Limiting liability for solicitors

Of the many types of risk that a law firm faces, the client claim is the most likely to be the catastrophic single event that can put the very existence of the firm at risk. Should a negligence claim be successful, and the damages awarded exceed the firm’s indemnity cover, the partners will have to meet the excess – which may well signal the end of the firm.

Contractual limitation of liability

It is against this background that many firms seek to limit their potential liability to their clients by contract. Until recently, the limiting of liability was considered a theoretical rather than a realistic possibility reflected in the language of various reports.1 However, limiting liability is now commonplace. In 1999, a survey for the City of London Law Society found just 20 per cent of firms limited their liability to the client. By 2008, however, Legal Risk LLP’s Top 100 Professional Indemnity and Risk Management Survey revealed that all respondents to the survey were limiting liability either as a matter of routine or occasionally.

Against the combined effects of the increase in the minimum level of cover from £1m to £2m (or £3m for LLPs), the revised terms on aggregation (outside the scope of this article) and the hardening of the insurance market, this issue takes on still greater topicality.

Although it is clear that complete exclusion is not only unlawful and unprofessional (see rule 2.07 of the Solicitors’ Code of Conduct (the Code)), void for a contentious business agreement and likely to be unreasonable under the Unfair Contract Terms Act 1977 (UCTA), it is quite permissible to limit liability to a specific figure (provided it is at least the minimum level of cover) and to exclude certain types of loss.

Clearly, the place to limit liability by contract is within the documentation that forms the contract – for a solicitor this will typically be the retainer letter. It is certainly better to have it there than in the firm’s general terms of business.

A typical simple limitation of liability clause will limit liability to a specific sum usually linked to a level, not necessarily the highest, of indemnity cover. It may also be sensible to consider seeking to exclude indirect or consequential losses – again subject to not producing a figure below the minimum level of cover. It is important, however, to note the distinction between direct and indirect losses – Hotel Services Limited v. Hilton Hotels International (UK) Limited [2001] 1 All ER (Comm) 750. It is important to distinguish between a ‘limitation’ of liability and an ‘exclusion’ of liability. The distinction may appear obvious, but it is not always so.2

In drafting any limitation clause, regard must be had to rule 2.07 of the Code (and paragraphs 64-72 of the Guidance to rule 2). Two key points emerge from the Code and the Guidance: first, there is no reason why you cannot agree with the client that liability rests with the LLP rather than with individuals – indeed this is expressly recognised in paragraph 70 of the Guidance; and second, liability can be excluded to non-clients – again this is recognised in paragraph 72 of the Guidance.

Additionally, regard must be had to the requirements of UCTA. The Unfair Contract Terms in Consumer Contracts Regulations 1999 are outside the scope of this article although they are broadly to the same effect.

The Guidance explains that provisions limiting liability must be reasonable. Any limitation must be brought to the attention of the client and the acceptance of such a provision should be evidenced or confirmed in writing. The Guidance also makes clear that liability for fraud cannot be excluded.3

UCTA regulates the extent to which liability for things done in the course of business can be excluded or limited. Section 2(2) provides that clauses that restrict liability for negligence are ineffective except insofar as they satisfy the requirement of reasonableness. Indirect ways of limiting liability are all caught by UCTA , for example, making liability or its enforcement subject to onerous conditions, excluding or restricting remedies, subjecting a person to prejudice in consequence of pursuing a remedy and excluding or restricting the rules of evidence or procedure.

Reasonableness

The reasonableness test is set out in section 11 of UCTA, with guidelines in schedule 2 for the sale or supply of goods – there is no guidance for the supply of services. As these guidelines are no more than the court would consider in any event,4 they are a sound starting point for the consideration of reasonableness for the supply of services.

The schedule 2 guidelines cover the parties’ bargaining positions, any inducement to agree to the term, knowledge of the term, whether any condition to the limitation could be expected to be complied with and whether the goods were specifically for the customer.

Section 11(4) of UCTA provides that reasonableness is assessed with regard to the resources available to meet the liability should it arise and the extent to which insurance was available.

The existence and amount of insurance is inevitably going to be key in assessing reasonableness, but so equally will the minimum levels of cover – the regulatory authorities are satisfied that the public is protected by a given level of cover. That is not to say that limiting liability to the minimum will be the right thing for every practice. It might well be for a small high street practice with the minimum insurance cover, but would not be for a magic circle firm undertaking high value work with substantial cover and substantial resources of its own.

The application of the reasonableness test

In Moores v Yakeley [1998] EWHC TCC 288, the defendant architect successfully limited his liability. The limit was not an arbitrary figure; it was based on his estimate of the likely cost of the work, and was a rational attempt to limit the defendant’s liability to the costs of construction. The client himself had said in evidence that it would be “fair enough”. The fees which the architect would reasonably have expected to earn were less than one-tenth of the limitation. A consideration of the bargaining position of the parties resulted in the client, who was a man of considerable means, being held to have been in a stronger position than the architect because of the severe recession in the construction industry at the time.

