Professional negligence litigation rise down to the unscrupulous few

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Economically speaking, the law is generally thought to be a counter-cyclical profession.

An increase in litigation is usually a side-effect of recession.

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Often, this litigation is against professionals, an obvious example being the glut of cases during the 1990s against valuers and conveyancing solicitors arising from the crash in the property market.

Another effect of recession is that business ethics can become stretched or ignored.

Thus, the character whom 20th century judges rather quaintly called ‘the rogue’ appears more frequently in the law reports.

His reappearance during the current recession is promoted by, in particular, the use of email.

Many things which were, in earlier times, said on the telephone or in meetings, and were therefore harder to prove, are now set out and preserved in the form of emails, and the increasing stress laid by the court on proper ‘e-disclosure’ indicates that this trend will continue.

This article discusses a series of points arising from recent cases involving rogues and professionals.

Stone & Rolls

Generally, the professional who is caught up in transactions undertaken by the rogue is innocent, and they and their insurers frequently feel that it is unfair that they should be blamed.

The recent case of Stone & Rolls v Moore Stephens [2009] UKHL 39 shows the ex turpi causa principle being deployed to defend such a claim.

The maxim ex turpi causa provides that a claimant may not succeed if their claim is founded on their own wrong – in other words, if they seek to recover compensation for the consequences of their own wrongful conduct.

In Stone & Rolls, the claimant company was a ‘one-man band’ run by the rogue.

The company obtained monies under letters of credit by producing fake documents purporting to evidence commodity trades.

These commodities existed only in the fertile imagination of the rogue.

The company went into liquidation, owing large sums to the victims of the fraud, which had sued it in the tort of deceit, and obtained judgment.

The liquidator (who was, of course, representing the company, albeit bringing the action for the benefit of the victims, as its creditors) sued Moore Stephens, the company’s auditor.

The allegation was the familiar one: that Moore Stephens had failed in its duty, and that a competent audit would have uncovered the deceit earlier, and reduced the liabilities arising from it.

By a majority of 3:2, the House of Lords dismissed the claim, holding that the ex turpi defence was made out.

The majority took the following points:

  • The relevant wrongdoing must be personal to the claimant. Thus, the principle does not apply to vicarious responsibility for the wrongs of another. However, this qualification did not assist the claimant on the facts, because Stone & Rolls was a one-man company, and the rogue held all the shares. The company was directly liable in deceit;
  • The principle may not apply, even where the ‘directing mind and will’ of the company is fraudulent, if there are innocent shareholders who suffer;
  • Cases where the company is not obviously a ‘one-person company’ will be difficult, and depend on their facts;
  • The argument that the claim was brought by the liquidator for the benefit of the creditors as victims of the fraud failed, because the effect of so holding would be equivalent to deciding that the auditor owed a duty of care to creditors of the company to detect and advise about the fact that it was trading fraudulently. In so deciding, the majority applied Caparo v Dickman [1990] 2 AC 605.
The view of the minority, lords Mance and Scott, was that the maxim did not apply, because the proceedings were brought with the object of benefiting the victims of the fraud – an explanation not accepted by the majority.

The court was, therefore, divided on the question of how the victim and the villain should be identified.

Application of the precedent

It is submitted that Stone & Rolls may have a limited application across the professions, because usually the facts will be such that a straightforward plea of no causation/no reliance will produce the same result.

Take, for example, a development company that takes advice from an architect about whether alterations to its planned development are permitted by an existing planning permission.

Suppose that, initially, competent advice is given to the effect that the alterations take the development outside the scope of the relevant permission, but that the matter is referred to a more senior member of the firm, who negligently takes a different view.

Suppose finally that the company builds the development, is required to pull it down and rebuild, and seeks the costs as damages; however, it is obliged to disclose an internal email from the managing director, in response to the initial competent advice, saying ‘I don’t care what the architect says, go ahead anyway and never mind the planning laws’.

