Introduction

Lenders are becoming increasingly concerned about the number of claims for professional negligence they have against solicitors, where they are faced with insurers declining cover. Historically this was usually seen in claims against sole practitioners but there has been a trend for cover to be declined where small firms are involved. This often leaves lenders with an uncertain claim on the Solicitors' Regulation Authority ("SRA") Compensation Fund ("Fund"). What if anything can a lender do in such circumstances?

Reasons for declining a claim

Solicitors are required to have insurance cover which meets the requirements of the minimum terms set by the SRA. The minimum terms allow insurers to decline cover for a particular claim if the circumstances giving rise to the claim involve dishonesty or a fraudulent act or omission committed or condoned by an insured partner. So insurers may, following investigation of the claim, conclude that the insured solicitor was involved in the fraud and therefore decline cover.  

However in the case of a partnership or a LLP or other incorporated body, innocent partners or insured members should continue to benefit from cover under the policy. Insurers are more readily trying to establish that all of the insured partners were aware of the dishonesty or fraud and therefore decline cover against all of the insured partners.  

An example of this is the case of Goldsmith Williams (a firm) v Travelers Insurance Company Limited [2010] where Goldsmith Williams sought to challenge Travelers declining cover in relation to the firm of Joshua & Usman Legal Services Limited. Goldsmith Williams failed in its attempt to show that one of the directors was an innocent party where one of the other directors had stolen a lender's mortgage advance.

Procedure for declining cover

Insurers will wish to be in a robust position before declining cover to avoid claims against them by their insured and also third parties. Typically an insurer will investigate a claim by conducting an informal interview with the partners, followed by an investigation into the practice. This leads to a more detailed analysis of the client account and drawings of the partners. The next stage involves more specific enquiry into the details of the claim being made under the policy and the knowledge or involvement of each of the partners.  

Once investigations are completed, all partners are invited to attend a noncompulsory indemnity conference to address issues raised by the investigation. If the insurer then seeks to decline cover under the policy it obtains counsel's advice, usually from a Q.C. following which a full report is compiled by the insurer's legal advisors with a recommendation. If the insurer then decides to decline cover, the insured partners still have a right to challenge the decision through an arbitration.

As lenders will no doubt be well aware, insurers are keen to maintain that any reasons for declining cover are a matter of strict confidence between insurer and insured.

What can lenders do when faced with an insurer declining cover?

A lender can take some steps to recover its loss. It can claim against the partners in the firm but of course this depends on whether they have any assets. Hopefully, a claim will have been notified to the fund but if it has not, the lender should consider notifying a claim. However, the application must be made to the fund within twelve months after the loss reasonably should have come to the lender's knowledge. It is possible that a lender could find itself outside this time limit without any reasonable prospect of a recovery.  

Lenders also have statutory rights against insurers, currently under The Third Parties (Rights Against Insurers) Act 1930 which is soon to be replaced by The Parties (Rights Against Insurers) Act 2010. The 1930 Act allows a third party such as a lender who has a claim against an insured to enforce that claim directly against the insurer.

However there are significant hurdles to overcome in order to enforce those rights. A lender wishing to use the 1930 Act would have to bankrupt the partners in the firm (or they would have to already be bankrupt) and obtain a judgment against the firm. Once those hurdles have been overcome, the lender then has rights against the insurer as if it had stepped into the shoes of the insured partners to obtain information about the decision to decline cover and to challenge the insurer's decision to do so.

The lender may well face further hurdles if it wishes to challenge the insurer. The insurer is entitled to rely on technical defences in the policy terms to defend itself, so for example, it can rely on non notification of a claim or if the insured was only able to challenge the insurer's decision to decline cover within a certain time period, the lender may find that it is outside that time limit.

Third Party (Rights Against Insurers) Act 2010

The 1930 Act was criticised because of the hurdles it placed on third parties using the rights it granted. This led to the 2010 Act which was expected to come into force on 06 April 2011, but a date has still to be decided. The 2010 Act much reduces those hurdles. Whilst it still requires the insured to be insolvent before the third party can assume his rights, the requirement to have obtained a judgment against the insured is relaxed.

Instead, the 2010 Act provides that liability only needs to be established at the point a third party seeks to enforce an insured's rights under a policy, not the point the third party brings proceedings for such enforcement. The 2010 Act also limits the effect of the technical defences referred to above, by, for example, providing that the third party can fulfil reporting duties under the policy in place of the insured.  

Of more relevance to lenders is the clear procedure defined by the 2010 Act relating to requests for information. Where a lender reasonably believes that an insolvent insured has incurred a liability, a request can be made to the insurer for information regarding the policy.

Such information includes the terms of the policy, whether a claim has been notified and whether there have been any proceedings between the insurer and their insured. In the event that proceedings have been brought, and this includes arbitration, the third party can request copies of all documents served in the arbitration and orders made. Upon such a written request, insurers must provide the information within 28 days.

The 2010 Act will apply where either or both the insolvency event, such as the bankruptcy of the insured partners or the insured's liability occurs on or the date the Act comes into force. Where both occurred before this date the 1930 Act will continue to apply.  

What are the practical implications for lenders?

The important point to keep in mind is that if an insurer has legitimately declined cover, the statutory rights given by the 1930 Act or the 2010 Act will not assist. Indeed the Goldsmith Williams case referred to above is a good example of a claim taken all the way to trial in the hope of establishing the insurer's liability, no doubt at considerable cost, only to fail.  

What the 2010 Act will do, is to make it easier and much cheaper for a lender to be able to investigate whether an insurer had good grounds to decline cover and also to challenge a decision to decline cover without facing the significant hurdles presented by the 1930 Act. Insurers may well face a growing number of requests for information but are likely to react by making sure they are in a robust position to face up to challenges over whether they were entitled to decline cover.  

Conclusion

From April, lenders who suspect they have been the victim of dishonest or fraudulent conduct by their conveyancing solicitors and face an insurer who has declined cover will still need to pursue the bankruptcy of the insured partners in order to challenge the coverage decision. Once at that stage, however, the lender will be better placed to mount their challenge or seek disclosure of the underlying reasons behind declinature.  

No doubt the new rights given by the 2010 Act will be used by lenders and other third parties to challenge insurers but it remains to be seen whether in the long run this will lead to lenders making recoveries which they would otherwise have not made.