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5 March 2014
Professional indemnity cases keep hitting the court lists as settlement values continue to rise
Recent cases have put the spotlight back on solicitors’ professional negligence. But what should lawyers do to mitigate the chance of a claim against their firm? This week’s panel of experts debate the key professional indemnity issues affecting the legal profession and others.
Do you expect insurers to re-draft mitigation cost clauses in the wake of Mr Justice Eder’s decision in Standard Life Assurance Ltd v Ace European Group & Ors? How important do you think this judgment will be?
Sarah Clover, joint head of professional and financial disputes team, Clyde & Co: In our view, the judgment will have differing impacts across the professional indemnity (PI) market. For example, it is likely to be more relevant to the policies of financial services professionals operating in a market in which there is a greater climate of pressure to settle before there is a claim, not least from the FSA. So it is likely that in this market at least insurers will review their wordings. However, whether changes will be made will be dependent on the specific wording in place.
In relation to solicitors, the minimum terms make provision for payment of defence costs, so you would not normally expect to see a provision allowing the solicitor to make a payment without reference to the insurer. So we do not think this will be a factor for the solicitors’ market.
Ian Peacock, partner, Bond Pearce: The scope of an insured’s entitlement to cover for mitigation costs has been a vexed issue for years. But the size of the liability here is likely to lead underwriters to look afresh at their wordings. So, for instance, policies that cover “mitigation costs” are likely to see clauses tightened so as to restrict recovery to payments, costs or expenses incurred with the sole or dominant purpose of avoiding or reducing third-party claims. That said, there is a difficult line to be tread here because insurers also need to be careful to ensure that any restricted wording does not act as a disincentive to insureds to take steps to minimise claims.
At the same time, it is important to remember that the Standard Life situation was an unusual one. Mitigation costs are generally well below the costs of potential claims. And few insureds are willing to put their hands in their pockets in the way that Standard Life did without authority to proceed from their insurers.
David Rutherford, partner, Ince & Co: The short answers are, I think, “no” and “not very”. It makes sense, when insuring entities such as Standard Life, to provide cover in a way that affords the entity the necessary flexibility to be able to respond to events without having to wait for the inevitable claims to come in or to await a direction from the regulator. If that is accepted, then the clause in question was neither controversial nor particularly generous to the insured, which had to prove that the loss it sought to recover had been reasonably and necessarily incurred in taking action to avoid or reduce claims or deemed claims.
The requirements of both reasonableness and necessity should provide adequate protection for insurers, which would not wish to pick up payments made for commercial reasons.
I do not foresee insurers seeking to amend such clauses to introduce a “dominant purpose” test, which would be wholly unsatisfactory for the reasons the judge gave. Of course, all this assumes that insurers had in contemplation covering, under the mitigation clause, wholesale solutions for wholesale problems, as opposed to covering expenditure incurred in contemplation of and to avoid or reduce a claim by an individual third party.
In the unlikely event that an insurer is using this clause but with individual claims actually in mind then, yes, there will need to be some tightening of the language.
Is it an important decision? Stripped of the issue of motive it is really only an exploration of the facts of the particular case, without shedding any great light on the meaning of “reasonably and necessarily incurred”. What it does do, incidentally, is to remind folk how to draft a truly embracing aggregation clause, learning from the lessons of Lloyds TSB General Insurance Holdings v Lloyds Bank Group Insurance Company (2003).
David Simon, managing partner, Robin Simon: I anticipate that insurers will review their wordings in the light of this decision, although wording is only part of the issue. The case seems to have turned on a factual determination by the court as to what was really the motivation for taking the remediation steps. Even if the policy used words such as “solely” or “exclusively”, the court would still have to look at the facts surrounding the insured’s decision to spend the money on remediation.
Remediation provisions of this sort have long been commonplace in PI cover for the construction industry and while they often give rise to issues between insurers and the insured, by and large they work effectively to “oil the wheels” in giving commercial effect to the insurance cover.
I don’t think the case is very important – I think that it was decided in the way that most practitioners would have expected and the surprise came not in the result, but in the fact that insurers had sought to argue the point.
There has been a spate of public professional negligence claims against solicitors’ firms. What impact will this have on the solicitors’ professional indemnity insurance market?
