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Cite as: [1999] Lloyd's Rep IR 516, [1999] EWCA Civ 1884

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IN THE SUPREME COURT OF JUDICATURE No QBCMI 1998/1289/3

IN THE COURT OF APPEAL (CIVIL DIVISION)

ON APPEAL FROM ORDER OF MR JUSTICE MANCE

Royal Courts of Justice

Strand

London WC2

Monday, 19th July 1999

B e f o r e:

LORD JUSTICE PETER GIBSON

LORD JUSTICE JUDGE

LORD JUSTICE CLARKE

MDIS LIMITED

(Formerly McDONNELL INFORMATION SYSTEMS LIMITED )

- v -

SWINBANK

LONDON & EDINBURGH INSURANCE COMPANY LIMITED

AEGON INSURANCE COMPANY (UK) LIMITED

(Handed down judgment

Smith Bernal Reporting Limited, 180 Fleet Street,

London EC4A 2HD

Tel: 0171 421 4040

Official Shorthand Writers to the Court)

MR JONATHAN GAISMAN QC and MR ROBERT BRIGHT (Instructed by Messrs Wilde Sapte of London) appeared on behalf of the Appellant

MR DANIEL SEROTA QC (Instructed by Messrs Williams Davies Meltzr of London) appeared on behalf of the Respondent

J U D G M E N T

(As Approved by the Court )

(Crown Copyright

LORD JUSTICE CLARKE:

1. This is an appeal from an order of Mance J dated the 31st July 1998 in which he made a declaration under RSC Order 14A as to the true meaning of a provision in a contract of insurance.

The Facts

2. I take the facts largely from the judgment. The plaintiff (“MDIS”) is a software house. Silkolene Lubricants Plc (“Silkolene”) is or was a manufacturer of paints, oil and lubricants. On the 1st August 1991 MDIS concluded an agreement with Silkolene for the development and supply of software and the supply of certain computer hardware, intended to constitute a process control system (the “MD Process”) software, which would interface with the financial processing system (“Griffin”) produced by another company and to be supplied under a separate contract with MDIS. By letter dated the 6th June 1995 Silkolene treated MDIS as in repudiation of that contract and on the 20th September 1995 it commenced proceedings for damages.

3. In its statement of claim Silkolene asserted that MDIS had misrepresented the compatibility of the Griffin and the MD Process software, that it was in breach of contract by failing to deliver the MD Process software by March 1992 or within a reasonable time and failing to complete delivery of it, by failing to provide proper maintenance and enhancements to the Griffin software and by supplying a defective MD Process software. There were also allegations that the compute hardware supplied was inadequate, due to slowness, to run even the software which had been supplied, and that MDIS was in breach of another agreement dated the 6th April 1994 for a Matrix Purchase Order Processing system, by failing to supply that system by the 13th June 1994 or within a reasonable time or in part at all. The statement of claim did not however make any allegations of fraud.

4. On the 9th April 1997 Silkolene’s claim was compromised before discovery by MDIS paying £863,178.58 together with Silkolene’s costs. In this action MDIS claims an indemnity in respect of that liability subject to the policy excess of £143,000.

The Insurance

5. The policy of insurance is described as professional indemnity insurance. It is contained in the Certificate which provides so far as relevant as follows:

2. Operative Clause

The Underwriters will indemnify the Assured to the extent and in the manner detailed herein against any claim for which the Assured may become legally liable, first made against the Assured and notified to the Underwriters during the period of the Certificate arising out of the professional conduct of the Assured’s business as stated in the Schedule alleging:

(a) Neglect Error or Omission

any neglect or omission including breach of contract occasioned by same.

(b) Dishonesty of Employees

any dishonest, fraudulent, criminal or malicious act(s) or omission(s) of any person employed at any time by the Assured.

The Assured will not be indemnified against any claim or loss, resulting from the dishonest, fraudulent, criminal or malicious act(s) or omission(s) perpetrated after the Assured could reasonably have discovered or suspected the improper conduct of the employee(s).

No indemnity shall be provided to any person committing any dishonest, fraudulent, criminal or malicious act(s) or omission(s).

any claim arising from unintentional breach or infringement of or unauthorised use of confidential information, trade secrets, patents, copyrights, or the systems or programs of others.

(d) Libel and Slander

any claim arising from the publication or utterance of a libel or slander.

3. Loss of Documents

Underwriters will indemnify the Assured up to the Limit of Indemnity as specified in the Schedule against:

(i) legal liability which the Assured may incur by reason of any claim first made against the Assured and notified to the Underwriters during the period of the Certificate in consequence of documents having been lost, damaged, destroyed, mislaid, distorted or erased;

...

