Court of Appeal gives guidance on aggregation, and answers the question: when does a solicitor ‘condone’ the acts of their dishonest partner?

The Court of Appeal handed down its decision in Discovery Land Company LLC v Axis Speciality Europe SE on 15 January 2024. It dismissed an appeal by the insurers of a firm of solicitors concerning the application of professional indemnity policies which adhere to the SRA’s Minimum Terms and Conditions (the MTCs), and in doing so has found that:

• For insurers to show that the MTCs’ dishonesty exclusion excludes a claim against a firm, all partners/directors of a firm will need to be shown to have committed or condoned the acts that caused the claim against the firm. Condonation requires knowledge of the causative dishonest behaviour, and to demonstrate that knowledge will require a detailed factual investigation in each case. General reprehensible or dishonest behaviour on the part of the condoning partner will not be enough, without more, to show that the test is satisfied.
• In applying an aggregation clause containing the linking provision “similar acts or omissions in a series of related matters or transactions”, again a detailed factual enquiry will be necessary. The questions of whether acts and omissions are ‘similar’ and whether matters and transaction are ‘related’ will be considered at a granular level.

Background

The background relates to the purchase of a Scottish castle by Discovery Land Company LLC (“Discovery Land”) in 2018. Jirehouse Partners LLP (“Jirehouse”) was a law firm controlled by a Mr Jones. Mr Prentice was the other partner in Jirehouse.

Discovery Land and affiliated entities engaged Jirehouse to structure the property transaction and transferred $14.5m to Jirehouse for the purchase. However, Mr Jones paid the sum away to a company he controlled and kept most of the funds for himself. He then convinced Discovery Land to send a further $9.3m to purchase the castle (the “Surplus Funds”); once purchased, without Discovery Land’s knowledge he used the castle as security for a loan of circa $4.9m (the “Loan”), again most of which Mr Jones used for his own purposes. When the transactions came to light, Discovery Land obtained judgment against Jirehouse. It brought a private prosecution against Mr Jones after the CPS declined to do so, and he was imprisoned for 12 years in 2022. Discovery Land also pursued the insurers of Jirehouse, Axis, in these proceedings.

Condoning dishonesty by a fellow partner – dishonesty exclusion

The MTCs contain a dishonesty exclusion providing that the insurer need not indemnify any claims arising from or involving dishonest acts or omissions “committed or condoned” by the insured. Where the insured is a company/LLP, the exclusion does not apply unless all directors/partners condoned the dishonesty. For example, in a firm with two partners such as Jirehouse, it may be obvious that one partner committed a dishonest act but to apply the exclusion to the firm insurers would also need to show that the other partner either ‘committed’ or ‘condoned’ the dishonesty which gave rise to the claim.

The question before the Court of Appeal was whether, absent any evidence that he had direct involvement in the dishonest acts, Mr Prentice had condoned them. In the 2022 High Court judgment, the judge ultimately found that Mr Prentice had not condoned Mr Jones’ dishonesty, for reasons explained below.

The Court of Appeal made the following findings as to the law on condonation (approving and building upon the first instance judge’s reasoning):

• To ‘condone’ will be given its ordinary meaning, i.e. to accept or approve the dishonest behaviour, even if by silence.
• There must be a causative link between the dishonest behaviour said to have been condoned and the claim for which indemnity is sought.
• Knowledge of the dishonest behaviour is required in order to condone it.
• However, an individual could gain that knowledge by condoning a whole pattern of dishonest behaviour; even if he or she were not aware of the specific causative act, if other similar acts had been condoned the knowledge requirement could be met.

The Court of Appeal then considered the High Court’s findings of fact, i.e. the facts to which the principles above would be applied. The High Court had made numerous adverse findings against Mr Prentice – that he had lied on several occasions, lacked the necessary integrity to be a solicitor, and was aware that Mr Jones was breaching the SRA’s core conduct principles (such as the temporary use of client money to address Jirehouse’s cashflow issues).

Despite these factual findings, the High Court had found that although Mr Prentice had sufficient information to engage his professional responsibilities, his failure to investigate matters further was not because he suspected that client monies were being used improperly. He did not have the requisite knowledge of Mr Jones’ dishonesty – and therefore could not condone it.

The Court of Appeal acknowledged that another judge, making the same findings of fact, might have drawn different and less favourable conclusions about Mr Prentice’s knowledge, but ruled that the High Court judge had carried out a proper process of evaluating the evidence and was entitled to reach the view that he did. The Court of Appeal emphasised the uphill battle that will face any party seeking to overturn a first instance finding of fact – they will need to show that the findings were “plainly wrong” – or to overturn conclusions reached on those findings on appeal where they were reached on a rational basis.

Aggregation

A second question arose for the Court of Appeal: if Axis was not entitled to decline the claim on the basis of dishonesty, was Jirehouse entitled to two limits of indemnity (one in respect of the Surplus Funds claim, and one in respect of the Loan claim), or did Mr Jones’ dishonest activities mean that the claims aggregated so that a single limit applied?

The Court of Appeal applied the Supreme Court’s 2017 judgment in AIG v Woodman, which involved a policy with similar aggregation provisions. In both cases, the question was in effect whether the claims aggregated on the basis they were “similar acts or omissions in a series of related matters or transactions”. In Woodman, the Supreme Court had reached the view that whether matters or transactions were “related”:

• was a highly fact-sensitive exercise;
• depended upon there being some “inter-connection” between them “in significant ways”; and
• required them to “in some way fit together”.

