The Quebec Court of Appeal ordered five insurance companies to pay approximately $4.1 million to a bailiff’s firm after it refused to cover its losses and legal fees in a case that clarifies when professional indemnity claims can be triggered and reiterates yet again the principle that lawyers should not have two masters.
In a dense and complex 30-page ruling dealing with an insurance claim arising out a “very complicated and very unusual underlying facts,” the Quebec Court of Appeal maintained its trend of broadly interpreting claims and professional liability insurance policies in favour of claimants, according to insurance lawyer experts.
“In the most general way, this ruling is part of a trend that gives rights to the insured,” observed Valérie Lemaire, an insurance lawyer with Langlois Kronström Desjardins LLP in Montreal. “Is it to the detriment of insurers? I don’t think so. Insurers are being asked to analyze its policies in the most liberal fashion possible. It invites insures to be very transparent with its insured.”
The long legal saga began in 2006 when the courts ordered Ronald Weinberg, co-founder of the animation company Cinar, to sell his homes in Montreal and Magog in the Eastern Townships as part of a legal dispute with the new owners of the entertainment firm. A bailiff’s firm was given a mandate to proceed with the “forced sale” and collect monies to be disbursed to creditors upon approval by the courts. About $5.8 million was recouped from the sale of the two homes, some of which was distributed to creditors who did not contest the legal process. Monies that were not disbursed were transferred from the bailiff’s trust account to another account, which invested in short-term asset-backed commercial paper.
On February 2008, the lawsuit between Weinberg and Cinar was settled. However the bailiff informed the two parties that the monies recouped from the sale of the homes were not available because they were invested in short-term asset-backed commercial paper, something that was done without the consent of the creditors or the court. Following a series of legal maneuvers by creditors and several lower court judgments against the bailiffs, the bailiffs turned to its insurers on February 2008 and filed a notice of claim under its professional liability insurance policy. The insurers denied coverage and refused to defend the bailiffs but did provide the services of a lawyer ex gratia, meaning that the insurers offered legal services to the insured without prejudice or as part of the coverage mandate. After a ruling Quebec Court of Appeal in April 2009 which compelled the bailiffs to pay the monies back, coupled with by the refusal of the insurers to provide coverage, the bailiffs had no choice but to borrow nearly $4.5 million to pay off the creditors. On February 2010 the bailiffs sued the insurers, and more than a year later on December 2011 won their case before Quebec Superior Court who ordered the insurers to pay the bailiffs $4.2 million. The lower court held that the bailiffs were “justified” in claiming insurance coverage. It also held that the insurers failed to comply with their obligation to provide legal services to the bailiffs – findings that were upheld by the Quebec Court of Appeal.
The appeal court, after examining the conduct of the insurers, upheld the lower court finding that the insurers created an “ambiguous and confusing situation” by giving a law firm the double mandate of protecting the interests of the insurers and the insured. That led to situations where the bailiffs made decisions that were not to their advantage but favoured the insurers. “The insurers placed their commercial interest before the interests of the insured,” succinctly noted appeal court Justice Lorne Giroux in a unanimous ruling in Continental Casualty Company v. Taillefer 2014 QCCA 2001.
“That conflict is a structural conflict, and whether it was in the context of an ex gratia gesture or in the context of an acknowledgement of partial coverage situation, the same problems exist,” noted Nick Krnjevic, a Montreal insurance lawyer with Robinson Sheppard Shapiro LLP. “You can’t have an attorney wearing both hats because inevitably conflict situations come up. You need to be upfront and have very clear communications between the parties, explaining what is happening, and who’s acting for whom to make sure that these problems don’t arise.”
