What? How? Can a Principal limit third party liability for its Appointed Representatives?

Need to know

Section 39 of the Financial Services and Markets Act 2000 sets out the appointed representatives regime. A principal of an appointed representative (a “Principal”) can limit its third party liability under section 39 for what activity its appointed representative (or “AR”) carries out, but not how its AR carries out activities under the Principal’s appointment. The test has recently been clarified by the Court of Appeal (KVB Consultants v Jacob Hopkins McKenzie¹).

Some examples of what this clarification means are:

• A Principal appoints an AR to sell its insurance. The AR agreement limits sales to the Principal’s professional indemnity (PI) insurance. As well as the PI insurance, the AR ‘sells’ clients its own Ponzi scheme. The Principal is not liable to the clients for the Ponzi scheme sales. The AR agreement limits what the AR does (it can sell PI insurance but not the Ponzi scheme).
• The AR negligently sells the Principal’s PI insurance. The Principal is liable to the clients for these negligent sales. Although the AR could sell PI insurance (the what in this situation) it did so negligently. The AR’s negligence goes to how the AR agreement was performed. 

It is not possible in law for an AR agreement’s drafting to change a how into a what. Each AR relationship will need to be analysed on its own facts and the commercial reality. Whilst the examples above are clear-cut, others may be harder to discern:

• The AR purports to write a life insurance policy on the paper of a Principal which is not licensed to write life business. It could be argued that the Principal is not liable to the third party life insurance buyers because the AR has gone far beyond what activity was permitted (only PI insurance).
• The AR places a $10m limit PI policy for the Principal, where the Principal’s AR agreement with the AR only permits the AR to bind PI up to a $5m limit. In this situation, it could be argued that the AR’s actions (binding a $10m limit rather than $5m) go to how the AR operates under the AR agreement (selling PI itself – the what – is permitted). If so, the Principal would be liable to the $10m PI policy buyers.
• The AR purports to sell a directors’ & officers’ policy (D&O) for the Principal. The Principal is licensed to write PI business but not licensed to write D&O.  For our purposes we will assume that this also breaches the AR agreement. This example is a closer what/ how call. D&O is unlicensed business and obviously not PI. On one view, the D&O is beyond what the AR is permitted to do. Conversely, it could be argued that PI and D&O are both financial lines insurance, and the AR’s D&O underwriting therefore goes to how the AR has performed. Each situation will turn on its own facts; here one would need more information to decide whether this is a what or a how.

There are critiques of the KVB reasoning (including a dissenting judge in the decision itself). We understand that leave has been sought for a Supreme Court appeal. We will be monitoring the progress of this, so that we can report further if the Supreme Court provides further guidance.

Action points

The Court of Appeal’s what/how test will assist Principals and Appointed Representatives when structuring new relationships and reviewing existing ones.

Each party will need to ensure that AR relationship risk (including potential third party liability) is appropriately identified and managed. This will particularly be the case if the what/ how distinction is not clear-cut. Action points could include greater AR supervision by the Principal, and review of their respective professional indemnity policies’ coverage and limits.

For a more detailed review of the background facts in KVB, see HFW’s case update in our July Insurance Bulletin here.

Appointed Representatives are currently the target of regulatory focus (see HFW’s recent updates here and here).  Principals and ARs also need to have this on their respective risk radars.

Footnote

1. [2024] EWCA Civ 765