8. Exclusions

Underwriters will not provide indemnity against:

(a) Any claim or loss alleging death or bodily injury to any person or physical loss or damage to property (except in so far as indemnified by the Loss of Documents Extension), unless such claim or loss arises out of advice, design, specification or formula.

(b) Any claim or circumstance known to the Assured prior to the inception of this Certificate and which the Assured at such time knew or should have reasonably assumed might result in a claim against the Assured.

...

13. Claims Procedures

Assured’s duties

It is a condition precedent to the Underwriters’ liability under this Certificate that:

(a) upon receipt by or on behalf of the Assured of notice whether written or oral of any intention to make a claim against the Assured which may be the subject of indemnity hereunder or of any allegation which might give rise to such a claim, or upon the discovery of a circumstance which may become the subject of indemnity hereunder the Assured shall notify the Underwriters in writing of such receipt, allegation or discovery as soon as practicable and shall provide full information in respect thereof so far as such information is in their possession or control.

If during the period hereof the Assured shall become aware of any circumstances which may subsequently be the subject of a claim under this Certificate and shall, as soon as practicable during the period hereof, give written notice to Underwriters of such circumstances then such subsequent claim hereunder shall be deemed for the purposes of this Certificate to have been made during the period hereof.

The Assured shall not admit liability for or settle or make or promise any payment in respect of any claim which may be the subject of indemnity hereunder or incur any costs or expenses in connection therewith without the written consent of the Underwriters who, if they so wish, shall be entitled to take over and conduct in the name of the Assured the defence and/or settlement of any such claim for which purpose the Assured shall give all information and assistance as the Underwriters may reasonably require.

SCHEDULE

...

5. Business:

The development and supply of computer solutions comprising application specific software, the provision and installation of hardware, where appropriate, together with the necessary related services to complete the solution, including facilities management, maintenance services and software support and the provision under licence of the company’s applications development tools and as more fully declared in the proposal form and any accompanying information submitted with the proposal form.

The Claim

6. Paragraphs 1 and 2 of the points of claim set out the terms of the contract relied upon. The only part of clause 2 which is relied upon is clause 2(a). It is common ground that the cover afforded by clause 2(a) does not include (as the judge put it) deliberate neglect or error or deliberate omission to do that which the insured knows he should do. In short clause 2(a) is a neglect or negligence clause, whereas clause 2(b) may be described as a dishonesty clause. It was expressly conceded before the judge that the exception in the second part of clause 2(b) is an exception only to the cover afforded by clause 2(b) and not to the cover afforded by clause 2(a). As I understand it, that is because clause 2(a) does not provide cover in respect of dishonesty so that such an exception is unnecessary.

7. Paragraph 3 of the points of claim sets out Silkolene’s claim and paragraph 4 reads:

The claim by Silkolene arose out of the professional conduct of the Plaintiff’s Business as stated in the Policy Schedule and alleged neglect, error or omission and/or breach(es) of contract occasioned by the same.

There then follow four particulars of Silkolene’s claim none of which alleges fraud. Paragraphs 5 and 6 of MDIS’s points of claim allege an estoppel with which we are not concerned on this appeal. Paragraph 7 alleges the compromise and paragraph 8 simply alleges that in the premises MDIS is entitled to be indemnified under the policy. It is thus clear from the points of claim that MDIS’s claim is made solely under the cover afforded by clause 2(a) of the Certificate. No claim is made under clause 2(b).

The Defence

8. In the points of defence the underwriters set out clause 2(b). In paragraph 7 the underwriters plead as follows:

The claim made against the Plaintiff by Silkolene was a claim arising out of fraudulent misrepresentations by the Plaintiff and resulted from dishonest, fraudulent, or malicious acts or omissions perpetrated after the Plaintiff could reasonably have discovered or suspected the improper conduct of its employees.

As the judge pointed out, as particulars of their plea in paragraph 7 the defendants assert, in summary, (1) that MDIS fraudulently represented to Silkolene, in order to induce the making of the agreements with Silkolene, that MDIS had started development work on the software and was continuing such work during the course of the negotiations as part of an on-going project, whereas this was not the case and the development depended upon Silkolene entering into the August 1991 agreement, (2) that MDIS, by contracting with Silkolene in August 1991 for delivery by March 1992, represented to Silkolene that it believed on reasonable grounds that it could comply with that obligation, whereas it knew that it could not, and (3) that, when by the end of 1991 it had become apparent to Silkolene that MDIS could not deliver as agreed, MDIS told further lies as to the reasons for the delay.