Surprisingly, the appeal court also applied the principle of estoppel, a doctrine in which a court prevents a litigant from taking an action the litigant normally would have the right to take in order to prevent an inequitable result. In this case, the appeal court concluded that because of its conduct the insurers were estopped or forbidden from invoking the argument that they had no obligation to defend the bailiffs, said Lemaire. “The principle of estoppel is normally used in situations where an insurer is forbidden from invoking an argument when it denies coverage to a policyholder,” explained Lemaire. “But in this case it was used to prevent the insurers from arguing that it had no obligation to defend the insured because it acted in a reprehensible manner. That’s an important development because very few rulings have taken such a position when it comes to an insurer’s obligation to defend.”
The appeal court also provided clarity over the difference between a claim in respect to a contract to deposit compared to a claim for damages stemming from professional services, said Krnjevic. The insurers argued that they had no obligation to provide coverage to the bailiffs under its professional indemnity policy because it was a simply a case of handing back to creditors the money that was placed in the trust account. But the situation was much more complicated. When the bailiffs were given the mandate by a judge to sell the homes, Weinberg launched a variety of legal challenges against creditors. Moreover, the identity of the creditors was not determined nor was their status. The money generated from the proceeds of the sale of the homes was put into trust pending the resolution of determining who the creditors were and how much they were owed. “In this case, the creditors were not the guys that deposited any money so there was no contract,” said Krnjevic.
By the same token, the appeal court held that bailiffs were covered by their professional indemnity services policy because even though the bailiffs erroneously invested the proceeds from the sale of the homes in a manner that they were not supposed to, they were investing the trust money for the benefit of the creditors, pointed out Krnjevic. “If you do something that you are not supposed to, that you don’t have the authority to do while you are acting in the course of rendering professional services, that omission in this context could be reasonably seen as professional errors,” said Krnjevic. “That’s practical. When you think of the purpose of insurance, it is to provide a source of indemnity to third-party victims. So you need to have a reasonably liberal and expansive interpretation of the coverage.”
The appeal court did however reduce the award granted by the lower court. The appeal court held that the interest that the bailiffs incurred when borrowing the $4.5 million, which amounted to approximately $112,000, is not something that should be paid by insurers. “That’s a new development,” says Bernard Larocque, a litigator with Lavery, de Billy in Montreal. “The fact that you don’t have the money to pay creditors at the moment when it is due is not the fault of the insurer. That’s a question that often comes up, and this ruling provides guidance over what is payable and what is not.”
In a scandal that has shaken the Montreal legal community, well-regarded Montreal law firm Kaufman Laramée LLP faces at least five lawsuits arising from the alleged fraud by former clients of Dany Perras, a lawyer who resigned abruptly from the roll in October in 2011 after the Barreau du Québec launched an investigation into the misappropriation of funds allegedly committed by Perras. The former Montreal lawyer, who briefly practiced at Kaufman Laramée for six months in 2011, faced a hearing this past January before the Bar’s Disciplinary Council. A decision is expected shortly.
The plaintiffs, members of the Montreal Jewish community, claim they were approached by Perras to participate in business opportunities that required them to make short term loans to be held into the trust accounts operated by the firm and Perras before paying out a pre-determined rate of interest. One set of investors suing Kaufman Laramée for a total of $1.65 million allege that the firm was negligent because it failed to inform them that Perras was no longer a partner when they made the deposits, says the plaintiff’s counsel Sylvain Deslauriers, head of Montreal law firm Deslauriers & Co. While the law firm and Perras ended their partnership in June 2011, Perras was allegedly allowed to maintain an office until September during which time Perras held himself out as a Kaufman partner and allegedly continued to receive deposits from the plaintiffs.
In light of the actions against it, Kaufman Laramée turned towards the Professional Liability Insurance Fund of the Barreau du Québec. But the Quebec professional liability insurer denied coverage and refused to defend Kaufman and its partners because it felt Kaufman and its partners did not provide professional legal services – a position that the Quebec Court of Appeal endorsed in a succinct nine-page ruling.
After examining the allegations made by Deslaurier’s clients, the appeal court held that perhaps Kaufman Laramée committed a civil fault by failing to inform the investors that Perras was no longer a partner but in no way could it be qualified as a professional fault.
