Limited ambition

Risk management should be high on the agenda of any law firm. Clive Greenwood looks at the ins and outs of the increasingly popular option of converting to an LLP

Professional indemnity insurance is expensive and, as a percentage of revenue, increasingly so. Add to this the increasingly competitive legal marketplace and a blame-orientated society, and the writing is on the wall for law firms: you fail to put risk management at the top of the agenda at your peril.

Many have turned to the limited-liability partnership (LLP) as a partial solution to their liability worries. Conversion to LLP status is, however, a time-consuming and complicated process. It also brings with it new regulations and obligations for accounting and disclosure of profits, which go against the grain for some individuals. So is it worth it?

LLP – the pros and cons

The draw of LLP status is, of course, its limited liability. Unlike a partnership, in which partners have unlimited liability, members of an LLP are liable only up to the amount of their personal investment in the LLP.

However, that may not be the end of the story. There remains the possibility that, under common law, an individual member involved in giving advice can be held personally liable to the client for negligence. This is on the basis of the concept of personal assumption of responsibility. This has not yet been tested in the context of an LLP, but has previously arisen in other contexts where professional advice was given.

In Williams v Natural Life Health Foods Ltd (1998), which involved a claim against an individual director of a company for negligent advice, the House of Lords laid down a three-stage test: 1. Was there an assumption of personal responsibility by the individual professional giving the advice?; 2. If so, did the client rely on the assumption of responsibility?; 3. If it did, was it reasonable for it to do so? In this case, the company director was found not to have been personally liable for the advice given.

Other cases have gone the other way, including Merrett v Babb (2001) and most recently the Hong Kong case of Yazhou Travel Investment Company Limited v Bateman Starr & Others (2004), where individual solicitor employees of a law firm were found personally liable for their negligence.

However, perhaps of particular significance for LLPs is the 2001 case of Bradford & Bingley Plc v Hayes and Dunphys West London, in which a building society sought to establish that a valuer, whose limited-liability company it engaged to perform a valuation, was personally liable. The court found that there was no assumption of personal responsibility, nor that the building society had relied upon any such assumption. Judge McKinnon stated: “To impose liability… would undermine the whole purpose of creating a corporate entity with limited liability.”

While the position on personal liability remains unclear, all steps possible should be taken to prevent any of the three tests in Williams being satisfied, including:

Ensuring that all clients are made aware that they are dealing with a corporate body with limited liability.

Include disclaimers and exclusions of personal liability in all terms of business and retainer letters.

Sign all correspondence (letters, faxes emails etc) on behalf of the LLP.

Avoid any suggestion in correspondence or discussions that the individual is assuming personal responsibility for the work.

Of course, it is not just future liabilities that a partnership needs to consider. The historic assets and liabilities of the partnership must also be dealt with. On conversion to an LLP, most if not all of the existing business and assets of the partnership will normally be transferred to the LLP. As to existing liabilities such as negligence claims, a decision will need to be made as to whether to transfer them or leave them with the partnership (with appropriate run-off insurance cover being taken out by the partners). Other liabilities of the partnership will require novation or the consent of third parties to a transfer, such as banking facilities and the leasehold of premises.

While conversion to an LLP will give individuals more peace of mind, its protection of personal assets will only bite where there is a ‘catastrophic’ claim of a value so high that it exceeds the LLP’s insurance cover and the value of its assets. Most claims are not of this nature. Accordingly, firms should in any event give thought to limiting liability for more ‘run of the mill’ claims.

There is evidence to suggest that law firms, taking up a practice that has been common in the accountancy profession for some time, are increasingly seeking to limit their liability by capping the amount of any negligence claim by way of liability caps in retainers. These are covered by the general law on limitation of liability and are therefore subject to the requirement of reasonableness imposed by the Unfair Contract Terms Act 1977 and, in the case of a consumer client, by the requirement of fairness imposed by the Unfair Terms in Consumer Contracts Regulations 1999.

But for all law firms, while limiting liability for negligence claims is unquestionably important, it is only one element of risk management. In this competitive market, risk management should be about the broader protection of the reputation of the firm and its financial stability. The reputation of a firm is significant not only in terms of how the firm is viewed by existing and prospective clients, but also by existing and prospective employees and partners. This will have a direct impact on the ability of the firm to recruit and retain the quality of personnel required to compete in the market. Reputation is crucial and damage to reputation is not something for which insurance can be purchased.

This being the case, every firm would be well advised to conduct a detailed internal audit to identify the areas of its business that present the greatest risks to its reputation and financial stability – eg which areas of the practice give rise to the greatest number of complaints (from employees, clients etc) and what is the basis for most negligence claims brought against the practice? Action then needs to be taken to change and improve those areas to reduce the risk to the firm as a whole.

However, a ‘tick box’ approach saying that, as a result of the internal audit, we now have a policy relating to X is not sufficient. Going forward firms must ascertain their own areas of particular risk and be rigorous in tackling those areas, even if doing so might result in very difficult decisions being taken.

Clive Greenwood is joint head of the partnership group at Lewis Silkin; he was assited in this article by associate Tamar Halevy