Feature: Holding lawyers to account

Sound policies and processes for lawyers taking on new work are essential, and firms can learn some lessons from the experience of accountants. Simplicity, transparency and careful supervision are the ideal qualities for a firm with a culture of compliance.

By Andrew Scott, risk management partner, Barlow Lyde & Gilbert

There has been a seismic shift in law-firm risk management over the past ten years, to the extent that it is now regarded by most law firms of any size as an integral element of how they conduct and control their business. The few doubters who remain will be in for a shock later this year when the new Solicitors’ Code of Conduct is brought into force. Rule 5 will make risk management a professional obligation.

A proper risk-management strategy will cover all aspects of a firm’s business, including strategic, financial, compliance, IT and HR risks, but this article focuses on what remains for most firms the biggest area of potential exposure – the work they do for their clients. I examine this risk using experience built up within Barlow Lyde & Gilbert, handling the defence of large numbers of often difficult and sensitive professional-liability claims against solicitors and other professionals, including accountants. Based on that experience, what are the key areas where law firms can make a difference to their potential professional-liability exposure?

It started with the accountants

Today’s focus on risk management in law firms has its roots in a radical new defensive approach adopted by the largest accountancy firms in the 1990s. Hit by waves of massive claims, particularly against their audit arms, these firms became much more sophisticated in their approach to
client relationships. While clients were still, quite rightly, generally regarded as ‘a good thing’, there was also an increasing recognition that a small number of clients could be more trouble than they were worth. Firms began to score the risk potential in each new engagement. In each case, the question was the same. Does the benefit to us in taking on this work outweigh the risks associated with it? As the 1990s progressed, the large accountancy firms slowly and quietly shed some of their higher-risk clients.

At the same time those firms were becoming increasingly sophisticated in other ways. There was greater recognition of the importance of specialist knowledge and experience, coupled with a greater willingness to insist that certain work is only handled by members of specialist teams. Huge effort was devoted to improving and standardising terms of engagement, including the capping of liability wherever possible, and where capping was precluded by legislation (in relation to auditing), high-profile campaigns were pursued for a change to the law. In cases where powerful groups of clients such as banks proved resistant to capping, high-level lobbying and negotiation eventually led to a solution. Other risk-management effort was devoted to ensuring that reports were appropriately caveated and limited in their circulation; that drafts and copies were appropriately marked; and that working papers were only retained if it was essential to do so.

Lawyers – the unwelcome truth

Lawyers are (pleasingly) generally less patient than accountants with rigid rules and standardised approaches. Nevertheless, good risk management in law firms needs to recognise a fundamental and possibly unwelcome truth. There is a very real element of commoditisation in what lawyers, and indeed all professionals, do. Much of daily practice is routine, involving steps and wordings that have been paraded countless times before in what are often very similar circumstances. A good lawyer will be on the lookout for the subtle signs that suggest a particular point is worth pursuing hard, or that it should be traded, and will also have an eye on how the client’s objectives fit within the bigger picture. At root, however, save for in a few unusual and complex situations, an experienced lawyer seldom operates outside his or her technical comfort zone.

What this means in practice is that relatively few mistakes happen that could not have been avoided with a little more routine care. Of course, ultimately it is impossible to legislate for those difficult and pressured situations that may lead to a wrong call being made. The opportunity to operate within usual procedures and guidelines may also be curtailed by the client’s over-ambitious timetable or the cutting-edge nature of what is being done (although risk of this sort should be capable of being dealt with in the engagement letter). At root, however, many problems could be avoided if partners and staff were clearer about the policies and procedures in place – and were given greater encouragement to apply them.

This is not to say that law-firm managers should strive to create a culture of form-filling and box-ticking, and they would almost certainly fail if they did! What it does suggest, however, is that there are risk-management lessons that can be learnt from the approach adopted by the large accountancy firms.

Client and matter acceptance

Most law firms will have some basic procedures in place regarding client and matter acceptance, at least as regards money-laundering obligations. How many firms, however, pause to carry out a proper assessment of the credit risk associated with a new client, or have an independent procedure for determining whether other risk factors inherent in a particular matter make it an undesirable economic proposition? To take an easy example, it is unlikely to make sense to take on a client who is going to demand a very high level of care and attention on a difficult and challenging job but who evidently wants to pay bargain-basement prices. There are also obvious questions to consider regarding the prospective new client who has made claims against his last three law firms, or who has spent the last year playing tag with his creditors.

There is a danger in being over-prescriptive – and good lawyers will rebel against over-prescription in any event. However, it makes sense to have a simple acceptance procedure, backed by appropriate training and periodical file audits, which will help to make it second nature for lawyers to reflect on these points. It also serves to transfer decision making from the prospective engagement partner to someone more independent if a particular threshold is reached.

Engagement letters

Most firms now issue engagement letters. However, there are still huge differences in terms of the amount of care and thought that goes into devising firms’ standard terms of business – and into the task of adapting standard letters for the particular work to be undertaken. Terms of business, in particular, often fall into the trap of setting out at great length what the client can expect of the law firm, without also setting out, simply and clearly, what the firm expects from the client. There are also varying degrees of sophistication when it comes to introducing appropriate caveats and restrictions on the law firm’s obligations, including proportionate liability clauses and liability capping where appropriate. A well-devised liability clause, for example, will seek to restrict the firm’s liability to that share of the client’s loss that it is fair for the firm to bear, having regard to the extent to which others
have responsibility for it – including the client and the client’s other advisers. It will be worded so as to operate even if another responsible party is unlikely to pay because of insolvency or a contractual restriction.

