Charles Attwell and Paul Smith are solicitors and risk consultants who support Travelers claim and underwriting teams. They help law firms to identify and avoid professional indemnity insurance risks.
Here they explain some common errors in company and commercial law and how to avoid them. (1 June 2020)
Company and commercial work ranks seventh in our data showing which areas of work in law firms generate the most negligence claims. It ranks fifth in terms of the value of the claims.
Most errors occur during preparation and negotiation of contracts, when the final contract fails to reflect the client’s intentions — or the advice given by the firm misses something important.
We do see claims involving areas such as M&A and intellectual property. While these claims are relatively small in terms of frequency and impact, that may change.
This article highlights some of the more common issues, and how your firm can reduce the risk of a claim.
1. Agreeing the retainer
Around 33% of company and commercial claims are linked to some failure to agree and then manage the retainer. Often, the problem starts with a lack of clarity around the facts and what the client wants.
- in an asset sale a firm failed to scope the retainer on the issue of tax advice, so despite accountants also being retained this left the firm vulnerable to an allegation of failure to advise on tax
- alleged failure to advise individual on his UK tax affairs, although the firm’s actual client was a non-UK company which the individual funded
- Get the facts. Understanding exactly what the matter involves reduces the chance of a mismatch between what the client wants and what gets recorded in any document.
- Document the retainer. This helps identify your client’s intentions and manage expectations. It also flags up any assumptions that need to be discussed. Is tax advice included?
- Schedule any deadlines. Schedule key actions and highlight them in your planning for each matter.
- Have systems to support legal service delivery. For example: client acceptance; file opening and closure processes; multiple diary systems; checklists for mapping workflow and guiding activity on a matter; work handover processes.
- Consider using a multiple diary system and task planners for each fee-earner and each case.
Establish the underlying facts
When receiving instructions from a client, a checklist approach can be extremely helpful in establishing the facts. For example, in the case of sale of goods contract, here are a few illustrative headings:
- Which laws affect the business? For example, those covering product safety, or the Consumer Contracts Regulations
- Price and payment terms
- Deliverables, including specifications, Service Level Agreements, and timings
- Guarantees, warranties, indemnities, and limiting liabilities
- Implied terms and statutory rights
- Retention of ownership
- Dispute handling
- GDPR and IP
- …and so on
What are the client’s assumptions about the retainer, and yours? Identify and test these assumptions.
2. Drafting errors
Drafting errors produce a quarter of the claims we see in company commercial work.
- acting on a sale and purchase agreement, a firm failed to include a term that was required to limit the client’s liability in the event of certain claims arising above a certain limit
Various different causes can drive drafting error. Typical issues include frequent and complex changes to instructions shortly before completion dates; demanding clients; poor record-keeping; and overstretched fee-earners with insufficient time and resource to review documentation.
Part of the solution is to get the facts, document the retainer, and track and review progress.
- Apply scenarios. What if the other party becomes insolvent; or the property price falls (or rises); or the exchange rate changes during a transaction?
- Work through any formulae.
- Recognise that reviewing documents is hard work. Concentration levels fall quickly, especially when no problems are apparent at an early stage. It’s easy to become ‘routine-blind’ to error.
- Review draft documents systematically. Use drafting software, or operate the ‘four eyes’ system where one person reads out the document as another follows the text to spot errors.
- Track individual workloads. Avoid overloading people. Stress and fatigue affect performance and risk perception (tired people take more risks, which is one reason why casinos operate late into the night).
3. Progressing the matter
Once a matter is in progress, it can be easy to overlook issues and to communicate inadequately with the client.
- acting on the purchase of a business for a client, the firm failed to check the seller’s calculations as to the redemption of a mortgage and a set-off of the purchase price
- without the client buyer’s authority the firm suggested changes to a contract, which allowed the seller to renegotiate the agreed terms
- last-minute changes were made to the terms of a deal by the counter-party and reflected in the terms of the contract, but the firm failed to alert the client to the change until it was too late to avoid potential loss
The underlying cause tends to be systems failure – not using the retainer documentation to manage the process, not following the systems that are in place, or simply lacking adequate systems in the first place.
- Document any late instructions. Problems often arise when instructions change, so make attendance notes and immediately amend any plans that need to change.
- Track and review progress. How is the retainer progressing against what you were originally instructed to do?
- Supervision. Monitor workloads and identify issues.
4. Not following clear instructions
Some claims reflect a serious mismatch between what the client believes has been agreed and what appears in the documentation.
- where a client invested in a project and transferred funds to be held in an escrow account, the firm failed to set up the account or to place a secured charge on the company and its assets and the investment was subsequently lost
- where a husband and wife were selling their nursing home property and related business to family members, annuity payments were to be made for the remainder of the couple’s lives. The firm failed to specify in the contract when the payments would cease when either or both died. Payments ceased following the death of one spouse, and a claim followed
- Check the client’s agreement with the terms of the retainer in the first place. This helps to reveal any errors or omissions.
