On Wednesday last week the Court of Appeal threw the solicitors' insurance regime into turmoil. It ruled that solicitors could not comply with their obligation to give preinception disclosure or their obligation to notify circumstances where the information that needed to be disclosed was subject to legal advice privilege.

The Nature of "Claims Made" Policies

Like most professional indemnity policies, solicitors' insurance provides cover on a "claims made" basis; it insures solicitors against liabilities from claims made during the currency of the policy. A necessary incident of "claims made" insurance is the additional cover for claims made after the policy period but arising from circumstances notified during it. If the professional cannot notify circumstances to his existing insurer but has to disclose them on renewal he will be left without cover for the subsequent claim. The new insurer will either deny cover or exclude any claim arising from the disclosed circumstance. If the professional does not disclose the circumstance the insurer will either avoid the policy (if possible) or seek reimbursement for the losses under the policy.

This "claims made" insurance is the scheme that the Solicitors Regulation Authority has prescribed for solicitors; it is approved by both the Master of the Rolls and Lord Chancellor; and it is the insurance which the Solicitors' Indemnity Insurance Rules 2009 requires every solicitor to take out. Those rules set out the terms that every such policy must contain - the "minimum terms".

Legal advice privilege does not excuse disclosure obligations

Despite all of this, last week the Chancellor said that it was just tough (in only marginally more judicial terms). A client's legal advice privilege is a fundamental human right and the solicitor was not entitled to ignore it, even if that meant that the "insurance is vitiated" or "the notification inadequate". So, where the solicitor's obligation to notify circumstances under his insurance conflicts with his duty to keep his client's affairs confidential, the solicitor will have to breach his obligation to his insurer if necessary. As the Chancellor put it: "… that is the problem of the solicitor not the client".

He compared the situation to that of the solicitor in Hilton v Barker Booth & Eastwood [2005] 1 WLR 567 who found himself with irreconcilable duties to two clients where one had a criminal past. The solicitor owed a duty to one client not to disclose the criminal past to the other whilst at the same time owing a duty to the other to disclose the information. The one does not excuse the other. The comparison with Hilton was an odd one because the solicitor in that case voluntarily placed himself in a position of conflict. A solicit o r notifying circumstances or giving preinception disclosure has no choice in the matter.

Quinn's attempts to decline cover

The issue arose in a claim by Quinn Direct Insurance Ltd against the Solicitors Regulation Authority (through the Law Society). Quinn wrote a book of largely small firms of solicitors and is now in administration. In 2007 it agreed to underwrite a firm called South Bank Solicitors just a few months after the Law Society had commenced disciplinary proceedings against its two partners, Mr Onobrakpeya (for dishonesty) and Mr Ikoku (for alleged accounts failures).

There emerged a large number of claims against South Bank Solicitors and Quinn declined cover against Mr Onobrakpeya on the ground of dishonesty. It was left to cover Mr Ikoku unless it could show that he too had been guilty of dishonesty or condoned Mr Onobrakpeya's dishonest conduct. It was for the purpose of establishing that case that it wanted to have a look at some of the firm's client files. By that stage the files were in the possession of the Law Society's agents following its intervention in South Bank Solicitors. The Law Society refused to provide the any files except those where the client had made a claim against the firm; in those cases the Law Society took the view (relying on cases such as Lillicrap v Nalder & Son (a firm) [1993] 1 All ER 724) that the client had elected to waive privilege.

Quinn said that it was entitled to see the remaining files as a necessary implication of the regulatory regime. It argued that the insurance of solicitors was "meshed" into the regime as a result (amongst other things) of insurers' obligation to notify the Law Society of circumstances suggesting fraud on the part of an insured solicitor. This wasn't an attractive argument for Quinn to base its case on. The Solicitors Regulation Authority has public functions for the protection both of the public and clients. In contrast, Quinn was concerned to decline insurance cover on claims by those clients. This point certainly wasn't lost on the Court of Appeal and it rejected Quinn's case. Indeed, there is a strong sense that that the court simply didn't like what Quinn was trying to do.

Quinn's express purpose was to try and find material on which it could try and decline cover and the court appears to have approached the case on the basis that this was not in the public or client's interest. In one sense that may be right, but it ignores completely two countervailing points. The first is that it is not simply a question of whether or not the solicitor's professional indemnity policy responds; there is a Compensation Fund that will respond in some cases where the professional indemnity policy does not. Accordingly, it is also about making sure that the correct branch of the regulatory regime picks up the tab. The second is that there is a recognised public policy ground against allowing someone to insure against his or her own proven dishonesty. The position is therefore perhaps less starkly unattractive.

