Risk Management: Limiting solicitors' liability

In contrast to the attitude of major firms of accountants (and, indeed actuaries), solicitors have been generally reluctant to seek to agree limitations of liability with their clients (such limitations being permissible under the professional conduct rules, provided that they are not less than the minimum level of cover required by the Law Society – £3 million for LLPs and £2 million for other firms).

In response to research undertaken in 1999 by the City of London Law Society, one quarter of all the respondent firms stated that they included provisions to limit their liability, although most did so only rarely. Significantly, concern was also expressed by over half the respondents that they might become uncompetitive if they sought to impose limitations in circumstances where other firms had no such policy.

Subsequent surveys and anecdotal evidence demonstrate a trend towards a greater use of limitations of liability and these are, for example, now relatively commonplace in vendor due diligence reports prepared for bidders in M & A auctions (recognising that such reports address liabilities to third parties, not to clients). Concerns about becoming uncompetitive nevertheless remain and there is no evidence to suggest that limitations of liability are now widely accepted in mainstream M & A or finance work.

Whilst solicitors have been much less aggressive than accountants in limiting their liability, there are a number of reasons for this, arising out of important distinctions between the two professions. They include:

• their different claims profiles – whilst solicitors suffer a large number of attritional losses, the quantum of even the largest historical claims has been very much smaller than those against the large accountants;
• the greater level of insurance cover available to solicitors from (effectively) “the ground up”;
• the greater propensity of accountants to become embroiled in large corporate collapses;
• Competition Act considerations, which preclude discussion on limitations of liability as between law firms (solicitors having come to the issue later in the day); and
• the fact that the solicitor market is less consolidated at the top end, which makes it very competitive.

Notwithstanding the above and the increasing number of LLPs, the use of limitations of liability is increasing. There is unlikely to be any abatement in this trend, particularly given the propensity of other professions to limit their liability and the fact that the current availability of plentiful and reasonably priced excess layer cover cannot be guaranteed in the future (as to which, see the capacity “squeeze” of 2002).

Against that backcloth, what options are available to firms?

Options

They include the following:

• where other advisers (e.g. accountants) are proposing to limit their liability, the solicitor could seek to agree a similar limitation, although it may be difficult to ascertain the existence and terms of any such limitation. Accordingly, the better (and safer) option is for the solicitor to seek to agree a proportionate liability clause with the client, whereby if the solicitor’s ability to claim contribution is prejudiced, he will not be liable for any amount that he would have been able to recover but for the limitation agreed between the client and the other adviser;
• a limitation based upon the firm’s available insurance cover.
  • In that event, the firm would probably need to accept the risk of insurer insolvency and of the policy being vitiated or any claim for indemnity being repudiated for breach of policy terms and conditions;
• a specific monetary amount or “liability cap.”
  • Note, however, the need for some objective justification for the figure chosen. In this regard, it needs to be borne in mind that, in view of the “claims made” nature of professional indemnity insurance, the level of excess layer cover currently available to the solicitor may not be available should a claim materialise some years later.

Other possibilities include (a) a straight proportionate liability clause, (b) a default limitation in the firm’s General Terms of Business or (c) an exclusion in respect of indirect and consequential losses. Depending upon the particular facts, (a) and (b) may possibly be open to attack under the Unfair Contract Terms Act 1977 (“UCTA”), or the fairness requirements of the Unfair Terms in Consumer Contract Regulations 1999 where the client is a consumer. In relation to (c), the distinction between direct losses (on the one hand) and indirect and consequential losses (on the other) may not always be an easy one to draw (or, indeed, to explain to clients).

UCTA

Any limitation of liability will need to satisfy the requirements of the “reasonableness” test of Section 11. It follows that detailed consideration needs to be given to any proposed limitation of liability, having regard to the circumstances of the particular case.

In this respect, there are a number of points to bear in mind:

• a Judge will test the clause at its weakest point. If it fails at that point, it may well fail in its entirety as the court has no power of severance;
• the test is ultimately a discretionary one which depends on all the facts and the courts have not been wholly consistent in their approach;
• a Judge will apply the contra proferentem rule and construe any ambiguity against the party seeking to limit their liability.

