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Risk and rogues

Author: Frank Maher

Published: 09/02/2006 00:00

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Law firms are beginning to learn — in some cases, the hard way — that their insurance policy is not part of their risk management, but the last port in a storm, as the latest Legal Risk survey of the top 100 UK law firms reveals.

Firms are perhaps recognising, too, that although insurance premiums have been low for years, that may not continue indefinitely. If they were unable to obtain cover, they would end up in the ‘Assigned Risks’ pool with both reputational consequences and enormous premiums: for example, just the basic compulsory £2m cover would cost more than £1.4m for a firm with £10m fee income.

While solicitors in England and Wales still enjoy the widest cover of any profession in the world, firms are learning that the policies do not cover every loss.

One major insurer has imposed larger excesses for claims arising from circumstances which firms failed to disclose on renewal — but how many firms (or brokers) have read their policy? Non-disclosure also risks insurers seeking reimbursement, as befell one firm recently after failing to disclose an investigation by HM Revenue and Customs, which was connected with subsequent fraud claims.

Where excesses were previously capped with an aggregate of three or perhaps five, many now have either no aggregate limit or carry a smaller residual excess for subsequent claims, such is insurers’ concern to address the issues of attritional losses following adverse claims experience from personal injury, property and financial services work.

Hundreds of firms have been caught up in the £100m group action brought by insurers of the failed Accident Group, only to find that they have massive exposures to multiple excesses. Worse still, insurers are disputing their entitlement to indemnity for substantial referral fee claims, leaving many small high street firms with potential six-figure liabilities to defend out of their own resources.

The last renewal on 1 October, 2005, saw the new ‘aggregation rule’ introduced which will enable insurers to treat multiple claims arising from similar acts or omissions, or from one transaction, as one claim with one limit of indemnity. The change was the industry’s reaction to the House of Lords’ decision in the Lloyds TSB pension case. Many firms have recognised the threat this poses to their existence, if they were to face multiple claims in future — perhaps from a faulty rent review clause in a lease precedent, or a series of undervalued settlements of industrial disease claims, or perhaps financial services.

A major claim, lost at trial, resulted in one firm finding that one of its top-up insurers was insolvent. High-profile failures in recent years such as HIH Casualty and The Independent, have alerted many firms to this risk. Worryingly, for firms converting to limited liability partner-ship (LLP) status, there is no protection under the Policyholders’ Protection Act 1975, which caused more than a measure of concern on a large claim in which the writer acted recently for insurers of a large City firm.

While the incidence of rogue partners making off with money is thankfully rare, there have been a number of such cases over the years, with the risk highlighted by the recent example of Michael Fielding, sentenced to eight years’ imprisonment after making off to South America with more than £6m and costing his firm more than £1m in extra premiums; a loss that firms cannot insure, quite apart from the reputational damage, the partner time involved in clearing up the havoc left behind and the excesses and other losses incurred.

Over the years the writer has investigated many such cases on behalf of insurers and, more often than not, the losses have extended beyond client account to the partners’ own money. In broad terms, client account losses will be covered by professional indemnity insurance, but where the money has been siphoned off through an office account it will not, unless the firm has a fidelity policy. Even then, they will have to show they have complied with the policy terms, particularly in relation to recruitment checks, where many firms are falling down.

Firms have also been caught out with liability for previous firms’ claims under the so-called ‘successor practice’ provisions, which at times can strike seemingly randomly when recruiting takes place, leaving a firm with a tarnished claims record. In two cases, top firms have taken on partners from other firms but deliberately not taken on partners who were later struck off for fraud. Even so, they have found themselves on the wrong end of substantial multi-million pound claims. In addition, there are more large claims around, a trend first reported in the US.

The threat to partner assets is therefore real, despite the breadth of the compulsory insurance all firms carry. So what are they doing about it?

More firms responding — nearly 30% —have appointed full-time risk managers, a figure that has doubled year on year over the last three annual surveys. Many other firms have appointed other managers to address the issue too. A quarter of respondents now have partner committees dealing with risk, against none two years ago.

Most top firms are now limiting liability contractually, at least some of the time, with less than 10% not doing so at all. Similarly, the majority of these firms have either converted to LLP status or are planning to do so this year — 57% in all.

Recruitment checks when making lateral hires of partners have improved dramatically over the three years surveyed, though there is still room for some significant improvement with, for example, a quarter of firms not enquiring about claims records, even though recruitment of a rogue partner, perhaps already known to their current insurers, could make a firm uninsurable. The ease with which fraud-sters can move from firm to firm, leaving a trail of destruction in their wake, is remarkable.

Firms are also addressing other issues. In one recent example, a major City firm consulted the writer about ways of improving cheque-signing procedures to reduce the risk of rogue partner activity of the type outlined above.

So, overall, the message is very positive. While there is always more that can be done, the signs are that, at the top of the market, law firms are addressing risk issues more actively and, in due course, this can be expected to filter down to the lower end.

Frank Maher is a partner at Legal Risk.

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