Turning a blind eye — what is required to condone dishonesty

We consider the recent case of Discovery Land Co LLC v Axis Specialty Europe SE [2023] EHHC 779 (Comm), in which the Commercial Court examined the meaning of “condone” in the dishonesty exception of the SRA Minimum Terms and Conditions of Professional Indemnity Insurance for Solicitors (“the MTCs”). The judgment also considered the aggregation wording in the relevant insurance policy, which mirrored the corresponding provision of the MTCs.

The background

AXIS was the primary layer professional indemnity insurer of Jirehouse Partners LLP and two private limited companies, Jirehouse and Jirehouse Trustees Ltd (“JTL”) (together, “the Jirehouse Entities”).

Discovery Land Co LLC (”the Company”) had obtained judgments against the Jirehouse Entities in respect of two claims concerning client money provided in connection with the purchase of Taymouth Castle in 2018 and 2019.

The first claim (“the Surplus Funds Claim”) involved Mr Jones, a director of the limited companies and a member of the LLP, dishonestly removing $14,050,000 from JTL’s account, which related to the Company’s purchase of Taymouth Castle.

The second claim (“the Dragonfly Loan Claim”) involved Mr Jones, dishonestly and without authority, arranging and drawing down £4,980,470 from Dragonfly Finance s.a.r.l. as a loan against security over Taymouth Castle over a period of circa three weeks then removing that sum from Jirehouse’s client account.

The Jirehouse Entities had not satisfied the judgments, having ultimately been intervened by the SRA and become insolvent. It was not in dispute that the Company was entitled to pursue against AXIS the rights (if any) of the Jirehouse Entities to be indemnified, under the terms of their insurance (“the Policy”), in respect of the judgments.

Reflecting the wording of the relevant provision in the MTCs, Clause 2.8 of the Policy permitted Axis to decline cover in respect of,

“Any claims directly or indirectly arising out of or in any way involving dishonest or fraudulent acts, errors or omissions committed or condoned by the insured, provided that:

(a)              the policy shall nonetheless cover the civil liability of any innocent insured; and

(b)              no dishonest or fraudulent act, error or omission shall be imputed to a body corporate unless it was committed or condoned by, in the case of a Limited Liability Partnership, all members of that Limited Liability Partnership.”

The question for Knowles J was whether Mr Prentice, the other director of Jirehouse and a member of Jirehouse Partners LLP, had condoned the acts of dishonesty by Mr Jones thus entitling AXIS to decline cover.

The condonation of fraud question

In addressing the condonation of fraud question, the court not only had the benefit of hearing evidence from Mr Prentice but it also had available a transcript of “much of” an indemnity interview carried out by Mr Jamie Smith KC in June 2019, at the request of AXIS.

Knowles J concluded that the word “condone” should be given its meaning in “ordinary language”, conveying acceptance or approval. He also observed that, in some situations, the condonation/approval did not require “an overt act”.

Knowles J also agreed with the submission for Axis that:

“...there is nothing in the language used to suggest that it is only if a person knows of a particular fraudulent act before or at the time it is committed that he is taken to have condoned it.  It is enough to know and condone a pattern of dishonest behaviour of which the particular fraudulent act forms part.”

It was not AXIS’s case that Mr Prentice specifically approved the dishonest acts of Mr Jones in relation to the Surplus Funds Claim and the Dragonfly Loan Claim. AXIS contended that Mr Prentice (a qualified solicitor, who had been in the employ of Jirehouse for more than a decade and had previously worked in the regulation of financial services) was aware of previous improper use of client money by Mr Jones and was also aware of Jirehouse’s financial problems and hence, the temptation or need for Mr Jones “to help himself to client funds”. AXIS further argued that it was in an attempt to cover up this awareness that Mr Prentice “…told a number of significant lies, either in evidence at trial or to Mr Smith KC in June 2019.”

Axis relied upon the definition of “blind eye knowledge” in Group Seven v Nasir [2020] Ch 129 at [60], i.e. that turning a blind eye requires a suspicion “firmly grounded and targeted on specific facts” and a deliberate decision to “avoid obtaining confirmation of facts in whose existence the individual has good reason to believe.”

Before applying the law to the relevant facts, Knowles J observed that, “…the question, if there was condonation, of what it was that was condoned will require close attention on the facts.”

