Potential Liability To Non-Clients In Transactional Work

One of the many areas of risk which solicitors face in an increasingly demanding environment is a potential exposure to third party claims. This article looks at the issues which may arise in the context of transactional work and offers some practical suggestions as to how these may be addressed.

Identifying the Client and Other Recipients of the Advice

In very broad terms, a solicitor may in certain circumstances owe a duty of care to non-clients, usually where it appears that the third party is reasonably relying upon the advice or information provided by the solicitor.

Hence, the prudent solicitor will know at every stage of a transaction:

• the identity of the client – all transactions involve parties with differing interests and these may include the shareholders, the directors, the company and the financiers;
• whether the client is passing on the advice to third parties who have an interest in the transaction – in that event, it is necessary to identify and clarify the existence and scope of any duty of care which may arise; and
• whether another party to the transaction appears to be relying upon the advice – for example, where such a party is not independently advised.

The prudent solicitor will attempt to limit the persons to whom he owes a duty of care, save where the provision of advice to third parties is in accordance with accepted commercial practice and the implications have been fully and properly considered.

Each of these issues is considered below:

Is the Client Passing on the Advice to Third Parties who have an Interest in the Transaction?

A duty of care may typically arise where:

• the advice is required for a purpose which is made known to the adviser at the time when the advice is given;
• the adviser knows that the advice will be communicated to the third party (either directly or as a member of an ascertainable class) in order that it may be used for that purpose;
• the adviser knows that the advice is likely to be acted upon by the third party for that purpose without further enquiry or the obtaining of independent advice; and
• the third party acts upon the advice to his detriment.

The issue of duties to third parties has been brought sharply into focus by the decision of the Scottish Court of Session in Royal Bank of Scotland v Bannerman Johnstone Maclay & Others, TLR 1 August 2002. The Scottish Court held that, in the absence of a disclaimer, a company’s auditors could owe a duty of care to a lending bank (notwithstanding the absence of any direct contact between the parties) if the auditors knew (or ought reasonably to have known) that the bank would rely upon the audited accounts when making its lending decisions. In the light of that knowledge, it was the omission to send a disclaimer to the bank, rather than any positive action by the auditors, that supported the existence of a duty of care.

Whilst that decision is subject to appeal, it prompted the Institute of Chartered Accountants in England and Wales to issue further specific Guidance to Members in January 2003 on the basis that, even if the Bannerman Judgment were overturned on its particular facts, the finding at first instance might represent a trend in judicial thinking which might be followed by the English Courts and encourage third parties to pursue claims. Although auditors and reporting accountants are in a particularly exposed position, there is no reason why the principles in question should not apply to other professions, including solicitors.

Regardless of the outcome of the appeal in Bannerman, the legal basis for incurring third party liabilities is well established in English law and it follows that solicitors must guard against inadvertently assuming responsibility to non-clients.

Does Another Party to the Transaction Appear to be Relying on the Solicitor’s Advice?

A number of the principles relating to the existence of third party duties are illustrated by two contrasting cases.

In Dean –v- Allin & Watts [2001] PNLR 39, a loan had been made to an unincorporated business by a private individual, who was not separately represented. The borrower’s solicitors were instructed to provide an effective security and they advised that security could be provided by a deposit of title deeds, which they agreed to hold to the Claimant’s order. In the event, the business failed, the return of the deeds was demanded and, by reason of non-compliance with Section 2 of the Law of Property (Miscellaneous Provisions) Act 1989, the Claimant was constrained to agree to their return. He therefore lost the benefit of his security.

The Claimant issued proceedings against the borrower’s solicitors, alleging the existence and breach of an implied retainer and a duty of care.

The Court of Appeal held that:

• an implied retainer had not arisen as between the Claimant and the solicitors. This was indicated neither by the broad picture of the relationship nor by the specific facts;
• on the particular facts, however, the solicitors owed the Claimant a duty of care. Although a court would be slow to find an assumption of responsibility by a solicitor towards a party entering into a transaction with that solicitor’s client where there was a conflict of interest, there was no conflict of interest in the provision of effective security in the present case and it was intended that the Claimant should benefit from this. The solicitors knew or ought to have known that the Claimant was relying upon them; there was the necessary foreseeability of damage and proximity; and it was fair, just and reasonable for the law to impose a duty of care.

The factual position in Dean –v- Allin & Watts was somewhat unusual and, as the Court of Appeal emphasised, the courts will generally be reluctant to recognise the existence of a duty of care where this would give rise to a conflict of interest. The decision does, however, highlight the need to be alert to potential problems, particularly in circumstances where the other party is unrepresented.

Contrast the position in BDG Roof-Bond Ltd (In Liquidation) –v- Douglas & Others [2000] PNLR 273, in which the company had purchased Mr Douglas’ 50% shareholding in the company for £135,000. Mr Douglas had been represented in the transaction by solicitors, who were named as Second Defendants in the action. The company subsequently went into liquidation and the liquidator sought to recover damages against the solicitors on the grounds that the purchase was invalid by reason of non-compliance with various provisions in the Companies Act 1985.

