Case Alert - [2016] UKSC 57

Supreme Court holds exclusion clauses do not always have to be construed narrowly/finds exclusion in PI policy applied.

Mayer Brown for appellant, Ozon for respondent

The insured solicitors had arranged funding for disbursements incurred by their clients in order to pursue personal injury claims. When those claims were abandoned, following the solicitors' breach of duty to their clients, the funders sought recovery from the solicitors, on the basis that the solicitors were in breach of contract with the funders. The solicitors sought to claim under their professional indemnity policy. The policy excluded cover for any "(a) trading or personal debt of any insured, or (b) breach by any insured of the terms of any contract for the supply to, or use by, any insured of goods or services in the course of the insured firm's practice".

The Court of Appeal held that the loans had been part of the obligations assumed by a solicitor in respect of his professional duties to his clients, rather than obligations personal to the solicitor, and so the exclusion did not apply. The Supreme Court has now allowed the appeal from that decision (Lord Carnwath dissenting). It has held as follows:

(1) Exclusions should not always be construed narrowly. Lord Toulson said that: "The fact that a provision in a contract is expressed as an exception does not necessarily mean that it should be approached with a pre-disposition to construe it narrowly. Like any other provision in a contract, words of exception or exemption must be read in the context of the contract as a whole and with due regard for its purpose. As a matter of general principle, it is well established that if one party, otherwise liable, wishes to exclude or limit his liability to the other party, he must do so in clear words; and that the contract should be given the meaning it would convey to a reasonable person having all the background knowledge which is reasonably available to the person or class of persons to whom the document is addressed. ..This applies not only where the words of exception remove a remedy for breach, but where they seek to prevent a liability from arising by removing, through a subsidiary provision, part of the benefit which it appears to have been the purpose of the contract to provide. The vice of a clause of that kind is that it can have a propensity to mislead, unless its language is sufficiently plain. All that said, words of exception may be simply a way of delineating the scope of the primary obligation".

Lord Hodge put the matter slightly differently. He agreed that an exclusion clause should be read in the context of the policy as a whole and went on to say that "There may be circumstances in which in order to achieve that end, the court may construe the exclusions in an insurance contract narrowly. … But the general doctrine…that exemption clauses should be construed narrowly, has no application to the relevant exclusion in this Policy. An exemption clause, to which that doctrine applies, excludes or limits a legal liability which arises by operation of law, such as liability for negligence or liability in contract arising by implication of law…. The relevant exclusion clause in this Policy is not of that nature".

Lord Mance and Lord Sumption agreed with both judgments.

(2) Turning to the particular exclusion in question, Lord Hodge held that the loans provided to the solicitors' clients were a service which the funders provided to the solicitors. A breach of the contract to supply those services therefore fell within the scope of the exclusion clause. Lord Toulson held that the "essential purpose" of the exclusion should be seen in the context of the essential purpose of the policy. Here, the purpose of a solicitors' professional indemnity insurance policy is to protect "that section of the public that makes use of the services of solicitors" (broadly, clients, "quasi-clients" and third parties to whom undertakings are given). The funders did not fall within those categories. Instead, the funders and solicitors had struck a commercial agreement as principals for their mutual benefit.

The exclusion therefore applied and the insurers were not liable to indemnify the solicitors.

COMMENT: Textbook commentary frequently provides that there is a general rule that exclusions should be construed narrowly. This Supreme Court judgment provides a more nuanced approach, though. The exclusion here applied to breach of the terms of a contract, but Lord Hodge said that it did not fall within the definition of an exclusion which excludes liability "which arises by operation of law, such as…liability in contract arising by implication of law" (ie, (presumably) rather than by agreement between the parties). The rationale for that may be that the insurer and insured should be free to agree an exclusion of a liability which was in turn voluntarily agreed by the insured with a third party (rather than imposed on it by law, perhaps without the insured's awareness), and there is no reason to construe such an exclusion narrowly.