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Practical limitations

17 October 11

Some frequently asked questions on solicitors limiting their financial exposure liability to clients (part 1 of 2)

by Charles Sandison

The Legal Risk Conference provided a forum for practitioners to discuss how to set realistic limits on liability which are both acceptable to clients and effective. One of the questions raised was:

How do you suggest we go about assessing the firm’s exposure in high value engagements and deciding on the appropriate level of liability cap?

This is by no means a straightforward exercise, for a number of reasons. Although it should be obvious that the level of fee does not bear any relation to the potential financial exposure, it is something which can be forgotten – even a transaction at a relatively modest fee may be dealing with subject matter that exceeds a firm’s cover level by many times.

Client buy-in?

When assessing exposure and potential liability capping, there has to be an awareness, at the outset of the engagement, as to the potential level of exposure in the event of a claim.

Matters are not always simple. There can be resistance to liability caps, and this may come from the firm itself and/or the client.

There can often be reluctance by solicitors to discuss capping liability, on the basis of an adverse reaction from the client. There may be a perception that a client would refuse to accept an engagement based on a capped liability, or (perhaps even worse) insist that the level of the cap is increased.

Informal research which has been conducted across a wide base of firms in the UK over the past few years seems to suggest that, contrary to solicitors’ own views on client reactions, most clients (particularly corporate clients) have a more pragmatic approach to liability caps. This may well be because clients who are used to seeing engagement caps from other professionals are more ready to accept similar conditions from solicitors.

Where to set the cap?

If one can overcome internal resistance to the question of liability caps, there is then a further matter to be considered – the internal assessment of risk. There can be a significant practical problem when dealing with liability caps where there is no way of achieving a “firm wide” approach to assessing the liability exposure. A smaller firm may not have the luxury of having a partner to whom such matters are referred for a decision, nor might they wish to have an additional formalised written process to assess potential risks. However, an effective system can be as simple as discussing a particular matter with a partner. This kind of independent check need only be a five minute discussion and, if there is a risk of a high value claim, this investment of time at the outset of the engagement is worthwhile.

However, this approach does rely on individuals thinking through the engagement and understanding the potential exposure. Without having an understanding of the firm’s risk tolerance (and the firm’s indemnity limit), it is unlikely that individuals can effectively implement an effective approach to capping liability.

In deciding on the appropriate level of liability cap, a number of factors will require to be taken into account. When setting the limit, the provisions of reasonableness in the Unfair Contract Terms Act (UCTA) must be borne in mind.

Clearly, an important factor is the total value of the transaction, and the “worst case” loss which could occur. Once that is determined, a view might be taken on whether the “worst case” would ever be likely to occur, or whether any “realistic loss” would be lower. This then enables determination to be made as to whether the liability cap should be set at the realistic loss figure or at some other level, such as the level of the firm’s current insurance.

One particular issue to note is that if the liability cap is set at the firm’s current level of cover, the firm may, in the future, have a gap between its insurance cover and liability limit, should it subsequently reduce its level of Master Policy top-up cover. If a claim were to be intimated when cover was held at a lower level, the firm would only have the benefit of the cover to the lower amount, regardless of when the negligent action took place (or the date of the engagement letter).

Charles Sandison is a partner at The Commercial Law Practice LLP
 
Next month’s article will consider whether it is possible to ensure that a liability cap, once determined, will be effective. The views in this article are those of the author and not necessarily of The Commercial Law Practice LLP.

Time to test your knowledge

Look out for the CPD quiz on the Marsh website which will accompany the second part of Charles Sandison’s article on limiting liability.

 

In the meantime, here is a taster:

Which of the following statements regarding limiting liability are true?

a. Solicitors who limit their liability to clients are in breach of the practice rules and may face disciplinary sanctions

b. It is the value of a claim when/if it arises that is relevant when assessing the firm’s exposure and the adequacy of its PII – not the transaction value at the time of the error/omission giving rise to the claim

c. Limiting your liability to clients at less than £2m (the Master Policy limit of indemnity) may be considered a professional misconduct matter

d. Solicitors are entitled to limit their liability to clients at a level below the level of top-up cover their practice holds.

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