“This fault is not at all linked to a professional service, that is a service rendered in the exercise of the profession of lawyer, a sine qua non condition to the applicability of the obligatory professional responsibility insurance coverage by the Barreau du Québec,” said the panel of three judges in one of the few decisions in Canadian case law that examined the interplay between insurance coverage and professional legal services. “There is an absence of any allegation regarding a fault committed by the lawyers of the firm acting in a professional capacity while Perras was no longer a member of the firm Kaufman Laramée LLP.”
Neither did the law firm provide professional legal services in two other lawsuits launched by investors, added the appeal court. In these two actions, the Sofer Foundation and Chaim Mermelstein allege that they were solicited by Perras to participate in a transaction with a Swiss corporation that was raising funds to assist a U.S. company withdraw from bankruptcy. After agreeing to participate in Perras’ proposal, the plaintiffs deposited sums into Kaufman’s trust account and signed deposit agreements, naming Kaufman as escrow agent. But unbeknownst to the plaintiffs, when Perras left the Kaufman partnership, the law firm transferred their deposits from the firm’s trust accounts into Perras’ personal trust account. The plaintiffs contend that Kaufman and its partners transferred the deposits without authorization, in breach of the parties’ deposit and escrow agreements.
“The deposit of monies was not done by way of professional services, but rather following an investment proposition,” noted the appeal court in Kaufman Laramée c. Fonds d’assurance responsibilité professionelle du Barreau du Québec 2014 QCCA 804. “Providing investment dealer services is certainly not a service rendered in the exercise of the profession of a lawyer.”
The ruling has left more than one lawyer puzzled. Deslauriers notes that the ruling hinges on what is deemed to be professional legal services. “If, as was the case with my clients, a law firm vaunts its reputation, touts the reputation of its partners, and is aware or should have been aware that one of its partners was conducting transactions within the firm that gave the appearance it was business linked to the law firm, I am not certain that this is not something that is linked to a professional legal service,” said Deslauriers. “In this case, my clients state that the firm’s letterhead was used, that (business) was conducted in their office, and that the monies were held in trust by the law firm or Perras’ own trust account.”
Montreal lawyer Alain Chevrier, who represents the Sofer Foundation and Mermelstein, too is baffled by the ruling. “The ruling has wide and important implications because it effectively states that in cases where monies are diverted by a partner, there is no insurance coverage by the Barreau’s professional liability insurer,” said Chevrier, who admits that the appeal court’s ruling is not a favourable one for his clients as the opportunity to hold the Barreau’s professional liability insurer at least partly responsible to indemnify them has gone by the wayside.
Chevrier also points out that his clients claim that Perras represented himself as a lawyer acting for a Swiss corporation so “I have a difficult time understanding how the Quebec Court of Appeal could conclude that the services he rendered were not legal professional services.”
But Neil Stein, another Montreal lawyer who is representing several clients seeking monies arising from the alleged misappropriation, believes the appeal court ruling is sound and a clear warning to both lawyers and their clients to be wary when engaging in business ventures. “The ruling stands for the proposition that if a lawyer’s trust account is used for business purposes as opposed to professional purposes that you don’t have insurance coverage with the bar insurance,” says Stein of Stein & Stein Inc. “It is a clear message to both lawyers and clients that if you are engaging in business venture with your lawyer that the business venture is not covered by professional liability insurance. It is a business venture, and not a professional service that is being rendered.”
In a rather sad and unusual twist, the case is also pitting alleged victims of the defalcation against each other. When Perras returned the deposits to the Sofer Foundation and Mermelstein, the Barreau — who by that time was investigating the former lawyer regarding a number of alleged defalcations — seized the their bank accounts until the ownership of the monies returned by Perras could be determined. The Sofer Foundation and Mermelstein are demanding the return of their monies while the clients represented by Stein are claiming that the monies in the bank accounts belonging to the Sofer Foundation and Mermelstein actually belongs to them.