The Court of Appeal held that:

• the solicitors had not been retained by the company to act in relation to the transaction and, accordingly, they did not owe any contractual duty to it. The fact that Mr Douglas had arranged for the company to pay the solicitors’ bill did not affect this conclusion, as such a practice was commonplace in small private companies;
• the solicitors did not owe a common law duty of care to the company. There was insufficient proximity between the parties in circumstances where the company was “on the other side of the fence” from the solicitors’ client in the transaction; nor was it fair, just or reasonable to impose such a duty of care.

Disclaimers and the Unfair Contracts Terms Act 1977

When reports or letters of advice are prepared which might possibly be the subject of broader circulation, it may be appropriate to consider the inclusion of a disclaimer of liability to third parties. Where the law of England and Wales applies, such a disclaimer will be subject to the “reasonableness” test contained in the Unfair Contracts Terms Act 1977. In the case of such a non-contractual notice, it must be fair and reasonable to allow reliance upon the exclusion, having regard to all the circumstances obtaining when the liability arose or (but for the notice) would have arisen. The burden of establishing the reasonableness of the exclusion will be on the solicitor.

The Use of Opinion Letters

Opinion Letters are letters to third parties (normally financiers) which are designed to provide assurances on a limited number of specific issues. They are common in the world of Banking and Finance and are also sometimes provided in corporate transactions (for example, in the acquisition or disposal of shares or in the issue of debt or other securities). They are a normal part of doing business but require strict adherence to a firm’s internal rules and established precedents. Critically, they must be limited to matters of law not fact.

Opinion Letters vary in scope but will typically include opinions on one or more of the following:

• a company’s capacity and authority to enter into the agreement;
• that the agreement contains “valid and binding” obligations which are enforceable;
• that any payments under the transaction are not subject to any withholding tax or stamp duty;
• that any Judgment will be binding upon the parties and that any Judgment in the relevant jurisdiction will be enforceable.

The City of London Law Society has established ten principles which govern the use of Opinion Letters and these must be adhered to. A number of firms involved in Banking and Finance work have established Opinions Committees, one member of which must authorise each Opinion Letter, together with the partner with overall responsibility for the matter in question. The rationale of this approach is to develop a pool of expertise and attempt to ensure that consistently high standards are maintained in the provision of such letters.

Practice Points

• In order to try and limit the potential for third party claims, a solicitor may wish to include a term in his retainer with the client that, unless otherwise expressly agreed in writing, his services are provided solely for the benefit of the client and that he accepts no responsibility to anyone else. The inclusion of such a term in the retainer will put the solicitor in a better position to resist client pressure to pass on the relevant advice to third parties. Where disclosure is to be made, the solicitor will be in a better position to agree a satisfactory basis for such disclosure to the third party.
• Where advice may be passed to third parties, it is important to clarify the existence and scope of any duty of care which may arise. The appropriate use of disclaimers will (subject to the application of the Unfair Contracts Terms Act 1977) help to protect the solicitor’s position. The wording and terms of any exclusions or limitations of liability require careful consideration.
• It is important to ensure that any disclaimer is not overridden by any statements or representations which are inconsistent with it (whether made contemporaneously or at a later date). For example, it might be alleged that comfort was sought and obtained from the solicitor by the third party in relation to the contents of a report or opinion letter.
• Where a party is unrepresented, it is important to ensure that no retainer arises by implication and that no common law duty of care is assumed to that party. One way of seeking to negate any assumption of responsibility is for the solicitor to make it clear in writing that the unrepresented party should obtain independent legal advice, having regard to the conflict of interest and that the solicitor accepts no responsibility to it.
• Where Opinion Letters are provided, it is important that the principles enunciated by the City of London Law Society are adhered to. The use of Opinions Committees will also help to ensure consistency and generate a pool of relevant expertise.
• Solicitors may also be asked to provide less formal “letters of comfort” to third parties on behalf of clients. Particular care is required in these circumstances, given that the liability risks are exacerbated by the commercial context and the inherent conflict of interest. Such letters have proved to be fertile ground for claims against professionals in recent years.
• Care is also required if a third party makes a specific enquiry of a solicitor, with a view to obtaining a response which could constitute an actionable representation. This position was most graphically illustrated in ADT v Binder Hamlyn [1996] BCC 808. In that case, a partner in the Defendant accountants stated, during the course of a meeting with the prospective purchaser, that he stood by his firm’s earlier audit. It was held that this gave rise to a voluntary assumption of responsibility and a liability of £65 million plus interest and costs. Whilst the action was eventually settled pending the hearing of an appeal, the decision illustrates the scale of third party liabilities to which professional advisers may be exposed.
• Where contracts are governed by the law of England and Wales, regard must be had to the potential impact of the Contracts (Rights of Third Parties) Act 1999. It is, therefore, advisable for the retainer letter between the solicitor and the client to state that, unless expressly provided, none of the terms of the retainer shall be enforceable by any person who is not a party to it.