Insurance Update October 2007

Insurance Update October 2007 In brief... 2 Notification of circumstances... 2 Insurance law reform... 2 Corporate manslaughter... 2 Companies Act 2006... 2 Conflict of interest... 2 Court fees... 2 Estimates & budgets... 2 TCC pre-action protocol... 3 LCS initiative... 3 Auditors... 3 MAN Nutzfahrzeuge AG v Freightliner Ltd importance of SAAMCO in the context of special audit duties and liability to third parties... 3 Stone & Rolls Ltd v Moore Stephens application of ex turpi rule to companies suing their auditors... 4 Construction of policy...5 Tesco Stores Ltd v Constable public liability insurance does not generally provide cover for pure economic loss... 5 Notification... 6 HLB Kidsons v Lloyds Underwriters effect of clause in professional indemnity policy requiring notification of circumstances as soon as practicable... 6 Solicitors... 8 Funnell v Adams & Remers claimants costs of extricating themselves from predicament caused by solicitors negligence are recoverable... 8 Mills & Reeve LLP is a limited liability partnership regulated by the Solicitors Regulation Authority and registered in England and Wales with registered number OC326165. Its registered office is at Fountain House, 130 Fenchurch Street, London, EC3M 5DJ, which is the London office of Mills & Reeve LLP. A list of members may be inspected at any of the LLP's offices. The term "partner" is used to refer to a member of Mills & Reeve LLP. 1

In brief Notification of circumstances see under Notification below for a summary of Gloster J s ground-breaking judgment about notification of circumstances in Kidsons v Lloyds Underwriters. Insurance law reform the consultation period ends on 16 November 2007. Links to a summary of the paper, the full paper and the three issues papers (on misrepresentation and non-disclosure, warranties and intermediaries and pre-contract information) are available on the Law Commission s website. See the August 2007 Insurance Update for more information. Corporate manslaughter - the Corporate Manslaughter and Corporate Homicide Act 2007 received Royal Assent on 26 July 2007 and comes into force on 6 April 2008. The Act creates a new statutory offence of corporate manslaughter replacing the common law offence of manslaughter by gross negligence. It will apply to companies and other corporate bodies (in the public and private sector) and other bodies such as Government departments and police forces. Directors and managers can still be held to account through existing health and safety laws and the common law of manslaughter. Companies Act 2006 some sections of the new Companies Act came into force on 1 October 2007. These included those concerning derivative claims by shareholders and directors new statutory duties. The duty to promote the success of the company for the benefit of the members replaces the duty to act in the best interests of the company and requires directors to give proper consideration to certain factors, set out in statute, when reaching decisions. These include the interests of the company s employees and the impact of the company s operations on the community and the environment. Companies are being advised to check their director s liability indemnity arrangements and D & O cover. Conflict of interest AKAI retained RSM Robson Rhodes LLP to act as its expert in an action against its auditors. Robson Rhodes then announced that it was going to merge with Grant Thornton, which in turn was acting on behalf of the auditors being sued by AKAI. In view of the resulting conflict of interest, AKAI applied successfully to the court for an interim injunction restraining the merger unless the accountants involved gave AKAI appropriate undertakings - Akai Holdings Ltd v RSM Robson Rhodes LLP [2007] EWHC 1641 (Ch). Court fees new court fees came into effect on 1 October 2007. These include a hearing fee of 1000 for multi-track cases based on the cost of one day in court. It is planned to introduce a system of additional daily or half-daily fees in due course for longer trials in commercial cases with a pilot in one of the specialist courts in 2008. Estimates & budgets the courts are going to get tough about costs estimates and cost budgeting is still being considered as an option to clamp down on escalating court fees. Master Whitaker, the new Senior Master of the Queens Bench Division, has asked leading City firms to provide feedback to the Civil Procedure Rules Committee about proposals to 2