The burden of establishing the reasonableness of the limitation will be on the solicitor. The court will have “regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made” (see Section 11). Thus, the reasonableness of the limitation is to be judged at the time the contract was made and the circumstances of the loss which the client ultimately suffers are not directly relevant.

Section 11(4) of UCTA specifies two particular matters to which regard must be had where a person seeks, by reference to a contract term, to limit his liability (as to which, see 2 and 3 below).

Schedule 2 of UCTA also sets out five guidelines for the application of the reasonableness test. Although they are only statutorily applicable to other sections of UCTA (namely, Sections 6 and 7 relating to sale of goods, hire purchase etc), the courts nevertheless consider them. See The Flamar Pride [1991] LR 434.

In the context of a solicitor’s limitation of liability, the principal factors which a court is likely to take into account are:

1. The client’s likely level of loss

In a sense, this is the starting point in considering the reasonableness of any limitation. See the approach adopted by Dyson J in Moores v Yakeley Associates Limited, 28th October 1998. In the case of a specific monetary limit/”liability cap”, can an objective justification be offered for the figure agreed with the client?

2.The level of insurance cover available to the firm

• What is relevant, for present purposes, is the availability of insurance cover, rather than the actual insurance position. Hence, the fact that a solicitor had chosen to insure himself for substantially more than the limitation does not, in itself, establish that the limitation was unreasonable (although this may be a factor to take into consideration).
• Having regard to the “claims made” basis of cover, a firm is also entitled to take into account the fact that the current level of cover may not be available in the future, at the time when a claim might be made against it (or when a circumstance is notified to insurers). This should, where relevant, be reflected in the definition of the “available insurance” in any limitation of liability;

3. Any other resources available to the firm

• Although this is also one of the specific considerations mentioned in Section 11(4), in the context of larger limitations running into tens of millions of pounds, it is less likely to be a major factor;

4. The bargaining position of the parties

In many cases, the client will have substantial bargaining power, e.g. because of its corporate size and financial strength or its ability to instruct the firm’s competitors if it dislikes the firm’s proposed terms. There may, however, be particular circumstances where such apparent bargaining power may be diminished, e.g. where most firms with the relevant expertise and resources to undertake the work are conflicted out. Time pressures may also leave the client in a weak position, e.g. where the firm had previously acted for the client in circumstances where it would now be difficult or time consuming for the client to change solicitors in respect of a new matter. Hence, in St Albans City Council v International Computers (1995) FSR 686, Scott Baker J was prepared to take account of the suggestion that the Claimants were “over a barrel” because of the tight timescale;

5. Alternative opportunities available to the client to instruct another firm of solicitors without having to accept a similar limitation of liability clause.

• If such an opportunity was available, it will strengthen the firm’s position under this factor, but potentially weaken it in relation to the practice of the profession (see 7 below);

6. The client’s knowledge of the term

• This factor is very important and it will always assist the firm to show that the client was made fully aware of the existence, scope and terms of the limitation clause (for example, where the limitation was freely negotiated or drawn clearly to the client’s attention). The firm should also endeavour to ensure that appropriate representatives of the client were made aware of the term, i.e. directors or senior representatives, rather than subordinate employees.
• Apart from nurturing good client relations, in the event of a subsequent challenge to the reasonableness of a clause, the firm’s position will also be strengthened if it is able to demonstrate that the reason for the introduction of the limitation was explained to the client in relatively simple terms;

7. The practice of the profession

• It will assist the firm to show that other firms of solicitors incorporate similar types of limitation clauses. In practice, the more common they become, the more willing Judges are likely to be to accept that they are reasonable, particularly in the commercial context.

A further consideration is the fee charged for the assignment. Although this is not a designated factor under UCTA, it is relevant to the broader commercial context and was referred to in this respect by the Court in Moores v Yakeley Associates Limited.

The important point, for practical purposes, is that if the reasonableness of any limitation of liability is challenged, the firm’s actual level of insurance cover will be before the court and a partner from the firm will have to get into the witness box in order to try and justify the reasonableness of the limitation. Whilst it must, therefore, be a matter for each firm to consider and formulate its own policy on these issues, it is suggested these matters militate in favour of not taking too restrictive a view.