“My clients were certainly happy that the Bar on its own initiative took proceedings to try and safeguard the monies by way of an injunction that froze monies in the accounts of Sofer and Mermelstein,” said Stein. “Of recent date, the Bar has now sort of tried to take the position that it no longer has an interest because all of the people who have a claim to the money have intervened into the proceedings and they can fight their own battles so to speak.”
In the meantime, the trustee of Perras’ bankruptcy also is claiming a stake. He is claiming that all of the monies belongs to the trustee in bankruptcy because all of the transactions were not real business transactions and as a result the money should be on a pro-rata basis distributed to all of the creditors. “It’s an unfortunate and sad affair for everybody involved,” said Stein.
Both Kaufman Laramée and the Barreau did not return calls.
This story was originally published in The Lawyers Weekly.
On an unusually warm and foggy Saturday evening this past December the $1.7-million home of Dany Perras was set ablaze, the third time in the space of a year an act of vandalism targeted the former Montreal lawyer. Perras, who resigned abruptly from the roll in October 2011, is under investigation by the Quebec Bar for allegedly orchestrated a multi-million dollar Ponzi scheme through his lawyers’ trust account. It’s been more than 16 months since the scandal that shook the Montreal legal community erupted, and the fallout is still being felt. Successfully petitioned into bankruptcy, Perras is the subject of an ongoing criminal probe and a host of legal proceedings – many of which are under court seal — launched by more than a dozen creditors seeking an amount surpassing $6 million.
The Perras case is unique, and yet at the same time it is not. The former Montreal lawyer is not the first nor will he be the last advocate accused of misappropriating funds from a trust account. Disciplinary notices posted by law societies are replete with hearings of lawyers who were unable to resist the temptation of dipping into their trust accounts. Even then, it can be forcefully argued that defalcation is anomalous. As Susan Forbes, director of insurance of British Columbia’s Lawyers Insurance Fund, which manages the Law Society’s insurance program, points out that “when you consider that there are 10,000 practicing lawyers in BC and there are only one or two a year that get involved with theft, that is a very small percentage.” Tom Schonhoffer, the executive director of the Law Society of Saskatchewan, has another take. “If you look through the billions of dollars that go through trust accounts, defalcations would be a fraction of a fraction of one percent.”
Three wise monkeys
But it happens more frequently than the profession cares to admit, particularly thefts from a law firm’s general accounts. David Debenham, a certified fraud specialist and investigator who is a partner with McMillan LLP in Ottawa, estimates that only one in ten frauds perpetrated by lawyers, law clerks or staff, come to light. “A lot of firms that had lawyers or law clerks or staff that commit fraud tend to indemnify clients and not report it — it’s sort of the (profession’s) dirty little secret,” says Debenham, a certified management accountant who is hired by law firms to investigate fraud. He says that there is no doubt that the number of misappropriation cases is growing exponentially.
Though he doesn’t go that far, the chief executive officer of the Professional Liability Insurance Fund of the Barreau du Québec says that the insurer has had to grapple with a “significant” increase in defalcations over the past couple of years. What’s more, the amounts being misappropriated are larger than ever. “I have been here for 25 years, and we never saw situations like that ten years ago,” says René Langlois. The figures bear him out, at least in Quebec. The Quebec liability insurer paid out nearly $20 million in claims in fiscal 2011, almost double compared to the preceding year, according to its latest annual report. In Ontario, total claim costs may top the $100-million mark, reveals Lawpro’s 2011 annual report. The number of claims reported – 2,468 – is higher than it has been at any point since 2000 and 11 per cent higher than in 2010. Similarly, claims frequency (number of claims per 1,000 lawyers – a better barometer of trends) is up to 107 from 99 a year earlier.
Yet Dan Pinnington, vice president, claims prevention and stakeholders relations at Lawyers’ Professional Indemnity Company (Lawpro), a wholly Canadian owned insurance company that provides professional liability insurance to lawyers in Ontario and title insurance coast-to-coast, maintains that though the insurer deals with them regularly and “occasion we have seen some very large losses, either through lawyer fraud or staff fraud, I can’t say we have had an increase.”
