Manage your cost-cutting

‘‘To every action there is an equal and opposite reaction.”

Newton’s Third Law of motion might equally be said to apply to firms. Firms have little choice but to cut overheads; considering the effects of doing this may help them to do so more effectively and minimise risk. Carrying on our theme of managing credit crunch-related risk, we look at some areas where cost saving can have hidden dangers if it is not properly managed.

As an example, Legal Risk’s Top-100 Professional Indemnity and Risk Management Survey reveals that 14 per cent of top-100 firms responding changed insurers when renewing cover on 1 October 2008. For the top-30 firms, the figure was even higher at 23 per cent. Of those that changed insurer, 71 per cent of the top-100 firms, and all those in the top-30, did so to save costs – security of the insurer was the reason given by one firm.

This is all entirely understandable, and nobody is saying that firms should not do it. However, we have seen situations where the result was to expose the firm to the risk of being uninsured for substantial claims. Firms may lose sight of the extent of their obligations to make full disclosure to insurers. They may make an inadequate enquiry of partners as to whether there is anything to declare. Some do not check that they have had a 100 per cent response rate. We advise checking with all staff, because even the most junior may know something that should be disclosed – one example being a multimillion claim on which I acted for insurers where the cause was a letter in a wrong envelope.

Firms also need to consider whether there is anything else they should be disclosing to insurers in addition to claims and circumstances – perhaps they are aware of a serious problem with a fee-earner, have put right some problem files at their own expense, but have not yet identified the full extent of the issue.

Problems like this can affect large firms as well as small ones, and at my firm we are seeing more policy coverage disputes than ever before. Although the statutory cover for solicitors provides some protection from insurers avoiding claims or policies, this may not apply to top-up policies. Even in primary layer policies, there is usually provision entitling insurers to seek reimbursement, an additional premium or a larger excess where disclosure has been inadequate – partners in one firm are currently exposed to personal liabilities running into millions of pound.

Redundancy is another area of cost-saving that needs careful planning. Sadly, the need is unavoidable for many firms, but do you simply let people go or do you, for example, ensure that you have managed the file handovers effectively?

We recently prepared a checklist for a major European firm and found the list of matters to consider (over 40) surprisingly long. As well as the amount of intellectual capital walking out of the door, there are significant risks on specific client matters, such as the failure to tie up loose ends. There may also be problems dealing with the defence of claims going forwards.

Pruning the risk team may seem like an opportunity to save costs – after all, they are not fee-earners, are they? But when there are more risks to address, not less, this might prove to be false economy. The high profile allegations of banks failing to pay sufficient heed to their risk management team are a stark warning to firms. More UK firms are recognising the need for their head of risk management (whatever the particular designation may be) to be involved at senior management level. We understand this is being mirrored in the large Australian firms too.

New and emerging areas of risk, increased focus on existing risks and additional client interest (particularly in tenders) mean there is little scope for cutting risk teams. More focus is needed on information security, business continuity, client credit risk and overseas offices – traditionally low risk, but not any more.

Perhaps even more significantly, the rising tide of regulation will not go away. Firms are cutting jobs and the Solicitors Regulation Authority is recruiting. Representing firms under investigation, many of them entirely reputable top-100 practices and some of whom understandably feel besieged by their situation, has been the largest growth area in our practice in recent years. Expect more regulation – not less.

So, by all means cut costs, but make sure the price paid later is not so high as to negate the benefits – perhaps even several times over.

Frank Maher is a partner at Legal Risk LLP and a member of the editorial board. He can be contacted at frank.maher@legalrisk.co.uk