The point at issue in this case, arising out of the notorious Brandons debacle, concerned whether a claimant could still pursue the professional indemnity insurers of a bankrupt solicitor even where a claim had not been established before the bankrupt’s discharge. The conclusion is of importance to professional indemnity insurers.
Over a two-year period, Dixit Shah acquired a number of solicitors’ practices which traded under the BJ Brandon Group name. The Law Society intervened in September 2000, and it alleged it discovered that Shah had misappropriated around £12.5m of client funds before disappearing abroad.
The Law Society compensated the alleged victims and consequently became statutorily subrogated to their rights and remedies, and began proceedings to recover the monies paid out against the partners of the law firms, including three discharged bankrupts. The Law Society sought to recover, under their professional indemnity policies, using the 1930 Act. The Act provides that on the bankruptcy of an individual (or the insolvency of a company) protected by third-party liability insurance, the bankrupt’s rights to claim on the insurance are transferred to the third-party claimant. The right to sue only arises, however, once the existence and amount of the insured’s liability has been established by action, arbitration or agreement.
As the three bankrupts had been discharged from bankruptcy before the Law Society issued the recovery proceedings, the insurers argued that liability had not been established, no judgment had been, or now could be, obtained against the discharged bankrupts themselves, and so the cause of action was extinguished. The Law Society sought to amend its claim form so as to include a claim for a declaration that the discharged bankrupts were, prior to their discharge, liable to the Law Society and that the debts could be proved against them in bankruptcy.
The decision
Mr Justice Floyd found against the insurers, holding that the discharge of the bankrupts did not extinguish the underlying cause of action on which the obligation to pay was founded, so that there remained the possibility of a claim after discharge. Relying on obiter comments in the decision of the Court of Appeal in FSCS v Larnell Insurances (in liquidation) [2006], the judge concluded that it would suffice for the purposes of the 1930 Act for a third party to prove a claim in bankruptcy, and that a judicial decision would not be necessary. The admission of a claim in bankruptcy gave the claim the necessary ‘elevated status’ and the release of the bankrupt was irrelevant. It did not matter that the insured suffered an indemnifiable loss at a time when he could not make a claim under the policy, following the transfer of rights.
The provision by which the Court can deal with the question of admission of a proof of debt is section 363(1) of the Insolvency Act 1986. This section was wide enough to give the court jurisdiction to decide a question properly arising in a bankruptcy, whether of law or fact - even if the use of this section for this purpose, rather than for the purpose of obtaining the right to vote in or gain a dividend from a bankruptcy, was unusual. The Law Society’s action will continue for a judicial determination on the proof via this route. The insurers were given permission to appeal.
The main consequence for professional indemnity insurers is that claims against bankrupt insureds cannot be opposed on a technical point purely by having been pursued after the bankrupt professional has been discharged. This would otherwise have created a logistical challenge for claimants; following the Enterprise Act 2002, a discharge can be obtained one year from bankruptcy.
The decision comes in a deteriorating economic climate in which claims against professionals appear to be rising. This alternative route of proving a professional’s bankruptcy appears likely to be of considerable interest to claimants. Professional indemnity insurers will be concerned as to whether a trustee admits a claim in the insured professional’s bankruptcy, particularly where it is considered that any claim should not be admitted, notwithstanding it may still be open to the insurer as an interested party to challenge the admission of the claim under section 303 of the Insolvency Act 1986. The judgment approved previous case law (in Re Menastar Finance [2003]) indicating that the trustee of a discharged bankrupt’s estate must act in a quasi-judicial capacity in assessing the merits of any claim before any claim is admitted in the bankruptcy.
There may be many instances where a trustee is not inclined to admit a claim. Floyd held that in circumstances where a trustee simply does not have the resources to investigate the proofs of debt, and unless and until the court directs the trustee in the exercise of its powers, the trustee is under no duty to investigate the proof and the proof of debt should accordingly be ‘held over’. Faced with these issues, insurers who intend to defend a claim against a bankrupt professional may wish to suggest that the trustee should either reject any proof in whole or hold the proof over.
There may nevertheless be practical implications in relation to ongoing costs. If a negotiated settlement cannot be achieved promptly then the insurer may be requested to provide the trustee with an indemnity in relation to any proceedings into which it is brought. It may be possible, however, to persuade the trustee to seek an indemnity from the claimant in relation to any adverse costs order, which the Law Society agreed to provide in this case, or a formal direction that the trustee need take no step (and therefore need not incur any costs) in those proceedings.
Insolvency practitioners will also be interested in these findings given that the principles will be equally applicable to company liquidations.
It remains to be seen whether the point will be challenged or re-opened in future. For now, professional indemnity insurers will need to review their exposures in the light of this judgment.
Philip Murrin is a partner and Evi White an associate at Davies Arnold Cooper.
