Solicitors’ PI Insurance – success breeds success in coverage dispute

In a dispute regarding the scope of compulsory professional indemnity insurance for solicitors in Northern Ireland, the Court of Appeal in Royal & Sun Alliance Insurance Ltd and ors v Tughans has recently upheld the earlier decisions that the insuring clause is sufficiently wide to cover liabilities which include a firm’s fees, in this case a very substantial success fee. The Court’s analysis highlights the significance to its decision of the breadth of the insuring clause, the function of compulsory PI cover being the protection of both clients and solicitors, and the composite nature of the policy.

The Tughans Fee

The dispute arises from the sale in Northern Ireland of a portfolio of loans by the National Asset Management Agency (NAMA) in 2014 to Cerberus Capital Management (Cerberus) for £1.3 billion, following the 2008 financial crash. A Mr Ian Coulter, then managing partner of Tughans, a partnership practising in Belfast, and also Chairman of the Confederation of British Industry, was at the forefront of the sale initiative. Mr Tuvi Keinan, a partner at Brown Rudnick LLP (BR), was approached by Mr Coulter to find a potential purchaser for the portfolio. BR entered into a retainer with the buyer, Cerberus, which provided for BR to receive a success fee of £15 million upon successful completion of the acquisition, and was subject to certain representations and warranties, including that BR would not make/promise to make any payments to anyone in breach of anti-corruption laws. BR was also required by the terms of its engagement letter with Cerberus to obtain certification of those same representations and warranties from Tughans, with whom BR had agreed to share the success fee with the result that Tughans stood to receive £7.5 million on completion (Tughans Fee). The terms provided importantly that the success fee would not be payable unless and until Cerberus accepted Tughans’ certification. Mr Coulter made the required certifications which Cerberus accepted.

Prior to completion of the sale, NAMA came to learn that BR had sub-contracted part of their work to Tughans and agreed to share the success fee. This prompted NAMA to seek confirmation from Cerberus that no part of that fee would be paid to any current or former member of the Northern Ireland Advisory Committee (NIAC). Both Mr Coulter and Mr Keinan provided such confirmations to Cerberus, whereas it was later said that a Mr Frank Cushnahan, a member of NIAC from 2010 to 2013, had in fact been working closely with Mr Coulter and even had his own room at Tughans from which to conduct his own business interests.

The sale to Cerberus completed and Mr Coulter, apparently unknown to his partners at Tughans (Mr Coulter had not in fact opened a file for the matter), invoiced BR for the Tughans Fee. £9 million (the Tughans Fee with VAT on top) was deposited in an account which it was suggested was not Tughans’ ordinary office account. Shortly thereafter, Mr Coulter disclosed to his partners that he had generated a more modest fee of £1.5 million plus VAT from a highly confidential transaction, before transferring the balance of £7.2 million to a company in his own name in the Isle of Man.

Unsurprisingly, matters quickly unravelled for Mr Coulter who then disclosed the full amount of the Tughans Fee and the whereabouts of the balance. Some £6 million was returned to a Tughans account, the Law Society of Northern Ireland was notified, Mr Coulter promptly resigned and Tughans notified its insurers. The firm avoided an intervention upon providing undertakings that it would not deal with the fee in any way, save to permit the payment of tax due on it, leaving a balance in its account of some £4 million. Criminal charges were then brought against both Mr Coulter and Mr Cushnahan.

The claims against Tughans

BR entered into a settlement with Cerberus, with BR and its insurers taking an assignment of Cerberus’ claims against Tughans, and then pursued Tughans for damages for misrepresentation, breach of contract, breach of fiduciary duty and negligence. Damages representing the entire £15 million success fee were claimed, along with damages in respect of costs incurred by Cerberus and BR relating to the criminal and civil investigations, and for lost profit. Significantly, however, no claim was made for rescission of the retainer with Tughans, nor any restitutionary claim, whether in unjust enrichment or as constructive trustee of the Tughans Fee: the claims against Tughans were for damages only and involved affirming the Tughans retainer. Those claims were stayed pending the outcome of the criminal proceedings, whilst in the meantime Tughans sought a declaration of cover in arbitration proceedings against insurers.

The scope of cover

Tughans had compulsory insurance as required by the Law Society of Northern Ireland in terms which those familiar with the SRA Minimum Terms will recognise, the insuring clause of which provided:

“The insurers will indemnify the Insured in respect of claims or alleged claims made against the Insured … in respect of any civil liability (including liability for claimant’s costs and expenses) incurred in connection with the Practice…provided that no indemnity will be given

1. to any individual committing or condoning any dishonest fraudulent criminal or malicious act…” 

Whilst ‘Tughans (a firm)’ was named in the arbitration proceedings, it was the equity partners who were each responsible for the partnership liabilities, they were the insureds under the composite policy and it was the scope of the cover for their individual liability which was in issue in the case.

The coverage dispute

Insurers had declined cover on two grounds: first, that Tughans’ involvement did not meet the policy requirement that a claim be in respect of civil liability “incurred in connection with the Practice carried on by or on behalf of the Solicitor” (the Solicitors Practice Issue) and, secondly, because the policy was a contract of indemnity which would only respond to a loss, whereas any liability on the part of Tughans in respect of the Tughans Fee was not a loss because the partners had received and retained it.

The arbitrator rejected insurers’ argument on the Solicitors Practice Issue, finding that the various services provided by Mr Coulter were sufficiently solicitorial in nature. He went on to determine that there was no legal basis to strip out the Tughans Fee from the general declaration of cover since it formed part of the claim for damages and there was no basis for removing it merely because Tughans had made a ‘gain’ by its receipt. Declarations were accordingly made that insurers were liable to indemnify all of the claims and defence costs. Whilst there was a carve-out of cover for any restitutionary claim, this did not assist insurers since there was no claim for restitution and, even if there was, it would be treated as ancillary to the damages claim.