Throughout the judgment, Mr Prentice was, justifiably, criticised by Knowles J, who found that although a plainly well-educated man, Mr Prentice had “a tendency to adjust his evidence at trial to distance himself from events and circumstances and the personal risk that closeness to those events and circumstances might involve.” In particular, Knowles J found that Mr Prentice:

• was dishonest in the evidence that he gave in response to two winding up petitions against Jirehouse Capital Finance Limited, another entity with which Mr Jones was involved, demonstrating “ … he was willing to go to considerable lengths for Mr Jones, including asserting solvency when he had insufficient grounds for supposing Jirehouse CF to be solvent, and was himself suggesting to Mr Jones to place it into some sort of insolvency procedure.”
• lied to Mr Smith KC, when he told him that he did not know that the $14,050,000 had been received into the account of JTL. The judge commented that he had no doubt Mr Prentice was aware of the receipt of the money and that he had, in giving evidence at trial, sought to downplay his role.
• “made up” his evidence at trial about being shown an internal accounts document, to justify his false representation to a company called Rheno that their monies were held on Jirehouse’s client account. Further, he did not concern himself with whether the statement was true or false.

It was also accepted that there were persistent cashflow difficulties at the Jirehouse Entities, such that at the material time the firm was in difficulty meeting the payroll expenses and that Mr Prentice’s evidence on that issue was not correct.

Notwithstanding the cumulative implications of past events and Mr Prentice’s role therein, Knowles J declined to conclude that Mr Prentice had condoned the dishonesty of Mr Jones in relation to the Surplus Funds Claim and the Dragonfly Loan Claim, finding that the cash flow problems did not indicate to Mr Prentice that Mr Jones was misappropriating client funds or committing any other kind of fraud and further, that Mr Prentice’s failure to investigate the position was not because he suspected that if he did investigate, that is what he would find. In short then, that the two ingredients of blind eye knowledge (1) the existence of a suspicion that certain facts may exist, and (2) a conscious  decision to refrain from taking any step to confirm their existence, were not demonstrated. 

Knowles J went on to conclude that:

“…Mr Prentice did not condone Mr Jones acting dishonestly or fraudulently. If he did, then what he condoned was the use by Mr Jones of client monies to address temporary exigencies and pressures. Those acts by Mr Jones were not the acts involved in the claims in respect of the Surplus Funds Claim or the Dragonfly Loan Claim, and nor do the claims directly or indirectly arise out of them. It may be that had Mr Prentice looked into the question of whether client monies were being used to address temporary exigencies and pressures that would (by one means or another) in the event have prevented “Mr Jones [from] perpetuat[ing] the fraud in the Taymouth Castle [t]ransaction”, but that causal link is not provided by the terms of Clause 2.8.”

In arriving at his decision in respect of dishonesty, Knowles J placed weight upon a number of key factors that, in his judgment, militated against finding in favour of Axis. In particular, he accepted the Company’s point that, given the nature and detail of an investigation by the SRA in 2017, which led to no further action against Jirehouse, its result “...would have served to reassure someone in the position of Mr Prentice that accounting obligations were being complied with.” Later, at paragraph 141 of the judgment, he went on to say:

“But when one reviews the decade, the SRA investigations and reports are important. This is not to pass judgment on their quality; that is not my function in this case. Rather it is to note that their outcomes affect my confidence that had Mr Prentice questioned or looked into matters at the time he would have encountered matters that meant that continuing to work with Mr Jones would condone dishonesty or fraud on the part of Mr Jones or the Jirehouse Entities, that would give rise to or would involve the claims for the Surplus Funds Claim or the Dragonfly Loan Claim.”

Pausing there, it is an unusual feature of this case that a number of historic reports to the SRA and their subsequent investigation did not unearth evidence of Mr Jones’s fraud earlier. The exact scope and remit of the 2017 investigation are unclear from the judgment, which simply describes it as “...another investigation...”, which would “…examine the business management and accounts of the Jirehouse Entities”. Notably, by the end of the investigation, Jirehouse had liabilities of £779,000, PAYE and VAT were not being paid as they fell due and Mr Jones was using client monies without authority. However, the investigation was closed on 6 October 2017. Indeed, the SRA did not strike off Mr Jones from the Roll of Solicitors until 2022, following his committal to prison for 12 years as a result of a private prosecution brought against Mr Jones by Discovery Land Company. We are not aware that any investigation has been commenced following the judge’s numerous findings of dishonesty by Mr Prentice and his finding that Mr Prentice was “unsuitable to be a solicitor. …. did not have the sense of personal responsibility required and he did not see how serious his own professional obligations were.”

