Professional indemnity (PI) insurance provides vital cover if a client claims against a financial services business. A recent case reveals how the courts view a client’s loss due to a financial advisor’s bad financial advice and a PI insurer’s obligation to cover the advisor against legal liability to compensate the client for the loss.
In the case of Oosthuizen v Castro and Another  ZAFSHC, the client consulted the financial advisor on a potential investment and was advised to invest a large amount in a property syndication. The syndication subsequently turned out to be dubious; the investment was worthless and the client lost the money she had invested. The client sued the advisor to compensate for her loss.
The advisor claimed indemnity from his PI insurer, however, the insurer denied its liability to indemnify the advisor. It said the claim fell within the exclusion clause in its insurance contract, which states: “The Insurers shall not indemnify the insured in respect of any loss arising out of any claim made against them … in respect of any … depreciation in value of any investments or as a result of any representation, guarantee or warranty.”
According to this clause, the PI insurer is not liable for claims where a loss is due to depreciation in value of any investments, or if an advisor provides any representation, guarantee or warranty regarding the performance of investments.
This set of facts leads us to ask the million-dollar question: when is a PI insurer liable to indemnify the insured in terms of a PI policy?
The court referred to Jackson & Powell on Professional Liability 8th edition, paragraphs 15 to 22, which pertains to the reasonable care and skill to be exercised by a broker: “… a provider of financial services will be under an implied, if not express, contractual duty to exercise reasonable care and skill in carrying out the services required of him/her.”
Taking into account the PI insurer’s agreement, the court concluded that: “The insurer has undertaken to indemnify defendant against losses arising out of any legal liability, arising from claims … for breach of duty … by reason of any negligent act, error, or omission, committed in the conduct of the defendant’s business.”
The court also provided the following guidelines:
- The client is the ultimate beneficiary. The advisor must be entitled to indemnification, as the ultimate beneficiary is the client who got wrong (negligent) advice from him. The court aims to protect clients’ interests in matters relating to bad advice.
- It’s not a case of an investment depreciating, if an investment is worthless from beginning to end. The PI insurer’s exclusion clause excludes depreciation of an investment. However, the client’s investment did not depreciate, as the investment had always been worthless. The amount ‘invested’ was not enough to pay the interest of the thousands of ‘investors’ who became involved in the scheme prior to the client.
- Representations, guarantees or warranties. If an advisor makes a representation or guarantee to an investor that an investment will increase by 100% in a year’s time, the insurer can rely on the exclusion clause and refuse to indemnify the advisor. In this case, the advisor advised the client that the investment was entirely safe and that any argument to the contrast was unfounded. But the client did not rely on any representation, guarantee or warranty as to the performance of the investment.
Taking these guidelines into consideration, the court found that the advisor was entitled to indemnification. The fact that the advisor did not act with due care and diligence was obvious and easily proved, but the advice did not fall under the extent of the PI insurer’s exclusion clause.
The courts will interpret exclusion clauses in PI policies restrictively and PI insurers will not always be able to rely on exclusion clauses to sidestep their responsibility to provide PI cover and pay a claim.
While the judgement provides good news for the right to claim against a PI policy, every case will be judged on its own merits.