Court of Appeal confirms success fee recoverable under solicitors' professional indemnity insurance

In Royal and Sun Alliance Insurance Ltd & Ors v Tughans [2023] EWCA Civ 999, the Court of Appeal held that insurers were obliged to indemnify the insured solicitors firm, Tughans, under a professional indemnity (PI) policy for a success fee which it had had to repay because of various allegations including misrepresentation, breach of contract and deceit.

BACKGROUND

A solicitors' firm, Brown Rudnick LLP (BR) engaged Tughans to perform professional services on a transaction.

BR's engagement letter with its client provided that BR would be entitled to a fee of £15 million upon successful completion of the transaction (the Success Fee). Importantly, the engagement letter contained a section where BR made various representations and warranties. Of relevance were those where BR warranted not to make any payments to anyone in breach of applicable anti-corruption laws, nor promise or make such payment to, or for the use of, any government official (together the Anti-corruption Warranties).

Under Tughans' retainer with BR, the firms agreed to share the Success Fee 50:50 in the event the transaction went ahead. The retainer provided that Tughans would receive its portion of the Success Fee (the Tughans Fee) on the same terms as BR's entitlement to the Success Fee, including the Anti-corruption Warranties. The transaction went ahead and Tughans received its portion of the Success Fee.

However, it later emerged that the managing partner at Tughans who had led on this matter, a Mr Coulter, had in fact received the Tughans Fee and had paid a significant amount of it into a bank account for his own benefit. Mr Coulter subsequently resigned and criminal charges have been brought.

BR commenced proceedings against Tughans seeking to recover the Tughans Fee and other damages for loss. It was alleged that statements made by Mr Coulter were fraudulent on the basis that he had intended to transfer part of the Tughans Fee to another individual in breach of the Anti-corruption Warranties. BR claimed damages for loss and damage on various grounds including fraudulent and/or negligent misrepresentation, misstatement or deceit as well as breach of fiduciary or contractual duties owed to BR and/or negligence. Alternatively, BR sought a contribution under the Civil Liability (Contribution) Act 1978.

Insurance

Tughans were insured under a PI policy (the Policy) underwritten by various insurers led by RSA. The Policy's insuring clause provided that Insurers would indemnify Tughans:

"…. in respect of any civil liability (including liability for claimant's costs and expenses) incurred in connection with the Practice carried on by or on behalf of the Solicitor or any Predecessor provided that no indemnity will be given

1. to any individual committing or condoning any dishonest fraudulent criminal or malicious act or omission
2. to any partnership or incorporated practice or limited liability partnership in respect of any dishonest fraudulent criminal or malicious act or omission committed or condoned by all of its Partners directors officers or members."

Tughans notified Insurers of the firm's involvement in the transaction as a "circumstance" under the Policy and Insurers declined cover. Insurers considered that the claims arising from Tughans' involvement in the transaction did not fall within the terms of the Policy which required claims to be "in respect of any civil liability ... incurred in connection with the Practice carried on by or on behalf of the Solicitor". Further, Insurers argued that the Policy was a contract of indemnity which would only respond to a loss, and that any liability in respect of the Tughans Fee was not a loss because Tughans had wrongly received and retained it (i.e. any liability was restitutionary in nature).

Tughans issued a notice of arbitration against Insurers seeking a declaration of cover. The arbitrator found that all claims for loss and damage that might be brought by BR (and the other interested parties) in connection with the transaction would fall within scope of the Policy, subject to the application of the relevant terms and conditions. It was found that:

1. Whether or not Mr Coulter intended to share the Tughans Fee with an individual in breach of the Anti-corruption Warranties did not add much to Insurers' case. Either way this was a fee due and payable to Tughans for work done; and
2. Mr Coulter had undertaken activities which were sufficiently solicitorial in nature and therefore fell within the Policy wording of work "in connection with the Practice carried on by or on behalf of the Solicitor".

While the arbitrator carved out from cover any liability for a restitutionary claim, this did not include the Tughans Fee. There was no legal basis for removing that element of loss on the basis that Tughans made a "gain" by receipt of the fee. Where an indemnity is due for a claim for damages or equitable compensation there is no reason to qualify that indemnity. As such, in circumstances where BR's claim was not framed in restitution, this did little to change the position for Insurers. However, the arbitrator made clear that if a restitutionary claim was to be brought it would be treated as ancillary to the compensatory claim which, as per the declaration, would attach to the Policy subject to its terms and conditions.

Insurers sought to challenge the arbitral award on various grounds and were ultimately permitted to do so under s.69 of the Arbitration Act 1996 on the basis that the arbitrator’s conclusion that the Policy was capable of providing an indemnity in respect of Tughans’ liability in connection with the Tughans Fee was wrong in law.

