Professional negligence: Courage under fire

Recent media stories suggest that the current recession will trigger a huge increase in disputes, including claims against lawyers. And the legal profession is itself concerned - a recent risk management survey sponsored by Marsh of the UK's top 100 law firms indicates 79% of respondents believe that the downturn increases the risks faced by their firm, including that of clients looking to apportion blame, other key perceived recessionary risks being bad debts, credit problems and increased regulatory burden.

Historical experience

Sadly, history offers lawyers little comfort in this respect. The Solicitors Indemnity Fund (SIF) used to maintain and make reference to claims statistics for all firms of solicitors in its annual reports. The statistics contained in SIF's reports following the recession of July 1990 to March 1991 demonstrate a very marked increase in claims, which did not return to their former level until the indemnity year 1997-98.

True, the biggest single element of that increase was real estate-related claims but it is notable that the current recession, just like the 1990s one, has been accompanied by a severe downturn in real estate values, both residential and commercial.

Logic also tells us to be concerned. Recessions cause losses which need to be recouped, especially where a new management team or, following business failure, a liquidator or administrator is appointed. The worse the recession and the greater the number of insolvencies, the more this is likely to be so. As a former Chancellor of Exchequer Nigel Lawson commented in a recent newspaper article, "a cyclical downturn associated with a collapse of the banking system is by an order of magnitude more than a nominal cyclical downturn".

Recessionary pressures

Not only do recessionary pressures induce people to commit fraud, but sharply reducing asset prices, together with increased redemption demand by investors, also lead to the increased detection of fraud. High profile examples of this, from which professional negligence claims inevitably flow, include the Bernard Madoff scandal and some recently reported scams in the UK 'buy-to-let' property market.

Commercial lawyers tend to be very active in an economic boom and such activity not only generates more contracts to litigate over in the inevitable subsequent 'bust' but it also creates the risk of such lawyers cutting corners as they attempt to meet increased client demand.

Finally solicitors, like many other professional advisers, are perceived to have deep pockets by virtue of the mandatory professional indemnity insurance which they carry. However, solicitors typically do not seek to limit their liability very extensively when agreeing terms and conditions with their clients, unlike other such advisers whose attempts to do so have broadly been upheld by the courts in cases such as JP Morgan Chase v Springwell Navigation Corp and the earlier IFE v Goldman Sachs.

Even where solicitors are not initially seen as responsible - at least primarily - for a loss, it seems inevitable that as credit crunch disputes increase solicitors will get drawn into them, particularly given the extreme complexity of some of the contracts generated in the financial services field, for example in relation to credit derivatives.

Some comfort may be drawn from the fact that little credit crunch litigation has been reported in the UK so far, notable examples being the RAB Capital claim in relation to Lehman and the SRM Global claim against the government regarding Northern Rock. However, consistent with the 1990s recession we have already seen a noticeable increase in real estate and dishonesty-related claims, while the historical data suggests that we can expect a time-lag of a year or so before a general increase in claims is experienced.

Currently the top priority among corporates is understandably survival and business stability. Once this has been secured, experience tells us that a board's focus will turn to seeking compensation from professional advisers, often just as the economy is beginning to climb out of recession.

Sources of claims

Where will these claims come from? Common sense suggests that we need to look to the market sectors that have been hardest hit by the recession because this is where losses will be greatest. A recent 'sector vulnerability analysis' conducted by PricewaterhouseCoopers indicates the most vulnerable sectors in descending order to be: manufacturing (especially of metal products); financial services; hotels and restaurants; engineering; transport; telecoms; construction; textiles and oil; and gas. To these market sectors past experience tells us that we should add real estate (both residential and commercial) and fraud, wherever it occurs, in order to make our list complete.

Among this list, 'financial services' covers a wide range of activities including not just sub-prime lending and associated credit derivatives, but also other areas in which serious loss has been suffered such as private equity, the hedge fund industry and pension funds.