As to liability capping, although there seems to be an increasing trend towards its adoption it is by no means uniform. Nor does it appear that firms’ guidance to partners and staff is necessarily very sophisticated – either how to come up with an appropriate cap for a particular engagement, or how to communicate with the client about it. For instance, it is unlikely to make sense for a large firm with £100m of professional-indemnity cover to cap liability at, for example, £5m. The risk is that if a very large claim emerges such a cap will prove ineffective just when it is needed most. The courts have confirmed that law firms, like any other organisation that seeks to cap liability, need to propose a cap that has regard to the circumstances of the client and the transaction, and that should be willing to negotiate with the client about the level of cap if that is appropriate. Marplace (Number 312) Ltd v Chaffe Street (2006) was a rare example of a court considering these issues in the context of a law firm’s terms of business. There, the defendant firm’s case-by-case approach to capping, discussion with the client and willingness to negotiate, were all factors which counted in its favour in the court’s eventual determination that the cap was reasonable under the Unfair Contract Terms Act 1976.

As to tailoring letters of engagement, it can be just as important to say what the law firm will not be doing. If there is a foreign-law element that the firm cannot cover, or if tax advice may be needed and the firm will not be providing it, that needs to be stated. Similarly, the extent to which the legal team will or will not have responsibility for the financial structuring of a deal, or for considering any of its commercial aspects, should also be stated. Care is also needed with such basic steps as identifying the client (including getting proper evidence of instructions if, for some reason, the first approach is from an intermediary). All of these matters can be covered in guidance to partners and staff, backed by training and periodical file audits.

The role of the specialist

As law and regulation become increasingly complex, the opportunity for lawyers to practise safely as generalists is waning. Specialist work is usually better handled by specialist lawyers. It is easier to make sure this happens in a collegiate environment, where an unbridled culture of ‘eat what you kill’ runs the risk that partners will try to hold on to jobs they are not necessarily equipped to deal with.

The dangers of operating in such a specialist sector without the requisite expertise were graphically illustrated in Hurlingham Estates v Wilde & Partners (1997), where a solicitor was held to have agreed to advise on all aspects of a transaction, including tax, and the Judge said:

“Mr X, the solicitor, assumed the full role in the transaction and responsibilities to be expected of a solicitor having the conduct of it. I have no doubt that, if he had at the meeting of 29 May exposed his ignorance and unfitness to have the conduct of the matter as he should, the clients… would have immediately instructed someone competent instead. Mr X must have known and feared this. He entered the tax minefield armed only with a precedent book (as he frankly admitted) not knowing what to look
for or the significance of anything he found.”

Of course, gaps in expertise can sometimes be filled by specialist counsel. The courts have confirmed that reliance on outside assistance of this sort can be appropriate, provided that the solicitor applies thought and common sense to the advice received and questions anything obviously unusual.

Drafts and reviews

It is also a golden rule that drafts should be marked as drafts, and that all formal reports and advices should make clear who can and cannot rely on them and for what purpose. Accountants regularly issue formal reports for a wide variety of purposes, and they are used to incorporating standard text restricting the use to which documents can be put, at any rate without further consent. Law firms are getting more sophisticated about this too, but there is still some way to go.

Also, the pronounced pyramid structure of the large accountancy firms has always put a premium on procedures for review of work within a team. In the audit sphere, for example, the rule is that all work carried out must be reviewed by the next most senior member of the team, with overall responsibility resting with the partner. Legal work, which is generally less formulaic in nature, does not lend itself so well to such a structure, but it is still a model worth bearing in mind. In particular, law firms could benefit from clearer procedures for the independent review of significant work products such as reports, advices and final transaction documents. Clients can sometimes prove resistant to paying for such reviews, but there may be other ways to incorporate quality-control procedures of this nature into overall pricing.

Overall lessons

A number of lessons emerge therefore. First, it is important to have clear policies and procedures in place, and to police them, with a view to ensuring that basic risk-management steps are appropriately implemented. Policies and procedures will cover the areas mentioned above, as well as areas such as conflicts and confidentiality; the giving of undertakings; arranging cover for absences; and dealing with complaints and claims. The list is potentially quite a long one. The trick is for the guidance to be as short and as clear as possible.

Second, policies and procedures need to be backed by appropriate training. This will be designed not only to provide familiarity with policies and procedures, but also to generate more general awareness of risk and how to manage it. It is important that lawyers continue to apply independent thought and common sense to situations and stay alert to the potential for problems.

Third, all of this will work best in a supportive and collegiate culture in which partners are willing to share work, and indeed where people are generally willing to come forward and talk about problems as they arise, so that expertise can be garnered from across the firm with a view to devising solutions.

Finally, focusing on the client dimension, for many common problems the solution simply lies in good communication. This means being clear with the client about what the lawyer will and won’t be doing; what the role of other advisers will or should be; what the risks are for the client; and what the job is likely to cost. All of this should be recorded in writing, in the engagement letter so far as possible, or in subsequent correspondence or notes. Allied to this is the desirability of making a cold assessment of whether a particular client or job is worth taking on in the first place, and the need for sensible procedures and communication with a view to restricting the firm’s liability to reasonable limits in the event that something goes wrong.

Andrew Scott is risk management partner at Barlow Lyde & Gilbert. He can be contacted at ascott@blg.co.uk