The Supreme Court found that commonalities between the claimants in the Woodman case (being investors in two failed development schemes) meant that there were two claims, not a single claim, due to differences between the schemes.

In this case, Discovery Land was claiming both for the additional $9.3m Surplus Funds procured from it by Mr Jones for the purchase, as well as the Loan loss of $4.9m. Again, the question was whether these were “similar acts or omissions in a series of related matters or transactions”.

The Court of Appeal in Discovery Land reached the view that the Loan and Surplus Funds transactions were not sufficiently similar. At a high level, as contended for by Axis, there were similarities – the theft of monies from client account and the close connection of the Discovery Land affiliated entities who had suffered the loss. However when considered in more detail, there were important differences, such as the specific acts giving rise to the thefts and the entities suffering the loss (Discovery Land and its SPV).

Furthermore, the Court of Appeal supported the first instance reasoning that the Surplus Funds transaction and the Loan transaction were not related; they did not ‘fit together’ (in the sense of the Supreme Court’s reasoning in Woodman) as they were not substantially interdependent. The fact that the losses both related to the same property, and were suffered by closely related clients, were not sufficient to provide the necessary ‘related’ link.

Comment

Dishonesty/Condonation

Whether or not a partner (or co-director) in a law firm has “condoned” the dishonest behaviour of others will always, the Court of Appeal held, be a question of fact. There will undoubtedly be a great many who, on the facts of this case, consider that Mr Prentice's conduct ought to have afforded Axis with a coverage defence. The Court of Appeal was certainly critical of his behaviour and went so far as to say that a different first instance judge might well have found in favour of Jirehouse’s insurers. Absent a conclusion that was not “plainly wrong” and “rationally unsupportable”, however, the Court of Appeal elected to stand by the judge at first instance’s findings of fact and the conclusions drawn from them.

To that extent, Mr Prentice’s conduct/the court’s views in respect of it have little bearing upon how other, similar, cases might be decided. However, the Discovery Land case addresses an important issue for solicitors more generally: where one partner/director acts dishonestly, at what point do the actions or knowledge of all others amount to “condoning” their colleague’s dishonesty?

The key findings on this issue were threefold:

1. First, the bar is a high one for insurers. Establishing dishonesty on the part of any partner/director in the first place will often be challenging and requires compelling evidence. Insurers will then need to demonstrate that the allegedly condoning partner/director had knowledge of the alleged dishonest conduct (though, in certain circumstances, this might include knowledge of a pattern of dishonest conduct, even if the specific causative act of dishonesty in question was unknown to them);
2. Second, the dishonesty condoned must be causative of the claim being declined. Absent it forming part of a pattern of dishonest behaviour, the condonation of a different act of dishonesty irrelevant to the claim under consideration does not engage the exclusion; and
3. Third, and in consequence, the fact that the condoning partner/director is, like their fraudulent colleague, a ‘bad apple’ is not a proper basis for applying the dishonesty exclusion. Even individuals who have engaged in unmeritorious conduct will not be excluded from cover (and neither, therefore, will the firm be) if the claim for which indemnity is sought does not arise from that conduct. It is the specific causative act of dishonesty under scrutiny, and the condoning partner’s knowledge of it, which is determinative of the exclusion’s application.

In short, where condonation is being considered, insurers will need to be sure of their ground in order to establish that the exclusion applies to an individual who did not take part in the dishonesty but became aware of it. Discovery Land makes plain that this test will be a tough one to meet in many instances. Of course, whilst (like any other) the profession will have some ‘bad apples’, most solicitors will ensure that they adhere to their professional obligations – including acting with integrity, protecting client money and assets and reporting any serious breach of the SRA’s regulations by another solicitor – such that precisely where the line is drawn on condonation will not arise.

Aggregation

Aggregation clauses, as acknowledged by the Supreme Court in Woodman, may operate in favour of the policyholder (by capping the per-claim deductible) or insurers (by capping the sum insured) depending upon the circumstances. Where aggregation clauses require ‘the same’ or ‘similar’ acts or omissions and/or ‘related matters and transactions’, the court is likely to engage in a granular factual exercise rather than approach the analysis at a high level.

Taking a step back, and whether looked at from the perspective of Discovery Land (and its related entities) or the solicitors, the two claims may have arisen from the same transaction, i.e. the purchase of the castle by Discovery Land via its SPV, such that Jirehouse was entitled only to a single limit of indemnity to respond to any claims arising from it. That argument however does not seem to have been pursued. The court’s view in any event was that this transaction was simply the opportunity for the theft of the Surplus Funds and the Loan monies: in this case, the two thefts gave rise to two limits of indemnity due to the insufficient commonality between them.

That the analysis might have gone either way demonstrates that, when faced with a prejudicial decision taken on aggregation by an insurer, policyholders should analyse the facts of their claim carefully in order to scrutinise whether multiple claims aggregate/do not aggregate under the policy as alleged by the insurer. The difference between paying one or multiple excesses, or having available one of multiple limits of indemnity is often the difference between a business surviving a claim and being unable to withstand the financial burden of it. Taking stock of whether what the insurer is (no doubt confidently) presenting as the correct analysis can therefore be a worthwhile, and perhaps business critical, exercise.

Tom Pangbourne, Daniel McKeown
Indemnity Legal
18.01.2024

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