As we have seen, regulation has also recently become a cause for concern. Increased regulatory exposure of clients in the financial services sector may cause knock-on problems for the lawyers advising those clients. In addition, solicitors face greater pressure from their own regulator, the Solicitors Regulation Authority (SRA), whose chairman has recently expressed concern at the risk of fewer people left to carry out compliance tasks as law firms implement redundancy programmes.

The recently publicised US class action against the Royal Bank of Scotland (RBS), in which Cherie Booth QC has been appointed as special adviser in respect of two UK pension fund claimants, highlights a further potential source of claims in the UK, flowing from the notorious 'long-arm' jurisdiction of the US courts. By contrast, our own currently restrictive 'opt in' approach to class actions makes any significant increase in UK class actions unlikely at present. However, the scope for derivative actions brought by shareholders in the company's name has been significantly widened under the Company Act 2006 in respect of conduct and events occurring after October 2007 when the relevant provisions came into force.

Types of claims

We can expect many claims against lawyers to be brought in the context of a broader dispute in which one party to an agreement seeks either to enforce it or to escape from obligations under it. For example there has already been a number of cases of banks seeking to renegotiate loan terms on the basis of alleged breaches by the borrower of the loan agreement; alternatively arguing that commitment letters are unenforceable as 'agreements to agree' or, in any event, not specifically enforceable. Material adverse change clauses have also been under the spotlight.

Claims against lawyers will plainly be fact-specific but, among others, we can doubtless expect arguments along the following lines:

• inadequate 'due diligence' in the broadest sense (for example regarding the target company of a private equity transaction or opinion letters in relation to structured investment vehicles or generally in relation to a prospectus);
• the agreement doesn't do what the client (or possibly all the parties) intended;
• the client was not advised as to the full effect of the agreement; or
• the agreement does not adequately protect the client's interests in circumstances which have subsequently materialised.

The last of these specimen arguments may frequently come close to a contention that the solicitor should have advised as to the commercial wisdom of the deal - with the benefit of hindsight 'covenant-lite' transactions, for example, may no longer seem as acceptable as once they did!

This argument may be thought to have taken a battering in recent cases such as Football League v Hammonds but it will not go away for as long as solicitors do offer commercial advice to their clients, effectively assuming the role of general 'trusted adviser', and/or fail to document the terms upon which they are instructed in an engagement letter.

In the real estate field, lenders typically claim they would not have lent (either or at all or so much) but for their adviser's negligence. However, the outcome of such claims may be a little different from those in the '90s because judicial authorities with regard to causation contributory fault and dishonesty have developed the law since then and the Council of Mortgage Lenders' handbook has clarified the scope of solicitors' duties.

The litigation landscape

Procedurally, the legal landscape has also changed with concern at the cost of litigation promoting a major rise in mediation and attempts to streamline the conduct of large cases. The funding of litigation is also different now with conditional fee arrangements increasingly commonplace and the recent emergence of after-the-event insurance and third-party litigation funding.

One would need a fully-functioning crystal ball to predict the combined effect of all these changes upon the bringing of recessionary claims against lawyers and their outcome. However it can safely be predicted that, if the recession is a severe one, the volume of such claims is going to increase significantly.

Risk management

Where claims against solicitors relate to work that has already been done, it may be argued that the die is substantially cast. However there is still much to be said for a review of sample files in identified problem areas. This should not only help to develop a firm's risk management model going forward, but can also assist to preserve crucial evidence relevant to potential claims.

The early identification of a problem can sometimes also lead to the avoidance or mitigation of loss. Even where that is not possible it may assist with the management of client relationships.

Finally, some potential claims may be avoided altogether by enhanced risk management now. Points to consider here include the fact that the issue of large and unexpected bills without prior discussion with the client often generates unwelcome counterclaims in negligence. Poor vetting of new clients or instructions typically causes a range of future problems, including conflicts of interest. And work done by lawyers without appropriate expertise, whether because they have been redeployed from a quiet area or as a result of 'hoarding', carries obvious risk.

Richard Dedman is a partner in the professional and financial disputes team at Barlow Lyde & Gilbert.