19 November 2007
The world of business is a risky place. The practice of law is a business and, like any other business, is susceptible to all manner of strategic risk. Greed, stupidity and bad luck can befall even the most successful firm, and many firms are still struggling to learn the skills of business management and the management of risk.
Many firms are still run as groups of individuals, each responsible for their own part of the enterprise, but with inadequate central implementation of strategic risk management. Regulatory change and the state of the economy are two key areas of strategic risk that need to be navigated to be successful.
For law firms in England and Wales regulation is at a turning point. The new Solicitors' Code of Conduct and the implementation of the Legal Services Act represent a major overhaul of the regulation of legal services in England and Wales.
How does this impact upon risk?
Change of any kind is difficult to implement. Solicitors are in a busy, competitive environment and will have needed to find the time and the personnel to review, digest and communicate the scope of the changes. This activity is non-fee-earning and, as such, will probably not get as much attention as it needs to in many firms.
The lead-up process to the Legal Services Act cast the regulators of the legal profession, particularly of solicitors, in a poor light. The regulators will likely be trying to change that perception by applying greater oversight and attention than ever before. Legal practitioners will need to keep their eye on compliance issues to safeguard against unpleasant and reputation-damaging attention from the regulators in the future.
There is already inconsistent adherence to rules of compliance. There is a generation of lawyers who do not have adequate understanding of the regulations with which they should comply. There are widespread failures of compliance and inadequate supervision, particularly in volume operations. This will inevitably lead to claims, particularly if there is a serious downturn in the economy.
It is worth noting that the Minimum Terms and Conditions of Professional Indemnity Insurance for Solicitors allow the exclusion of fines and penalties, as well as the exclusion of an order or agreement to pay the costs of a complainant, regulator, investigator or prosecutor of any professional conduct complaint against, or investigation into, the solicitor's professional conduct.
Insurers do not like to cover fines and penalties imposed by regulators, and will not offer this cover if they do not have to. With the regulators under pressure to impact on the profession in a more aggressive way and being watched by the Legal Services Board to ensure they do so, this aspect of exposure could be expensive and not something that can be completely protected against by insurance.
The implementation of the Legal Services Act will begin to put enormous pressure on firms to be competitive or die, as one of the main purposes of the act is to increase competition and rid the scene of non-competitive firms.
There is a big gap in the middle. The very big firms know what they will do about the changes in the regulatory climate; the very small firms and sole practitioners will probably be sucked up or swept away in the aftermath. But what becomes of the mid-range firms? How do they stay competitive?Competitive pressure can often result in cutting corners, and cutting corners can result in sloppy or even unethical behaviour, which inevitably results in damaged clients and professional negligence claims.
The professional liability insurance market is already complaining vehemently about the levels of premium and is giving warnings about the future consequences in terms of a market shift. An increase in the number of claims will bring this about more quickly than any other catalyst.
The ups and downs of the economic cycle also have an important influence on the fortunes of commercial law firms.
Braced for claims
While it is probably fair to say that large, well-managed commercial firms watch the balance of their practice and adjust to suit the changing economic trends, a downturn in the economy will always mean more claims against professional advisers.
People do not take legal action against their advisers when they are happy with the results of their transactions and investments. But when things do not turn out as they hoped and expected, they will look for someone to blame.
I do not agree with certain political commentators who suggest that Britain does not have a 'blame culture'. A blame culture is a modern business concept. A global economy means increased homogenisation of business expectations and the remedies used to support those.
If there is a downturn in the economy, there will be a marked increase in claims against commercial law firms arising out of or exacerbated by:
- contractual drafting errors that permit unanticipated consequences;
- allegations of conflict and breach of duty;
- unclear scope of the engagement; and#clients who turn out to be less than ideal with the benefit of hindsight.
The globalisation of legal services also increases risk. When representing clients in the US and elsewhere or networking with or merging with firms in other jurisdictions, one needs to be aware of the differences in the legal systems and the cultures. Even if you have no local offices or assets, it does not mean that someone cannot take an action against you there.
There are also more draconian remedies that some jurisdictions can use against you. Do you understand them? Are you protected against them as well as you can be? What are your insurance arrangements? Do they adequately cover you for the changing face of your practice? Firms have had unpleasant surprises in this area.
There are a number of ways in which firms can protect themselves. They must:
- understand the regulations, how they affect the business and what the consequences of regulatory disapproval might be;
- ensure that those affected by the regulations appreciate the importance of their knowing the scope of and complying with them;
- train, induct, monitor and review so that adherence becomes second nature. This should be as important and well respected a part of the business as 'rainmaking';
- analyse the business, hire as senior employees or seek outside assistance from trained business people, who can help plan business strategy in light of the opportunities and threats of the changing regulatory scene and the potential economic upheavals;
- ensure that they are properly protected in terms of any insurance products and services that are available. Understand what can and cannot be insured;
#understand the jurisdictions in which they operate and what the pitfalls of operating in these might be;
- be on guard for signs of 'bad behaviour' internally that is driven by competitive pressure;#be diligent in terms of telephone notes, meeting notes, engagement protocols and other risk management techniques; and
- look out for greed and stupidity and ensure that there are contingency plans in the event of bad luck.
Sandra Neilson-Moore is European practice leader for law firms' professional indemnity at Marsh