Finally, the client had had the advice of his solicitor before agreeing to the terms of this contract, and both he and his solicitor were happy with the terms. He considered the extent of the defendant’s insurance cover, which was twice the limit, and weighing all the factors concluded that the limit was a reasonable figure at which to limit his liability.

A fairly standard limitation clause was considered recently in Marplace v Chaffe Street [2006] EWHC 1919. The clause in the retainer letter limited liability to £20m. The reasonableness, or otherwise, fell to be assessed by the client’s main arguments that:

The firm had a higher level of insurance cover than £20m;
The solicitor advised that the potential loss was within £20m; and,
In light of the fiduciary relationship the solicitor could not rely on the clause without full advice on the potential claims and their magnitude or unless the client had had independent advice.

The solicitors argued that the clause was reasonable having regard to:

The fact that their turnover was £4m;
The limit was not a standard term; and,
Interest and costs would potentially be added to the £20m so there was “head-room” between the limit and the cover.

Mr Justice Lawrence Collins had little hesitation in finding the clause reasonable. In particular, he held that: (i) the client, sophisticated and familiar with such clauses, was aware of this one and discussed it, and it was not presented as non-negotiable; and, (ii) the limit was struck on “reasonable commercial principles” taking into account the cover, its expense and the circumstances of the transaction.

Reflecting this trend towards accepting reasonableness, at least in a commercial context, the Court of Appeal (the Court) upheld a limitation of liability provision in an agreement for serviced offices in Regus (UK) Limited v Epcot Solutions Limited [2008] EWCA 361. Perhaps the most notable feature of the case, once it reached the Court, was its effect of reducing Epcot’s counterclaim from £626m to £50k, acknowledging the effectiveness of the limitation provision.

Regus excluded liability for mechanical breakdown and for matters they had not had a reasonable opportunity to put right. It also limited liability to direct loss up to 125 per cent of the fees paid or £50,000 (whichever was the higher). The main argument concerned whether the clause was unreasonable as the clause operated “in any circumstances” and thus operated even if Regus was in deliberate breach. The Court rejected a hypothetical analysis rather it should be construed, as with all contracts, against the facts known at the time. The parties contracted with the “expectation of honest dealing” and in that context “in any circumstances” did not exclude, for example, fraud. On the facts, the Court found the clause reasonable, relying on:

Epcot’s awareness of the clause and having contracted on that basis before;
Epcot using a similar clause in its own dealings with customers;
That other aspects of the contract were energetically negotiated;
That there was no inequality of bargaining power as Epcot could have and did use a local competitor; and,
That Regus advised Epcot to insure and Epcot was in a better position to assess and quantify its insurance requirements.

Common law/contract

At common law, there are further hurdles to overcome. Firstly, the party intending to rely on a limitation of liability will have to prove that the clause was incorporated. In this respect, paragraph 65 of the Guidance is of key importance. The clause must be sufficiently drawn to the attention of the other party and a signature should, in practical terms, be seen as evidencing that the clause has been properly drawn to the attention of the client. As the signature will evidence what has happened, the process of drawing attention to the clause has to be gone through on each occasion.

Lord Denning’s ‘red hand’ rule provides that “some clauses… would need to be printed in red ink on the face of the document with a red hand pointing to it before notice could be held to be sufficient”– J Spurling v Bradshaw [1956] 1 WLR 461. When applying the rule, the courts consider the nature of the transaction, the character of the parties to it and whether in all the circumstances it is fair to hold the clause effective – Interfoto Picture Library v Stiletto Visual Programmes [1987] 1 QB 433.

Some firms try to rely upon a clause along the lines of ‘your continued instructions will be treated as acceptance of these terms’ and others insist on a signed copy of the retainer. A combined approach is probably the most practical. A signed retainer is more essential for matters where the realistic potential exposure is higher than the limit.

Furthermore, the clause must cover the liability in question. Many of the issues that would have otherwise arisen as matters of construction are now, out of judicial preference, taken as matters of reasonableness under UCTA – George Mitchell v Finney Lock Seeds [1983] 2 AC 803. Clear words are required to exclude liability for negligence as the courts regard it as “inherently improbable that one party to a contract should intend to absolve the other party from the consequences of his own negligence” – Gillespie Bros Ltd v Roy Bowles Transport [1973] QB 400. Notwithstanding this move away from issues of construction, the contra proferentum rule remains alive and well.5 The rule is flexible in nature and results, for example, in exclusion clauses being construed more strictly than limitation clauses.

Sophisticated clauses

The basic clause is one that limits liability to a specified figure: ‘Our maximum liability for any loss or damage is limited to £[X]million.’

Sophisticated limitation clauses might also have a provision stipulating that claims must be made within a particular period. Such clauses may require notification of claims within a first period and the commencement of claims within a further period. Such clauses are generally enforceable if reasonable, although have not been tested in a professional rather than a commercial context.6

Another variant is to exclude a particular type of loss. This would typically be indirect or consequential loss: ‘Our liability is only for loss directly caused by us – we have no liability for any indirect or consequential loss.’ Such a clause must not have the effect of reducing liability below the minimum terms – additional words would need to be added to provide for this.

