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KVB Consultants: A Reality Check for AR Statutory Vicarious Liability Claims

The High Court in KVB Consultants v Jacobs Hopkins McKenzie and others has made it clear that principal firms cannot exclude liability for their appointed representatives through drafting contracts which are detached from factual reality

Appointed representative (AR) arrangements arise where firms authorised to carry out regulated activities (principals) under s19 of the Financial Services and Markets Act (FSMA) 2000 contractually agree to allow unauthorised individuals or firms to carry out regulated activities on behalf of the principal firm.

AR arrangements are commonplace; you might have had dealings with an appointed representative without initially knowing that they authorised via a principal business. The AR regime allows smaller firms to offer regulated services at more economic rates. However, the bone of contention is; who is responsible when the AR’s activities cause consumers to suffer losses?

The Financial Services Compensation Scheme (“FSCS”) foots the bill when regulated businesses are unable to meet their liabilities to consumers. Faced with high volumes of AR-related FSCS claims, which accounted for 61% of the value of claims between 2018 and the first half of 2019, the FCA introduced new reporting obligations for principals in 2022 to enforce proper supervision of ARs. But what happens when prevention fails and losses occur?

Who is responsible for the activities of AR’s?

FSMA only holds the principal responsible in relation to business for which it has accepted responsibility in its agreement with the AR. Most consumers will be unaware that principals can limit the scope of their responsibility using the AR agreement. Further, consumers are unlikely to be aware of what the AR has agreed with its principal ahead of doing business with the AR. In our experience, the nature of the arrangements only become known to consumers after something has gone wrong and a dispute has arisen.

When will principal firms be responsible for the activities of their appointed representatives?

The first step when a claim is made against a principal is to examine the AR contract to see what the principal had permitted and accepted responsibility for. Anderson v Sense Networks Ltd.’s “what/how?” distinction specifies that principals can exclude liability for specific activities (the “what?”) but not the way in which activities are undertaken (the “how”?). An example noted in Anderson is that principals cannot only accept responsibility for ‘suitable’ advice, as suitability is an example of how the regulated activity (i.e., giving advice) is carried out.

What happened in KVB Consultants?

26 investors were trying to pursue KCL (the principal firm) after having lost money investing in a residential property scheme managed by, its now insolvent AR, JHM.

Under the AR agreement, JHM was only permitted to carry out certain activities in respect of certain kinds of clients. Amongst other things, the agreement forbade JHM from handling retail clients, managing collective investment schemes (CIS), or any other scheme involving pooled money. Yet the clients were, in fact, unsophisticated retail clients, and JHM’s property schemes were textbook CIS under s235 FSMA, seven of which were unlawful.

As this should have been apparent to KCL, the High Court was not prepared to let bad drafting undermine justice by allowing the what/how? test to be applied in a manner “divorced from commercial reality”.  HHJ Paul Stanley KC made clear that the decision to exclude investors based on their characteristics was a how distinction, as it did not concern the nature of the permitted activities themselves. Although KCL could not be held responsible for the operation of a CIS, given that principals cannot give their ARs permission to do this in any event (pursuant to FSMA 2000 (Appointed Representatives) Regulations 2001, SI 2001/1217), KCL did permit JHM to advertise and advise on its schemes – thus responsibility for this enabled the courts to find KCL responsible for the claimants’ overall losses, whether or not they could legally permit JHM to run a CIS.

HHJ Paul Stanley KC sought to ‘see through’ the drafting of the AR agreement and the misunderstanding of JHM and KCL as to what constitutes a CIS. The judge also found that the fact that these businesses shared a common belief that the property investments were not a CIS was irrelevant.

What will change?

Following KVB Consultants, principal firms might well revisit their agreements with their ARs and, in particular, any terms which may be considered to seek to exclude liability for a ‘how’ by trying to disguise it as a ‘what’. The case is also a reminder of the need to monitor and understand the activities of ARs.

For consumers, the decision could be said to extend the scope of claims against principals, and potentially less consumers being restricted to FSCS compensation, which is sometimes inadequate.

Contact a disputes specialist

If you are affected by issues relating to an investment or pension, please get in touch with our team of Financial Services Litigation experts by calling 0345 209 1046 or get in touch online for a free initial consultation.

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