In such a case, we might say that the loss has been caused by the deliberate or reckless decision to build unlawfully, so that Stone & Rolls applies.

But it would be simpler to say that the bad advice did not cause the unlawful building, and was not relied on when the decision to build in that way was undertaken.

Illustrating the same point, Lord Brown, in Stone & Rolls, gave as an example the case of a solicitor who declares only six months’ fees to his accountant, while setting off against them 12 months’ operating expenses.

He held – with respect, correctly – that it was inconceivable that, when discovered and fined by HM Revenue & Customs, the solicitor could sue the accountant to recover the interest and penalties on the additional tax due.

The reason that an auditor’s case is different is because the auditor is employed (among other things) to detect and report on fraud.

Hence, the auditor, unlike other professionals, must enquire into suspected wrongful conduct, and report on it. One of the things that the auditor is relied on to do is to detect fraud.

Other professionals give their advice on the basis that the client will rely on it, and thereby act properly.

Note that the concept of founding one’s cause of action on wrongdoing has to be applied carefully.

It is not enough simply to point to unlawful conduct on the part of the claimant – he must be positively asserting that wrongful conduct as a key part of his case (although the matter must be looked at pragmatically, rather than by enquiring technically whether the unlawful conduct is pleaded – see Stone & Rolls).

Where the wrongful conduct is simply part of the background, the principle cannot apply.

Thus, there is no ex turpi problem where, for example, a company sues its solicitor for negligently advising it as to its defence of a prosecution arising out of the manner in which it did business.

If the company alleges that, properly advised, it would have seen that it had no defence, and pleaded guilty at the first opportunity (thereby mitigating its penalty and saving on defence costs), it is submitted that it would be no answer to say that the prosecution (by definition) arose out of unlawful conduct.

In the rare case where the professional is complicit in the wrongful conduct, however, and the rogue does rely on the advice in furtherance of his schemes, ex turpi causa is a defence.

See Nayyar v Denton Wilde Sapte [2010] PNLR 15, where a solicitor advised and assisted her client in an attempt to obtain a lucrative contract by bribery.

The contract was not granted to the client, even though the bribe was paid over, and retained.

The attempt to sue the solicitors to recover the bribe was defeated by (among other defences), ex turpi causa.

Wider implications

The approach of the majority in Stone & Rolls – that is, rejecting the claim as constituting, among other things, an attack on Caparo – emphasises the need to ensure that the activities of the rogue do not warp the general principles of the law of professional liability.

So, for example, in Frank Houlgate v Biggart Baillie LLP [2010] PNLR 13, the Court of Session held that a solicitor engaged in a conveyancing transaction was entitled to assume that his client was honest, in default of evidence to the contrary.

He had no duty of care to the other side to enquire into that point (applying Gran Gelato Ltd v Richcliff (Group) Ltd [1992] Ch 560, itself approved in White v Jones [1995] 2 AC 207) or to provide accurate information or advice (unless he specifically assumed responsibility to do so).

Lord Drummond Young held, however, that, where the solicitor was put on notice of the fraud or facts pointing in that direction, he came under a duty not to participate in or connive at the fraud, and would be liable if he did so.

Investment schemes

A number of large-scale actions have arisen as a result of investment schemes in which the rogue promises guaranteed returns on significant sums of money, and then absconds with the communal pot, or invests it speculatively (and contrary to the rules of the scheme) so as to generate the promised return, and thereby loses the pot.

Sometimes, the solicitor retained to advise becomes a trustee of the scheme (which obviously lends it credibility), and is induced to act in breach of trust or to connive at such a breach.

In such cases, the breach of duty as trustee is usually self-evident. But it by no means follows that the firm is liable.

In Walker v Stones [2001] QB 902, the Court of Appeal had to construe section 10 of the Partnership Act 1890.

It decided that a firm of solicitors is not generally liable for the acts and omissions of a partner who is acting as a trustee. Hence, the firm cannot be sued in respect of acts and omissions of a partner in their capacity as trustee.

