Could you be held liable for the fraudulent actions of another?  If you are an employer and one of your employees is involved in fraudulent activities, then yes.

Here, we look at the principle of vicarious liability and the circumstances in which an employer can be liable for acts committed by its employees during the course of their employment. 

Vicarious liability

The principle of vicarious liability determines that an employer can be liable for acts committed by its employees during the course of their employment. Employers originally had some protection if they could demonstrate that an employee's actions did not reasonably fall within the remit of their employment, when the employee had been on a "frolic of their own". However, this defence has been eroded over the years and an employer can now find itself on the hook in a much wider range of circumstances.

When will an employer be liable?

An employer will be liable for the act of its employee if there is a sufficiently close and direct connection between what the employee was employed to do and the act committed by the employee. In other words, was the risk of the act reasonably incidental to the purpose of the employee's employment?

An employer could therefore find itself liable when an employee steals goods entrusted to the employer by a third party, or defrauds a client of the employer while in a position of trust. It is not sufficient to give rise to vicarious liability, however, that the employee simply used his employment to gain the opportunity to commit the offence.

But what constitutes fraud? An employer could be liable for the 'fraudulent acts' of its employees when it may not have been immediately apparent that a fraudulent act had even occurred.

What is fraud?

The traditional view of fraud is "the use of false representation to obtain an unjust advantage". In civil cases this has been referred to as the tort of deceit. However, there has been a divergence between criminal and civil definitions of fraud that may expose an employer to greater liability.

The case of Cavell v Seaton Insurance [2009] dealt with the issue of what constituted fraud in contractual disputes. The judge held that it was possible to commit fraud in civil law without making a deceiving, fraudulent representation, provided that a benefit was obtained from some form of dishonest conduct. This meant that where the parties had agreed that one would be released from liability "save... in the case of fraud", a court has held that this actually meant that the party would be released "unless they had engaged in some form of dishonest conduct resulting in an advantage" throughout the performance of the contract.

As a result, any dishonest conduct by an employee, including theft, could be considered to be fraud – resulting, of course, in potentially wider liability for the employer.

How much can employers be liable for?

An employer would be liable for the whole of the loss or damage caused by an employee (as would the employee as the 'tortfeasor'), unless there is any suggestion of contributory negligence on the part of the wronged party. Losses should then be apportioned according to each party's level of blame.

How can employers reduce their liability for employee fraud?

Firstly, it is not possible to exclude an individual's personal liability for fraud. No-one anticipates or would accept fraud when entering into a contract, so the injured party is entitled to treat the contract as void from the beginning.

However, in the case of Frans Maas (UK) Ltd v Samsung Electronics (UK) Ltd [2004], the court drew a distinction between fraud used to induce a contract on the one hand, and fraudulent dishonesty that may arise during the course of the operation of a contract on the other.

In this case, the court concluded that it is possible for an employer to limit its exposure to the latter type of 'fraud' and it is therefore open to a party to seek such limitation of its liability in its contracts. Some standard industry-wide terms and conditions (for example freight) do include limitation of liability clauses which could apply to fraudulent dishonesty during the operation of a contract. However, it may be unlikely in practice that a counterparty – certainly on bespoke, individually negotiated contracts - would agree to any form of limit on fraud or dishonesty. The potential for a party to exclude such form of fraud in such contracts has, therefore, limited effect in reality.

Points to consider

As a result of the wide definition of 'fraud' and an employer's potential exposure for the 'fraudulent acts' of its employees:

  • Cavell has shown that 'fraud' can have a much wider meaning than the parties may expect (in particular, including 'dishonest conduct' which, in itself, includes theft).
  • Limitation of liability clauses are commonly stated not to apply to 'fraud' and so the clause should be clear whether this includes or excludes 'dishonest conduct'. If the clause is silent on this point, it may be deemed to include 'dishonest conduct'. 
  • Following on from Frans Maas, employers may now seek to include limitation of liability clauses which limit exposure to fraudulent dishonesty during the operation of a contract. It is unlikely though that a counterparty will agree not to hold an employer liable for any kind of fraud during the operation of a contract. 

Employees also have, as part of their employment, the opportunity to commit dishonest acts which could inadvertently be furthered because of an employer's procedures or actions. In practical terms there are steps employers can take to minimise this risk:

  • The employer and the owner of the goods should ensure that at least one of them will bear the cost of insuring valuable goods – frequently also a consideration that the courts will take into account!
  • Employers should take all reasonable steps to avoid doing anything that could materially assist or contribute to theft: for example, restricting access rights of staff or implementing a series of checks and security arrangements.