Limiting liability for solicitors – part two

The first part of this article considered the basic structure of limiting liability. As limitation is now commonplace, it should not be difficult to persuade a judge that limiting liability is fair and reasonable. The language of the clause is more likely to be a risky area. Try to resist being a lawyer and drafting against every conceivable eventuality and remember that a simple clause is likely to be more effective¹.

A more sophisticated approach is not to limit liability to a specific figure, but rather to vary the limit according to the nature of the risk. To make the use of the limitation practical, some degree of standardisation is necessary. One method is to use a traffic light system: green for standard matters, amber for higher value matters and red for the highest value. Using such a system will enhance the reasonableness of the approach – avoiding the ‘one size fits all’.

Contentious business agreements

With one exception, there is no distinction on limiting liability according to the nature of the work undertaken. Section 60(5) Solicitors Act 1974 (the Act) contains a specific provision relating to the exclusion of liability in contentious business agreements (CBA): “A provision in a contentious business agreement that the solicitor shall not be liable for negligence, or that he shall be relieved from any responsibility to which he would otherwise be subject as a solicitor, shall be void.” The section only relates to a retainer under a contentious business agreement (as defined by s59) not to all contentious work.

The section relates solely to contentious matters as defined in the Act being work undertaken in relation to actual proceedings before a court or arbitrator and solely to work undertaken under a CBA. Not all retainers relating to contentious matters are CBAs for they “must be sufficiently specific – so as to tell the client what he is letting himself in for by way of costs …. this is not [a CBA] as to remuneration at all. It is simply an indication of the rate of charging on which the solicitors propose to make up their bill².” A CBA prevents a solicitor suing a client on a bill, rather they must apply to the court to enforce the agreement under s61. It follows that most retainers for contentious work are not CBAs and the restrictions in s60(5) will rarely be relevant.

In the unlikely event that the retainer is a CBA, the first limb of the sub-section prohibits complete exclusion of liability for negligence rather than a limitation of liability.

The second limb is more perplexing. Logically, the draftsman must have intended a responsibility other than not to be negligent, and there are many such duties in the Act. It is those responsibilities, it is submitted, that the section is directed at.

Furthermore, it is vital to appreciate that the contractual limit will often be set having regard to insurance arrangements current at the time of the retainer. Insurance is invariably on a claims-made basis and if the level of cover reduces (perhaps due to the firm reducing in size) the cover at the date of the claim might be quite different to that at the time of the retainer. Still further there may be an aggregation provision within the policy and the limit of indemnity may not be available on an each and every claim basis.

Mission creep

One of the main planks for a comprehensive risk-management strategy is to try and ensure all work is covered by the retainer. You should make as clear as possible what you are doing for the fee. Equally, or indeed more, important is to spell out what you are not going to do.

One of the biggest dangers is going outside the scope of the retainer. You might, for example, put considerable care into defining the scope of your instruction and all goes well with the client. One year later, the client asks for some unconnected advice informally during one of your many telephone conversations and advice is given. The original retainer excluded everything outside of the strict limits of the original retainer. Although a duty of care will inevitably exist, and even a retainer, it may not be governed by the limitation of liability in another (the original) retainer.

Still more concerning is acting for a company and being asked to provide (and providing) some advice to the director on a personal matter. Doing so is entirely understandable, but with a different client again the retainer may be ineffective.

Liability to non-clients

Claims do not have to come merely from clients. The claim from a non-client is a particular concern especially as the potential to limit liability is arguably removed due to the absence of a contract within which to limit liability. It is not unusual for a retainer to benefit the non-client and, if so, the non-client may have rights under the Contracts (Rights of Third Parties) Act 1999 (1999 Act). For this reason, the 1999 Act is often excluded from the retainer and a disclaimer of any responsibility to third parties included. Accountants have been particularly alert to the potential for claims from non-clients arising from audit reports in accounts. A Scottish decision³ caused considerable concern to the profession and resulted in audit reports being amended to expressly exclude any liability to anyone other than the company and its members. The suggested text for auditors in the ICAEW publication Audit 1/03 is: “This report is made solely to the company’s members, as a body, in accordance with section 235 Companies Act 1985. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report or for the opinions we have formed.” No doubt, with suitable amendments, the use of this sort of clause will become more prevalent with solicitors. The auditor, however, has the unique advantage that the product of the audit are the signed accounts and the audit report is an integral part of the accounts, so the notice is given to the reader of the accounts. Solicitors do not usually have the luxury of a single document being the work product.

A disclaimer of liability is not construed in the same way as an exclusion clause. The existence of a disclaimer may be sufficient to negate a finding of assumption of responsibility and reasonable reliance. In McCullagh v Lane Fox [1996] PNLR 205, Hobhouse LJ explained that the court should “treat the existence of a disclaimer as one of the facts relevant to answering the question whether there has been an assumption of responsibility by the defendants for the relevant statement. The question must be answered objectively by reference to what the reasonable person in the position [of the plaintiff] would have understood at the time he finally relied upon the representation”.

A disclaimer of responsibility is preferable to a limitation of liability as the contractual limit of liability may not bind a non-party to the contract⁴. Although a contractual provision limiting liability may seem unlikely to apply to a non-party, there are respectable grounds to argue that the contractual provisions for limitation should apply. First, if the non-party sued under the 1999 Act, the solicitor would have all the defences that he would have had to a claim by the client available to him – section 3. Secondly, the scope of the duty the court may recognise could be crafted so as to be consistent with the contractual duty to the client⁵.

There are legitimate arguments against this, however it is suggested that this is, indeed, the correct analysis. Support can be derived from South Australia Asset Management Corporation v York Montague Ltd [1997] 1 AC 191. The scope of a duty is “that which the law regards as best giving effect to the express obligations assumed.”