require firms to provide binding costs budgets at the outset of cases, with sanctions if these are exceeded. TCC pre-action protocol the protocol for construction and engineering disputes, which applies to professional negligence claims against architects, engineers and quantity surveyors, has been amended twice this year. For the latest version which came into effect on 1 October 2007 click here. Those acting for defendants should note that they have 28 days to reply to a letter of claim or with agreement they can extend time for up to a maximum of 3 months only. The protocol also encompasses claims for professional fees Cundall Johnson and Partners LLP v Whipps Cross University Hospital NHS Trust [2007] EWHC 2178 (TCC). LCS initiative for the next six months the Legal Complaints Service is going to require solicitors insurers to pay awards it makes for inadequate professional services where the firm in question cannot or will not pay. Auditors MAN Nutzfahrzeuge AG v Freightliner Ltd importance of SAAMCO in the context of special audit duties and liability to third parties [2007] EWCA Civ 910 The Court of Appeal has upheld the decision of Moore-Bick LJ (sitting as a Commercial Court judge) that Ernst & Young were not liable to indemnify Freightliner against a claim for fraudulent misrepresentation brought by MAN in respect of their purchase of Freightliner s subsidiary ERF. MAN sued Freightliner for 350m in damages arising from losses made after the acquisition of truck manufacturer ERF from Freightliner s predecessor Western Star. Freightliner in turn sued their auditors E&Y, alleging that they should have picked up on the fraudulent accounting of ERF's financial controller, Mr Ellis. E&Y admitted that their statutory audits of ERF had been negligent but denied that they had assumed responsibility for a special audit duty to Western Star in respect of representations made to MAN as to the accuracy of the ERF accounts. There was no factual basis for a challenge to the judge's finding that it was not foreseeable by E&Y that Western Star would make any representations as to the accuracy of ERF's accounts which went beyond, or were outside, those contained in the share purchase agreement. Freightliner had not shown that E&Y knew that Western Star was intending to make representations as to the accuracy of accounts in its negotiations with MAN and it could not be said that, in making the audit statement as to the relevant accounts, E&Y was assuming responsibility to protect Western Star from liability for dishonest statements which Mr Ellis might make as to the accuracy of those accounts. Comment: although auditors do not owe a duty of care to shareholders or prospective purchasers in undertaking a statutory audit of the target company, it is possible for auditors to take on a special audit duty whereby they intend that their statement will be communicated to and relied upon by a particular person for a particular purpose in 3

connection with a particular transaction. In this case, the Court of Appeal commented that E&Y might well have been found to have undertaken a special audit duty to Western Star (or so far as relevant to MAN) in respect of the use which they could foresee would be made of their audit statement as a basis for representations and warranties in the share purchase agreement. However it was not breach of that duty which gave rise to the loss for which Freightliner seeks to hold E&Y liable. That loss was the direct result of the dishonesty of Mr Ellis rather than the inaccuracy of the accounts themselves. Applying the SAAMCO (South Australian Asset Management Co) test, the relevant question was therefore whether E&Y undertook a special audit duty to Western Star and MAN in respect of representations which might be made by Mr Ellis as to the accuracy of the ERF accounts to which their audit statements related. They did not. So whilst this is a good decision for auditors, it does not mean that auditors in other cases will escape a finding that they assumed a special audit duty, breach of which did give rise to the relevant loss. Auditors still need to take care to disclaim responsibility to any third party something E&Y had not done in this case. Stone & Rolls Ltd v Moore Stephens application of ex turpi rule to companies suing their auditors [2007] EWHC 1826 (Comm) The ex turpi causa non oritur actio rule comes into play where the claim is founded on, or arises from, an illegal act of the claimant, or where the illegal act has to be pleaded or relied upon in order to sustain the claim. The question which arose in this case is when, if at all, will a claim by a company against its auditors infringe this rule? Moore Stephens (MS) were the auditors of the claimant company. The company, by its owner and controller Zvonko Stojevic, had committed letter of credit fraud against several banks and was liable to repay them. It brought these proceedings against MS alleging that, because of their negligent audits, they failed to spot the fraud. The claimants argued that, had MS performed their duty properly, they could and should have blown the whistle on the fraud thereby bringing it to an end. Had Mr Stojevic brought the claim himself, it would definitely have been defeated by the ex turpi rule. The judge concluded that there was no reason why this should not also be the case if the acts of the wrongdoer could be attributed to the company. Mr Stojevic was clearly the directing mind and will of the company and it would be artificial in these circumstances not to fix the claimant with his knowledge and wrongdoing. However, this alone was not sufficient to justify striking out the claim. The judge concluded that claimant companies should not be prevented from pursuing actions against negligent auditors by an unforgiving application of the ex turpi rule. The objective of the rule can be met by preventing the wrongdoer from benefiting from any recovery and there is no principled reason why defrauded creditors of a company should be in a worse position than those whose debts arise in the ordinary course of business. Comment: this claim for 90 million is one of the largest to be brought with the help of independent litigation funding. The claim is being led by Stone & Roll's liquidator on behalf of the company's creditors and funding for the claim is being provided by IM Litigation 4