9. While MDIS acknowledges that certain employees in its sales team lied to Silkolene in the negotiations proceeding the August 1991 contract, and in particular deliberately oversold the state of development of the MD Process, it will, if it becomes material, be an issue whether Silkolene was through a consultant aware of such lies and overselling and whether Silkolene was in any event induced to enter into any agreement with MDIS by them. It will, if material, also be an issue whether Silkolene’s claims, which MDIS compromised, can be regarded as caused by or arising out of such lies, either in whole or in any part. Mr Bright, who represented MDIS before the judge, emphasised before him that Silkolene had never pursued any claim in deceit or for misrepresentation by overselling, whereas MDIS alleges, although this too is in issue, that Silkolene knew or had the means of knowing that such claims were open to it during the course of its proceedings against MDIS. Mr Bright also emphasised before the judge the distinction between the measure of damages in tort or for misrepresentation and the measure in damages for the breaches of contract which formed the primary basis of Silkolene’s claims against MDIS.

10. However, like the judge, we are not concerned with the validity of the allegations made by either side or with any issues of fact. For present purposes it is sufficient to note the way in which the case for each side is pleaded and the fact (as already stated) that Silkolene at no stage either made a claim against MDIS in respect of fraud or alleged fraud on its part either in the pleadings, in correspondence or at all.

The Issue

11. Since this is a contract of indemnity it is common ground that in order to recover under it the insured must establish a loss, either by judgment or arbitration award or by agreement: see Post Office v Norwich Union Fire Insurance Society Ltd [1967] 2 QB 363, approved in Bradley v Eagle Star Insurance Co Ltd [1989] AC 957. It is also common ground that the loss must be in respect of a legal liability, if only because of the words “for which the Assured may become legally liable”. The issue between the parties is a narrow one. The underwriters’ case, both before the judge and before us, is that in order to succeed under clause 2(a) of the policy MDIS must show that it was legally liable to Silkolene in respect of “neglect error or omission including breach of contract occasioned by the same”. The case for MDIS, on the other hand, is that so to hold is to disregard or to give insufficient weight to the word “alleging” in clause 2.

12. Mr Gaisman QC, who appeared before us on behalf of MDIS, submitted that in order for the insured to succeed under clause 2(a), the loss established by the judgment, award or agreement must be in respect of a legal liability for a claim “alleging any neglect error or omission including breach of contract occasioned by same”. He submitted that it is not necessary for the insured to prove that the proximate cause of the loss as so established was the neglect itself. It is sufficient if the liability is for or in respect of a claim alleging such neglect. He submitted that the underwriters’ construction does violence to the words of the clause, which can be broken down into four limbs, and rewritten in this way:

The Underwriters will indemnify the Assured to the extent and in the manner detailed herein against any claim

(i) for which the Assured may become legally liable

(ii) first made against the Assured and notified to Underwriters during the period of this Certificate

(iii) arising out of the professional conduct of the Assured’s business as stated in the Schedule

(iv) alleging (a) neglect error or omission including breach of contract occasioned by same ...

I agree that clause 2(a) can indeed be rewritten in that way. Moreover, Mr Gaisman correctly submitted that (i), (ii) and (iii) are either agreed or very likely to be established. As to (iv) he submitted that in the light of Silkolene’s allegations against MDIS, it too is plainly established since there can be no doubt that it was Silkolene’s claim, which alleged breach of contract caused by neglect and contained no allegation of fraud, which was compromised and led to the liability which is the subject of the claim. The judge rejected that submission. The question is whether he was right to do so.

Discussion.

13. Mr Gaisman’s submissions have an undoubted attraction if attention is focused on the words of the introduction to clause 2 and of clause 2(a). Moreover I accept his submission that in any process of construction it is appropriate to take the language of the particular clause as the starting point. It is, however, not in dispute that the words used must be considered in the context of the particular clause as a whole and that the clause must in turn be considered in the context of the policy as a whole, which must in its turn be set in its surrounding circumstances or factual matrix. Moreover, as Lord Hoffmann pointed out in the now well known case of Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at pp 912 and 913, interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract and the meaning of the document is what the parties using the relevant words against the relevant background would reasonably have been understood to mean.

14. Both before the judge and before us considerable attention was paid to the decision of Devlin J in the well known case of West Wake Price & Co v Ching [1957] 1 WLR 45, where he was considering a similar but different clause. Mr Gaisman submitted that this contract must be construed in accordance with its terms and not by reference to the terms of a different contract between different parties in different circumstances at a different time. I accept of course that we are construing this contract and not the contract in the Ching case. However, both the decision and the dicta in that case can in my judgment properly be treated as relevant to the construction of this clause since they have been well known amongst insurance lawyers and indeed brokers for many years and would be likely to have been in the back of the minds of those negotiating this contract. I shall return to that case in a moment, but I shall first consider what appears to me to be the correct construction of the clause without regard to it.