Most misappropriations are committed by solo practitioners or lawyers practicing in an association where they might be physically be present with other lawyers but are running their own trust accounts. Most thefts are usually small amounts. Cases like Howard Lorne Tennenhouse, who was disbarred by the Law Society of Manitoba last year after pleading guilty to taking nearly $1-million from 54 residential school survivors, is the exception to the norm. “Usually what happens is that it starts as a one-off that they just do for an emergency, then they do it a few more times and it goes from there,” says Debenham, the author of The Law of Fraud and the Forensic Investigator.
Defalcations committed by a partner working in a law firm is atypical. But when it happens the amounts that are misappropriated often are sizeable. Ottawa lawyer Leslie Andrew Vandor was disbarred last year by the Law Society of Upper Canada (LSUC) for misappropriating more than $2-million, most of which came from his father’s estate and Vandor Investments Ltd.. He was also found to have misappropriated funds from Lang Michener, which has since merged with McMillan LLP, in 2008.
The Perras case
The Perras case is all the more exceptional because it is a cautionary tale that underscores the exposure and “world of trouble” law firms can be drawn into when faced with a rogue partner. Kaufman Laramée LLP, the Montreal law firm where Perras briefly practiced for six months in 2011, too has been ensnared in the legal maelstrom and now faces five lawsuits from Perras’ former clients arising from the alleged financial fraud. Even lawyers acting on behalf of “parties that were basically conned by Perras” are sympathetic to the law firm’s plight. “The circumstances here are horrendous for a law firm,” says Neil Stein of Stein & Stein Inc. “The last thing a law firm wants is to be sued. It is not imaginable that one of your own partners would put you into a situation of that nature. They don’t deserve it.”
The plaintiffs, members of the Montreal Jewish community, claim they were approached by Perras to participate in business opportunities that required them to make short term loans to be held into the trust accounts operated by the firm and Perras before paying out a pre-determined rate of interest. The investors are suing Kaufman Laramée for a total of $3.1 million, alleging that the firm was negligent because it failed to inform them that Perras was no longer a partner when they made the deposits, says the plaintiff’s counsel Sylvain Deslauriers, president of Montreal law firm Deslauriers & Cie. The firm and Perras ended their partnership in June 2011, but Perras was allowed to maintain an office until September when he set up his own separate office. “The firm was victimized by an individual who was recommended by a large national recruiting firm who came with good credentials,” says Kaufman’s counsel George Pollack, a partner in the Montreal office of Davies Ward Phillips & Vineberg LLP. “We didn’t know to what extent he was abusing the hospitality that was accorded to him.”
On their own
Making matters worse, Kaufman is on its own to defend the actions. Quebec’s professional liability insurer has denied coverage and refused to defend the firm and its partners because it felt they did not provide professional services – a position that Quebec Superior Court Justice David Collier endorsed in a ruling released just days before the blaze struck Perras’ residence. “It cannot be concluded that Perras or Kaufman rendered professional services to the plaintiffs by accepting deposits, acting as escrow agent, or transferring funds from one trust account to another,” Collier wrote in one of the few decisions in case law that examined the interplay between insurance coverage and professional legal services. “A solicitor-client relationship does not arise from the mere receipt of funds for deposit…Taking the pleadings at face value, it appears they provided investment services to the plaintiffs.”
That was also the conclusion that the Ontario Court of Appeal came to six years ago in a case pitting Cassels Brock & Blackwell LLP against Lawpro. In considering a number of transactions that were similar to the Kaufman case, the appeal court found that a trust account transaction was not a professional service, and that it fell under the policy’s investment exclusion, because it was not “ancillary” to legal services. “A person who is a lawyer may wear more than one hat, but just because at most times that person wears the hat of a lawyer does not mean that he always acts qua lawyer,” wrote the court in a brief three-page ruling.