Where a limitation of liability is being sought, the factors set out should be considered, internal advice can be obtained and a short note can be placed on the file in order to record the thinking behind the relevant limitation (recognising that the exercise is, to an extent, necessarily “broadbrush”). If this approach is adopted and the position is explained to the client in an open and transparent way, there should be reasonably good prospects of withstanding any challenge under UCTA.

Limiting liability to third parties

If advice may be passed to third parties, it is important to clarify the existence and scope of any duty which may arise. Whilst the policy of most firms is to try and limit the persons to whom they owe a duty of care, there are occasions where a third party’s reliance upon the solicitor’s advice is reasonable and is in accordance with accepted commercial practice. Where a decision is made that a third party ought reasonably to be entitled to rely upon such advice, consideration can be given to agreeing an appropriate limitation of liability.

There are a number of ways in which this can be achieved, including the following:

• The solicitor can seek to utilise the provisions of the Contracts (Rights of Third Parties) Act 1999 and include a term in his retainer letter which gives the third party a benefit, subject to a limitation of liability (i.e. the right to rely upon the firm’s advice, with the remedy of a claim for damages, but subject to a limitation clause).
  • Although such a contractual limitation clause is not subject to UCTA (the relevant provisions of the Act having been disapplied by Section 7(2) of the 1999 Act), this would not preclude a claim by the third party against the firm in tort. Accordingly, any limitation will be subject to the reasonableness test.
  • The retainer letter can be drafted in such a way as to make it clear that nothing therein will create a solicitor-client relationship between the firm and the third party.
• An alternative approach would be for the client to enter into a simple contract with the third party (e.g. its bankers), which includes a term limiting the liability of the solicitor in respect of any advice provided to the third party (with the firm utilising the provisions of the 1999 Act).
• The firm could expressly acknowledge the existence of a duty of care in correspondence with the third party, subject to a limitation of liability. Hence, the firm consents to reliance being placed upon its advice, acknowledges that it owes a duty of care to the third party and limits its liability to that third party.
  • Where appropriate, use can also be made of signed acknowledgment letters, under which the third party acknowledges the basis upon which a duty of care is accepted by the solicitor. Where a third party can be persuaded to sign such a letter, this has the considerable advantage that it cannot then credibly deny having full knowledge of the matters set out therein, including the limitation of liability. In appropriate cases, such letters might also operate as an evidential estoppel.
• In some limited circumstances, it may be possible to contend that the client was acting as an agent for the third party when agreeing to a limitation. Killick and Anor v PricewaterhouseCoopers [2001] PNLR 17 concerned a claim by the estate of the late Matthew Harding against PwC in connection with PwC’s valuation of his shares in Benfield. Pursuant to the company’s articles of association, the shares were to be offered to various classes of person at a valuation to be determined by the company’s auditors.
  • PwC valued the shares at £2.10 per share, whilst the estate contended for a valuation of £4 per share (giving rise to a claim of around £30 million). PwC had, as a term of their engagement, agreed a limitation of liability of £10 million with the company. The estate denied that they were bound by this limitation and also contested its reasonableness. Both issues came before the court on the claimants’ application for summary judgment.
  • Neuberger J (as he then was) held that, although the claimants were not a party to PwC’s retainer, it was arguable that PwC could rely upon the £10 million cap on the grounds, inter alia, that in negotiating it, the directors of the company had acted as the shareholders’ agents. Accordingly, he ordered that this issue should proceed to a trial.
  • The Judge declined to deal with the reasonableness of the £10 million cap on the grounds that this was a question of fact which should not be dealt with on an interlocutory basis, save in a clear case. He therefore ordered that the action should proceed to trial on that issue also.

Drafting issues

The drafting of limitation clauses requires considerable care, particularly given the application of the contra proferentem rule and UCTA.

A number of relevant considerations are summarised below:

• consideration can be given to an aggregate limitation of liability to:
  • all persons collectively who are the firm’s clients in relation to the retainer; and
  • (where applicable) to any person who is not a client in relation to the matter (i.e. a third party) but who the firm agrees should be entitled to rely upon its services or advice in relation to the matter (e.g. the client’s financiers).