15. As indicated in paragraphs 11 and 12 above, the question is whether the parties agreed that the loss ascertained by the award, judgment or agreement (as the case might be) must be proximately caused by neglect, which I shall use as a shorthand for the cover identified in clause 2(a), or whether it is sufficient if the loss so ascertained is in respect of a claim alleging such neglect or, put another way in the context of a settlement, is contained in an agreement settling a claim alleging neglect. Mr Serota relied in particular upon the underlying nature of the policy as a contract of indemnity and submitted that the loss must be proximately caused by a peril insured against, namely neglect. He further submitted that the meaning of the clause could be ascertained by reference to the exception in clause 2(b), to which I shall return in a moment. The judge preferred Mr Serota’s submissions to those being advanced on behalf of MDIS. So do I.

16. The effect of Mr Gaisman’s submissions is that where the claim which is settled was advanced by the claimant only as a claim for neglect the underwriters are liable even if they can prove that the proximate cause of the liability was the dishonest or fraudulent act of an employee of the insured perpetrated after the insured could reasonably have discovered or suspected such improper conduct. In my opinion a consideration of clause 2 read as a whole leads to the conclusion that the parties did not intend such a result. It is common ground that where the claim alleges dishonesty by an employee, which I shall use as a shorthand for the cover identified in clause 2(b), the effect of the exception to clause 2(b) is that, whatever the nature of the claimant’s allegation, the underwriters are not liable if they can prove that the proximate cause of the loss was dishonesty was perpetrated after the insured could reasonably have discovered or suspected improper conduct.

17. In these circumstances I do not think that it makes sense to hold that underwriters agreed to indemnify the insured where the claim alleges neglect but where the loss ascertained by settlement or determination of the claim was proximately caused by dishonesty perpetrated after the insured could reasonably have discovered or suspected improper conduct but not where the claim alleges dishonesty. I can see no reason why the underwriters should have agreed to indemnify the insured (or indeed why the insured should expect to have been insured) in the one case and not in the other. That is especially so given that in the latter case, where dishonesty is alleged, underwriters will not be liable if they can establish the relevant facts, even if none of the material emanating from the claimant would establish such a defence.

18. I agree with the judge that Mr Gaisman’s submissions place more weight on the single word ‘alleging’ than it can in its context properly bear. Mr Gaisman criticised the judge for failing to explain what he thought ‘alleging’ in fact meant. I do not accept that criticism. The judge said this:

The certificate wording is no model of precise draughtsmanship. Clause 2 deals in a rolled up way with different times and concepts. Its reference to ‘any claim for which the Assured may become legally liable, first made ...’ refers first to the need for a third party claim to be made and notified during the period of the certificate and secondly to the idea of legal liability (which either exists or does not from the time of the original act, error or omission, etc.) or possibly, the establishment of legal liability for a third party claim by judgment, award or agreement. The use of the word ‘alleging’ in relation to sub-clause (a) and (b) is understandable in so far as clause 2 is concerned with a third party claim, and, in location and grammar, ‘alleging’ appears to qualify ‘first made’ or possible ‘any claim’. It does not fit in with the concept of either original or established liability, unless at least, it is read in a broad sense wide enough to allow consideration of the real nature of such liability. Furthermore, while the word ‘alleging’ leads naturally into sub-clauses (a) and (b), the scheme then breaks down, since sub-clauses (c) and (d) both commence ‘any claim arising from ...’ - language which, it might be thought, required an enquiry into the real cause of the claim. The insurance provided by clauses 3 and 4 against the risks of loss of documents and infidelity of employees is also based on causation, including the third party liability cover afforded by clause 3(i).

Subject to one small point, I agree with those conclusions. That point is that it seems to me to be clear that the word ‘alleging’ qualifies ‘any claim’. I do not see how it can qualify ‘first made’. Otherwise I agree with the judge that a consideration of clause 2 as a whole leads to the conclusion both that it cannot be read entirely literally and that it is concerned to impose liability where the proximate cause of the liability to the claimant is one of the insured perils in one of its sub-clauses.

19. The judge then considered clause 2(b) and its exception which I have discussed in paragraphs 15 and 16 above. He pointed out that in that exception the parties abandoned ‘alleging’ in favour of ‘resulting’, which he said again suggests that the basic cover afforded by the sub-clause was itself viewed as cover against claims resulting from dishonesty. Again, I entirely agree.

20. In my judgment, when clause 2(a) is read in the context of clause 2 as a whole and when it is borne in mind that this is an indemnity policy, the correct construction of it is clear. It is that underwriters will be liable where the proximate cause of the loss ascertained by judgment, award or compromise was one of the perils set out in clause 2. In this way underwriters are not liable, not only if the proximate cause of the loss is the dishonesty of the insured itself, but also if the proximate cause of the loss was not neglect but dishonesty of an employee perpetrated after MDIS could reasonably have discovered or suspected the improper conduct of the employee concerned.