Another factor that appears to have held sway with Knowles J is the fact that, ultimately, Mr Prentice resigned when Mr Jones told him that the Dragonfly Loan monies had been paid away. Knowles J opined that, had Mr Prentice suspected at an earlier date that client monies were being misused or stolen, he would have resigned earlier. This appears to have given him some comfort in his finding that there had been no such earlier suspicion on Mr Prentice’s part.

It is also clear that Knowles J was concerned that the documents that he was working from appeared incomplete. He refers to the point a couple of times, saying at paragraph ten of his judgment:

“Documents have been obtained from Jirehouse’s servers and from regulatory files of the SRA. In the result the Court also has before it many documents, however these are not complete and some are heavily redacted, apparently on the basis of claims to legal professional privilege. I am left feeling quite sure that not all the relevant facts are known about the period of more than a decade that this case spans.”

Of key import was the lack of documentary evidence that Mr Prentice knew at the time that $14,050,000 had been removed from JTL’s account. Therefore, we are left to wonder how the outcome would have been affected had the full facts been known to the court. 

Aggregation

The court then moved on to consider aggregation, albeit briefly. Clause 5.2 of the Policy provided:

“5.2            ONE CLAIM

All claims against one or more insured arising from:

…

(c)        one series of related acts or omissions;

…

(e)        similar acts or omissions in a series of related matters or transactions;

will be regarded as one claim for the purposes of the policy and the payment of any excess.”

Following Lord Bishop of Leeds v Dixon Coles & Gill [2021] EWCA Civ 1211, Knowles J concluded that the thefts were brought about separately. Therefore, the Surplus Funds Claim was not caused by the same series of acts as the Dragonfly Loan Claim, so as to bring both within Clause 5.2(c).

Knowles J then went on to consider Clause 5.2(e) of the Policy.  Applying AIG Europe Ltd v Woodman [2017] UKSC 18, he considered the question of whether the transactions “fitted together” and concluded that they did not.  He summarised the position as follows:

“Although they both involved Taymouth Castle, the Surplus Funds Claim involved the theft of a client’s purchase monies under a proposed purchase transaction that did not depend on a loan, whilst the Dragonfly Loan Claim concerned the theft of monies lent to a client under a secured lending transaction arranged later.”

Therefore, the court held that the claims were not to be regarded as one claim.

Commentary

The question of condonation of fraud is highly fact sensitive and some of the facts in this case were somewhat unusual. Notwithstanding that, some practitioners may consider the decision surprising given the court’s findings that Mr Prentice had been dishonest in certain respects. What also emerges from this judgment is the extent to which the court viewed the issue through the lens of public policy.

As early as paragraph 13 of the judgment, it is clear that Knowles J expressly had in mind that the “principal purpose” of the SRA Indemnity Insurance Rules 2013, which contained the MTCs, was to “…confer on the Law Society the power to safeguard the lay public.” In support of that proposition, he cited Impact Funding Solutions Ltd v Barrington Support Services Ltd [2017] 2 All ER (Comm) 863.

Whilst not specifically mentioned in the judgment, the Company, unlike an individual claimant, would, most likely, have been ineligible for a grant from the SRA Compensation Fund, which is only available to companies with an annual turnover or assets of less than £2 million. Therefore, had the court not found in its favour, it would have walked away empty-handed despite being the victim of fraud.

Policy considerations were clearly at the forefront of his mind when Knowles J observed, in the endnote to his judgment,

“…it may surprise the client community, and the public, that insurance, which is part of a framework required for their protection, may protect them where one of two partners was dishonest but not where the insurers can show the second partner condoned the dishonesty of the first…the point just mentioned may be suitable for joint review by The Law Society and the SRA.”

Whereas it seems apparent the SRA consider that the right balance is struck and public interest is served, by a dishonesty exclusion that permits insurers to decline cover for condoning partners and, indeed, the Law Society has said, “the solicitors body has no plans to explore the points raised by Judge Knowles about professional indemnity insurance” in the judgment.

This case also highlights the difficulties for insurers in obtaining enough evidence of condonation of fraud when a firm has been intervened. Often, it is simply not possible for them to locate, obtain and/or present to the court all of the evidence that might assist their case.