Fraud has been a common theme running through claims against small firms of solicitors and accountants since the 2008 financial collapse. Typically, these might be claims against solicitors for failing to report fraudulent conveyancing transactions to lenders, or claims against accountants for participating in or failing to spot fraudulent tax avoidance schemes. However, insurers are increasingly prepared to investigate whether the insured is dishonest and, if so, to decline cover.

How do you decline against a whole firm?

There are minimum terms regulating these policy wordings and they are insured friendly for public policy reasons. However, there is no cover for a dishonest insured. The definition of an insured is wide and includes employees, partners, members, consultants and directors. So, whilst a dishonest fee-earner is not entitled to cover, in order to decline against the whole firm, insurers generally need to establish in the case of:

  • a partnership - that all the partners are dishonest
  • an LLP - that all the members are dishonest
  • a limited company - that all the directors are dishonest

Dishonesty here not only includes those who commit a fraud, steal money etc but importantly, whether the insured have dishonestly participated in or condoned a fraud. In other words have they turned a blind eye to the dishonest conduct of their clients, third parties or partners?

Also, if a “partner” does not have a say in the running of the business and/or share the profits, he is unlikely to be a real partner. However, if he is held out as a partner and the claimant relies on this, insurers will still need to prove he is dishonest before declining cover for the claim.

In the case of limited companies with multiple directors, if you can establish that a single director was dishonest, it is possible to decline cover for the whole company on the grounds that the dishonest director effectively stood in the shoes of the company. This is difficult to prove but it is usually the case that he controlled the company and made all the decisions.

So what’s the civil law test for dishonesty?

The courts have wrestled with an explicable test for dishonesty. In the 2002 decision of Twinsectra v Yardley, the House of Lords provided a twin objective and subjective test:

  • the defendant’s conduct must be dishonest by the ordinary standards of reasonable and honest people; and
  • the defendant actually realised that by those standards his own conduct was dishonest.

The Solicitors Disciplinary Tribunal applies this test when prosecuting solicitors. However, since Twinsectra, both the Privy Council in Barlow Clowes v Eurotrust and the Court of Appeal in AG of Zambia v Meer Care have applied a more objective test.

In short, it now appears the correct test is to consider whether an honest person (with the same knowledge, belief and characteristics as the defendant) would have acted in the same way in the circumstances. The test is decided on the balance of probabilities.

A quick checklist for your dishonesty investigation

  • Is it worth it? Think carefully before embarking on what could be an expensive investigation and remember that you will need separate coverage panel solicitors to investigate dishonesty to avoid conflicts of interests.
  • Ultimately, unless the insured’s dishonesty is very clear, you will need to work towards inviting the relevant individuals at the insured to a recorded indemnity conference, where your leading counsel will cross-examine them before advising on declinature.
  • So before instructing coverage panel solicitors think about:
    • what dishonest behaviour you wish to investigate – blind eye fraud can be difficult to establish; and
    • how many partners/directors/members you will have to investigate and, in the case of partners, whether they are equity or salaried.
  • Once the investigation is underway, you may have to move quickly especially if the claim is advanced or proceedings are active.
  • Reserve your rights – avoid both any suggestion you have affirmed cover or the insured misunderstanding the purpose of the investigation.
  • Ensure claims panel have taken steps to preserve files and electronic information at the insured.
  • Remember to treat the insured fairly. In particular, try and avoid disclosing the investigation to the claimant’s solicitors – if they get a whiff of the dishonesty investigation, it can cripple the insured’s defence.
  • Think about whether you wish to meet the insured at an early stage at their offices so you can reach an early view, possibly before incurring more costs. The alternative is to move straight to the indemnity conference. But be careful, insureds often refuse to attend two meetings.
  • If you proceed to an indemnity conference, make an informed decision afterwards. But if it is necessary and commercially sensible to investigate further then do so. When making a decision, think about the strength of the case and whether it will resist a challenge by the insured or a claimant.