21. Mr Gaisman submitted that that conclusion is wrong because it ignores the necessity to identify the way in which the claimant’s claim was put. He recognised that it was not appropriate to concentrate on the writ or points of claim served by the claimant, but he said that attention must be directed only to material emanating from the claimant. However, I do not think that that approach makes commercial sense. It might work to the disadvantage of either the insured or underwriters, depending upon the facts of a particular case. In a case like the present it might work to the disadvantage of underwriters by precluding them from identifying the true proximate cause of the insured’s liability. On the other hand it might well work to the disadvantage of the insured. Thus a claimant might simply assert a breach of contract on the part of the insured without making any assertion as to whether the proximate cause of the breach was neglect or dishonesty of an employee (or indeed of the insured itself). In that event it might not be possible to show from the material emanating from the claimant that the claim alleged neglect, from which it would follow, if Mr Gaisman’s submissions were accepted, that the insured would not be entitled to recover under the policy.

22. That does not seem to me to be a sensible construction of the contract. Claimants may have many reasons of their own why they choose to put their case in a particular way, regardless of what would be held to be the true proximate cause of the insured’s liability. One common example, which was identified by Judge LJ in argument, was a claim against say a solicitor or accountant which could be put as a claim for fraud or a claim for negligence. In such a case it would ordinarily be sufficient (and much easier) for the claimant to put its case only in negligence. Thus the claim might be put in negligence or it might be put in negligence and fraud and in either case it might be settled. It is common ground that in both cases underwriters would not be liable if the proximate cause of the loss was the fraud of the insured and that in the second case they would not be liable if they could establish that the proximate cause of the loss fell within the exception to clause 2(b) because of the principle in Wayne Tank and Pump Co Ltd v Employers Liability Assurance Corp Ltd [1974] 1 QB 57. I do not think that the parties can have intended that the underwriters should be liable in the first case if they can establish the same facts. Equally, for the reasons given in paragraph 21 I do not think that the parties intended that the insured should not be covered if the true proximate cause of its liability was neglect, but it was not possible prove it by reference only to material emanating from the claimant. In either case, underwriters’ liability depends upon the true facts and not simply upon the way in which the claimant chooses to put its case.

23. It does not of course follow that it would not be possible to devise a clause which had the effect contended for by Mr Gaisman, but I agree with the judge that this clause has not achieved that result. Moreover I also agree with him that his conclusion is consistent with the approach of Devlin J in the Ching case to which I now turn. In that case Devlin J was considering a Lloyd’s accountants’ indemnity policy which covered the insured against

loss for any claim or claims which may be made against them ... in respect of any act of neglect, default or error on the part of the assured ... or their partners or their servants, in the conduct of their business as accountants ...

In addition the policy included a QC clause (or a KC clause as it was at the time of the policy) whereby it was agreed that underwriters would pay

any such claim or claims which may arise without requiring the assured to dispute any claim, unless a King’s Counsel (to be mutually agreed upon by the underwriters and assured) advise that the same could be successfully contested by the assured, and the assured consents to such a claim being contested, but such consent not to be unreasonably withheld.

Devlin J considered the meaning of both clauses. With regard to the first clause, which he called the main indemnity clause, he said (at p 49):

The essence of the main indemnity clause - as indeed of any indemnity clause - is that the assured must prove a loss. The assured cannot recover anything under the main indemnity clause or make any claim until they have been found liable and so sustained a loss. If judgment were given against them for the sum claimed, they would undoubtedly have sustained a loss and the question would then arise what was the cause of the loss. If the proximate cause (this seems to be the test; Goddard and Smith v Frew [1939] 4 All ER 358) of the loss was the dishonesty of their servant, they could not recover under the policy; if on the other hand it was their own neglect, they could recover. If the action between the claimants and the assured did not settle the question of causation, it would in all probability settle the facts in the light of which the question could be answered. But all this would involve publicity which, where charges of professional negligence are made, might do considerable harm to an assured over and above the amount of any judgment obtained against him. For this reason professional men may prefer paying a bad claim to fighting it. Obviously one of the main objects of a QC clause is to give the assured additional cover, not only against the costs of litigation but also as a protection against unwelcome publicity.

In that case the court was considering the QC clause and was thus considering the position before the liability of the insured had been ascertained by judgment or agreement. It is important, however, to note that, in the context of the main indemnity clause which Devlin J was considering, he said that once the loss had been ascertained (or as he put it sustained) it remained for the insured to prove that that loss was proximately caused by neglect. Devlin J put what is essentially the same point in this way (at p 50):

If the action against the assured succeeds, a loss will be proved; but it would still be open to underwriters to assert that the loss is not within the policy. For example, a claim which appeared on presentation to be in respect of negligence might turn out in reality, when all the facts are known, to be in respect of fraud. It would then be open to the underwriters, irrespective of whether they could properly be made liable for the costs of the action, to refuse to pay the claim.

