UK: To Litigate Or Not? What Insurers Need To Consider Before Going To Court

Last Updated: 28 May 2009
Article by Nichola Evans

It's official, the UK economy is now in a recession. And inevitably, the insurance sector will see a rise in fraud, an increase in the level of defaulters and a squeeze on profits. It will also see a hike in the number of litigation cases, according to Nichola Evans, partner at law firm Browne Jacobson.

To badly paraphrase Jane Austen, it is a truth universally acknowledged that commercial litigation increases during a period of recession. With commentators now suggesting that we are entering the worse recession for 50 years what is likely to be the legal fallout?

Statistics show that litigation is rising. Whilst the number of cases being issued in the Commercial Court fell between 1999 and 2005, they rose again significantly in 2006. The Ministry of Justice Judicial Statistics show that in 2005 49,442 cases were issued whereas in 2006 this figure jumped to 61,691 cases. There was a further increase in 2007 and most commentators expect that trend to continue for the foreseeable future.

As companies face more and more financial pressure, they are forced to look at their bottom line. This leads to debts being chased more effectively, but one further consequence is that companies will look to their advisers and analyse the quality of the advice which has been given.

The recent financial crisis – which has hit global markets and banks alike - has led to what one newspaper called a "tsunami of lawsuits". There has also been judicial comment upon the likely rise in litigation most notably in the case brought by RAB Capital against PricewaterhouseCoopers, the administrators of Lehman Brothers.

So far the bulk of the litigation has been brought in the United States, much of it by way of class action – where many individuals group together to bring a case against a third party such as a company. Part of this is due to the fact that in the US one has the ability to claim punitive damages and also the Claimant is not responsible for the Defendant's costs.

"There have been various forms of claim and inter alia:

  • Investors v banks – this can relate to allegations of negligent misstatement, the purchase of asset-backed securities based on bad loans or for improper accounting.
  • Businesses v banks – in particular pension funds companies who have assessed how much money has been lost on the back of sub prime investments.
  • Banks v banks – for instance Barclays Bank who sued Bear Stearns over its management of a hedge fund.
  • Businesses v lawyers and accountants and these types of claim have taken various forms.

The common theme here is that in due course – some taking months, some years - these claims will all arrive on the desks of the insurers of the defendant companies.

Over the coming years it is anticipated that the legal fallout will dwarf that of any other crisis of any other time, including Enron. An examination of a couple of cases in this particular area - which have been decided in the last twelve months - are of interest as they may provide us with valuable lessons for the future.

HLB Kidsons v Lloyds Underwriters & Others [2008]

This is a Court of Appeal decision and results from an appeal made by Kidsons – the accountancy firm - against a High Court ruling that they had failed to notify their professional indemnity insurers in relation to a number of claims relating to tax advice.

Under the terms of their professional indemnity policy of insurance, Kidsons was obliged to notify a claim "as soon as practicable of any circumstance of which they ... shall become aware during the [policy period] which may give rise to a loss or claim against them". The policy was a "claims made" policy.

Kidsons sold tax avoidance products through a partner company, where one of its employees raised concerned about the implementation and design of a number of the products it was marketing. Subsequently, the firm wrote to its brokers on a number of occasions about various concerns that it had about the products.

It was simply a matter of time before a claim was filed against the firm, citing a number of allegations, specifically, that the products were flawed; that the products were mis-sold and that there were failures in the implementation of the scheme.

This case turned on whether there had been an adequate notification of the claims from the firm to its insurers and if so when. Not all of the letters written were held to constitute adequate notice.

So what constitutes notification? Lord Justice Rix held that it had to be "reasonably clear" on an objective basis to the insurer that what was being notified was intended as a trigger to cover being granted.

It is also clear that the insured has to be aware of the circumstances which may give rise to the claim on an objective basis. The Court of Appeal did not give an opinion as to what constitutes a "circumstance" but if one looks to the lower court it was suggested that this needs to be a "fact, event, happening or state of affairs".

In some respects this sounds rather woolly and does not provide the clearest of guidance for insured. So what should an insured party look out for? It is submitted that the concerns of others can amount to a "circumstance" even if the insured believes that the concern of others are unjustified. However, it is important for the insured to provide sufficient detail to allow the insurer to make a decision on those facts. Lord Justice Toulson suggested that if a report was not sufficiently detailed then it may not give rise to a claim. This does not give insurers carte blanche to reject a claim if it is imprecise though! It is a case of fact and degree in each and every matter.

This obviously creates something of a minefield for brokers though and will probably result in brokers having to be a little more pro-active, particularly if there appears to be a shade of grey to what the insured is actually doing. Brokers will need to understand what the insured is trying to notify and if that is not immediately clear make appropriate enquiries of the insured. Once the broker has made such enquiries then the broker will also need to make sure that each and every underwriter has received adequate notice of the claim.

J P Morgan Bank (Formerly Chase Manhattan Bank) v Springwell Navigation Corp [2008]

This case related to a claim made against the bank alleging a failure to advise in relation to emerging market investments. Springwell was investing heavily in a particular type of derivative instrument reference to bonds. When the issuer of the bond defaulted, the portfolio collapsed in value. Springwell claimed damages alleging that J P Morgan should have advised that this was not an appropriate investment.

The claim was dismissed. The court found that no advisory relationship existed and that the obligations of an investment manager or asset manager were not imposed. In reaching this decision the court took account of how the business between the parties was conducted. In addition the court reviewed the contractual documentation which existed between the parties and this showed that the parties contracted on the basis of a trading and banking relationship and this also meant that no advisory duty came into existence.

Although this case does not form new law, it is a useful reminder of what hoops a claimant needs to jump through in order to bring a claim. The case is a timely reminder that one needs to carefully analyse the scope of the retainer and therefore the nature and extent of the duty owed by the professional before looking at the issue of whether or not the professional exercised the requisite degree of skill and care that one would expect of a professional in that position.

Trends For The Future

Claimants tend to underestimate how much time and effort they need to put into the preparation of the case, from instructing a solicitor to locating documents and dealing with the burden of disclosure through to the preparation of witness statements and attendance at trial itself. This may in part explain why although there are more claims being issued, these have not made their way to trial. In a soft market, Defendants are more likely to look to settle claims and use alternative dispute resolution (ADR) procedures to achieve the same even if there are reasonable prospects of success. With the hardening of the market insurers are more likely to vigorously defend claims and only settle those that are entirely meritorious. Expect to see more contested claims in the first instance.

Furthermore, one has to bear in mind that litigation is an expensive process and given the economic climate, businesses are going to have to weigh up whether they wish to commit to a legal spend or whether the monies that would be involved could be better invested in the business. A lot of publicity has been given to the "no win, no fee" basis upon which cases can be fought. However for complicated cases of this sort, it may be difficult to find a solicitor to take the case on this basis. In addition, when a case is adopted on this basis one would normally take out and insurance product so that in the event that the case is lost, one's opponent's costs are met. Again, this is not a cheap process and a proposed Claimant would need to take a good commercial look to see if this could be justified.

Looking ahead, we are most likely to see litigation from some of the larger commercial organisations and certainly one of the most fertile areas for such action will surely be mortgage fraud. More specifically, we are also likely to see a rise in litigation among firms that have pushed the envelope of prudence when developing the newer investment vehicles."

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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