5. Legal advice
Around a third of claims relate to advice failures. These can be the result of getting the law wrong or getting the facts wrong.
- when acting for a client in connection with a loan to a company, the firm failed to advise correctly on the joint and several guarantee terms – resulting in a loss when there was a default on the loan
- the client, a director and shareholder, became liable to meet an additional substantial payment under the terms of a facility agreement. The firm failed to challenge the payment on grounds of unenforceability
- failure to explain the potential impact of the borrower’s bankruptcy on the lender client’s charges
- failure to structure correctly a reduction in a client’s share capital, so that it did not take effect and resulted in stamp duty and tax penalties
- a firm’s allegedly defective advice that the costs in connection with setting up a particular employee benefit trust could be offset against corporation tax
Advice failure can be caused by the sort of process and systems issues discussed earlier. But they are also caused by situations where there is a communication breakdown, people lack support or are unsupervised, and the firm’s culture does not encourage discussion and information-sharing.
- Promote an ‘open door’ culture. Encourage discussion of challenging cases and issues.
- Create ‘knowledge exchanges’. Provide regular opportunities to raise and discuss issues, and to tap into colleagues’ knowledge.
- Offer mentoring schemes. This can be a structured way for knowledge to be passed on.
- Set up feedback schemes. These provide opportunities to discuss risk issues, including both claims against the firm and ‘near misses’ – where things have gone wrong without ultimately resulting in a loss or claim.
There can be enormous pressure from clients to complete a transaction quickly once the matter reaches a certain stage. But your fee-earners need to take the time to get all of the details right.
- when instructed to send the proceeds from a company sale to the shareholder’s bank account, the firm failed to check the account details and sent the monies to an unrelated account
- Avoid a last-minute scramble to complete work.
Improving risk management
When taking steps to reduce the risk of having to make a professional negligence claim against your PI insurance, it may be useful to think in terms of these four headings:
- People – whether clients or those within the firm providing the service.
- Process – the steps in delivering the retainer, dealing with the matter to completion.
- Systems – that underlie all the work that the firm does – file opening, client due diligence, IT, HR, communications within the business, diaries and file closure.
- Risk management – the extent to which good practice in risk management is followed in the firm.
Start with a thorough ‘onboarding’ process, to identify the client’s legal needs. Take a statement from the client, setting out the facts of the matter. Use headings such as the ones below to provide clarity and structure to these facts. Adopting this project management approach will help you to plan and control the matter (and its profitability) through to completion.
- Initial business case – the purpose of the matter.
- Scope – the activities to be performed, the resources needed, and the outcome (eg a contract, or a sale).
- Deliverables – specific tangible outcomes that satisfy specific named objectives.
- Assumptions – assumptions that the client can confirm are correct (eg a particular property is owned by X; or a particular document has not been superseded by another document).
- Dependencies – a series of steps to be taken in sequence, including the question of what happens if a step does not take place (what is critical, what is not?).
- Limitations – on the scope of the legal advice, based on the information available and the areas of law to be covered (eg is tax advice covered, or IP law?).
- Unknowns – factors where there is no information, which could affect the outcome.
When progressing a matter, use systems like these to keep control of the various issues:
- Issues log – a straightforward log of things that arise which may have an impact on the project (eg what may impact the parties’ rights to change or exit from the deal).
- Risk control log – any checks or solutions that need to take place (eg extensions or terminations – there will usually be a follow-on action that must be monitored or completed).
- Revision history – changes to the matter and why they were made (eg where new information means that the original plan needs tweaking).
- Change control – a way of preventing mission creep, so that if a matter materially changes the firm can then reset the budget, resources, timings and expectations of the outcome (eg if a seemingly straightforward transaction is revealed to be a complex one, or if circumstances have significantly changed that will impact the end result (such as Covid-19).
- Earned value – a cost-benefit analysis carried out during the course of the matter to check that the original commercial logic still stacks up in light of any changes (eg in any M&A deal a number of factors can erode the value to one party or another).
We have provided a separate note to address the Covid-19 and operational risk challenges facing law firms.
There are countless different situations that can lead to a PI insurance claim from a law firm, but hopefully this note has given you helpful ideas about where to focus your risk management efforts and the sort of controls you can use.
- How to avoid professional negligence claims in residential conveyancing, wills and probate, commercial property and commercial litigation.
- PI insurance for law firms FAQs: Part one (50 FAQs)
- A series of podcasts on risk, including: Dishonesty risk in legal service delivery - Podcast 3
- Covid-19 and operational risk.