Mr Gaisman submitted that when the judge said ‘when all the facts are known’ he meant ‘when all the facts are known from the judgment’. However, I do not so read it. In my opinion Devlin J simply meant that if on the true facts the proximate cause of the loss was fraud which was not covered under the policy, underwriters would not be liable.

24. Before the judge Mr Bright conceded that Devlin J’s approach to the clause in that case was correct and that, if the word ‘alleging’ in clause 2 had read ‘in respect of’ he could not have distinguished what he said in the above passage. Mr Gaisman was not I think willing to go so far, but in my judgment Mr Bright’s concession was correctly made and I have already given my reasons for concluding that the use of ‘alleging’ does not make all the difference. This contract should in my opinion be construed in the same way. The judge expressed his final conclusions in this way, after pointing out what he described as the haphazard results which flow from Mr Gaisman’s submissions, which are I think similar to those in paragraphs 21 and 22 above:

But, ultimately, as between insured and insurers, it is established liability which this insurance pays, and it is upon the nature and causation of any liability established that I consider the insured’s right to indemnification must depend. In a case which goes to judgment, the judgment will, as Devlin J said, “in all probability settle the facts in the light of which the question could be answered”. In a case compromised short of judgment, it is necessary and appropriate to ascertain the real basis on which the case was compromised. That depends not upon what the third party may have alleged, although that is an important consideration when seeking to understand the overall position. It involves taking an overall view of the nature and causation of the liability recognised by the compromise. A defendant who, confident of success on the allegations made, nonetheless settles before discovery knowing that, if he continues, documents will reach the other side which will enable different allegations to be made to which he will or may have no answer, cannot on this basis ground his claim against his insurers solely and artificially on the allegations which happen to be made against him. He must address the real basis of such liability as is established by the compromise which he makes.

I agree.

25. It follows that, while, by reason of the compromise, MDIS has proved a loss, it must be established that the loss was proximately caused by neglect. It is, in my judgment, open to the underwriters to assert, as they do in paragraph 7 of their points of claim quoted above, that the loss resulted from the dishonest acts of the insured’s employees perpetrated after MDIS could reasonably have discovered or suspected the improper conduct of such employees. In that event the loss would not have been caused by neglect and MDIS would not be able to recover under the policy. The question how that issue will be resolved does not arise on this appeal, but for the reasons which I have tried to give, which are essentially the same as those given by the judge, I would dismiss the appeal.

26. Since writing the above I have had the advantage of seeing the draft judgments of Judge and Peter Gibson LJJ. I entirely agree with the judgment of Judge LJ. I also agree with Peter Gibson LJ that the proviso to clause 2(b) is an important provision because (as I said in paragraph 23 above) I do not think that the parties can have intended that the underwriters should be liable if the facts fell within the proviso. Thus they did not intend that they should be liable in respect of any claim or loss arising from dishonesty perpetrated after MDIS could reasonably have discovered or suspected improper conduct. Nor (as Peter Gibson LJ has pointed out) did they intend that any indemnity should be provided to any person guilty of dishonesty.

27. I agree with Peter Gibson LJ that one way of construing clause 2 consistently with that view of the parties’ intentions would be to hold that that the proviso is an exception, not only to the cover afforded by clause 2(b), but also to that afforded by the remainder of the clause including clause 2(a). I would if necessary so hold, but I remain of the view expressed above that a preferable route to that conclusion is that adopted by the judge. As Judge LJ puts it, the word “alleging” is not entirely happy. It cannot be read literally because, if so read, it makes no sense in the cases provided for in clause 2(c) and (d). The problem is solved if “alleging” is read as meaning simply in respect of, so that MDIS must prove that the proximate cause of its loss was one or more of the events identified in clause 2(a), (b), (c) or (d).

LORD JUSTICE JUDGE:

I agree with Clarke L.J.

By this contract for professional indemnity insurance, indemnity was provided against any legal liability incurred by the appellants (MDIS Limited) in the four distinct situations defined in the operations clause (clause 2).

This provides:

"The Underwriters will indemnify the Assured to the extent and in the manner detailed herein against any claim for which the Assured may become legally liable, first made against the Assured and notified to the Underwriters ..... arising out of the professional conduct of the Assured’s business ..... alleging:

(a) Neglect, Error or Omission

any neglect error or omission including breach of contract occasioned by same.

(b) Dishonesty of Employees

any dishonest, fraudulent, criminal or malicious act(s) or omission(s) of any person employed at any time by the Assured.

The Assured will not be indemnified against any claim or loss, resulting from dishonest, fraudulent, criminal or malicious act(s) or omission(s) perpetrated after the Assured could reasonably have discovered or suspected the improper conduct of the employee(s).