Clover: Although there have been some high-profile cases in the legal press recently, we do not think that this is a significant increase above the norm. While we agree that there has been an increase in claims by financial institutions against law firms and an increase in cases involving defalcations from client accounts, overall the expected flood of recessionary claims against solicitors has not materialised. One theme we have identified is that claims and settlement values are continuing on an upwards trend and this perhaps explains the increase in aggregation disputes across a number of lines of PI business, including solicitors. It is also worth noting that, in recent times, there have been a number of decisions which have been favourable
to the profession, where the courts have sought to contain rather than expand the duties of legal advisers to their clients.
However, one key issue affecting the insurers in the solicitors market has been their dissatisfaction with the indemnity insurance regime and in particular the workings of the Assigned Risks Pool (ARP). We see this as being a bigger factor guiding changes in the market. While we have seen a number of insurers exit the solicitors’ market over the last couple of years, there are signs that some are considering that the time is right to return to this area.
Peacock: There have always been peaks and troughs in the number of claims against solicitors in any given period. In my experience, the fall-out from a property recession usually hits three to four years after the crash, and the current recession is no different. The effect on premiums of a rise in claims is obvious. However, the greatest impact on the market has been the number of insurers willing to provide cover. In recent years the number of new entrants seems to have exceeded the number of those retrenching. And the changes to the ARP arrangements may well lead to a continuation of that trend.
Rutherford: I very much doubt the profession’s claims record of late will dampen insurers’ enthusiasm for this class of business and, while their appetite remains, we should not see a general rate increase. This is probably just as well, as I do not think the current level of economic activity is helping the smaller firms to improve their financial lot. What would affect the market, I think, is if the proposed changes to the ARP and, particularly, the funding arrangements, are not carried through.
One issue which has risen up the market’s agenda as a result of recent claims experiences is aggregation. It was the view of some that the additions to the aggregation clause in the minimum terms would not achieve what the market had in mind, a view that appears to be borne out by some of the arguments being canvassed in cases currently before the court. Of course, while aggregation will generally suit most primary insurers (but by no means all), the top-up market has a different perspective and there is, of course, some overlap between the two markets. Whether these markets can approach the problem as one will be interesting to observe.
Simon: The cases that get reported are, of course, only the tip of the iceberg and while they grab the headlines, they are not having a direct impact on the PI market – cases like that will always happen and insurers are enured to the odd big case.
The real issue for insurers is the cumulative cost of thousands of more run-of-the-mill cases (arising, for instance, from the lenders’ litigation), where the costs, particularly the claimants’ costs, boosted by aggressive CFAs, tend to become rapidly disproportionate to the sums in issue.
What are the key professional indemnity issues facing lawyers post-recession and how are they best mitigated?
Clover: Post-recession the main claims trends have been lender claims, pensions claims and property claims and we are starting to see claims by blue-chip financial institutions against the big firms. While the fundamental causes of claims remain the same as they have always been, in recessionary times there are a number of exacerbating factors, including the effect of clients seeking more work for less money; a reduced focus on risk management procedures where, for example, the client won’t pay for a second pair of eyes; pressure to do work at the last minute or to do more work because departing fee-earners are not replaced, leading to mistakes; redeploying staff to unfamiliar areas, coupled with lack of supervision; and using outsourcing as a cost-saving tactic. Key issues here are quality of work and security of information.
The key to managing these risks remain the usual ones – properly scoping the engagement and ensuring proper systems are in place for supervision and client acceptance. Data security procedures and systems are a growing issue for firms, not least because of the service requirements imposed by financial institutions and other clients that are subject to their own regulatory requirements in relation to data security.
Peacock: In times of recession, claims by lenders always dominate. So lawyers should check the recently updated Law Society practice note on lender requests for files before responding to fishing requests. Going forward, good systems, training and supervision are key in reducing the risk of claims. Property fraud seems as prevalent as ever, so lawyers should make sure to carry out identity checks on their client and the other party’s conveyancer.
Another common problem is recovering fees from cash-strapped clients, which often resort to spurious negligence allegations to avoid payment. A well-drafted engagement letter and clear costs advice that is reviewed regularly will help reduce these types of claims.
