The Court of Appeal’s judgment
A series of related acts or omissions?
HDI argued that Mrs Box’s thefts were a series of acts and omissions which were related, forming part of an extended course of dishonest conduct on multiple occasions over many years. Whilst accepting that this was a fact-sensitive question, there was nothing to suggest that there had been any break in Mrs Box’s dishonest conduct and all her thefts were underpinned by the dishonest way in which she had treated the firm’s client account. This, HDI argued, engaged Limb 2.
The Court of Appeal considered both Lloyds TSB General Insurance Holdings Ltd v Lloyds Bank Group Insurance Co Ltd  (Lloyds TSB), and AIG Europe Ltd v Woodman  (AIG) in rejecting HDI’s arguments.
Considering Lloyds TSB, the Court of Appeal concluded that before a series of acts or omissions can be said to be related, a unifying factor has to be identified, expressly or impliedly, in the wording of the clause. For example:
- If there is a series of acts A, B and C, it is not enough that act A causes claim A, act B causes claim B and act C causes claim C.
- What is required is that claim A is caused by the series of acts A, B and C; claim B is also caused by the same series of acts; and claim C too.
On the present case, this requirement would only be satisfied if each of the relevant claims arose from a combination of the relevant thefts. However, this was not the case here – one claimant’s claim would arise from a theft of its money and have nothing to do with a separate theft from a separate client. Neither claim would therefore arise from the same related series of acts.
AIG concerned Limb 4 and HDI sought to rely upon the Supreme Court’s statement that for transactions to be related, there must be “some inter-connection” between them, suggesting that the inter-connection between Mrs Box’s thefts was that they all arose out of her dishonesty. However, the Court of Appeal dismissed the suggestion that AIG impacted the argument run by HDI. In doing so it focussed on Lord Toulson’s comments in AIG, when discussing the need for a series of related matters of transactions to engage Limb 4 (Limb 2 was not the subject of argument in AIG), that:
"If insurers were permitted to aggregate all claims arising from repeated similar negligent acts or omissions arising in different settings, the scope for aggregation would be so wide as to be almost limitless."
The Court of Appeal concluded that Lord Toulson’s comments suggested that Limb 2 would not permit aggregation of claims arising from repeated similar acts of negligence either, which would be no different when considering repeated similar acts of dishonesty.
HDI’s argument was based on the MTCs definition of ‘claim’.
“Claim means a demand for, or an assertion of a right to, civil compensation or civil damages or an intimation of an intention to seek such compensation or damages.
For these purposes, an obligation on an insured firm and/or any insured to remedy a breach of the Solicitors’ Accounts Rules 1998 (as amended from time to time), or any rules (including, without limitation, the SRA Accounts Rules 2011) which replace the Solicitors’ Accounts Rules 1998 in whole or in part, shall be treated as a claim, and the obligation to remedy such breach shall be treated as a civil liability for the purposes of Clause 2, whether or not any person makes a demand for, or an assertion of a right to, civil compensation or civil damages or an intimation of an intention to seek such compensation or damages as a result of such breach…” [our emphasis]
Any breach of the Solicitors Accounts Rules had to be remedied promptly including replacement money improperly drawn from a client account.
HDI argued that:
- It was the duty of the innocent partners, on discovery that money had been taken from client account, to replace it.
- The second paragraph of the definition permits innocent partners to make a claim on their insurers for the money required and to do so before any clients know that they have cause for complaint, let alone before they assert a claim.
- Upon notification of Mrs Box’s thefts to HDI, the innocent partners were treating the shortfall in client account and the need to make it good immediately as a single deemed claim under the policy.
- Having recovered £2 million, which was a single limit of indemnity but less than the shortfall in the client account, they were not entitled to extend their protection beyond the limit of indemnity by treating subsequent claims, arising from the deficiency, as separate claims.
This argument was roundly rejected by the Court of Appeal. Mrs Box’s thefts were found to have given rise both to the right of the innocent partners to claim the amount needed to remedy the shortfall in the client account, and to a separate claim to indemnify them against liability to their clients. These represented separate claims, rather than a single claim as contended on HDI’s behalf.
The client account: a chink of light?
An issue arose during argument which was addressed briefly in the judgment:
- DCG operated a single mixed client account, with ledgers maintained in respect of each individual client.
- Had DCG operated separate bank accounts for each client, it would have been straightforward to identify those clients from whom Mrs Box had taken money. However, where funds are held in a single client account, the matter was less straightforward. Where there is one fund, who is to say which client’s money has been stolen?
- Whilst, in practice, a fraudulent solicitor will seek to cover their tracks by making a dishonest balancing entry in one client ledger, this would notionally allow the fraudster to decide where to allocate the loss arising from their theft. The Court of Appeal expressed doubt as to whether this was an appropriate methodology to determine who had suffered losses from a client account theft.
- During the course of argument Phillips LJ suggested that the position may be that each client is entitled to call for payment of their money and if they are not paid (due to a client account shortfall) they will have a claim. That shortfall will not be attributable to any one particular theft, but to the cumulative effect of all the thefts that have taken place.
- On that analysis it could be said that each client who has a claim against the firm has a claim which arises from all the acts of theft taken together, potentially satisfying Limb 2.
In circumstances where the thefts were not exclusively from MCB’s client account, and since the argument had not previously been raised, the Court of Appeal left the point undecided. We can anticipate this argument being developed in subsequent client account shortfall claims.
The Court of Appeal’s judgment, like the first instance decision, will be of concern to primary layer insurers (and welcomed by those only providing excess layer cover to solicitors). As indicated earlier, these sort of frauds often span many years and numerous clients. Aggregation arguments often advanced by primary layer insurers will now be more difficult to sustain. Multiple primary limits of indemnity may be repeatedly “hit” by such claims.
In an already hard market, with many firms seeking to renew in October, the decision could not have come at a worse time. We anticipate primary layer underwriters will regard this decision as material to their pricing. Further due diligence/auditing of financial systems (including enhanced financial risk questionnaires and disclosure) as to the potential for financial mismanagement is also likely. Firms may wish to be proactive and show underwriters that their payment procedures have been tightened to make the risk of client account fraud less likely.
After the Lloyds TSB decision, the insurance market lobbied the Law Society for a change to the aggregation provisions in the MTC. Similar steps could be taken again. But that will not help firms struggling for cover this October. One can also anticipate resistance to this on the basis, often quoted, that the primary purpose of solicitors’ PI insurance is the protection of the public and not necessarily the solicitor.
Related item: Aggregation of client account thefts: a challenging first instance decision for primary layer insurers