UK: What Lies Beneath

Last Updated: 21 August 2008
Article by Fergal Cathie and Gaby Kaiser

In the current climate it is, unfortunately, becoming increasingly common to see claims against professionals that include allegations of dishonesty. An allegation of dishonesty can have reputational and financial consequences for individuals, firms and their professional liability insurers, and requires a rigorous and careful analysis.

This article provides an overview of the current state of the law, dealing in particular with the decisions in Twinsectra Ltd v Yardley and Others (2002) and Barlow Clowes International Limited v Eurotrust International Limited (2006), and considers how the courts have approached the application of these decisions. Although an exhaustive discussion of all the issues arising out of claims involving dishonesty (including the vicarious liability of "innocent partners") is beyond the scope of this article, we will briefly consider the application of the test for dishonesty in the context of claims against professionals and provide a reminder of some of the issues that insurers should consider when reaching a decision as to whether or not an indemnity should be provided.

What is the test?

An objective test for dishonesty was set down by the Privy Council in Royal Brunei Airlines v Tan (1995); in particular, Lord Nicholls concluded that: "acting dishonestly, or with lack of probity, which is synonymous, means simply not acting as an honest person would in the circumstances. This is an objective standard". Lord Nicholls went on to identify that "carelessness is not dishonesty" but also that "honesty is not an optional scale, with higher or lower values according to the moral standards of each individual".

The Tan test was scrutinised a few years later by the House of Lords in Twinsectra. In Twinsectra, the House of Lords upheld the objective test laid down in Tan but arguably introduced an element of confusion by effectively adding a second subjective stage to the test. In particular, their Lordships concluded that: "a dishonest state of mind requires consciousness''that `one is transgressing ordinary standards of honest behaviour" (our emphasis). The consequence of the foregoing appeared to be that a two-stage test required an individual to know that the relevant facts would alert the ordinary person to the dishonest nature of the transaction and that the ordinary person would have concluded that the transaction was dishonest.

Twinsectra created a degree of uncertainty and has since been subject to considerable scrutiny and debate, not least by the Privy Council in Barlow Clowes. In Barlow Clowes, their Lordships sought to provide clarity, although there remains considerable debate as to whether this was achieved; in particular, their Lordships sought to eliminate some of the confusion over the interpretation of the subjective element of the test in Twinsectra.

In rejecting the submission made on behalf of Mr Clowes, the alleged fraudster, that the court had to consider whether or not he appreciated that his actions would be considered to be dishonest by generally accepted standards of dishonesty, their Lordships accepted that, although Lord Hutton's judgment in Twinsectra might have suggested that such an approach was appropriate, a subjective analysis was not in fact part of the test.

Although Barlow Clowes appeared to reinstate the objective test, subsequent decisions suggest that the judiciary is not yet entirely clear. In Abou-Ramah v Abacha (2006), the Court of Appeal concluded that it did not need to consider whether the decisions in Twinsectra or Barlow Clowes conflicted with one another, given the particular facts of the case, but Lady Justice Arden concluded that an objective test, per the Court of Appeal in Barlow Clowes, should be applied.

More recently, in The Attorney General of Zambia for and on behalf of the Republic of Zambia v Meer Care & Desai & Ors (2007), Mr Justice Peter Smith concluded that the "analysis [as to whether the test was objective and/or subjective was] largely a matter of over elaboration" and that the "test for dishonesty is essentially a question of fact whereby the state of mind of the Defendant had to be judged in the light of his subjective knowledge but by reference to an objective standard of dishonesty".

In Zambia, Peter Smith J suggested that lawyers had been "sidetracked by Twinsectra"; he agreed with and quoted Lord Clarke MR's article "Claims against Professionals: Negligence, Dishonesty and Fraud" (2006) in which he opined that lawyers and commentators had been wrong to conclude that Twinsectra was a departure from the objective test set out in Tan. That, of course, is essentially the same conclusion adopted by the Privy Council in Barlow Clowes. Peter Smith J reached the same conclusion in Hanco ATM Systems Limited v Cash Box ATM Systems Limited (2007), applying that it was not necessary to consider the relevant case law. It was found that Peter Smith J had failed to apply the test appropriately to the findings of fact made in respect of Mr Meer.

Notwithstanding the above, commentators and practitioners remain unclear as to whether or not a tension exists between the tests articulated in Twinsectra and Barlow Clowes, although Lady Justice Arden's judgment in Abacha suggests not. Similarly, Peter Smith J's interpretation of the test appears to accept the objective test originally formulated by Tan and adopted in Barlow Clowes.

Where are we now?

Is further judicial authority needed? There is no guarantee that an additional decision of the House of Lords will take us any further than Barlow Clowes, and the courts will continue to have to apply the law, whatever the criteria, to the specific facts, which will inevitably be difficult in cases of dishonesty

One final distinction to make is in the context of disciplinary proceedings against solicitors. In Bryant and Another v The Law Society (2007), on appeal from the Solicitors' Disciplinary Tribunal, the court decided that the test is: "as it was widely understood to be before Barlow Clowes, that is a test that includes the separate subjective element." In essence, the court considered that in the disciplinary context, the test should be more closely aligned to the criminal test, given the "extremely serious consequences" following a finding of dishonesty. It is not clear whether other professional bodies will take the same approach, but we consider that it would be difficult to justify a different approach to that which applies to solicitors.

Conclusion

It will be important carefully to assess, both at the outset and on a continuing basis, whether or not an indemnity can or should be declined on the basis of (alleged) dishonesty bearing in mind that, for some insurers, the policy will require them to be responsible for the payment of defence costs until such time as an admission of dishonesty or a judgment has been obtained. Insurers should always consider whether or not to decline cover is the best approach from a commercial perspective given, for example, that a dishonest insured may seek to circumvent the dishonesty exclusion by agreeing to a settlement based on an admission of negligence, and then seek recovery of the settlement sum and costs from the insurer. In the absence of an admission or finding of dishonesty, it is not always easy for the insurer to refuse the request for an indemnity. It would, however, still be open to insurers to look into the details of the matter to seek to establish whether there was dishonesty.

Given the potential impact of a declinature upon a professional, both in reputational and financial terms, insureds will be keen to ensure that in every case involving allegations of dishonesty a careful and fair analysis of each case is undertaken as soon as practicably possible. On the other hand, insurers will wish to ensure that dishonest insureds do not receive the benefit of cover

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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