Commercial court confirms scope of professional indemnity insurance cover will extend to losses related to accrued contractual rights

SUMMARY

In Royal & Sun Alliance Insurance Ltd v Tughans (A Firm), the Commercial Court affirmed that professional indemnity insurance will cover loss relating to accrued contractual rights as damages, if all pre-requisites to cover have been complied with.  Unless the policy expresses otherwise, there will not ordinarily be cover for restitutionary claims seeking to reverse gains to which an insured was never entitled.  RSA was therefore liable to indemnify Tughans in relation to a claim for repayment of a success fee that had been contractually due to it when paid, albeit because of a serious irregularity of the arbitration proceedings, the award was referred back to the Arbitrator to consider whether Tughans was actually able to pursue such indemnification.  

FACTUAL BACKGROUND

In April 2014, Mr Coulter (Coulter), a partner at law firm Tughans (Tughans), facilitated the sale of a Northern Ireland property loan portfolio held by National Asset Management Agency (NAMA) to Cerberus, alongside law firm, Brown Rudnick LLP (BRUK).  The engagement terms provided that Tughans would receive 50% of a £15m success fee when the transaction completed and BRUK had received the success fee from Cerberus.  The only stipulations were that Tughans had to make certain representations and warranties - including confirmation that the success fee would not be shared with current or former members of NAMA - and Cerberus needed to confirm the terms were acceptable to it.  These pre-requisites fulfilled, £7.5m plus VAT was transferred to account details provided by Coulter on completion in August 2014.  

Coulter allegedly told the Tughans' partners that he had generated only a £1.5m fee and transferred the remainder of the success fee to his own company for onward transmission to a Mr Cushnahan.  Cushnahan was a former member of the Northern Ireland Advisory Committee (NIAC) who had previously been involved with the work of NAMA on loans included within the sold portfolio.  BRUK therefore alleged that the representations made to them by Coulter were false and issued proceedings against Tughans for damages and loss caused by fraudulent and/or negligent misstatement among other heads of claim.  BRUK included repayment of the success fee as part of its claim (the entirety of which had been returned to the firm and became subject to undertakings preventing its distribution without prior notice to the Law Society of Northern Ireland and the National Crime Agency (NCA)).  

Tughans notified its professional indemnity insurers, Royal & Sun Alliance Insurance Ltd (RSA), of BRUK's claim for damages but cover was formally declined.  One of the grounds for declining cover in relation to the success fee was that Tughans had not suffered "a loss such as would give rise to a right of indemnity from Insurers" as Tughans had retained the success fee, which would not have been available if Coulter had acted honestly.  In response, Tughans issued a Notice of Arbitration against RSA seeking an indemnity for the costs and damages incurred by the other partners in the firm in facing BRUK's claim.

KEY LEGAL POINTS

Tughans did not pursue a claim under the policy for its share of the success fee.  However, it did argue that its agreement not to seek an indemnity under the policy in respect of the success fee did not apply if the money became unavailable as a means of meeting its liabilities (because tax and VAT had been paid or due to Tughans' undertakings to the NCA).  Regardless, the Arbitrator found that there was "no legal basis for removing that element of loss" from the general declaration of an award for damages as the success fee had formed part of BRUK's claim against Tughans.  As a result, the Arbitrator held that to the extent that BRUK proved it had suffered loss and was awarded damages (including in relation to the success fee), RSA would be obliged to indemnify Tughans, but RSA would not be liable for any restitutionary claim.

On RSA's appeal against the Arbitrator's award, the Commercial Court found a "serious irregularity", as the Arbitrator had failed to conduct proceedings according to the procedure agreed by the parties (as defined in the pleadings) and had not allowed RSA a reasonable opportunity to present a factual case in relation to the success fee. This resulted in the award's remittance to the Arbitrator to determine whether it should be open to Tughans to pursue their indemnity claim without any qualification as to the success fees' continued availability, and to decide what relief to grant.

Meanwhile, the Commercial Court considered the scope of Tughans' engagement in the underlying transaction and the cover provided by the insurance policy wording.  While it was Coulter's purported misrepresentation that formed the basis of Tughans' alleged liability to BRUK, the truthfulness of Coulter's representations and warranties had not been imposed as a separate pre-condition to the payment of the success fee.  Further, Tughans' letter of engagement had not been rescinded by BRUK, and so it remained voidable but not void.  As the terms of engagement had been complied with and Coulter had "done what is necessary as a matter of contract to accrue a right to the fee", the Commercial Court found that the success fee was contractually due to Tughans.  As such, the Court stated that "an award of damages in the amount of the fee payable will ordinarily constitute a loss for the purposes of a professional indemnity policy".  

COMMENTARY

It remains the case, following this decision, that "it is the ascertainment of the liability by settlement, judgment or award which creates the indemnifiable loss in third party insurance cover", unless the policy specifically provides otherwise.  In this case, Tughans' liability to BRUK in relation to the success fee had not yet been ascertained as it was still to prove its loss in the underlying proceedings.

Meanwhile, the Commercial Court affirmed that indemnity insurance will only cover actual loss and not restitutionary claims seeking to reverse a gain that never belonged to the insured, without express reference to such cover in the policy.  Success fees will now fall within the definition of loss as damages to the extent that they accrue as a contractual right to the policyholder, subject to policy terms and conditions.

There is no indication that this finding is limited to the success fees of solicitors.  Policyholders from all industries that charge success fees as part of their professional funding options will likely also be in a better position to obtain these from insurers if they form part of their incurred professional fees.  Obtaining success fees as a derived benefit from a transaction giving rise to a liability under a policy will only work if the terms of the policyholder's role in that transaction are clear and remain effective.

Policyholders should:

1. check their insurance policy wording expressly provides for the scope of cover that they intend – prior to policy placement or renewal, policyholders should check that they are comfortable with all policy provisions, but particularly the scope of the insuring clauses, and definitions of "Loss" and "Claim";
2. clarify whether the truthfulness of representations and warranties given to them by third parties, imposes a separate pre-condition to a transaction, contractual relationship or future payment; and
3. consider whether it is beneficial to reserve the right to claim additional relief and/or to widen the scope of jurisdiction, where the applicable rules allow, when bringing a claim (so as to avoid the challenge and remittance of an award to a tribunal of first instance).