Demergers and continuing cover

by Alistair Sim

Professional indemnity insurance issues that require to be addressed in the event of a law firm demerger

The Journal, February 2004, page 34

---

It is critical that the professional indemnity insurance options and implications are fully understood and, crucially, reflected in the contractual arrangements entered into by the partners of a demerging firm (and joint instructions given to Marsh as regards the basis on which continuing Master Policy cover is to be put in place). Otherwise, there are potential risks for those concerned, including that of former partners of a demerged practice being exposed to unforeseen Master Policy premium loadings or self-insured amounts, or difficulties in effecting adequate cover in respect of pre-demerger work.

Three options for future cover

Master Policy cover, as with professional indemnity insurance generally, operates on a “claims made” basis: the cover that applies to a claim is the cover in place at the date of intimation rather than at the date of the (alleged) error or omission.

The “claims made” basis creates potential complications for the partners of demerging firms. Claims may arise post-demerger out of pre-demerger activities and there must always be clarity about the continuing Master Policy cover that will apply to such claims. Currently, the principals of a demerging practice have three options:

Continuation basis – a single continuing practice elects to be treated as the successor practice and that practice’s cover will apply in the event of a claim arising out of the demerging practice’s pre-demerger activities.

Break-up basis – the Master Policy record of the demerging practice is split and part allocated to each of the continuing/successor practices (i.e. practices joined or established by different contingents of the former partners).

Run-off basis – the Master Policy record of the demerging practice is ring-fenced and continuing cover is on the basis of “run-off cover” (explained later).

The implications of these bases are as follows:

Continuation basis

The Master Policy cover maintained by the practice electing to be treated as the successor practice will apply to claims arising out of pre-demerger activities whether or not the responsible partner ever became a partner of the successor practice, i.e. even if that partner established a brand new practice on the demerger.

It is the successor practice’s claims record that will be affected by such a claim as well as by the demerging practice’s historic Master Policy (rolling five year) record. Under the Society’s premium discount and loading arrangements, the successor practice may incur a loading as a consequence of a claim even if the responsible partner joined/established another firm at the time of the demerger.

Also, it is the principals of the successor practice who will be liable for the self-insured amount, jointly and severally, should the insurers require to take action for payment.

Break-up basis

If the parties agree to proceed on the break-up basis, the impact of any claim arising out of pre-demerger activities will depend on the agreement regarding the allocation of that claim between successor practices as well as the allocation of the demerging practice’s Master Policy premium contribution record. These two factors in combination will determine the premium discount or loading of each of the continuing practices under the Society’s arrangements.

Example:

The two partners of AB & Co agree to demerge their practice. Mr A establishes a new practice, A & Co as a sole practitioner. Mr B joins up with Ms Z to form a partnership BZ. All concerned agree that:

A & Co will assume responsibility for ongoing Master Policy cover in respect of any commercial property claim arising post-demerger out of pre-demerger work of AB & Co.

BZ will assume responsibility for ongoing cover in respect of any other claim that might emerge in relation to AB & Co. Both Mr B and his new partner Ms Z acknowledge and accept that they assume responsibility for every category of claim other than commercial property matters – that might include claims arising out of historic activities of partners and staff long since retired. It could also, potentially, include a claim arising out of dishonesty within AB & Co, for example misappropriation of clients’ funds by a member of cashroom staff.

The only claim on the record of AB & Co at the time of the demerger is a recently settled commercial property claim which involved a sizeable payment by the Master Policy insurers. This, by agreement, is allocated to the Master Policy record of A & Co. Its Master Policy premiums are therefore loaded in accordance with the Society’s discount and loading arrangements.

By electing to proceed on the break-up basis, the parties require to agree an allocation of AB & Co’s Master Policy premium contributions record, i.e. the record of Master Policy premiums paid by AB & Co at each of the most recent five renewals. Mr A and Mr B agree to allocate the contributions record equally (50% each) between A & Co and BZ. Again, that allocation is reflected in the level of discount/loading of the two practices in accordance with the Society’s arrangements. BZ commences with maximum low claim discount while A & Co commences with a loaded premium.

The self-insured amount applicable to a claim will be determined by reference to the schedule of insurance current at the date of first intimation. For claims relating to the demerging practice intimated after the demerger, the applicable self-insured amount will be in accordance with the relevant successor practice’s schedule current at the date of first intimation.

Run-off basis

If no ongoing practice agrees to assume responsibility for the demerging practice’s Master Policy record, then, whether by agreement or by default, continuing protection under the Master Policy scheme in respect of the demerging practice’s pre-cessation activities will be provided on the basis of Master Policy “run-off cover”.

“Run-off cover” is continuing cover under the Master Policy for the benefit of the former principals, employees etc. of the former practice, and their personal representatives.

In this event, the experience of claims arising out of pre-merger or pre-demerger activities of the practice(s) is ring-fenced and has no impact on the Master Policy position of firms which the demerging practice’s former partners join or establish. Run-off cover has the following implications:

1. Currently, there is no annual premium for run-off cover;
2. There may be a one-off charge for the benefit of the continuing cover but only if the demerging practice either has (a) less than a five year Master Policy record or (b) an adverse claims record as at 1 November following the cessation etc;
3. Although there may be a one-off run-off charge payable, by proceeding on the run-off basis, the principals concerned may avoid completely any ongoing premium cost implications of claims arising out of their past work and the impact of the premium discount/loading consequences of those claims.