No indemnity shall be provided to any person committing any dishonest, fraudulent, criminal or malicious act(s) or omission(s).

any claim arising from unintentional breach or infringement of or unauthorised use of confidential information, trade secrets, patents, copyrights, or the systems or programs of others.

(d) Libel, Slander

any claim arising from the publication or utterance of a libel or slander."

The drafting of the operative clause is not entirely happy. In the particular context of the argument before us the word “alleging” seems to be disconnected from the potential liability covered in (c) and (d). What however is clear is that the obligation to indemnify arises only when the legal liability of the assured is established. Legal liability cannot arise from the making of an allegation or the formulation or service of a claim.

If the argument for MDIS Limited summarised in Clarke LJ’s judgment were correct, the practical realities of their claim for indemnity would be obscured. The liability of the underwriters to indemnify the assured would depend not on an objective analysis of the true cause of the loss for which the assured was responsible, but rather on the way in which the claim against them by a third party was formulated and pursued, and if improper conduct within the meaning of clause 2(b) were not alleged, the underwriters’ exemption from liability would have no application. In other words the contractual entitlement of the underwriters to seek exemption from liability would depend on decisions, possibly ill-informed, possibly motivated by tactical considerations, by others to which they were not parties, and which, as between the underwriters and the assured, might very well be entirely fortuitous. This outcome would be contrary to the contractual intentions of the parties, who expressly agreed that the underwriters would not be required to provide indemnity against any “loss” caused by dishonest employees which the assured could reasonably have discovered or suspected.

The contention for MDIS is also inconsistent with the provisions of clause 13 of the contract which, as a condition precedent to the underwriter’s liability, requires the assured to “provide full information” relating to any claim. In a case where neglect or error alone is alleged, the information made available to the underwriters in accordance with clause 13 may nevertheless demonstrate that in truth the loss arose from dishonesty or fraud by the assured’s staff which the assured should reasonably have discovered or suspected. If Mr Gaisman’s argument were right, it would follow that despite the underwriters’ entitlement to know facts which establish that the assured’s legal liability to a third party arose in circumstances to which the exemption applied, if the party proceeding against the assured was either ignorant of all the facts, or for his own reasons elected not to pursue the more serious allegations, the underwriters’ knowledge could not be deployed to produce the exemption envisaged by the contract.

In my judgment the operative clause is concerned with the reality and not the epithet chosen by the third party to apply to the claim against the assured. The claim, or the allegation, triggers the process which may ultimately demonstrate the assured’s right to indemnity and the underwriter’s corresponding obligation to indemnify. If the result of this process demonstrates that the “loss” against which the assured is seeking indemnity in fact arises from improper conduct by employees within clause 2(b), in my judgment the underwriters are entitled to avoid liability where such conduct could reasonably have been discovered or suspected by the assured.

LORD JUSTICE PETER GIBSON:

This appeal gives rise to a short question of construction which I confess I have found more difficult than my Lords.

As Mr. Gaisman Q.C. for the Appellant in his excellent argument pointed out, four conditions require to be satisfied if the indemnity in the Operative Clause of the Certificate is to operate:

(1) the claim is one for which the Assured may become legally liable

(2) the claim is one first made against the Assured and notified to the Underwriters during the period of the Certificate;

(3) the claim is one arising out of the professional conduct of the Assured’s business as stated in the schedule;

(4) the claim is one alleging a matter falling within para. (a) or para. (b) or para. (c) or para. (d).

I need not linger long over the first three conditions, save to note that it is not in dispute that there must be liability on the Assured if the Underwriters are to pay. Whether that stems from the first condition or from what is implicit in the obligation to “indemnify” does not matter. I incline to think it is the latter, having regard to the wording of the first condition “ may become legally liable” (my emphasis). The dispute centres on the fourth condition.

Pace the judge, there can really be no doubt but that “alleging” qualifies “any claim” and not “first made”. Both are participles qualifying the noun “claim” and give rise to separate conditions. The word “alleging” has a precise and clear meaning as a matter of ordinary language and it barely needs further explanation. It requires examination of the nature of the claim being asserted. It does not require proof of the claim. Mr. Gaisman, relying on n. 57 to para. 28-54 in MacGillivray on Insurance Law 9th. ed. (1997), submits that the substance of the complaint against the assured must be looked at, and he concedes that such examination is not confined to how the complaint is put in the pleadings; but he says that it is confined to what the claimant is actually saying. The judge rejected the argument to that effect put forward by the Appellant, saying that it placed more weight on the single word “alleging” than it could in its context bear. But he did not in terms say what meaning he gave to “alleging”. However Mr. Serota Q.C. for the Underwriters submitted, I think correctly, that what the judge held it to mean was “resulting from” or “caused by”, and that was the construction for which Mr. Serota contended.

