UK: Professional Indemnity Bulletin

Last Updated: 9 October 2012
Article by Tom Bedford and Zoe Perry

Arrowhead Capital Finance Ltd (In Liquidation) v KPMG LLP

In July KPMG was successful in its application for summary dismissal of a claim worth more than USD$52 million.

Background

KPMG had been instructed by Dragon Futures Limited ("Dragon") to advise on creating/implementing due diligence procedures to enable Dragon to make VAT input tax claims on the sale and purchase of mobile telephones. In January 2004 the claimant, Arrowhead, agreed to make loans to Dragon on the strength of Arrowhead's business model which required these VAT input claims to be successful.

It transpired that the VAT input tax claims were connected to fraud, something Dragon should have been aware of, and accordingly HMRC rejected its claims for input tax. Dragon subsequently defaulted on the loan repayments, leaving a balance of some $52 million due to Arrowhead.

Assumption of duty/limitation

The claim by Arrowhead was for negligence in failing to carry out sufficient due diligence to identify the connection to fraud. Arrowhead argued that KPMG owed it a duty of care, because it had relied on that due diligence before agreeing to make loans to Dragon.

KPMG responded with a strike-out application. Arrowhead had never been its client, therefore it argued that it could not owe it a duty of care. The Court agreed, on the following basis:

  • There had been no direct communication between KPMG and Arrowhead prior to the loans being made;
  • There was no evidence to justify a reasonable conclusion by Arrowhead that KPMG had assumed a responsibility to it (the engagement letter between KPMG and Dragon was crucial to this conclusion);
  • Although KMPG would have known that its work would be considered by potential investors, it was not fair, just and reasonable to impose a duty of care on it in these circumstances.

KPMG also argued that Arrowhead's claim was statute barred. More than six years had passed since the loans had been drawn down.

The Court concluded that Dragon's covenant to repay depended on its ability to reclaim the input tax. It stated that the loans could only be repaid to Arrowhead if the VAT claims had succeeded, but that those claims were always going to fail (particularly because by November 2004, they had all been rejected by HMRC). The Court therefore held that even if "actual damage" had not been suffered when the various loans were advanced, it had occurred by November 2004, namely more than six years before Arrowhead brought its claim.

Conclusion

The case underlines the importance of carefully drafted engagement letters with appropriate limitations on liability. This was a key part of KPMG's successful strike out application and the Court's conclusion that it would be unjust to impose a duty of care on the defendant.

The judgement also provides further guidance on the Nykredit/AXA/Sephton cases on limitation, and includes analysis of how to determine the point at which damage first occurred.

Platform Funding Limited v Anderson & Associates Limited

Background

It was alleged that the defendant carried out a fraudulent mortgage valuation on a flat in Thamesmead. The flat formed part of a larger development consisting of flats sold predominantly by means of same day sub-sales and/or with significant incentives. The transaction itself was also part of a wider mortgage fraud.

In carrying out his valuation, the defendant had used comparables from the same development, despite the fact that by the time of the valuation the RICS Red Book required surveyors to consider comparable properties outside the immediate development. On the face of it, therefore, the valuation was negligent.

Causation

It was held that even if the surveyor had taken appropriate care, given the extent of mortgage fraud in the area and the inherent difficulties in providing an accurate valuation as a result of this, the valuation would have been the same. Further, the Court considered that it was the mortgage fraud itself which was the sole cause of the claimant's loss.

Conclusion

The case is likely to provide some comfort to surveyors. The defendant valuer was assisted by virtue of the fact that the criminal trial in respect of the various perpetrators of the fraud had already taken place, so the extent of their fraudulent activity was known to the Judge.

The judgement in this case may lead to surveyors arguing that where a transaction was part of a wide ranging mortgage fraud, the chain of causation between an alleged negligent valuation and a lender's loss will be broken.

As indicated above, this defendant was assisted by the criminal investigation and conviction of the fraudsters. Often this will not be the case and so whilst this judgement is helpful, proving such frauds in many cases will involve huge amounts of investigation, and therefore expense.

Andrew Brown v Innovatorone Plc – "The Innovator Litigation"

Background

The insurance market generally is familiar with this decision, which arises out of a class action by 555 claimants in relation to failed tax schemes. The defendants included law firm Collyer-Bristow ("CB"). CB had acted for Innovator, the promoter of the schemes.

CB were alleged to have acted in breach of trust, contract and fiduciary duty, to have been negligent and dishonestly assisted by distributing monies paid into its client account by the claimants without authority.

In his lengthy judgment, Mr Justice Hamblen found against the claimants, holding that as they were never CB's clients, CB owed them no such duties, nor did CB act dishonestly at any time. This aspect of the decision (like Arrowhead) underlines the importance of unequivocal engagement letters, and ensuring that the parties are clear as to who an appointed firm actually represents.

CB's claim against Lockton

Lockton were CB's appointed professional indemnity brokers for the purposes of obtaining insurance.

CB claimed that Lockton had negligently placed its professional indemnity insurance for the relevant insurance years into which these claims fell. The policy contained aggregation provisions in its different layers of cover, which CB argued meant that the cover in place would potentially have been insufficient to pay the likely damages and costs had CB lost at trial.

