This article has been produced by Jason Nash , Solicitor at law firm Browne Jacobson, in collaboration with Nicola Anthony, Risk Manager at Lockton.
Most firms very wisely seek to limit their liability to clients in their engagement letters. It makes sense to do this so the firm and the client both know how much financial compensation might be available if things go wrong.
But while limiting liability is good risk management practice, such clauses must be drafted carefully to be effective. Problems arise where the perceived losses are more than the limit of liability contained in the engagement letter. And if restrictions and exclusions are too onerous, they could be deemed unenforceable, leaving liability unrestricted.
Determining limits of liability
There are several parties who are very interested in the effectiveness of liability clauses – the client, the firm and their professional indemnity insurance (PII) insurers, lenders, litigation funders, or anyone else who is interested in the outcome of a professional negligence claim.
Professional indemnity claims are a significant concern for the profession and their insurers. In recent years, whilst the volume of claims has remained steady, the sums being claimed have risen significantly. As PII is one of the biggest costs to law firms, (together with rent and salaries) this means the higher costs of claims and resulting impact on premiums can have a devastating effect on a firm.
To protect themselves against the burden of claims, many firms seek to include a standard term in their engagement letters excluding liability for breach of contract or negligence or limiting the damages that can be claimed. This is sometimes linked to a clause seeking to reduce the limitation period to a shorter period of time than prescribed by statute.
Determining a fair and reasonable exclusion depends on circumstances. In deciding what negotiating position to adopt, firms should take into account a number of factors. Solicitors PII, as enshrined in the minimum terms and conditions (MTC), has consumer protection at its heart. As such, firms cannot effectively seek to exclude liability entirely to the client or easily limit their liability below the minimum level of cover. Linked to that is the requirement on solicitors (and registered European lawyers that are practicing as freelance solicitors) to carry ‘adequate and appropriate insurance’.
The starting point for firms will be to assess whether their minimum required level of cover is adequate and appropriate. This will depend upon a number of factors including client profile, the number and type of client matters, and the value of the transactions involved.
Ineffective and improper limitations
It’s also useful to consider what might happen if a high value transaction went wrong. When claims arise, a simple mistake can have severe financial consequences.
For example, it might be unwise for a small firm undertaking high value property transactions to take out only the minimum cover available. A limitation of liability clause in an initial engagement letter is not a ‘get out of jail free card’; if it’s decided the clause is ineffective, the full limit of cover will be exposed – trying to use both the limitation of liability twinned with a lower level of cover might not be effective if the clause is found to be unenforceable. The firm itself is then at risk once the full limit of insurance has been eroded, either by one single claim or a number of aggregated claims.
What’s more, if there are a series of related transactions it is important to properly understand how the aggregation clauses operate in insurance contracts. For example, in case a mistake made by a professional results in multiple people making claims against them, the aggregation clause might mean that the insurance company will only pay out up to one limit of indemnity, even if there are multiple claims. Recent cases on the issue of aggregation have been decided in favour of the insured (and the ultimate claimants who argued that the claims did not aggregate), but the risk of the insurance cover available being limited in this way remains.
In some larger claims, excess layer insurance might be triggered. That cover is becoming increasingly expensive in recent times because a significantly greater number of claims have hit the excess layer market over the last ten years.
Firms must also consider whether any limitation of liability clauses comply with SRA regulations. In 2021, the Solicitors Disciplinary Tribunal (SDT) imposed a fine on a firm for seeking to improperly limit liability and/or limit the timeframe for when a claim could be made. The SDT found these breached various provisions of the Solicitors’ Code of Conduct 2007 and the SRA’ Code of Conduct 2011.
Recommendations for firms
It is prudent to seek to limit liabilities within your firm’s engagement letter. However,although a limiting liability clause may seem like a solution to avoid potential financial consequences, they are not guaranteed to work.
Below, we’ve offered some key recommendations to keep in mind before and during implementation:
- Document any challenges and/or negotiations concerning a limitation of liability clause, explain why it is fair and reasonable and does not breach SRA Code of Conduct.
- Ensure adequate and appropriate insurance cover is in place to avoid a potential regulatory sanction
- If possible, document the reasons for any attempt to limit liability to a figure below the level of insurance cover
- Where a formula is used for determining a limitation of liability, make the basis for calculation clear
- Remember that it is not possible to exclude liability for matters such as fraud or an SRA regulated activity
- Where caps on liability are introduced, make clear whether the cap is an aggregate limit on liability, or applies separately to each breach or each claim
- Where possible, the client should be given sufficient time to consider the matter and/or take legal advice
Firms should take their own legal advice on the drafting of any clause that purports to limit liability.
For more information, please visit the Lockton Solicitors page, or contact:
Nicola Anthony, Risk Manager