Legal regulation raises the risk stakes

t’s that time again. The solicitors renewal season is upon us, with nearly 9,000 law firms in England and Wales renewing their primary cover from 1 October, and in many cases top up as well. The Law Society’s Minimum Terms and Conditions for 2007 will contain no major changes in compulsory cover.

As yet another year of low premiums seems to be on the cards, causing further disappointment for brokers on commission-based volume business, to say nothing of underwriters, can there be anything left to say? In the writer’s view, the answer is a resounding ‘yes’.

New laws, new rules and new regulators: the solicitors’ profession is entering a new era of regulation which carries many opportunities for change. Change means risk. The Legal Services Bill promises wholesale reform of the profession, and a new code of conduct comes into force on 1 July.

The Solicitors Regulation Authority (SRA), established by the Law Society as a semi-independent regulator, heralds a new approach to enforcement. Current intentions are said to involve a proportionate, risk-based approach with ‘light touch’ regulation. But that does not preclude tough action where deemed appropriate, and the issue of referral fees is high on the agenda, with a regulatory review of a number of firms under way.

Automatic run-off cover

Disciplinary action will be of interest to underwriters, not only because it may indicate an attitude to risk, but also because it may be life-threatening to the continuation of a practice and may invoke automatic run-off cover.

Clause 159 of the Legal Services Bill will enable the SRA to require solicitors to review files and to contact former clients notifying them of their right to make claims. This is in part a response to concerns over the miners’ compensation claims, but could result in reviews similar to the pensions review in the financial services sector.

Against the background of solicitors enjoying the widest compulsory cover of any profession in the world, adverse experience from these provisions and hardening market conditions in the future could impact on the availability of insurance for some firms or sectors of the profession.

The SRA’s new code of conduct is a complete rewrite of the solicitors’ rulebook. While a cover-to-cover read may leave one with a slight feeling of being surrounded by compliance wallpaper, the efforts to consolidate the various rules, guidance and codes into one rulebook written in reasonably plain English is to be commended.

Breaches of the code may be relied upon in professional liability claims (and this may be particularly relevant to the rules on conflicts and confidentiality), though it is questionable whether the rules generally are intended to give rise to a separate cause of action.

In many ways, apart from some key points mentioned below, little of substance has changed. Where change can be expected is in the area of enforcement and, despite the SRA’s light touch, intentions outlined above, under pressure to demonstrate that it can deliver as a fully-fledged regulator, it can surely be expected to strive hard to deliver.

Complaints are dealt with by the Legal Complaints Service. Expect a greater risk of firms having to pay awards for inadequate professional services, which are generally covered under the policy. The current maximum award is £15,000. Clause 138 of the Legal Services Bill increases this to £20,000 with power for it to be increased, and talk of £100,000 in the near future may not be far-fetched.

Of concern, the provisions may result in the loss of technical defences, by analogy with the financial services ombudsman regime. An example of this was the case of IFG Financial Services Ltd v Financial Ombudsman Services (2005). Here it was held that the ombudsman could require an investment adviser to pay compensation which a court of law would have held was not ‘fair and reasonable’.

The focus of the new code of conduct has been on a change to principles-based regulation.

The code contains six core regulatory principles enforceable in their own right and applicable in all circumstances (subject to some minor exceptions for overseas practice), even where more detailed rules exist elsewhere in the code.

Wide ranging

Those who are averse to rulebooks should derive little comfort from the fact there are only six core principles, compared with 11 for the financial services sector, as the six are wide ranging. They cover: justice and the rule of law; integrity; independence; best interests of clients; standard of service; and public confidence in the profession.

By comparison, nearly half the respondents to a recent KPMG survey of the financial services sector thought the move to principles-based regulation would lead to a greater risk of FSA enforcement action, so solicitors should beware.

The need for an audit trail in decision making processes, for example when considering conflicts issues, has never been greater.

The new provisions causing the most interest among the writer’s client firms are contained in rule 5. These require practices to implement business risk management and business continuity planning. This can only be for the good so far as insurers are concerned, though doubtless there will be wide variation in how firms implement procedures to deal with these issues.

Perhaps surprisingly, the greatest concerns have been expressed by the larger firms which one might expect would feel they were already more or less compliant. Many firms are implementing reviews of their risk management, either internally or with external help.

They are also training their staff in the code. Even though the fundamental changes affecting staff may be few, it is another way they can demonstrate to regulators that they have a positive attitude to compliance in the event that something goes wrong.

The much-vaunted ‘Tesco-law’ changes in the Legal Services Bill, effectively opening up the high street to the provision of legal services by major corporations, must involve the demise of many a high street firm.

A few partners may still be deluding themselves that they may sell out for vast sums of money, like the estate agents in the 1980s, but the majority are more sanguine and realise this is not going to happen.

The cessation of a number of practices will increase the number taking out run-off cover, which from an insurers’ perspective is one of the less attractive aspects of writing solicitors’ PI policies as it has to be provided under the Law Society’s minimum terms and conditions of insurance. So, a firm’s attitude to business risk and future planning is of more than passing relevance to insurers.

Closure of practices and mergers will also increase the number of firms exposed to successor practice liability. This is a problem which is not going away. Some firms are considering the issue proactively and managing it along with a variety of other merger-related insurance issues.

It continues to surprise the writer that even some of the largest firms finalise their merger deals and then tell their brokers and insurers about them a day or two before completion. One transatlantic merger, in which the writer advised one of the parties involved, a potential liability for a £500,000 additional insurance premium which had not been spotted but was wholly avoidable.

A review of the solicitors PI market would not be complete without a mention of The Accident Group (TAG) litigation. The action is at a point where detailed comment might be inappropriate. Suffice to say, that if there were to be a conclusion which involved firms being liable to pay multiple excesses, which they may not all be able to afford, or which they may contend are not properly due for one legitimate reason or another, the insurance market will have to consider its approach to them.

Firms with unpaid excesses have in the past understandably been declined cover by some underwriters. With TAG issues, the number of firms in this position may increase.

Activity in the US should not be ignored. More US firms are expected to open in London over the coming year. This may have implications for those involved in the solicitors PI market if they employ or merge with solicitors qualified in England and Wales: care is needed to avoid the type of problem outlined above.

In addition, exposure to US litigation is an increased risk even for firms with domestic practices. Domestic European firms have already found that they can be unwittingly caught up in class actions in the US. Furthermore, a shareholder action in Stoneridge v Atlanta Communications heading to the Supreme Court may result in new areas of accessory liability in securities litigation.

In conclusion, despite a rather benign market, there is plenty of change to justify keeping an eye on the radar over the coming year.

Frank Maher is a partner in Legal Risk Solicitor