When renewing professional indemnity insurance, a good early dialogue with your brokers is essential, particularly if you are planning any significant changes in terms of the make-up of your firm – for example mergers, lateral hires, conversion to ABS status – or to the type of business your firm undertakes.
Rutherford: What this (continuing) recession has shown, and it almost beggars belief, is that as the recessionary tide went out in and after 2008, the detritus revealed on the foreshore looked remarkably similar to the debris exposed when the tide went out after 1988. The property world now, as then, is inhabited by professionals who are either too sad to recognise a fraud when they see one or are just plain bad, and by lenders whose only concession to the lessons of the past appears to be a
reduction in loan-to-value ratios. The borrowers’ covenant? Ah, who cares? And the solution for lawyers? Well, reading the latest iteration of the Law Society’s guidance on the subject would be a start: it is longer than the old green card, but still a relatively short read.
Simon: I am not convinced that the recession itself creates professional
indemnity issues but it probably highlights the need for increasing emphasis on risk management. When firms are squeezed, there tends to be a dash for growth, with firms looking to take on lateral hires (always a risk area) or do work outside the comfort zone (a major risk area). It also makes it more difficult for a firm to risk-manage its ‘big billers’ – who often tend to generate claims as much as revenue.
Mitigation comes down to risk-management – something that is being given a much higher emphasis by the SRA’s Outcomes Focused Regulation, a development that comes to the assistance of PI insurers.
Settle, litigate or arbitrate – what is the best way to dispose of professional indemnity claims against a lawyer?
Clover: We do not think that you can choose any one over the other. The most important factor in each case will be to determine the appropriate exit strategy and to have the optimum end firmly in mind. The best method for resolving the dispute will be determined by that strategy. For example, while often the best way of resolving a dispute will be by dialogue between the parties and, in reality, the vast majority of cases settle in advance of trial, there are some cases where the parties are so far apart that a trial is inevitable. There will also be cases where there is precedent value in taking a strong case to trial. Arbitration is rarely used, probably because the professional indemnity pre-action protocol will apply and this tends to lead to mediation. However, arbitration is certainly a viable alternative dispute resolution tool for solicitors to put in their terms of business, particularly in view of the confidential nature of arbitral proceedings.
Peacock: If the claim is likely to succeed, then settle without a doubt. The earliest practical settlement, by mediation or straightforward negotiations, will usually minimise the level of claim payment, costs and adverse publicity for the insured firm.
However, for cases with really strong defences, most insurers are willing to litigate to avoid the perception that they will always pay out, and to keep profitable business from firms with good claims records.
Arbitration can be attractive for commercial claims, particularly ones involving sensitive commercial information which the parties do not want aired in court, or for issues of apportionment between defendants. However, it can have drawbacks in terms of costs and will not be attractive to claimants who see it as a means to avoid giving them their day in court.
Rutherford: There is an interesting debate to be had between litigating and arbitrating.
The latter has the advantages of privacy (which may suit both parties and not just the lawyers), but is likely to prove more expensive, even taking into account the savings to be made by avoiding the pre-action protocol phase, which on occasion hinders rather than helps the parties to get to the point where they can talk sensibly about the matter. There would be a disadvantage for the market as a whole if there were to be widespread adoption of arbitration as an alternative to litigation, because we will lose the value of the precedent, which is of particular importance where what is to be expected of a lawyer needs to be appreciated by the public. Not that I see much risk of arbitration replacing litigation as the channel of choice among the high street firms.
Settle rather than fight? There will always be a few cases that must be fought for the value of the precedent they will set but, those apart, efforts should always be made to resolve disputes amicably. If the question is, however, should professionals and their insurers settle all claims, even at an overvalue, then the answer must be “no”.
On the other hand, claims should not be fought for the sake of fighting – professionals should adopt a principled approach to the claims with which they are faced, and insurers should support them in that.
Simon: Very few PI claims against law firms result in arbitration. The majority are resolved at mediation, particularly if there are a number of parties involved in the underlying transaction. In many cases the best technique is to look at what may have been a long-standing and fruitful relationship between the law firm and its client and try to leverage off that to find a commercial solution. Obviously that is not feasible in every case, but litigation is a last resort, given my earlier comments about claimants’ costs and the distorting effect that these can have on the economics of resolution.