FIRST INSTANCE DECISION

In challenging the arbitration award, Insurers argued that if BR established that Tughans had a liability, it follows that Tughans never became entitled to the Tughans Fee, and so can suffer no loss in having to return it. In such circumstances it is not the purpose of a PI policy to pay solicitors a sum representing profit costs to which they were never entitled. Insurers argued that to grant Tughans cover under the Policy in respect of the Tughans Fee would, therefore, violate the principle of indemnity.

This argument was advanced by Insurers on two alternative bases:

• The Tughans Fee was never contractually due to Tughans because of the assumed untruth of the Anti-corruption Warranties.

This was rejected by Foxton J on the basis that the entitlement to the Tughans Fee accrued on the successful completion of the transaction, not on the truth of the representations/warranties made.

• There was no entitlement to Tughans Fee in substance because it was a fee procured by misrepresentation. Therefore, Tughans had no right to retain it and if it was obliged to return it, as part of a damages claim, it had not lost something to which it was entitled.

Foxton J also rejected this argument and concluded that if a solicitor has done what is necessary as a matter of contract to accrue a right to a fee, an award of damages in the amount of the fee payable will ordinarily constitute a loss for the purposes of a PI policy. Foxton J also concluded that the fee in this case was one which Tughans had contractually earned, and, when paid, was a sum which belonged in law and equity to Tughans.

COURT OF APPEAL DECISION

Insurers appealed and the Court of Appeal upheld Foxton J's judgment. The Court of Appeal held that Tughans had earned the Tughans Fee pursuant to the terms and conditions of its retainer and, as such, they had done what was necessary to obtain a right to the Tughans Fee. Therefore, any award of damages to BR would constitute a loss for the purposes of the Policy even if fees were included in the damages amount.

In the leading judgment, Popplewell LJ also considered the issues more widely which are particular importance to the general operation of PI insurance. Popplewell J noted:

1. the wording of the Policy was drafted in wide terms and was in respect of any "civil liability". It did not draw a distinction between liability for damages in respect of fees and any other form of liability and was consistent with the necessary function of PI insurance, i.e. solicitors purchase PI insurance for the protection of the public. With reference to Lord Brightman's observations in Swain v The Law Society [1983] A.C. 598 the purpose of such compulsory insurance is to ensure a solicitor is financially able to compensate a client for any liability they are found to owe to that client:

"The scheme is not only for the protection of the premium paying solicitor against the financial consequences of his own mistakes, the mistakes of his partners and the mistakes of his staff"; and

2. the dishonesty exception in the Policy made it clear that unless the individual claiming the insurance cover had committed or condoned the fraud, the fact that there is fraud of others which has given rise to liability is not a bar to cover.

As set out above, Insurers' argument was reliant on the indemnity principle, namely, that liability insurance is only intended to indemnify an assured in respect of its actual loss, but not more than that. To address this, Popplewell LJ turned to the wording of the Policy itself noting the indemnity principle will be: "one of presumptive interpretation and is subject to the policy wording which may clearly provide for recovery of either less or more than the actual loss". Here he found with reference to the facts of the matter:

1. even if there is misrepresentation, a loss is still suffered where a solicitor has earned a fee by way of a fully performed contract for services which confers a benefit of the contract performed, unless such a contract is avoided;
2. to hold that the Policy did not provide cover for the Tughans Fee would be contrary to the public interest purpose of compulsory PI insurance. Moreover, it would conflict with the commercial and regulatory function of PI insurance – the Policy was purchased to provide the partnership of Tughans with protection against their own negligent mistakes and/or the fraud of others;
3. Insurers' argument ignored the composite nature of the Policy and the fact that the claims are made under it by individual assureds. This, Popplewell LJ explained, was on the basis that it treated the liability for the Tughans Fee element of the BR claim as irrecoverable irrespective of the actual beneficial receipt of the fee by the insured individuals of Tughans. Any individual partner is liable for the whole of the partnership liability to BR and may not be able to recoup the balance from the other partners whereas, in regard to the Tughans Fee they would only be entitled to a proportion of the fee received by the firm subject to the internal profit arrangement of the firm. If the indemnity argument made was correct, this would leave each partner at Tughans substantially uninsured.

Insurers also argued that the indemnity principle precluded any cover for a liability for fees framed as a restitutionary claim, there being no reason for a distinction between the two. Popplewell LJ stated, obiter, that this argument was not correct: a restitutionary claim for money received but not earned could also be covered under a PI policy if the wording and facts of the case allowed it.

The appeal was therefore dismissed.

COMMENT

The decision will be welcomed by practitioners. Plainly however whether cover will be available to a solicitors' firm for its liability to a client for wasted fees will turn on the terms of the engagement letter, whether on the facts it was contractually entitled to the fees, and whether the services were in fact delivered.