Professional liability insurers
Those are the kinds of rulings that reassure professional liability insurers. All law societies in Canada provide provides professional liability insurance for negligence, but its scope varies from jurisdiction to jurisdiction. All law societies also have set aside funds to provide trust protection coverage to ensure that innocent members of the public do not suffer a loss through theft by a lawyer – so long as the lawyer who received the monies and deposited it in the trust account performed legal services. Indeed, in Alberta lawyers are prohibited from depositing money into their trust account if it is not in conjunction with legal services, notes Steve Raby, the outgoing President of the Alberta Law Society.
Other compensation funds, like Manitoba’s, are discretionary. “We protect against legal service,” says Allan Finebilt, chief executive officer of the Law Society of Manitoba, echoing the way many other compensation funds are managed by law societies. “We never had to go to court to establish that because it is a discretionary fund. We have no contractual obligation with the party.” In Nova Scotia the Lawyers Fund for Client Compensation takes a slightly different tack. It is a fund of first resort, and claimants are not required to exhaust other remedies, which is not necessarily the case with other compensation funds. “The approach we take is if a lawyer committed a defalcation and the victim is truly innocent, payment will be made,” says Darrel Pink, executive director of the Nova Scotia Barrister’s Society.
The liability and exposure law partners face when one of theirs misappropriates raises “interesting legal issues,” adds Pink. Not just in Nova Scotia, though, but across the country. In Nova Scotia if a lawyer practicing in a law firm steals money from a trust account, then the firm and its partners are jointly and severally liable – and it is an absolute liability. But when Halifax lawyer Srinivasen Pillay bilked $1.3-million from the trust account of the law firm McGinty McCleave between March 2000 and February 2005, the Nova Scotia legal community demonstrated an exceptional display of generosity. With the approval of its members, the law society imposed a one-time levee of $750 on each lawyer in the province to cover the bill. “In that case although at law the partners might have been liable they would not have provided compensation to the victims because it would have bankrupted them so we paid all those claims,” says Pink. Pillay, who was sentenced to four years in prison, was also ordered to pay $1.3 million in restitution to the Nova Scotia Barristers’ Society.
In Ontario, the legal landscape is slightly different. Minimum level so-called Innocent Party coverage is required for all lawyers practising in association, partnership (including general, MDP and LLP partnerships) or a law corporation with more than one lawyer. The coverage is designed to protect against the dishonest, fraudulent, criminal, or malicious acts or omissions of present or former partners, associates, employed lawyers and firm employees. “But if an employee stole money out of a general account – as opposed to a trust account – and stole the firm’s money, not the client’s money, in that case no client was aggrieved, no professional services were involved so certainly there wouldn’t be no coverage under the Lawpro policy,” notes Pinnington.
At the other end of the spectrum stands B.C. Its trust protection coverage insures all members of the Law Society of BC for claims arising from the theft of money or property relating to the member’s practice of law. Trust protection coverage offers an annual aggregate limit, profession-wide, of $17.5 million; each claimant may recover up to $300,000 per claim. “Where a lawyer does steal, our insurance benefits partners in the firm as well as the victim,” explains Forbes. “When we pay the claim we don’t subrogate the innocent partners in the firm. We protect all of them through compensation so the members are fully protected.”
Alberta law society tackling misappropriation head-on
But at least one law society is aggressively tackling the issue of misappropriation of funds in a no way no other law society has so far dared to. In a bid to address rising threats to the security of trust funds, the Law Society of Alberta introduced in 2011 a new regulatory structure that turns on its head the widely-held premise that lawyers have are entitled to have a trust account. Instead under the new Safety of Trust Property program, a law firm seeking to open a trust account must get approval from the Law Society. The firm must designate a specific lawyer who will be responsible for meeting the requirements set out by the regulator, and who will be held accountable for non-compliance. It has broad audit authority and through an automated audit program the law society is now capable of auditing 100% of accounting transactions of any law firm using approved law firm accounting. “We got scared in Alberta,” acknowledges Raby, who served as Chairman of the Trust Safety Program committee. “The numbers had been quite small until 2004 and it jumped dramatically to $1.4 million and then the next couple of yrs were $864,000 and $754,000. That’s when we had a look at our trust safety program.”