However, in complicated investment schemes, it is frequently possible to identify advice and misstatements about the workings of the scheme, or errors in drafting the scheme documentation, which can be sued upon, and can attract vicarious liability (see Dubai Aluminium v Salaam [2003] 2 AC 366).

Similarly, in Nayyar v Denton Wilde Sapte (above), another reason why the solicitors escaped liability was because their employee was not acting within the scope of her employment and/or within the ostensible authority given to her.

On the facts, she was broking and facilitating the deal, not giving legal advice.

Relevant factors included: the low level of truly legal work required (restricted to some elementary drafting); the high level of her remuneration (totally inconsistent with a time-charge basis and amounting instead to a commission); and uncertainty as to whether the fee was payable to her personally or to the firm.

Insurance brokers

Another effect of recession is that property insurers scrutinise claims with care.

This has the potential to increase litigation against insurance brokers.

It is now clear law that the days of the broker being able to act as a ‘post box’, passing information and enquiries from insurer to insured, are gone.

There is a positive duty to ‘get a grip’ (Alexander Forbes v SBJ [2003] Ll Rep IR 432).

The broker must understand their client’s business, and must give proper advice about points of insurance law and practice, for example, by explaining the definition of ‘material facts’.

See Jones v Environcom Ltd [2010] PNLR 27.

A broker must be astute to ensure that a fair presentation of the risk is made to insurers.

In James v CGU [2002] Ll Rep IR 206, insurers avoided the policy on a number of grounds.

These included non-disclosure of the fact that the insured was in dispute with the tax authorities in relation to VAT, and failure to account properly for PAYE. A formal enquiry had been commenced.

The court held that the insurers were entitled to avoid on this ground.

The information was material because it suggested that the insured did not run his business in a lawful manner, and did not keep proper records, as well as suggesting that the business might be in financial difficulty.

Does it follow that the broker’s duty to know their client’s business extends to enquiring as to its financial position? It is submitted that such a duty may exist, but cannot be pressed too far.

In James, the facts were strong. That the authorities were making formal enquiries plainly indicated an increased moral hazard, so far as insurers were concerned.

But Mr Justice Moore Bick accepted that there was also increased moral hazard where a business was struggling.

It is submitted that the broker need not scrutinise the accounts; but it may be that they should, as a matter of routine, enquire of the client’s accountant or auditor whether there have been significant changes in the client’s position.

Equally, another ground of non-disclosure which was made out in James was the failure to disclose that the insured was running a ‘sideline’ skip hire business (his main business being as a garage).

Diversification of trade is common in the face of hard times. Brokers need to make themselves aware of such changes.

The Environcom case gives a useful pointer towards the extent of a broker’s duty to enquire.

There, the broker was not negligent in failing to understand the technical details of the client’s unique manufacturing process, and realising that it would result in the generation of heat and the risk of fire.

But he was negligent in a related matter – namely, that he failed to give a sufficient explanation to the client about the meaning of materiality, thereby depriving the client of the information required to appreciate the materiality of those points.

Obviously, a broker sued for negligence in circumstances like those in James will contend that, even if enquiry had been made, the insured would not have given a truthful answer, or would have instructed that the matter not be disclosed to insurers, in any case.

This defence will be acutely fact-sensitive.

This article shows that, no matter what he is called, the rogue or fraudster plays an important part in modern professional negligence litigation, and gives rise to a number of interesting and difficult points.

Simon Howarth is a barrister at Crown Office Chambers

Solutions

This article was first published in the April edition of Solutions, the magazine of the Law Society’s Civil Justice Section.

The Civil Justice Section is a representative membership association of the Law Society, focusing on all areas of dispute resolution, including arbitration, litigation and mediation.

Benefits include the magazine, which is published quarterly; regular e-newsletters; free and discounted CPD-accredited events; and discounts on related products and services.

Membership is open to practising solicitors.

For more details, call 020 7320 5873, email civiljusticesection@lawsociety.org.uk or visit the Civil Justice Section on the Law Society site.

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