Example

If, in the earlier case study, the parties elected to proceed on the run-off basis:

1. Each of the new practices, A & Co and BZ would commence brand new Master Policy records, unaffected by any existing or future claims arising out of the activities of AB & Co. They would commence on a neutral premium rating (no discount and no loading);
2. Any claim arising post-demerger out of pre-demerger activities would fall to be dealt with under the run-off cover in name of AB & Co;
3. The self-insured amount applicable to such claims would be in accordance with AB & Co’s last-issued schedule of insurance and Mr A and Mr B would be jointly and severally liable to the insurers for that amount;
4. Such claims, being ring-fenced, would have no impact on the premium rating of A & Co or BZ.

Additional (“top-up”) insurance/cover

Top-up insurance is optional cover in excess of the Master Policy limit of indemnity. It is generally speaking a matter for the parties concerned to decide what level of cover is required having regard to a variety of factors, including the potential for claims in excess of the level of cover provided by the Master Policy arising out of the activities of the demerging practice for which they remain liable and/or have agreed to assume responsibility for providing continuing cover.
The parties need to be clear, and to document clearly, their rights and obligations in relation to:

1. Maintaining cover at a particular level (“not less than £x”, for example) and the circumstances, if any, in which either party may be obliged to concede to a reduction in the level of cover being maintained by the other(s);
2. Providing satisfactory evidence of that cover (probably on an annual basis);
3. Reciprocal commitments to co-operate in certain matters (for example to make such no-claim declarations as may be required to enable each other to put continuing cover in place in relation to the demerging practice).

Other matters to be agreed/documented

Ideally, the demerger agreement should also address:
Claims issues – requiring co-operation in relation to intimation, investigation and defence of any claim and reciprocal provision of information concerning claims relating to the demerging practice;

Self-insured amount – liability as between the former partners and who will be responsible for putting the insurers in funds at the stage when a claim is being settled;

Premium refunds – in certain circumstances, there may be a refund due to the demerging practice on the cancellation of its cover and replacement by cover arranged by the new/continuing practices. The parties should consider and document how such refunds are to be remitted or applied (for example, to account of the first premiums payable by the successor practices).

The Master Policy team at Marsh provides guidance on the options available to demerging practices in relation to professional indemnity insurance and the implications of those options. If required, this can include projections of the anticipated Master Policy premium impact of proceeding on the different bases.

Current Issue Features Braving the storm How different types of legal firm are coping with the current economic downturn, and how they see their future Civil justice: where next? An abridged version of the keynote address delivered to the conference on civil justice held in Edinburgh on 20 June Title Conditions Act: new registration procedures New procedures are in place for deeds intended to create new real burdens, to assist solicitors in complying with the requirement for dual registration Young lawyers reborn Interview with Scottish Young Lawyers Association President Maryam Labaki on SYLA's ambitions as it relaunches Shining some more light... Second part of overview of this year's Finance Act looks at the provisions on savings, pensions, residence/domicile and business taxes, among others Power to the tribunal? An advocate's and a solicitor's views of how the Scottish Government's proposed reforms to arbitration law might work in practice Piece by piece A progress report from England & Wales on the setting up of the complex regulatory machinery under the Legal Services Act 2007 The poor in our midst Interview with Scottish Solicitors' Benevolent Fund convener Craig Bennet, who aims to raise awareness of the Fund so it can provide more help to those in need Current Issue Articles Shifting sands President's message: with economic issues dominating the profession's thoughts, the Society is taking steps to provide advice and support to those in need A rank bad rule Opinion by two advocates that the Faculty's response to the OFT does its members a disservice by defending the cab rank rule and by resisting the use of ABS The Society's future role in complaints handling A reminder, in the light of reactions to the first levy issued on behalf of the new Complaints Commission, of when and how the Society's responsibilities are changing Appreciation: Lord Johnston Report of the tribute paid in court by the Lord President Professional Practice Committee New guidelines on acting as a company director; and document control and file tracking Facing the lean years Some advice on how to pull through a recession and be ready for the next upturn, as word goes round of legal firms looking at staff cuts and other measures (part 1 of 2) It's a web 2.0 world The interactive nature of web 2.0 technology presents business opportunities, while posing new risks for those with inadequate precautions as to employee internet use Questions, questions In reviewing their risk profiles and risk controls, all firms might benefit from conducting a self-assessment by addressing questions put by some insurers elsewhere Bare necessities Latest criminal cases, including offensive weapons; Moorov rule; withdrawal of representation; evidence of a deceased; contempt of court by solicitor Coming on the blind side A technical-sounding consultation, currently open for comments, covers some significant aspects of dispute resolution in employment Relocation, relocation A recent decision explores the matters to consider when one parent wants to relocate abroad along with their child Worse than the disease? Has the UK quietly outlawed "alternative" medicine through the Consumer Protection from Unfair Trading Regulations? Sleeping bounty The Scottish Community Foundation has a scheme to breathe new life into dormant charitable trusts Scottish Solicitors' Discipline Tribunal Reports relating to Eileen Agnes Coogans; Zosia Marion Elizabeth Fraser; Annaline Webster; Ian Samuel Gerard Donnelly; Mark David Sheppard Website reviews Reviews of sites of organisations concerned with domain name disputes Book reviews Review of Child and Family Law (Sutherland) Industry standard A survey south of the border suggests that in-house work in commerce and industry doesn't always match expectations - but most in-house lawyers expect to stay Meet the committee Profile of In-house Lawyers Group committee member Sara Scott What's in a motto? A sample of In-house Lawyers Group members' notarial mottoes, collected by ILG secretary Tricia Sim Leasing by example "Green leases" appear to be some way off yet for the UK, but a Canadian model now published shows how they might work Good call? Reply to article questioning the Donald Trump planning application call-in argues that the decision is both competent and consistent with proper operation of the system Home reports - the practice questions Open letter over reservations as to the Society's proposed guidelines on the operation of home reports, in so far as they deal with conflict of interest