Other law societies such as Manitoba and Nova Scotia are paying close attention. “We probably need to move into the 21st century in terms of our controls,” says Finebilt. “Given what the risk is people are recognizing over time that they want to invest more because ultimately you pay for the tools or you pay for the loss – and it is way cheaper to pay for the tools.” Pink, however, says that before proceeding law societies must grapple with over the appropriate amount of regulation. “Trust oversight is one of those areas where it is very risky but also very easy to over regulate,” points out Pink.
Nicolas Plourde does not seem to have such reservations. The former batonnier of the Barreau du Québec believes that the Barreau should be examining ways to bolster regulatory oversight over trust accounts. One model that he finds enticing is French-based Caisses des Règlements Pécuniaires des Avocats, better known under its acronym CARPA. In France lawyers are not allowed to hold clients’ money, but must pay it into the bar’s account, under the control of the president of the bar. There are over 100 CARPAs in France, and each is under the political and ethical control of the local bar. CARPA is not itself a bank, but works with banks. “The increase in number of claims and value of the claims from the Quebec professional liability fund, one of the causes being misappropriation of funds is worrisome – and that is why member premiums will be doubling from $600 to $1,286 this year,” says Plourde. “It has led us to question how we can do more to avoid such a situation”.
Left unsaid is that fraudulent schemes allegedly perpetrated by lawyers or former lawyers such as Perras would be snared long before they cause real damage.
This story originally appeared in the Canadian Lawyer magazine.
A ruling that ordered an insurance company to pay $460,000 to a Quebec couple after their financial advisor invested their retirement nest egg in promissory notes in scandal-plagued Montreal financial group Mount Real Corp. has raised questions over the scope of professional liability insurance coverage in the province and ostensibly broadened investor’s protection.
Quebec’s financial and insurance sectors are now worried over the impact of a Quebec Court of Appeal unanimous decision that declared inoperative clauses excluding gross negligence in professional liability insurance policies under the Act respecting the distribution of financial products and services (ADFPS). Law insurance experts are speculating that the finding may have a reach beyond the ADFPS, and affect professional liability insurance policies held by the indemnity funds of Quebec’s 44 professional corporations, including the Barreau du Québec. The Quebec legal society declined to comment.
“Indemnity funds have reason to worry,” said André Bois, an insurance lawyer with the Quebec City law firm Tremblay Bois Mignault Lemay. “They have the same kind of clauses cited in the ruling. This will have an enormous financial impact because by excluding gross negligence insurers face higher exposure to risk” which in turn will lead to higher costs that will ultimately be passed on to professionals who need liability coverage to practice.
Questions have also surfaced over whether the Autorité des marchés financiers, Quebec’s securities regulator, will now accept professional liability insurance policies that contain clauses that exclude gross negligence. AMF spokesperson Cathy Beauséjour said in an email that while the regulator is ensuring that all professionals who operate under the ADFPS are covered by liability insurance, it is too early “to appreciate the impact” the ruling will have. A lawyer who used to work for the AMF said he doubts the financial watchdog will now scrutinize insurance policies to determine if they have the exclusionary clause because it would be a moot exercise. “The court has already established that the exclusion doesn’t apply,” said the lawyer.
Grocery store operators Denis Guillemette and France Mercier lost $232,000 when scandal-plagued Mount Real was shut down by the AMF in 2005, leaving 1,600 investors holding an estimated $130-million worthless promissory notes. The couple, who had little knowledge about financial markets, had entrusted their life savings to financial advisor and planner Yves Tardif and gave him instructions to invest only in secured assets which he did not do. The couple then sued Tardif, his firm iForum Financial Services Inc. and their liability insurer Lloyd’s Underwriters. (Tardif was fined $104,000 last year after pleading guilty to acting illegally as a dealer, aiding with illegal distributions and making misrepresentations in securities transactions. In 2010, he was fined $453,000 for similar violations in connection with the Mount Real matter).
