UK: Insurance & Reinsurance Bulletin - September, 2009

Company Fraud: The Illegality Doctrine, Attribution & Third Party Funding

Stone & Rolls Limited (in liquidation) v Moore Stephens (a firm) [2009] UK HL 39
By Alison Zobel

The House of Lords has upheld the Court of Appeal's decision to strike out a claim against auditors for failing to detect a fraud committed by the claimant company. The case will interest auditors, and third parties seeking recovery following a fraud. The claim was brought with commercial third-party funding.

The Facts

Mr Stojevic was the sole director of Stone & Rolls ("the company"), which he used to defraud banks. In engaging Moore Stephens as the company's auditors, Mr Stojevic gave a fictitious picture of the company's business and accounts. The fraud was uncovered and the company found to be insolvent. The company's liquidators subsequently brought a claim against Moore Stephens for the benefit of the company's creditors.

Moore Stephens admitted breaching its duty to the company in failing to identify the fraud but was successful in arguing that the claim should fail on the basis of the principle 'ex turpi causa' which prevents a claimant from using the court to obtain benefits from his own illegal conduct.

Attribution

The issue arose as towhether Mr Stojevic's criminal acts and intentions should be attributed to the actual claimant, the company. The majority of the Lords decided that the fraud could be attributed to the company. Mr Stojevic was the sole controlling mind of the company and no-one else was involved. Mr Stojevic's fraud was therefore the act of the company.

It is possible that the approach taken by the Lords in this case could apply in situations involving more than one director or shareholder if all are complicit in the fraud. It is unlikely to apply in circumstances where there were "innocent" directors and shareholders.

Third Party Funding

This case has generated interest as it is one of the largest to date in the UK to be backed by commercial third-party funders. Such a high profile loss may impact upon the willingness of third parties to back future claims.

By Kapil Dhir and Andrew Carpenter

Section 59(1) Financial Services and Markets Act provides that an authorised firm must take reasonable care to ensure that no person performs a controlled function under an arrangement entered into by it, in relation to any regulated activity carried on by it, unless the FSA has first approved that person to perform that controlled function – the "approved persons regime".

In July 2009 the FSA confirmed, in policy statement 09/14, an extension of the approved persons regime for those individuals who perform a "significant influence" function at firms as follows:

• The scope and application of CF1 (director function) and CF2 (non- executive director) is extended to include those persons employed by an unregulated parent undertaking or holding company, whose decisions or actions are regularly taken into account by the governing body of a regulated firm.
• The definition of the significant management controlled function (CF29) is extended to include all proprietary traders who are not senior managers but who are likely to exert significant influence on a firm.
• The application of the approved persons regime to UK branches of overseas firms based outside the EEA is amended.

The approved persons regime will be subject to further review in light of the forthcoming Walker Review which is expected later this year when the FSA will look at the role of non-executives more closely, where it believes they should have intervened more actively within a firm's management.

The changes set out in the policy statement came into effect on 6 August 2009 with a transitional period of six months. Firms should review which individuals require approval and ensure that applications are made to the FSA ahead of the transitional period deadline.

Full details can be accessed at www.fsa.gov.uk/pubs/policy/ps09_14.pdf

By Richard Jowett and Andrew Dunn

The judgment in AIG UK Ltd & Ors v QBE Insurance (Europe) Ltd [2008] QSC 308 illustrates that reinsurance dispute forum shopping between different Australian states is not dead. Parties who choose Australian law and Australian courts potentially expose themselves to state forum shopping and pre-emptive strikes by their opposition.

In respect to direct insurance, the Insurance Contracts Act 1984 (Cth) and the Marine Insurance Act 1909 (Cth) (both Commonwealth Acts) respectively provide a nationally uniform framework for general (i.e. non-marine) and marine direct insurance. However, the Insurance Contracts Act specifically does not apply to reinsurance contracts. Reinsurance contracts may, nonetheless, be within the ambit of the various state legislation such as Part VI of the Insurance Act 1902 (NSW) and Part III Division 3 of the Instruments Act 1958 (Vic). This state legislation is not uniform between the States.

In the NSW judgment of HIH Casualty & General Insurance Ltd (in liq.) v R J Wallace [2006] NSWSC 1150, Einstein J of the NSW Supreme Court held that the NSW Act applied not only to insurance but also to reinsurance. He accordingly applied section 19 of the NSW Act to invalidate an arbitration clause in a reinsurance contract notwithstanding the reinsurer's attempt to argue to the contrary.

