Out-Law / Your Daily Need-To-Know

Zurich v Karim

Out-Law Guide | 09 Feb 2010 | 3:41 pm | 3 min. read

Two partners in a firm of solicitors condoned a third partner's fraudulent acts because they condoned dishonest general practices that allowed such acts to take place. Their liability insurance excluded dishonesty or fraudulent acts committed or condoned by the insured, so the insurance claim failed. 

Zurich Professional Limited v Karim & others

  • [2006] EWHC 3355 (QB)

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Facts

Mrs K, her son and daughter were partners in a firm of solicitors.  Mrs K, operating in breach of restrictions imposed on her practising certificate, exercised almost complete control over the firm's financial dealings.

Over a period of time, she arranged several fraudulent advances on properties, some on the family home, others on properties belonging to the firm’s clients. A spiral developed, as money received from one fraudulent transaction was used to discharge another. Eventually, the Law Society intervened and issued proceedings in August 2005. Other actions were brought by clients of the firm. 

The issue was whether the son and daughter were entitled to cover under the firm's professional indemnity policy. They maintained they had not been involved in and had not been aware of their mother’s dishonest activities. The insurer, however, applied for declarations that the claims fell within a specific exclusion in the cover. 

This provided that the insurer was not liable to indemnify any insured to the extent that any civil liability arose "from dishonesty or a fraudulent act or omission committed or condoned by that Insured, except that - (a) this contract nonetheless covers each other Insured….". 

Fraud and dishonesty

The classic test for fraud, set out in Derry v Peek in 1889, is "a false representation…made (i) knowingly, (ii) without belief in its truth or (iii) recklessly, careless whether it be true or false…" 

The test for dishonesty is slightly different. A person acts dishonestly if his conduct was dishonest by the standards of a reasonable honest person (an objective test) and he realised this was the case (a subjective test, depending on his own view of what constitutes dishonesty) (Twinsectra v Yardley [2002]. 

More recently, however, the emphasis has shifted to a more objective standard. "It is unnecessary to show subjective dishonesty, that is, consciousness that the transaction is dishonest. It is sufficient if the defendant knows of the elements of the transaction which make it dishonest according to normally accepted standards of behaviour" (Lord Justice Arden in Abou-Ramah v Abacha [2006] summarising part of the judgment in Barlow Clowes v Eurotrust International [2006]).

The judgment

The judge was satisfied that neither the son nor the daughter had been directly involved in any specific fraudulent property transaction.

Nevertheless, both of them knew they were supposed to be in control of the business but that their mother was treating the firm, the firm's money and client's money as her own and that they relied on her for money as and when they needed it. They must have known that there was not enough business being done to generate the level of drawings being made. 

In the judge's view, the son and daughter had divested themselves of any responsibility and were "profoundly reckless" as to how their firm was being run. "In my view this behaviour was consistently dishonest whether viewed by the test in Derry v Peak or Barlow Clowes".

Turning to the wording of the exclusion, the issue was whether the insurer had to show that a particular insured either committed or condoned the specific dishonesty or fraudulent act from which the claim arose, or whether it was enough if the insured condoned general practice or conduct which was dishonest or fraudulent and which allowed the specific acts of dishonesty or fraud to take place.

The judge held that the second interpretation was the correct one. He read the exclusion as treating "dishonesty" and "fraudulent acts and omissions" disjunctively, as separate concepts. A reasonable person reading the policy would be surprised if it allowed insurers to refuse cover to those in the firm that practised or condoned specific forgery but not to those partners who condoned more general dishonest behaviour that allowed the specific acts to take place. 

Had the son and daughter not allowed their mother to run the firm under the cover of their being qualified solicitor partners, she would not have been able to commit the fraudulent acts she did.  The exclusion applied.

Commentary

The case raises the question how innocent must an innocent partner be to retain cover under a professional indemnity policy.

Depending on the wording of the exclusion, the fact that a partner was not directly involved in the fraud may not be enough if he or she condoned a course of conduct which was dishonest or fraudulent and which permitted specific dishonest or fraudulent acts or omissions to occur.

In this case, there was not enough evidence to show the son or daughter had been directly involved in their mother's fraud. Had the clause required the condoning of a specific fraudulent act, the judge would have found that the exclusion did not apply, as a person cannot condone an act of which he or she is not aware.