Funding. They will no doubt have well in mind the Court of Appeal s decision in Arkin v Borchard where another professional funding company, MPC, was ordered to contribute to the successful defendants costs to the extent of the funding they had provided, which totalled 1.3 million. The court concluded that it is only fair that a funder who supports a claim for profit should be required to contribute to the defendant s costs if the claim fails and the claimant is unable to do so. Construction of policy Tesco Stores Ltd v Constable public liability insurance does not generally provide cover for pure economic loss [2007] EWHC 2088 (Comm) Public liability insurance polices provide cover against claims by third parties for personal injury or damage to property and are generally regarded as not affording cover against liability in contract for pure economic loss. The clauses of such a policy should be construed with this in mind. Accordingly it was inappropriate in this case to focus on words such as liable at law and all sums - previous cases concerning such words which did not concern this type of insurance were not helpful. During Tesco s construction of a supermarket over a railway tunnel at Gerrards Cross, the tunnel collapsed and the line, which was owned by Network Rail, was closed for 51 days. Tesco was liable to indemnify the train operator, Chiltern, under a contractual deed of indemnity for their revenue loss during this period and sought to recover this sum from their insurers. The claim failed. The policy only covered the liability of the claimant to third parties who, as a result of the construction works in question, had suffered the kind of harm that would give rise to an action in tort. The effect of the contractual liability extension under the policy was only to provide cover for liability in contract for harm which could have been recovered in tort. Had Chiltern owned the track, there would not have been a problem since the claim would have been covered as loss consequent upon physical damage to the track. Liability for what was, however, pure economic loss was not covered by the policy the contractual liability extension needed to be more explicit to have that effect. Comment: the type of policy may be the most important factor when it comes to construing its terms. The court s approach to construing this policy was therefore quite different to that which would be appropriate where similar words appear in a third party legal and contractual liability policy, a products liability policy or a products liability extension to a public liability cover. This may benefit insurers, as in this case, but the opposite may also be true. Earlier this year in C A Blackwell (Contracts) Ltd v Gerling Allegemeine Verischerungs-AG insurers were held liable because an all risks policy is presumed to cover all risks which have not been clearly and unambiguously excluded. 5

Notification HLB Kidsons v Lloyds Underwriters effect of clause in professional indemnity policy requiring notification of circumstances as soon as practicable [2007] EWHC 1951 (Comm) Kidsons, a firm of chartered accountants which merged with Baker Tilly in 2002, claimed under its professional indemnity cover in respect of claims made against it arising out of the tax avoidance schemes marketed by its subsidiary Solutions at Fiscal Innovation Ltd (S@FI). The policy period ran from 1 May 2001 to 30 April 2002. The claims against Kidsons were made outside the period of cover so it relied upon General Condition 4 (GC4) of the policy which enabled the insured to obtain an extension of cover for claims made after expiry of the policy provided the claim arise out of a circumstance of which the insured became aware during the policy period and in respect of which he gave notice to the underwriters as soon as practicable. Kidsons purported to give notice of the circumstances giving rise to the claims under GC4 by, in particular, two letters sent within the policy period on 31 August 2001 and 28 March 2002. Underwriters did not accept that any of the purported notifications complied with GC4. A plethora of issues concerning notification were decided by Gloster J. The findings concerning some of the most significant are set out below. The decision The judge held that there was no effective notification to the underwriters by the presentation of the August 2001 letter and other documents. The presentation to the Lloyd s Lead Underwriter of the March 2002 letter and other documentation was a valid notification as was the slightly later notice given to the underwriters in the company market. However, these notifications related only to two particular schemes and not to the whole range of tax avoidance products marketed by S@FI. The issue as to whether the claims which have arisen against S@FI fall within the scope of the circumstances notified remains to be decided on the basis of sample claims. Was GC4 a condition precedent? Despite the fact that the notice clause for claims made within the period of cover (GC3) was stated to be a condition precedent and GC4 was not so described, the judge held that compliance with GC4 was a condition precedent to liability. Notification in accordance with GC4 was necessary to obtain an extension of cover which would not otherwise exist and it would be linguistically superfluous to include the words condition precedent in these circumstances. Interrelationship between GC4 and the Minimum Terms Kidsons argued that the effect of the Institute of Chartered Accountants of England and Wales (ICAEW) Minimum Terms as reflected in the policy was to limit underwriters remedy for breach of the notification provision to compensation for prejudice. The judge rejected this argument. The Minimum Terms deal with the reduction of cover which exists rather than the creation of cover which would not otherwise exist. 6