I am afraid that I regard that as an impossible construction in the context in which, as the judge rightly said, “alleging” falls to be construed. I say that for the following reasons. First, “alleging” is simply not a synonym for “resulting from” or any other participial phrase pointing to causation. So to construe it involves rewriting the language of the condition which the parties chose. Second, the draftsman has used the very words “resulting from” in what I shall call the proviso, the two sentences following para. (b), to qualify “any claim or loss”. It would be remarkable if the draftsman by using different language, “any claim .... alleging”, intended the same meaning to be conveyed. The suggestion that the language of the proviso supports construing “alleging” as meaning “resulting from” is as logically flawed as it would be to suggest that “resulting from” in the proviso means “alleging”. The function of the proviso (to which I must shortly return) is to remove from the indemnity a class of claim or loss which need not be coextensive with the class of “any claim .... alleging” and which on its face differs from that class because of the different language qualifying “any claim”. Third, the draftsman elsewhere in the Operative Clause has twice used another term synonymous with “resulting from” but plainly not synonymous with “alleging”, viz. “arising from”, as qualifying “any claim” in paras. (c) and (d), and that leads again to the inference that the draftsman must be taken to have intended something different by the words “any claim .... alleging”.

Similar points can be made in relation to the language found in the authorities. I accept that cases such as Goddard & Smith v Frew [1939] 4 All E.R. 358 and West Wake Price & Co. v Ching [1957] 1 W.L.R. 45 would be so well-known to those operating in this field that they must have been in the minds of the draftsman and of those negotiating the contract. Yet the striking fact is that the language of the Operative Clause is quite different, and again this leads to the inference that the insertion of a condition in terms of “any claim .... alleging” was deliberately intended to mean something other than “all .... demands .... by reason of” (as in the Frew case)” or “any claim .... in respect of” (as in the Ching case).

If that is right, the fourth condition does not require any enquiry into the proximate cause of the loss to be indemnified against save where the language of a particular lettered paragraph points to causation. Thus in paras. (c) and (d) one looks to see whether the proximate cause of the claim is as described in those paragraphs. I should add that the infelicity of the language used in relation to those paragraphs - “any claim .... alleging .... any claim arising from” - exists on any construction of the Operative Clause and tells neither for nor against Mr. Gaisman’s construction.

The real problem in the case seems to me to arise in relation to the extent of the application of the proviso. If, as Mr. Serota concedes, the proviso only operates in relation to para. (b) so that it can only apply where there has been a claim alleging dishonesty, then it does produce the remarkable result that where negligence only is alleged but the proximate cause is seen to be fraud (perhaps after information is made available under clause 13, as Judge L.J. pointed out in the course of the argument), the underwriters are obliged to indemnify. At this point it is pertinent to refer to the text of the paragraph in MacGillivray to which the note relied on by Mr. Gaisman and referred to by me earlier is appended. In para. 28 - 54 it is said:

“Scope of the Policy. It is essential to appreciate that the purpose of the usual professional indemnity policy, subject to special wordings in particular cases, is to afford cover in respect of the liability of the insured for negligence on the part of himself or his employees .... It is not the purpose of such a policy to afford cover for liability incurred by the insured as the result of any dishonest or fraudulent act on the part of his employees”.

The note to the latter sentence, n. 57, after reference to authorities including the Frew case and the Ching case, reads:

“The Court must look at the substance of the complaint against the assured in order to say whether liability rests on negligence or fraud.”

This leads me to question whether the concession made by Mr. Serota was rightly made. I can see that the proviso in its position immediately after para. (b), which refers to “any dishonest, fraudulent or malicious act(s) or omission(s) of any person employed at any time by the Assured”, and before paras. (c) and (d) might naturally be expected to apply only to para. (b), particularly as it repeats the words “dishonest, fraudulent, criminal or malicious act(s) or omission(s)” in relation to the Assured’s employees. But there is a second sentence to the proviso:

“No indemnity shall be provided to any person committing any dishonest, fraudulent, criminal or malicious act(s) or omission(s).”

That suggests to me that the proviso goes wider than para. (b) relating to employees, but would prevent any indemnity to the Assured if dishonest. Further, it would accord with the general statement cited from MacGillivray if the proviso was treated as applicable also to claims not alleging fraud but alleging negligence. For my part therefore I would not accept Mr. Serota’s concession on what is a point of law, the true construction of the contract. That leads to the same result as that reached by the judge.

It is with considerable diffidence that I propound this as the solution to what I have called the real problem in the case. I am uncomfortably aware that I am not only differing in my approach from a judge of far greater experience in this field than I have but also from my Lords. Further, I am resting my decision on a point not tested by debate because of the concession made; but as my approach is a minority one, I have not thought it right to put the parties to the expense of a further hearing on the point. Nevertheless for the reasons which I have given I too would dismiss this appeal.

Order: Appeal dismissed with costs.