Problems with LLP structure and personal liability for members

One of the most obvious ways to manage the risk of a catastrophic client claim is to incorporate as an LLP. The perceived holy grail of incorporation as an LLP is to remove personal liability. The theory goes that the liabilities all rest with the LLP and if the claim exceeds the limit of indemnity, the LLP can be sacrificed leaving the personal wealth of the members untouched.

In many instances, the liability will indeed rest with the LLP and the member will remain inviolate (subject only to losing his wealth in the LLP, his livelihood and the possibility of clawback). Nevertheless, cases such as Williams v Natural Life Health Foods [1998] 1 WLR 830 and Merrett v Babb [2001] EWCA Civ 214 have left serious doubts as to whether the desired protection will be effective and, if so, under what circumstances.

There has been some discussion as to whether, in order to address the ‘ethos’ argument, members’ agreements should replicate much of what was in the previous partnership agreement, including such things as good faith between members. Any step in this direction runs the risk of fundamentally undermining the concept of limitation of liability. A member sued under the Williams and Merrett principles may seek a contribution from his fellow members if there is an express duty of good faith, the breach of which has exposed him to the claim.

Still less desirable is the concept of an indemnity between members, as this may cause more than the wrongdoing member to become insolvent.

Similarly, discussions prior to conversion to the effect of ‘we’ll each make sure the other keeps a roof over their heads’ notwithstanding the conversion to LLP, may give rise to misrepresentation or collateral contract claims. In the nightmare scenario, the wrongdoing member may become bankrupt and his trustee in bankruptcy may be pursuing the claims rather than the member himself.

Express agreement that the client holds the LLP liable, and not the member or member of staff, are commonplace, however, the member or member of staff is not a party to that agreement and cannot rely upon its terms. It is common for the 1999 Act to have limited application so as to enable a member to rely upon that provision. Similarly, entire agreement clauses and clauses determining how, and in what manner, variations to a member’s agreement can be made, are likely to be vital in such circumstances⁶.

The starting point for any personal responsibility, in contrast to LLP liability, is that the client contracts with the LLP and it is the LLP against whom they have a claim. It is only if the unusual circumstances of an ‘assumption of personal responsibility’ arise that the member will have a joint liability with the LLP.

That assumption of personal responsibility must, it appears, derive from “exchanges between the [parties]. The enquiry must be whether the [member] conveyed directly or indirectly to the [client] that the [member] assumed personal responsibility towards the [client]”. If such assumption were established, the client must prove reliance, but “the test is not simply reliance in fact. The test is whether the [client] could reasonably rely on an assumption of personal responsibility” – Lord Steyn in Williams.

The assumption of personal responsibility has to have in mind rule 2.02 of the Code of Conduct: “You must, both at the outset and, as necessary, during the course of the matter: … (d) ensure that the client is given, in writing, the name and status of the person dealing with the matter and the name of the person responsible for its overall supervision …”

The argument seems fairly clear that there are persons ‘responsible’ that have to be identified – whether that amounts to an assumption of personal responsibility is a nice argument.

It is clear that a serious personal risk remains for the solicitor, even within an LLP, whose relationship with a client is very personal, who stresses his personal involvement and who personally gives reassurance that the work of junior members of staff is correct. It is for these reasons that the little old lady who entrusted her affairs to her trusted adviser, who stressed that he would personally oversee matters, may be a more formidable foe than the large corporation. How the law will develop in this area will no doubt be keenly awaited.

Finally, there are a group of miscellaneous liabilities that either cannot be moved to the LLP or are not known about. These may include retired partner annuities, historic lease liabilities and claims for work undertaken for which releases cannot be sought or obtained. Firms with strong balance sheets have been able to get releases from banks and landlords in return for new covenants from the LLP.

Insurance and members’ agreements – managing the risk

If a member is the subject of a catastrophic claim and is personally insolvent, it has already been seen that an indemnity between members is undesirable. There may be no alternative other than to allow that member to become bankrupt.

There are two main ways to mitigate the effects of bankruptcy beyond normal commercial negotiation. First, there is the trust approach. A trust is established and set aside for the dependants of an insolvent member: the workings of the trust are a matter for the individual LLP. The dependants of members of the LLP could be members of the class of beneficiaries. Again, it will be a matter for each LLP to determine the extent to which the trust needs to be fully-funded or whether the members are happy with a promise of future income payments from the other members.

Second, there is the possibility of insurance. Insurance, designed to pay out to protect the family assets, is available. Insurance has the advantage that a cash reserve does not need to be built up to establish the trust fund. It is understood that the policy can have a limit of up to £10m and is available to all UK based LLPs subject to normal underwriting considerations. Legal Risk’s Top 100 Professional Indemnity and Risk Management Survey 2008 showed that 16 per cent of the top 100 firms have taken out such cover.

1. The ‘less is more’ concept is exemplified by the most popular (and many would say effective) retention of title clause – “Property of Unigate Dairies Limited” on a milk bottle.

2. Lord Denning in Chamberlain v Boodle & King [1982] 1 WLR 1443.

3. The Royal Bank of Scotland v Bannerman Johnstone Maclay [2005] 1 S.C. 437.

4. Killick v PricewaterhouseCoopers [2001] 1 B.C.L.C. 65.

5. Killick, op cit and Gorham v British Telecommunications plc [2000] Lloyd’s Rep PN 897, where it was suggested that the contributory negligence of the client might limit the claim of his dependants.

6. Although see Lowe v Lombank [1960] 1WLR 196.

Peter Ashford is head of the commercial disputes team at Cripps Harries Hall LLP. He can be contacted at peter.ashford@crippslaw.com