The Owners of the Kamal XXVI v The Owners of the Ariela – non-party costs application against insurers  EWHC 2531 (Comm) www.bailii.org/ew/cases/EWHC/Comm/2010/2531.html
The owners of the Ariela incurred costs of more than $1.25 million defending a fraudulent claim by the owners of the Kamal following a collision between their vessels. The damage alleged to have been sustained by the Kamal was held not to have been caused by contact with the Ariela and the judge concluded that the claim had been fraudulent from the outset.
The owners of the Ariela have not been paid their costs by the owners of the Kamal and brought a claim for a non-party costs order under s51 of the Senior Courts Act 1981 against the latter’s underwriters who, exercising rights of subrogation, supported and funded the failed action. The owners of the Ariela argue that the underwriters failed to investigate the claim properly and were culpable in not having discovered that the Kamal claim was fraudulent from the outset. They made an application for disclosure of the underwriters’ files, including privileged communications with their solicitors Ince & Co.
The judge held that it was appropriate to order disclosure, even though it will increase the costs of determining the s51 application. As for Ince & Co’s reports to the underwriters, the fact that they had been referred to in the statements of case did not mean that privilege over them had been waived. However, privilege had been lost because of the fraud exception. The fact that both the underwriters and solicitors were not implicated in the fraud was irrelevant – they had been used as the mechanism for achieving the client’s fraud and this was sufficient to preclude them from asserting both legal advice and litigation privilege.
The fraud exception was considered earlier this year in Allied Surveyors plc v Newcastle Home Loans Ltd  EWHC 1548 (Ch), an alleged mortgage fraud case in which Mills & Reeve was acting for one of two defendant solicitors. The claimant alleged that about 1,000 valuations carried out by the third defendant surveyor formed part of a systematic dishonest conspiracy to defraud mortgage lenders. It sought disclosure of privileged and/or confidential documents held by the defendant solicitors. The latter took the view that, where they had not been able to obtain waivers of privilege from their borrower clients who were not parties to the action, they could not properly consent to inspection.
The judge held that the fraud exception applied. It was accepted by the defendant solicitors that there was a strong prima facie case of fraud against some of the participants to the transactions. The fact that their clients were innocent made no difference – the innocence of a victim of fraud is not an answer if the documents in question were created for a criminal purpose. Disclosure of the third party’s iniquity must in the interests of justice prevail over the privilege of the innocent client.
This decision predated that of Quinn Direct Insurance Ltd v Law Society in which the Court of Appeal held that a solicitor is not entitled to ignore his client's privilege when notifying circumstances to his professional indemnity insurers. Given that the fraud exception was not raised in Quinn, it is likely that the decision in Allied Surveyors would have been unaffected by it. Nonetheless, solicitors will need to be certain that there is a strong prima facie case of fraud before handing over privileged documents in their files where they are unable to obtain a waiver of privilege from the innocent client. For guidance on disclosure issues in lender claims, see Stephen King’s briefing at http://www.mills-reeve.com/privilege131109.