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A dishonesty exclusion in a professional indemnity policy applied because a director of the insured knew of the dishonesty and fraudulent acts of her co-director, but overlooked them.

Goldsmith Williams (a firm) v Travelers Insurance Co Ltd [

  • 2010] EWHC 26 (QB)

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Facts

The defendant insurer provided professional indemnity cover for Joshua & Usman Legal Services Limited (JULS), which traded as Joshua & Usman Solicitors. JULS had two directors, Mr A and Ms U.

Mr A applied for a mortgage to buy a property and the mortgage provider instructed the claimant solicitors to act on its behalf. At some point during the transaction, Ms U witnessed Mr A's signature and certified a copy of his passport.

Instead of buying the property, however, Mr A stole the money. It turned out that he had also made false statements in the mortgage application.

In a separate transaction, Mr A's wife applied for a loan to purchase a property owned by Mr A.  Again, the claimant acted for the lender. Mrs A said the transaction was at arm's length but the sale was never completed and Mr A stole the money.

In November 2002 the claimant referred JULS to the Office of the Supervision of Solicitors and in February 2003 the Law Society intervened in the practice. In November 2003 it was struck off the Register of Companies. 

Meanwhile, the mortgage companies claimed against the claimant for the missing money (which the claimant repaid) and transferred their respective claims against JULS to the claimant by deed of assignment. The claimant restored JULS to the register in 2004 and obtained judgment against it in August 2007. 

The claimant now pursued the firm's professional indemnity insurer directly under the Third Parties (Rights against Insurers) Act 1930.

The insurer, however, relied on a term in the policy, which excluded any claim against any insured "arising from dishonesty or a fraudulent act or omission committed or condoned by such insured, except that
(a)  this policy shall cover each other Insured and
(b) no such dishonesty act or omission will be imputed to a body corporate unless it was committed or condoned by, in the case of a company all directors of that body corporate…"

The insurer said the claim fell within this exclusion because it arose from the dishonesty or fraudulent acts of Mr A and Ms U; alternatively from the dishonesty or fraudulent acts of Mr A condoned by Ms U.  Mr A and Ms U were the only directors of JULS at the time.

Judgment

The judge found that the exclusion applied, so the 1930 Act claim failed.

He applied the test for dishonesty set out in Twinsectra v Yardley [2002], which states that the conduct must be shown to be dishonest by the ordinary standards of reasonable and honest people and that the defendant himself realised that by those standards his conduct was dishonest. 

He also gave the word "condoned" in the policy its ordinary, natural meaning. In the context of this policy, that meant a state of affairs where a non-dishonest director knows of the dishonesty or fraud of his co-director yet overlooks it. 

There was no direct evidence to suggest Ms U participated in Mr A's fraudulent acts or benefitted from the theft of the money. She did, however, help him obtain the first mortgage by witnessing his signature and certifying a copy of his passport. But this conduct, on its own, would not have amounted to condoning Mr A's fraud.

The court, however, heard evidence of wide-ranging dishonesty on the part of Mr A, involving other mortgage applications that contained false information and improper transfers from the firm's client account.

Ms U has also made mortgage applications in her own right in which she significantly exaggerated her annual income and deliberately misrepresented the original purchase price, naming Mr A as her referee. She also assisted an employee of the firm to make fraudulent applications by certifying his passport and signing a letter that gave false details of his position and salary.

The judge concluded that Ms U knew that both Mr A and the employee were engaging in mortgage fraud. She therefore committed a fraudulent act when she witnessed Mr A's signature and certified a copy of his passport because she knew she was assisting Mr A to obtain a loan by deception. In the language of the criminal law she aided and abetted his crime.

On any view, her actions amounted to condoning his dishonest and fraudulent mortgage applications. 

Commentary

In reaching his decision, the judge followed the approach taken in Zurich v Karim, in which the policy excluded dishonesty or a fraudulent act or omission committed or condoned by the insured.

That case held that the terms of the exclusion did not require the insurer to show that a particular insured either committed or condoned specific dishonesty or a specific fraudulent act. It was enough that the insured condoned a course of conduct which was dishonest or fraudulent and which permitted the specific dishonesty or fraudulent act to take place.

This decision is also a reminder that an insurer facing a 1930 Act claim is entitled to rely on any policy defence it would have had against the insured. That will not change if and when the Third Parties (Rights against Insurers) Bill (currently progressing through Parliament) is passed.

The Bill will, however, allow a third party to issue a single set of proceedings against the insurer and (optionally) the insured, removing the need to restore a defunct company to the register in order to obtain judgment against it. In this case, the claimant had to jump through all those procedural loops, a process that took several years.