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The directing mind

18 July 05

Risks and risk management issues that arise when solicitors take on directorships in companies while acting as their legal advisers

by Alistair Sim


Solicitors take up directorships in companies outside their firms for a variety of reasons. The company may be a client of the solicitor’s firm; the company may be controlled by a client; the appointment may present an opportunity for the firm to attract or retain the company’s legal work or an opportunity to attract other legal work through contacts made as a result of being on the board.

Whatever the reasons, there is no prohibition on solicitors taking up appointments as company directors. However, there are a number of risk issues which should be borne in mind by practitioners who do take on the duties and potential liabilities involved in such appointments.

Is there a conflict?

A conflict between the roles of solicitor and director is a potential risk. Consider the position of a solicitor who is a non-executive director of a company and whose firm continues to be the appointed adviser to the company. A non-executive director owes his primary duty to the company and must act in its best interests.

There may be pressure on the solicitor to generate business for the firm, which could compromise his objectivity. In a service-tendering situation, there may be pressure brought to bear on the company to reappoint the solicitor-director’s firm. There may be difficulties in fulfilling dual roles where solicitors are appointed on a contingency/ success fee basis, or when it comes to negotiating fees. There is the potential for a conflict where legal advice is being provided to, for instance, shareholders with controlling interests.

There are a number of other areas where the potential for conflict could be imagined – it is more important that individuals are aware of the potential for conflict risks rather than concentrate on particular circumstances. In an ongoing relationship, there is always the potential for conflict to emerge – e.g. in relation to fees, or a potential claim, or where a contractual dispute arises with another company which is also a client of the solicitor’s firm.

Giving legal advice

There is a risk that the roles of legal adviser and director can become confused. This is particularly the case when legal advice is given without separate remuneration to the solicitor’s firm. This confusion can arise in the mind of both the solicitor and other directors.

Solicitors also require to consider issues of confidentiality when giving advice in such situations.

Risk management points

Some firms may decide to prohibit, or discourage, partners from accepting outside director appointments.

Where appointments are taken on, it is suggested that the individuals and the firms involved should take steps to mitigate the risks. These include the following points:

Raising awareness of the risks. There are numerous ways in which risks can arise in the role of non-executive director. Risks will develop over time and it is important that individuals keep their position under review and remember where their responsibilities lie. Prior to taking on the appointment, some level of risk assessment should be undertaken. Consider the company’s financial position and management.

Talking to the client. Discuss in depth with the directors of the company the role of the solicitor non-exec. Be clear from the outset what the company expects from the individual. It may be that the directors are unaware of difficulties which might arise.

Checking the conflict rules. If in doubt, consult with the Professional Practice team at the Society or do not act! The Master Policy imposes doubled self-insured amounts where a claim arises on account of a breach of the conflict rules.

Declining to give legal advice. Whilst a drastic option (particularly if the provision of legal advice was a factor in making the candidate’s appointment attractive to the board), this clearly addresses the risk of a claim against the solicitor-director arising out of advice qua solicitor. At least recognise the need to obtain external legal advice in appropriate situations.

Contractually defining the relationship of company, firm and solicitor. It is prudent to have the relationships between the parties defined in a way which makes clear their respective roles and responsibilities and the limits of any duties.

Clarifying how payment for services is treated. There should be clarity as to whether the director is to be paid remuneration or whether this is a fee for services payable to the firm.

Clarifying the insurance position. The indemnity insurance position should be clarified, if in doubt by consulting with the firm’s brokers.

On issues of Master Policy cover, the relevant policy provisions are:

Insuring clause: “claims… in respect of any civil liability… incurred in connection with the Practice carried on by or on behalf of the Principal Insured”.

Definitions of “Practice” and “Business”: “the Practice shall mean the Business of practising as a solicitor”; “the Business shall mean all manner of business… which is customarily (but not necessarily exclusively) carried on or transacted by solicitors in Scotland”.

Exception 13: “any claim or alleged claim arising out of the Insured acting as a director or other officer of any company or organisation but this exception shall not apply in respect of legal advice given or legal services rendered to that company or organisation”.

How these policy provisions apply in practice is best illustrated by reference to a series of case studies:

Case study A

Partner A accepts an invitation to become a board member of the local children’s charity. She attends all board meetings and participates in decisions concerning the charity’s activities as well as providing legal advice and guidance. She does this outside office hours and does not receive any payment, apart from travel expenses for attending an annual national charities conference for one day.

Exception 13 operates to exclude cover for any claim that arises out of A being a board member.

Is there cover for any claim arising out of legal advice A gives while attending board meetings? The details we have do not make it clear whether A has undertaken this role entirely on her own account unconnected with the practice. If it is “in connection with the practice”, then Master Policy cover will apply in respect of the provision of legal services. There is no prescribed test to be satisfied as a condition of cover but the authority or approval of fellow partners could be an indicator. Would A’s partners expect a claim against A to be covered by the firm’s Master Policy cover?

RISK MANAGEMENT POINTS

  • Be confident about duties and responsibilities involved in the appointment and the individual’s experience and skills to undertake the role.
  • Be clear, within the partnership, about the basis on which the individual partner is undertaking the external appointment.
  • Be clear as regards the applicability of Master Policy cover to the provision of legal advice by the solicitor-director.

Case study B

B is a partner in a commercial practice which has for many years represented company X Ltd. B has just been appointed non-executive director to the board of X Ltd. He participates in all matters that come before the board and advises specifically on legal matters. B’s remuneration from X Ltd forms part of his firm’s income.

Exception 13 operates to exclude cover for any claim that arises out of B being a board member but it does not exclude cover for legal advice. In this case, there seems little doubt that B undertook this appointment “in connection with the practice” and therefore claims against B or his firm as a result of B’s legal advice ought to be covered under the Master Policy.

RISK MANAGEMENT POINTS

  • Be clear that the company’s financial position and management are satisfactory.
  • Be clear about the role and the duties and responsibilities involved.
  • Be clear about the level and scope of the company’s D & O cover (see panel).

Case study C

C is a partner in a three partner firm. As a separate venture but with the blessing of both of her partners she decides to work with a friend from school who has trained as an IT expert to set up jointly a computing consultancy firm, with a hoped-for target market of solicitors and accountancy firms. The consultancy operates as a limited company, and C and her friend are the company’s directors and shareholders. C deals with all legal work personally. The company is not a client of the firm.

Exception 13 applies. Will any claim resulting have been incurred in connection with the legal practice of which C is a partner? No. There is no Master Policy cover for C’s involvement in this separate venture, which has no connection with the legal practice.

RISK MANAGEMENT POINTS

  • Be clear within the partnership that the individual partner understands that the directorship is entirely outside the scope of the partnership and its Master Policy cover.
  • Consider whether the purchase of separate professional indemnity cover for the separate consultancy activities, and D & O cover, may be appropriate.
  • Maintain an up-to-date register of outside interests of partners and take this into account in conducting conflict checks.

Summary

While cover under the Master Policy may depend on the individual facts of the external appointment, the position is that cover excludes:

  • activities unconnected to the insured practice;
  • liabilities more properly covered under other insurances (e.g. D & O cover – see panel).

It is in the interest of solicitors and their firms to consider thoroughly the risk issues involved prior to external directorships being taken on.