Insurers appealed in respect of the declaration as to their liability in respect of the Tughans Fee, the point of law being insurers’ contention that policies of professional indemnity insurance are not intended to indemnify for loss of a sum to which an insured was never entitled, there being no ‘loss’ and therefore no ‘insured loss’ at all. This was argued first on the basis that the Tughans Fee had never been contractually due on account of the (assumed) untruth of the representations made by M Coulter. Foxton J rejected this on the basis that entitlement to the fee accrued unconditionally upon the provision of the representations, regardless of their truth. That determination was not appealed.

Insurers alternative argument, however, was that Tughans had no entitlement to the fee “in substance”. It was a fee to which Tughans should not have been entitled because it was procured by misrepresentation. If it was in effect obliged to return it as part of a damages claim, it had not lost something to which it was entitled as a matter of substance, just as if the contract were avoided and it was obliged to return it, or its value, in a restitutionary claim: as it was put, “any defeasible contractual right to the fee was a matter of empty legal form, not substance” and affording cover in such circumstances would violate the indemnity principle.

The Judge likewise rejected this argument on the basis that, where a solicitor has accrued a right to a fee, an award of damages reflecting the fee payable will ordinarily constitute a loss for the purpose of a professional indemnity policy. In this case, the contract had not been rescinded and the Tughans Fee belonged in law and equity to Tughans regardless of whether payment of the fee might have been induced by misrepresentation. If there had been any misrepresentation it would have no effect on the solicitor’s entitlement to indemnity if sued for damages in the amount of the fee paid.

It was this alternative argument which came before the Court of Appeal. Lord Justice Popplewell, giving the only judgment, had no hesitation in dismissing insurers’ appeal for the reasons given by Foxton J, but made a number of additional observations on the indemnity principle which was at the heart of insurers’ submissions:

• The policy’s insuring clause is very wide, not limited to damages but affording cover for claims for any civil liability.
• An ascertained liability is generally regarded as a loss (without the need for prior payment to discharge it it) both in the general law and in liability insurance.
• A solicitor who has contractually earned a fee and is deprived of it by a liability claim does suffer a loss because they have provided consideration by way of the provision of solicitorial services which typically involve a cost (fee earner time, overheads etc) and therefore a genuine loss. They have also lost the opportunity to deploy the firm’s resources profitability elsewhere.
• The unusual size and structure of the Tughans Fee in this particular instance makes no difference to the point of principle – it was regarded by both parties as one commensurate with the value of the services Mr Coulter had provided which contributed to the successful Cerberus acquisition.
• It does not represent a windfall to Tughans if they retain the fee or any part of it where, unless and until the contract is avoided, they remain entitled to it. That is not a matter of technical or formal legality but a matter of substance, and to treat an earned fee but which is procured by misrepresentation in the same way as an unearned fee is a false equiparation.
• For the policy not to afford cover in these circumstances would run contrary to the functions of compulsory PI insurance for solicitors in protecting not only solicitors (from their own negligent mistakes and from the fraud of colleagues) but also the public, ensuring the solicitor is financially able to compensate their client for any liabilities found to be owed. On the insurers’ case, there would be no entitlement to indemnity even if Mr Coulter had absconded with the entire fee.
• Insurers’ argument ignored the composite nature of the policy, there being a number of separate contracts where the fraud of one insured does not affect the other’s right to indemnity. Any individual partner would be liable for the entire partnership liability to BR in respect of the Tughans Fee but would typically be entitled only to a proportion of that fee. If there was no cover in such circumstances, each innocent partner may very well be left substantially uninsured.

Finally, and whilst the issue did not arise in this case since the claim was one for damages, the Court did consider the position where the claim was restitutionary in nature. Whilst it was satisfied that the policy would respond to such a claim where the fee had been earned (because this represented a genuine loss), it was not prepared to accept that it would not necessarily respond to a restitutionary claim where the fee had been received but not earned, giving the example of a solicitor who receives money on account of fees before an employee negligently transfers the money away before the fee is earned. The Court declined, however, to express any concluded view, particularly given all the various circumstances in which restitutionary claims might arise.

Comment

Whilst innocent partners in law firms are entitled to cover under the SRA Minimum Terms for claims for damages resulting from the fraud of a rogue partner whose behaviour they have not condoned (on which point see the recent decision in Discovery Land Co LL v Axis Speciality Europe SE [2023] EWHC 779 (Comm)), the case highlight the potential risks to law firms and their insurers arising from atypical fee arrangements which in this instance resulted in the partners being pursued in respect of a £7.5 million fee generated by a retainer of which they were oblivious and where a file hadn’t even been opened. The Court’s decision will provide comfort for practitioners that they will have cover in respect of such liability, although they and their insurers will want to ensure that rigorous processes are in place when agreeing fee arrangements to minimise the risk of similar occurrences.

Whilst to some the decision may appear somewhat curious (insurers referred to the seemingly anomalous consequences which would follow for an insured depending on whether the fee had been paid by the client, in which case there would be cover, and where it had not, in which case an equitable set-off would be applied), the Court emphasised that in circumstances where the fee had not in fact been paid, there could be no ascertained civil liability on the part of the insured in respect of it (such as to bring it within the policy’s insuring clause), and so – in contrast to the position where the fee had been received – no liability on the part of the partners