A still more sophisticated approach (found in particular in the context of the professional team in building projects) is to include a ‘net-contribution clause’. The effect of such a clause is to short-circuit the effects of potential contribution claims and leave the professional with only that liability that it is fair for him to have, bearing in mind the blame attached to any other professional. A typical clause might provide:

‘Where any person is also liable to the client for, or has otherwise caused or contributed to, all or part of the same loss or damage as the solicitor (a responsible person), and/or where the client itself has contributed to such loss or damage, the solicitor’s liability shall be limited to such amount as is just and equitable having regard to the extent to which each of the solicitor, any such responsible person and the client is liable for, or has otherwise caused or contributed to, such loss and damage. Any limitation exclusion or restriction (however arising) on the liability of any responsible person and any other matter (whenever arising) including inability to pay or insolvency, affecting the possibility of recovering compensation from any responsible person shall be ignored in determining: (1) whether and to what extent that responsible person is liable to the company for, or has caused or contributed to, such loss and damage; and (2) the amount to which the solicitor’s liability should be limited.’ (This wording is based on the Financial Reporting Council’s Guidance on Auditor Liability Limitation Agreements.)

As the test under UCTA is ‘fair and reasonable’, it seems highly likely that such a clause, providing as it does for a just and equitable proportion assessed by the court, would be successful in its intended purpose. This is the more so as auditors are now allowed to limit liability (under sections 532-538 of the Companies Act 2006) provided the limitation is ‘fair and reasonable’. The Institutional Shareholders’ Committee and the National Association of Pension Funds have indicated that they consider the proportionate liability to be appropriate and have indicated that they are likely to resist other attempts at limitation.

The practical application of limiting liability

In all but boutique firms opening relatively few files or matters, the prospect of negotiating each limitation of liability clause is plainly impractical. For the vast majority of firms, some form of standard clause (or clauses) is inevitable.

The retainer or contract is often an amalgam of a letter and some standard terms and conditions. Due to the complexity (as well as the desire not to feature clauses concerning loss through negligence prominently) the limitation of liability is often in the terms and conditions rather than in the letter. The letter will refer to the terms and should have (ideally in bold) a clear reference to the key features of the clause and a direction to consider the full terms of the clause. This accords with paragraph 65 of the Guidance.

As has been pointed out above, the more commercial the client the better the prospects of a clause being held to be reasonable. Central and local government and similar bodies are probably best seen as somewhere between a commercial client and a consumer.7

Remember that claims may have very little connection with the fee or the size of the transaction and the potential loss needs to be considered with care. In considering the figure for the limit of liability, you should consider at least the following:

Whether interest is included (generally it should be);
Whether the claimant’s costs are included (generally not – including costs may mean that the client is eroding the potential pot for recovery by pursuing the claim, creating an incentive to settle);
The impact of aggregation under the indemnity policy (mirror what your policy provides for – at least for the same matter/client although the overall limit may perform the same function equally well);
That claims may be made many years after the event and as policies are written on a ‘claims made’ rather than a ‘negligent acts’ the terms and level of cover may be quite different;
Top-up policies may in the future have aggregate limits (as is common outside the UK);
Insurers may fail (LLPs are not covered by the Policyholders Protection Act);
Cover is not guaranteed both at the primary level and at top-up as non-disclosure, non-notification and failure to adhere to the claims procedure may all prejudice cover; and,
The size and nature of the firm may change with time, perhaps resulting in quite different demands for cover.

Many of these will be unknown to the client, and as section 11 of UCTA refers to the contemplation of ‘the parties’, you may need to educate clients on these matters especially for the unusual high-risk venture.

The offer to vary the limit (perhaps linked to a review of the fee) is a sound standpoint as it demonstrates at least a theoretical willingness to depart from standard terms that goes some way towards individual negotiation.

In the second part of this article (to be published in the February/March issue) I will consider contentious business agreements, retainer creep and the liability to non-clients, LLPs as a structure to limit liability, and insurance.

References

See, for example, Law Commission: Exemption Clauses Second Report, Law Comm No 69 (1975) paragraphs 198-200.
See the discussion in Watford v. Sanderson [2001] 1 All ER (Comm) 696 paras 49 – 58 per Chadwick LJ where the distinction is drawn between excluding a type of loss (indirect or consequential loss on the facts of the case) and restricting liability.
It is unclear whether vicarious liability (permissible at law) can be excluded – see HIH Casualty and General Insurance v Chase Manhattan Bank [2003] UKHL 6.
See St Albans City and District Council v International Computers [1995] FSR 686 (not affected on this point by the appeal reported at [1996] 4 All ER 481).
See generally Alisa Craig Shipping v Malvern Fishing [1983] 1 All ER 101.
See generally Senate Electrical v. Alcatel Submarine [1999] 2 Lloyds Rep 243.
See St Albans City and District Council v International Computers [1995] FSR 686 (not affected on this point by the appeal reported at [1996] 4 All ER 481.

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