The NSW and Victorian legislation is, on the whole, reinsured/ insured friendly and also contain provisions which could be relied upon by a reinsured to forgive non-compliance with claims conditions, including conditions precedent, provided that the reinsurer has not suffered prejudice as a result of the noncompliance. As noted above, the NSW legislation also contains a provision invalidating arbitration clauses. The Victorian legislation, although not worded in the same way as the NSW legislation, invalidates an arbitration clause to the extent it is a condition precedent to claiming in the courts.

If the NSW judgment of HIH v Wallace were to be followed in Victoria, section 27 of the Instruments Act 1958 (Vic) may be applied to forgive a reinsured for non-compliance with claims conditions if there has been no prejudice to the reinsurer.

Since Australia is a federation of states, in addition to the federal laws and court system, each state has its own court system, and any state court would be applying Australian law when applying either federal or that individual states' legislation to the resolution of a dispute.

In AIG v QBE, the underlying facts relating to the direct insurance claim which led to the dispute between the reinsurer and reinsured arose in Victoria. However, because the reinsurers were concerned about the Victorian legislation possibly being found applicable to the reinsurance contract, and therefore forgiving a non-compliance with a condition precedent in the reinsurance contract, the reinsurers sought pre-emptive relief in the Queensland Supreme Court on the basis that the parties had agreed to submit to the jurisdiction of any Australian Court for the purposes of resolution of the dispute.

The Queensland Act, unlike the equivalent NSW and Victorian Acts, did not have an equivalent provision which would have forgiven the reinsured for not complying with the condition precedent. The reinsured challenged the reinsurers' attempt to seize the Queensland Courts with jurisdiction, and failed.

The judgment serves as a reminder to reinsurers and reinsureds who are faced with a potential dispute under a reinsurance contract, where there is a choice of forum clause, to consider taking early pre-emptive action so as to establish jurisdiction in a state which may have more favourable laws applicable to the resolution of their dispute. A flipside is for international reinsurers entering into or renewing reinsurance contracts to revisit their choice of applicable law and forum selection provisions in light of the judgment in AIG v QBE, since a well advised Australian reinsured might also seek to forum shop in the event of a dispute to maximise its advantages.

By Ada Waddington

Without prejudice communications are in general inadmissible in subsequent litigation. However, this general rule is not absolute. It was held in Oceanbulk Shipping v TMT [2009] that without prejudice exchanges prior to the conclusion of a settlement agreement are admissible for the purposes of identifying the terms of the settlement and ascertaining the meaning of those terms.

The parties in this case entered into a number of freight forward swap agreements where they agreed to settle the debts between them as they speculated against movements in the freight market. When TMT failed to settle Oceanbulk's invoice for US$40.5 million, the parties held discussions over the unpaid amount which resulted in a settlement agreement. A dispute arose as to the meaning of a clause in the settlement agreement. TMT sought to rely on the without prejudice exchanges prior to the conclusion of the settlement agreement. Oceanbulk applied to the court to strike out TMT's case in this regard. Applying the House of Lords' decision in Ofulue v Bossert [2009], the court refused to grant the application.

It was held in Ofulue that not only are admissions made in a genuine attempt to reach a settlement inadmissible in subsequent litigation, such protection is not confined to distinct admissions but they also apply to the rest of the without prejudice communications. However, it was also held in Ofulue that there are certain exceptional instances where without prejudice material can be admissible. Without prejudice communications which resulted in a concluded compromise agreement fall under one of the exceptions.

The judge in Oceanbulk said "there was no cogent reason... that evidence of without prejudice exchanges should be admissible to identify terms but inadmissible as to the meaning of the terms..." The test is whether the without prejudice material is of probative value for ascertaining the parties' intentions and the meaning of a settlement agreement. If it is, it is admissible "to the extent that it would be if the exchanges had not been without prejudice". He concluded that the evidence TMT sought to rely on was of potentially significant probative value.

Whilst the courts will allow the admission of without prejudice exchanges in order to ascertain the meaning of settlement agreements, it appears that any actual admissions made by the parties during without prejudice negotiations remain protected. However, care should be taken when conducting any form of negotiations, whether they are without prejudice or not. It will also help if the resulting settlement agreement is carefully and clearly worded to avoid any ambiguity.

By Costas Frangeskides and Alexandra Cottrell

As you may recall (from our January 2009 Bulletin) Holman Fenwick Willan successfully represented Allianz of Egypt before the English Courts against Greek reinsurer, Aigaion Insurance Company, in claims for unpaid reinsurance balances. One of Aigaion's main arguments was that there was no reinsurance contract in place. Therefore, the case considered issues of importance to the parties in a reinsurance contract – particularly in relation to contract certainty.