Did the court understand the nature of the insurance and the solicitor's obligations under the Code of Conduct 2007?

Is it possible that in his obvious distaste for the claim the Chancellor was too harsh and overlooked the effect on the statutory scheme of insurance? It is not clear from the judgment whether he quite took on board the role and significance of the secondary cover for claims outside the period of insurance arising from circumstances notified within it. The notification clause that the Chancellor referred to in his judgment was not a clause which set out the mechanics for attachment of later claims and although the Chancellor accepted that the solicitor's failure to disclose may result in the insurance being "vitiated" or an "inadequate notification", there is no apparent recognition that it strikes at the very heart of how these policies operate.

Equally, there is no developed discussion of the fact that the disclosure is arguably sanctioned by the statutory scheme of insurance f o r solicitors and the secondary legislation (the Solicitors' Indemnity Insurance Rules 2009) which implicitly requires circumstances to be notified to insurers. Indeed, the Solicitors Regulation Authority itself tells solicitors at rule 20.09(2) of the Solicitors' Code of Conduct 2007 "If … you discover an act or omission which could give rise to a claim, you must: … notify your compulsory professional indemnity insurer under the Solicitors' Indemnity Insurance Rules …". The Court of Appeal appears to have completely overlooked this.

A similar issue arose in the House of Lords decision in Regina (Morgan Grenfell & Co Ltd) v Special Commissioner of Income Tax and another [2003] 1 AC 563, where the court was considering whether the investigative powers under section 20 of the Taxes Management Act 1970 entitled the Special Commissioner to call for disclosure of privileged material. The House of Lords held that that particular provision did not expressly or by necessary implication override legal advice privilege. However, the facts of Quinn are different and possibly less favourable and it is tempting to think that the court's distaste for Quinn's case influenced the lack of any developed consideration of this argument.

Of course, the arguments in Quinn all revolve around the regulatory framework for solicitors. That's fine (so far as it goes) for the primary layer of insurance but it could never have worked for excess layer insurers. For larger firms and excess layer insurers the problem was always going to be more difficult and Quinn has done them no favours at all in bringing the issue up for determination in the context of low-value mortgage lending claims and in a claim aimed at seeking to decline cover.

Solutions – Obtaining Consent and Terms of Business

So where do things go from here? The Chancellor's suggestion is that solicitors seek their client's consent to waive privilege. Of course, rule 20.9(1) of the Solicitors' Code of Conduct 2007 already tells solicitors: "… If you are a … manager of a firm and you discover an act or omission which could give rise to a claim, you must inform the client …". Many clients would rather be pursuing a claim against an insured defendant and may not mind an additional request to waive privilege for the purpose of a valid notification; indeed many claimants (when making a claim) ask that the insurer be notified. But this is not how things have been done and if it is to be the correct approach it will take some getting used to; there would be something terribly wrong in a system where the ability to comply with the duty of disclosure and the notification requirements turn on the consent of the client. That is to say nothing of the Solicitors Regulation Authority's own requirements under rule 20.09(2) of the Solicitors' Code of Conduct 2007, which appears to conflict with its position in Quinn.

Of course, solicitors might try amending their terms of business to permit disclosure of circumstances to insurers. This may not help in relation to any claims from previous retainers but would answer the problem in relation to circumstances arising out of new engagements. But is there something unsatisfactory about asking a client to waive a "fundamental human right" in blanket terms in relation to an unknown event in the future? There is an obvious difference between a waiver by the client actually making a claim and a waiver in relation to a set of circumstances that the client either does not know anything about or has not chosen to do anything about. On the other hand, the Court of Appeal in Hilton saw nothing wrong with an express (or even implied) waiver in relation to a solicitor's fiduciary duty of disclosure and it is difficult to think of many situations in which disclosing facts to an insurer would be acting adversely to the claimant's interests. The Solicitors Regulation Authority certainly appears to think that would be acting in the client's best interest.

There are clearly a number of different issues to consider where an infringement of legal professional privilege or confidentiality is necessary and it is difficult to predict quite what the reaction will be to this decision. There is significant scope for a variety of different approaches to the problem. The solutions above provide some basis for finding a path through the maze but it is clear that the process of disclosing and notifying circumstances is going to become a lot more sophisticated and time consuming than it has been up to now.

RPC Partner Nick Bird comments: If this decision is right then it may be much more difficult for solicitors to properly notify circumstances to their insurer and they may be without insurance. It may also mean that insurers are not able to require full disclosure of circumstances from solicitors. Either way, it's a bit of a mess. We look at where it went wrong and suggest some possible solutions.