Interrelationship between GC3 and the Minimum Terms This somewhat surprising part of the judgment is obiter but of significance nonetheless. Gloster J concluded that the Minimum Terms did not apply to the condition precedent in GC3, the notice clause for claims made within the period of cover. A failure by the insured to give notice in writing as soon as practicable of a claim in accordance with GC3 means that there is no coverage in respect of that claim. The public policy underlying the Minimum Terms does not preclude insurers stipulating in their contracts of insurance that cover will not obtain where the insured fails to give prompt notice of claims made or losses discovered. The opposite conclusion would effectively transform the policy into something akin to an occurrence policy and not a claims made policy. Is the subjective intention of the insured relevant to the interpretation of the notice? The fact that a document is not intended by the insured to constitute a notice does not preclude it from qualifying as a notice. However the insured s state of mind is relevant to determine the extent to which it was aware of and, hence capable of notifying, circumstances which might give rise to a loss or claim. If the insured is not aware of a relevant circumstance at the time he purports to give notice, the notice is ineffective. Can the awareness of one partner be imputed to another under a composite policy? Kidsons argued that the composite nature of the policy meant that awareness of any individual partner cannot be imputed to any other partner. This argument was rejected for various reasons, not least because Kidsons had presented its case on the pleadings as the Kidsons partnership seeking a declaration entitling it to an indemnity from underwriters with no suggestion that only some of its partners had been aware of circumstances at the relevant times. The judge also rejected the argument as a matter of principle. Knowledge on behalf of the partnership secretary or the relevant managing organ of a partnership can be imputed to all the partners. This means in turn that notice under the policy can be given on the partners behalf. The responsibility is on all partners to ensure that adequate notification procedures are in place once the firm is made aware of the relevant circumstances. What does an effective notification of circumstances look like? It should be in terms which leave the reasonable recipient in no reasonable doubt that it is purporting to notify a circumstance that might give rise to a claim. It should be made to the insurers claims representative or possibly to a placing underwriter in the context of renewal where the same information will be relevant for claims and placing purposes. It should refer to circumstances the 31 August 2001 letter referred to material information for insurers which was not the same thing, particularly not when addressed to the placing underwriter. It should identify an error, act or omission or potentially negligent or wrongful conduct on the part of the insured, identify a possible claimant or victim and the loss they may suffer as a result. Where a bordereau is presented as part of the purported notification it must be read together with the information presented in the underlying claims files which constitute the primary notification material. 7

What does as soon as practicable mean? Gloster J took 27 March 2002 as the start date for the purpose of working out the period that was as soon as practicable since at that date Kidsons had all the information it needed about the circumstances which were to be notified. Notice given a month or so later was held to be as soon as practicable since the market permits some latitude. However, notice given to the following market on 24 July 2002, almost three months after the expiry of the policy period and four months after the judge s start date, was not as soon as practicable. To whom must notice be given? GC4 referred to notice being given to the Underwriters. Such a term requires notice to be given to each underwriter or its duly authorised agent unless agreed otherwise between the parties or in a Market Agreement. The presentation to the following Lloyd s market in this case was not made until July 2002 and was not made as soon as practicable. Although in practice this point would rarely be taken where effective notice had been given to the lead underwriter and company market, the judge held that underwriters were entitled to take it and to insist on strict compliance with the policy. Comment: this is self-evidently an important decision which will be scrutinised at length (the judgment is 228 paragraphs long) in the next few months. The judge has granted permission to appeal but it is not yet clear how many and which of the issues will be reviewed by the Court of Appeal. Whether or not all or part of the judgment is upheld, it will be referred to for years to come for the wealth of its content about the operation of the market and the policy issues surrounding minimum terms and notification provisions. Solicitors Funnell v Adams & Remers claimants costs of extricating themselves from predicament caused by solicitors negligence are recoverable [2007] EWHC 2166 (QB) The claimants instructed the defendant solicitors to act for them in the negotiation of a lease of new business premises. Although the claimants wanted the freedom to erect certain structures, those works were included in a section of the lease that imposed obligations on the claimant, and consequently, the improvement effected by those works fell to be reflected in the rent review. The defendant admitted it had been negligent in failing to spot this consequence. The claimants entered the lease, but the business deteriorated. They extricated themselves from their predicament by accepting an offer to take an assignment of the lease for 45,000 and moved to smaller premises and claimed damages against the defendants. The parties agreed that the appropriate measure of loss was the cost of the claimant extricating itself from its predicament, coupled with the costs wasted by embarking on a venture that had to be aborted at an early stage. The defendant, represented by Mills & Reeve, argued that the claimants had suffered no loss because the business was failing in its new setting and they would have moved to the smaller premises in any event. The judge found for the claimant on causation. The act of extricating oneself from a predicament by taking reasonable steps does not break the chain of causation. If the 8

consequences flowing from that course of action were reasonably foreseeable then they were, in principle, recoverable. He concluded that the claimants decision to extricate themselves from the lease was triggered by the bad news about the rent review clause. There was, therefore, a causal link between the defendant's negligence and the losses suffered by the claimants. Miranda Whiteley Professional Support Lawyer for Mills & Reeve LLP 07918724051 miranda.whiteley@mills-reeve.com The contents of this document are copyright Mills & Reeve LLP. All rights reserved. This document contains general advice and comments only and therefore specific legal advice should be taken before reliance is placed upon it in any particular circumstances. Where hyperlinks are provided to third party websites, Mills & Reeve LLP is not responsible for the content of such sites. 9