Insolvency Exposure For Professional Indemnity Insurers.

In an important judgment for professional indemnity insurers, the court has held that

Discharge from bankruptcy means that a client can no longer pursue a bankrupt professional in respect of his bankruptcy debts (including potential liability for professional negligence)

It is however possible for the client to pursue the bankrupt's professional indemnity insurers direct under the Third Parties (Rights Against Insurers) Act 1930 using the proof of debt mechanism.

Professional indemnity insurers will need to review their potential exposure to direct claims by third parties in the light of the judgment. The decision will also be of interest to insolvency practitioners given that the principles will be equally applicable to company liquidations.

For a more detailed analysis of the decision and its implications,

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Full Article

In an important judgment for professional indemnity insurers, the Court has decided that whilst discharge from bankruptcy will mean that a client can no longer pursue a bankrupt professional in respect of his bankruptcy debts (including potential liability for professional negligence) it is possible for the client to pursue the bankrupt's professional indemnity insurers direct under the Third Parties (Rights Against Insurers) Act 1930 using the proof of debt mechanism.

In a case which is destined for the Court of Appeal, The Law Society has won the right to pursue a claim direct against the insurers of a solicitor in respect of his alleged professional liabilities by using bankruptcy procedures in circumstances in which it is no longer possible to obtain a judgment against the solicitor personally.

Facts

Over a 2 year period, Dixit Shah acquired a number of solicitors' practices on which The Law Society subsequently intervened in September 2000 only to discover that Mr Shah, so The Law Society alleged, had misappropriated [pounds sterling]12.5 million of client funds before disappearing abroad.

The Law Society compensated the victims of Mr Shah's alleged misappropriations and then sought to recover, by way of a subrogated claim, the monies which it had paid out to individuals who had been partners of Mr Shah; it is important to note that there were no allegations of dishonesty against those partners.

Three of those pursued by The Law Society (including a Mr Barda) were bankrupts who had been discharged from bankruptcy before The Law Society issued the recovery proceedings; they maintained that discharge from bankruptcy gave them a complete defence to The Law Society's claim and this was ultimately accepted by The Law Society.

The critical question for the Court was, therefore, whether The Law Society could proceed direct against the professional indemnity insurers of the discharged bankrupts under the 1930 Act in circumstances in which no judgment had been, or now could be, obtained against the discharged bankrupts themselves.

The Decision

It was common ground that the statutory transfer of Mr Barda's rights against his professional indemnity insurers to The Law Society took place immediately on Mr Barda's bankruptcy.

That said, The Law Society's own right to pursue the professional indemnity insurers direct would remain contingent, or inchoate, until Mr Barda's liability to The Law Society was established.

The Law Society could no longer pursue Mr Barda as his discharge from bankruptcy had the effect of extinguishing the remedy of enforcement against him; it did not, however (despite authority indicating otherwise) extinguish the underlying cause of action against Mr Barda.

Accordingly, it would be enough to establish an indemnifiable loss under the policy (which could be pursued by The Law Society direct against the professional indemnity insurers) for The Law Society to obtain a decision admitting its claim against Mr Barda in his bankruptcy; this would give the claim sufficient "elevated status" for the purposes of the 1930 Act; as the Court put it "Upon the debt being admitted, the inchoate rights which were transferred to the third party [i.e. The Law Society] are made good".

The appropriate provision by which the Court can deal with the question of admission of a proof of debt is Section 363(1) Insolvency Act 1986 which gives the Court a widely drafted power to determine all questions "whether of law of fact arising in any bankruptcy" and The Law Society's action will continue for a judicial determination on the proof via this route.

Analysis

Professional indemnity insurers have been given permission to appeal and there is little doubt, given that the 1930 Act is now more than 75 years old and that many changes have been made to bankruptcy law since it was entered on the statute book, that the operation of the 1930 Act is ripe for review.

In particular, following the Enterprise Act 2002, a discharge can be obtained 1 year from bankruptcy whereas adherence to the professional negligence pre-action protocol would, if no negotiated settlement was achieved, give very little time for a claimant to obtain a judgment against a negligent professional for the purposes of enforcement direct against insurers under the 1930 Act in the event that that professional is adjudged bankrupt. Accordingly, this alternative route of proving in the bankruptcy is likely to be very attractive to clients and other third party claimants in such circumstances. Professional indemnity insurers will need to review their exposures in the light of this judgment.

Insolvency practitioners will also be very interested in these findings given that the principles will be equally applicable to company liquidations. Indeed, the Court recognised that using the proof procedure for the purpose of enforcing rights under the 1930 Act (rather than obtaining the right to vote in, or gain a dividend from, a bankruptcy) was unusual and carried with it the possibility (which we suggest is very strong) that the proof procedure will become widely used for this collateral purpose.

From a practical perspective, a trustee (or liquidator) joined to proceedings for a judicial determination on a proof of debt in the future will no doubt, want (as did Mr Barda's trustee) to obtain an indemnity from the creditor concerned as protection against any adverse costs order made in relation to his or her involvement in those proceedings and, moreover, will want to seek a formal direction that he or she need take no step (and therefore incur no costs) in those proceedings.

The Law Society v. Official Receiver & Another [2007] EWCA 2841(Ch)

CMS Cameron McKenna acted for Mr Barda's Trustee in Bankruptcy 

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 18/12/2007.

Mr Richard Curd 

CMS Cameron McKenna LLP 

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