For a recap of the facts of the case, please see "Allianz v Aigaion - Broker's liability for premium" in our January 2009 issue: http://www.hfw.com/news/newsletters/2009/insurancereinsurancebulletin-issue05

In summary, the Allianz v Aigaion judgment was an important reminder of the risks of doing business by email and of inaccurate electronic placing slips. Such slips may result in a binding contract – even where terms previously negotiated by email have not been included. Accordingly, it is very important that insurance and reinsurance market participants be extra vigilant when conducting business by email and that they ensure that e-slips contain all of the terms they require.

Lloyd's Market Bulletin's guidance on contract certainty

Perhaps as a result of the Allianz v Aigaion case, and due to the increase in Lloyd's market business being accepted overseas by managing agents' own operations, Lloyd's made enquiries regarding local placement procedures in Singapore. While recognising that London placement procedures are not necessarily transferable to overseas territories, Lloyd's felt it was appropriate to clarify expectations, via additional guidance.

In that regard, Lloyd's Market Bulletin dated 18 March 2009, sets out guidance regarding contract certainty in the placement of business in overseas territories, with particular reference to the Singapore market. By doing so Lloyd's sought to assist managing agents trading in local markets to manage the risks associated with contract certainty within the placing process.

While it was accepted that it is not possible to impose all London market contract certainty procedures across the board, the report encourages managing agents in Singapore "to adopt Lloyd's subscription business processes where risks are co-insured, to assist in the delivery of contract certainty, and for greater process efficiency for all parties". In doing so, the report refers its readers to a number of websites which contain such principles and guidance – in particular, www.marketreform.co.uk

Conclusion

More and more business is being conducted these days by email, whether it be placing of insurance business or negotiating general sale and purchase contracts. As the Allianz v Aigaion case demonstrates – and the Lloyd's market bulletin recognises – brokers and other such business people, need to be extra careful that the resultant contract is certain and contains all of the terms they require. Failing this such exchanges are bound to result in costly litigation.

Terms Of Release From Contracts

Cavell USA Inc and Anr v Seaton Insurance Co & Anr [2008] EWCH 3043 (Comm)
By Geoffrey Conlin

The claimant managed the defendant insurance companies' runoff. The relationship soured and the parties entered into a Term Sheet providing for the "orderly" termination of their relationship. The Term Sheet contained a wide-ranging release from claims in the claimant's favour with a carve-out for "fraud". It also contained a clause providing for English law and jurisdiction.

The insurance companies commenced proceedings against the claimant in New York alleging that that the claimant had fraudulently subordinated their interests to those of their reinsurers. The claimant contested the jurisdiction of the New York Court and commenced proceedings in the London Commercial Court.

The following preliminary issues, regarding the interpretation of the jurisdiction and release clauses in the Term Sheet, were ordered to be tried.

• Had the parties agreed to submit all disputes, including claims in "fraud", to the exclusive jurisdiction of the English Courts?
• What was meant by the word "fraud" in the carve-out to the release clause and were the New York claims "claims in fraud"?

The Judge, applying the ordinary rules of construction (ICS v West Bromwich), held as follows:

• The parties agreed to submit all disputes, including claims for "fraud", to the exclusive jurisdiction of the English Courts. It was "fallacious" to suggest that because "fraud" was carved out from the release, it was excluded from the Term Sheet. The commercial purpose of the term sheet (for the orderly handover of the parties' disputes) and the unreasonableness of the consequences inherent in the defendants' argument supported this conclusion.
• Having considered the authorities, the Judge held that the word "fraud" involved the use of false representations to obtain an unjust advantage. It had its primary meaning of "deceit" and not some wider meaning. There is no "generalised tort of fraud". Whether any particular head of claim could be brought within the primary meaning of the word "fraud" was for another day.

Comment

This case is reminder of the care that should be taken when drafting documents and the foresight required when considering the terms of any release. It is also a useful reference point for discussions regarding the meaning of the term "fraud".

News: Peter Schwartz

Peter Schwartz, formerly a Partner with Mayer Brown International, joined our London office on 1 September as a Consultant. He is a well known and highly experienced insurance & reinsurance specialist, with a practice that spans dispute resolution and corporate.

Peter has for many years acted for a number of very high profile clients in the London and international markets, especially in the reinsurance market and has strong links with academia, which he will continue to develop.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.