Lloyd’s argued that the couple were partly to blame for their financial woes, and that the financial advisor acted outside the areas of professional responsibility covered by the insurance policy. But in a 36-page ruling that upheld a lower court ruling, the Quebec Court of Appeal in Souscripteurs du Lloyd’s c. Alimentation Denis & Mario Guillemette Inc. 2012 QCCA 1376 dismissed those arguments, and seemingly broadened the scope of what constitutes “professional activities” covered by professional liability insurance policies.
Willful blindness was not an issue in this case, wrote Justice Marie-France Bich in her reasons. The appeal court found, based on the lower court’s appreciation of the evidence against Tardif, that the financial planner had breached his legal and professional obligations under the ADFPS. Informed by the oft-cited Supreme Court of Canada ruling in Laflamme v. Prudential-Bache Commodities Canada Ltd. 2000 SCC 26,  1 SCR 638, Justice Bich said that given the complexity of the investment sector and its inherent risks, “it must be recognized that if a person entrusts such decisions to a financial advisor or intermediary because he or she has little investment knowledge, that person is not under an obligation to constantly check and double check when, rightly so, the person has deferred to a professional in order to avoid” doing that.
Serge Létourneau, who successfully plead the case for the couple, said that allowing an investor with little investment know-how to “lower his vigilance” and defer to a professional is an important finding because Quebec courts often have interpreted the relationship between investor and financial advisor as a business relationship. That means that investors had to demonstrate that they paid the same attention and care as they would in a business relationship in their dealings with financial advisors. “The essence of a professional relationship is confidence, and this confidence allows an individual to defer to a professional,” said Létourneau, founder of the Quebec City law firm Létourneau Gagné.
But Yan Paquette, a Quebec City litigator specializing in financial markets, warns that investors with limited knowledge do not have a free pass. Last October the Quebec Court of Appeal in Immeubles Jacques Robitaille inc. c. Financière Banque Nationale 2011 QCCA 1952 held that “even less seasoned” investors must be prudent, collaborate with the financial advisor and make a minimum effort to understand financial markets. Coupled with the Lloyd’s decision, Paquette says the appeal court is clearly stating that a financial advisor’s duty to inform is directly proportional with an investor’s knowledge. “The Lloyd’s decision places a burden on financial advisors to respect its duty to inform, said Paquette of Langlois Kronström Desjardins in Quebec City. “The less an investor understands the financial markets the greater burden a financial advisor faces to inform the client, and the reverse is true.”
The Lloyd’s ruling has also drawn concerns over what constitutes “professional activities” under liability insurance policies. Lloyd’s argued that since Tardif illicitly procured financial products governed by the Québec Securities Act, his actions were outside the scope of professional activities covered by the insurance policy. But the appeal court held that Tardif’s actions should be viewed as a whole, and that his unauthorized actions were the manifestation of improper financial planning. Since “the harm suffered by the couple stems directly from his bad financial planning,” the fault arose out of services governed by the ADFPS and therefore meets the definition of professional activities covered by the insurer.
“This ruling says that there can very well be a link between offering advice while performing financial planning and the act of selling financial products,” remarked Létourneau. “Each should not be examined separately. That finding has plainly overturned conclusions reached by Superior Court judges in other cases.”
Létourneau now wonders whether the provincial financial regulator will compel financial professionals to obtain insurance coverage that will encompass all activities as opposed to coverage that is limited to professional activities they are authorized to perform.
At the very least the finding will lead insurers and professionals to closely examine professional liability insurance coverage, says Bernard Larocque of Lavery, de Billy in Montreal. Thanks to the ruling, the scope of professional activities must be considered in light of the specific circumstances surrounding the case and all of the actions taken by the financial professional to determine if the fault is covered by the insurance contract, added Larocque.