Note also that the aggregation provisions introduced into the Law Society’s 2005 Minimum Terms and Conditions. Clause 2.5(b) provides that “…when considering what may be regarded as one claim for the purposes of the limit … (b) all claims against one or more Insured arising from one matter or transaction would be regarded as one claim.” Thus, for example, if problems arose on a substantial M&A transaction, claims against a law firm by its client and the relevant financiers would fall to be aggregated and could potentially take the aggregate sum in issue beyond the limit of the firm’s available insurance resources;

• it is prudent for the scope of the operative clause to be broadly drafted so as to encompass all claims arising out of, or in connection with, the retainer, whether arising as a result of negligence or otherwise;
• consideration can be given to agreeing costs-inclusive limitations of liability, although if a liability cap is for a relatively modest sum, it may be prudent to include a “carve out” in respect of legal costs in order to strengthen the firm’s position should the reasonableness of the limitation be subsequently challenged under UCTA. The rationale of this approach is that any clause which would reduce the effective compensation below the designated figure by reference to the claimant’s costs is more likely to be perceived as unreasonable under UCTA because of the opportunity which it would afford the solicitor to reduce the claimant’s compensation by insisting upon contesting liability;
• any clause should expressly state that there will be no limitation in respect of any liability for fraud, dishonesty, reckless disregard of professional obligations or any liability which cannot be lawfully limited;
• where there is a possibility of claims being pursued in other jurisdictions, consideration must be given as to what impact the local law will have on any limitation of liability and how the courts of that jurisdiction will interpret it;
• following the Court of Appeal decision in Merrett v Babb [2001], it is now relatively common for firms to disclaim and/or exclude personal liability for individual lawyers (save for partners in non-LLPs), given the exposure which solicitors face as a result of their personal dealings with clients. Consideration can also be given to encompassing LLP members, employees, consultants and any service company within the limitation of liability on a “belt and braces” basis. The inclusion of such personnel will provide a further line of defence should any disclaimer and exclusion not prove effective in law and language can be used which does not cast real doubt upon their effectiveness.

Practical steps

• consider the use of General Terms and Conditions of Business in order to:
  • incorporate a proportionate liability clause where other advisers limit their liability
  • lay the ground for the negotiation of specific limitations (e.g. liability caps), where appropriate
  • disclaim and exclude any personal liability on the part of employees, consultants, any service company and, in the case of LLPs, members
• explain any limitation to the client in simple terms
• be prepared to offer an objective justification for any limitation proposed to, or agreed with, the client
• ensure that draft specimen limitation of liability wordings (together with explanatory notes) are available to partners and fee earners
• ensure that internal advice is available
• keep it simple
• consider adopting an incremental approach, both internally and in dealings with clients

Future developments

Although LLPs are increasingly common, they are not a panacea for the liability risks facing lawyers in an increasingly demanding environment. The size of deals continues to increase, few (if any) relationships are sacrosanct and, as illustrated in recent years in the US, the fall out from corporate collapses can have serious implications for professional firms.

The extent to which contractual limitations of liability become commonplace in large corporate and commercial work will, however, depend upon a number of cultural issues and, in particular, the developing attitudes of:

• Partners – partner resistance is still probably a significant barrier to the introduction of limitations owing to concerns about potential loss of business;
• Clients – whilst the available evidence presents a mixed picture, there is still undoubtedly client resistance in certain sectors, such as finance;
• Professional indemnity insurers – although insurers encourage the use of limitations, they will generally not reduce their premiums just because the firm has a policy of limiting its liability. This is unsurprising in circumstances where there may be uncertainty as to how comprehensively any policy is operated in practice and also whether any such limitations will prove effective in law. Moreover, a large proportion of premia is attributable to the primary and lower excess layers of any law firm’s professional indemnity cover, covering exposures where limitations of liability are likely to be less common.

In conclusion, whilst there is still perceived to be some cultural resistance to seeking limitations of liability amongst lawyers, together with a degree of complacency, the issue is now regularly debated in the legal and professional press and there appears to be a greater willingness to raise it with clients. The likelihood is that such provisions will become more common during the next three or four years, although the extent to which they do so will probably be determined by the continued availability of reasonably priced excess layer cover and, in particular, whether the profession continues to avoid catastrophic losses.

A version of this article appeared in “Legal Week” on 3 August 2006.

This article also appeared in the Solicitors' risk awareness bulletin in November 2006. To view the full bulletin please click here.