

DLC is a property developer based in Arizona. In 2018 it became interested in buying Taymouth Castle in Scotland for development purposes. It instructed Mr Jones of Jirehouse to act for it in the purchase and transferred the purchase monies of US$14.05m to Jirehouse’s client account. On receipt, Mr Jones misappropriated the monies to companies under his control. Mr Jones also mortgaged the castle to a lender called Dragonfly Finance sarl. He drew down £5m and placed £1.9m of that back in DLC’s client account, because that was the agreed retention in respect of the purchase price for the castle. When completion was due to take place, Mr Jones (falsely) told DLC that he was unable to complete because of money laundering issues, and so needed a further US$9.3m, which he undertook to return as soon as it had completed (fictitious) due diligence checks.

In due course, DLC, having instructed new solicitors, discovered what had happened, and obtaining a freezing injunction against Jirehouse. It later obtained a default judgment but was unable to enforce it because Jirehouse was insolvent. DLC therefore brought a claim directly against Axis under the 2010 Act, meaning that it would effectively stand in Jirehouse’s shoes.

Axis’ primary defence, as set out above, was that it was not liable to indemnify Jirehouse against claims arising out of dishonest or fraudulent acts. The success of this defence turned on whether Mr Jones’ co-director, Mr Prentice, had ‘condoned’ Mr Jones’ dishonesty. Axis’ second defence was that the claim in respect of the first fraud (the misappropriation of client funds) fell to be aggregated with the claim in respect of the Dragonfly charge.

What did the court decide?

Condonation

Axis’ case on the condonation issue was that Mr Prentice had ‘blind eye’ knowledge of Mr Jones’ wrongdoing; it does not claim that he had actual knowledge. Blind eye knowledge requires the person (i) to suspect certain facts but then (ii) to take a conscious decision to refrain from taking steps to confirm that suspicion.

Since the judge found as a fact that Mr Prentice did not have blind eye knowledge, Axis’ task on appeal was to show that this finding was ‘plainly wrong’. It founded its argument on the Judge’s adverse findings about Mr Prentice, including findings of dishonesty, unprofessionalism, and a lack of integrity. It claimed that, in light of such findings, his central conclusion that Mr Prentice did not suspect Mr Jones’ wrongdoings was unsustainable.

Lady Justice Andrews, with whom Lord Justice Phillips and Lady Justice Elisabeth Laing agreed, rejected Axis’ argument. As she explained at para [65], the Judge’s conclusions were based upon a ‘perfectly proper evaluation’ of the evidence, and the Judge was entitled to conclude, as he did, that while Mr Prentice was prepared to lie about certain matters as part of his professional practice, he would have ‘drawn the line’ at turning a blind eye to a suspicion that Mr Jones had misappropriated client funds. Strikingly, the court commented that, while a finding by the judge appeared ‘unduly benign’ to Mr Prentice, it was nevertheless not ‘irrational’.

Aggregation

On aggregation, Andrews LJ agreed with the Judge that the two frauds were not ‘similar’ to the required degree. Misappropriating client funds is qualitatively different from misusing a client’s property as security for a loan. The fact that both acts involved Mr Jones acting dishonestly and thieving client monies, is not enough to make them substantially ‘similar’.

In any event, even if the acts were of a similar nature, they were not in a related series of transactions. Rather, the two wrongdoings were independent, or causally unconnected. They did not form part of a chain.

Case details 

• Court: Court of Appeal, Civil Division
• Judges: Lord Justice Phillips, Lady Justice Andrews and Lady Justice Elisabeth Laing
• Date of judgment: 15 January 2024

Article by Tom Bell – first published by LexisNexis