CB therefore sought an expedited hearing before the main trial, on the basis that Lockton's liability should be established first. They argued that if the claimants won, CB would in all likelihood face immediate collapse. CB also claimed that without knowing whether Lockton would be liable, it could not explore settlement with the claimants, because it would not know how much of that settlement it would have to fund itself.

Lockton argued against such a preliminary hearing, on the basis that there was no purpose to be served in establishing the issue of the extent of CB's insurance cover until such time as it was clear whether CB would be liable at all to the claimants. Lockton argued that following the trial in the main action, should CB actually be found liable, the basic building blocks would be established to then determine how the disputed aggregation clauses should be applied.

Outcome

CB's application failed. Although the Innovator litigation went in CB's favour, they are said to be considering their options.

Bryant v Solicitors Regulation Authority

Mr Bryant brought an appeal following the imposition by the SRA of conditions on his Practising Certificate. The claimant's practice had been intervened by the SRA. Mr Bryant was initially struck off for dishonesty, but on appeal he managed to persuade the Solicitors Disciplinary Tribunal to reduce his sanction to a two year suspension. Once his suspension had expired, subsequent Practising Certificates were issued subject to conditions.

The basis of Mr Bryant's latest appeal was that Solicitors practising subject to conditions found it almost impossible to obtain employment. The Court dismissed this, however, on the basis that even if conditions were not imposed, Mr Bryant would face the same difficulties given his disciplinary record which would need to be supplied to any prospective employer and their insurer. The difficulty of obtaining employment or indemnity insurance in the circumstances was not a sufficient reason to justify the removal of the conditions, especially as those conditions were sensible and proportionate.

First Reported Breach of a Regulatory Settlement Agreement

Earlier this year the Solicitors Disciplinary Tribunal (SDT) demonstrated how seriously it treats a breach of a Regulatory Settlement Agreement (RSA) by an individual. A Solicitor, Mr Bryson, had previously entered into a RSA with the SRA in May 2010 pursuant to which he had undertaken to make all reasonable efforts to trace and contact affected clients, having previously made unjustified deductions from their damages in respect of a "brokers fee" paid to a referrer. In consideration of his entering into this RSA he was severely reprimanded by the SRA and ordered to pay the costs of the investigation as well as providing full restitution to all of the affected clients.

It became apparent that Mr Bryson did not contact the clients as he had agreed and his default was reported to the SDT. The SDT felt that Mr Bryson's good faith must be open to question. Mr Bryson was suspended from practice for an indefinite period and ordered to pay the SRA's costs of £20,000.00.

This was the first case the SRA has taken to the SDT where a party to an RSA has not complied with its terms. The SRA reported that in almost all cases, compliance with the terms of an RSA is excellent but the case demonstrates how seriously any default will be treated.

Jackson reforms: an update

As the profession edges closer to the (current) implementation date for the Jackson reforms in April 2013, when The Legal Aid, Sentencing and Punishment of Offenders Act 2012 comes into force, further announcements are being made as to the details of the new costs arrangements.

One recent example is a small change to the existing Part 36 regime, whereby a defendant will have to make an additional payment to a claimant, where the defendant rejects a claimant's Part 36 offer but fails to beat the claimant's offer at trial.

It has come as no surprise that the additional 'sting' will be 10 per cent of the claimant's damages award (or in non-damages claims, 10 per cent of costs). For claims over £500,000.00, however, it is likely that the penalty will be limited to a maximum sum of £75,000.00. The existing penalties, such as the payment by the defendant of the claimant's costs on an indemnity basis, will also continue to apply.

Ariel Zeckler v Assigned Risks Pool Manager Capita Commercial Services Ltd (2012)

Can members of an LLP be held personally liable for their firm's unpaid insurance premiums? This was the issue at the centre of this case, which was heard at the High Court on 5 September.

Mr Zeckler, a member of Zecklers (which is no longer trading), argued that the statutory demand served upon him by the ARP for unpaid premiums was invalid. His case was that the ARP could not demonstrate that the normal rules relating to the 'veil of incorporation' should be set aside, given that because he had no personal contract with the ARP nor did he provide them with a personal guarantee.

The ARP's view was that members would be liable in these circumstances. Professional rules requiring members to maintain professional indemnity insurance were incorporated into the contracts of insurance between the ARP and the firms it insures (more particularly rule 10.3 of the Solicitors Indemnity Insurance Rules 2009).

The Court agreed with Mr Zeckler. The Judge, Nicholas Strauss QC, explained that he could see some merit in the argument that there was an implied contract between the members of a firm and its insurers, arising as a result of the professional rules. That said, he was not convinced by that proposition and could not get away from the lack of an express contractual provision to render members personally liable.

Many commentators are now raising concerns that this decision will deter new entrants to the solicitor professional indemnity insurance market once the ARP is abolished in October 2013. Any negative impact will be disappointing to the SRA, given its zero tolerance approach to non-payment of premiums over the past year.

One way to allow insurers to hold members personally liable for unpaid premiums is revised policy wordings, but this will only apply in relation to new policies. Amidst some criticism, the SRA is considering whether to appeal the decision.

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.

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