Safety in numbers
Solicitors came back from their summer holidays to a triple whammy. First came the news that the Law Society Regulation Board plans to make public the outcome of those disciplinary proceedings against solicitors that do not culminate in a hearing at a tribunal. Next was the revelation that a clampdown on referral fees rules was planned, after an investigation found that only 6% of firms were fully compliant. Last, the Law Society decided to pursue Freshfields Bruckhaus Deringer lawyers Barry O’Brien and Tim Jones over their role in Philip Green’s bid for Marks and Spencer.
So what are the potential insurance ramifications? Will enforcement action on referral fees, for example, directly impact a firm’s risk profile on renewing their professional indemnity or will there be indirect impacts as non-compliance indicates poor management and control?
The publicity change requires legislation, which the regulator hopes will be part of the package of regulations that follow implementation of the Legal Services Bill. It is driven by the consumer lobby but will it be of interest to insurers? Frank Maher, a partner at Legal Risk, says: “Publicity for presently unreported disciplinary cases would be unlikely to make much difference to insurance, since proposal forms often ask about disciplinary action anyway.”
Poor standards
However, Andrew Nickels, head of risk management at Zurich Professional Risk, the largest solicitors’ PI insurer, sees it as a positive move. “We would like those details to be made public, as it would give insurers more information about firms,” he says. “At present, the findings of disciplinary tribunals are not put into The Law Society Gazette for several months. Anything that exposes incompetence and unprofessional conduct among law firms is helpful.”
In fact, a problem for insurers, according to Mr Nickels, is the time it takes for the regulator to act: “There is concern that there is a growing trend in poor standards, of which referral fees are just one example. The report suggests there is scope for the Law Society to get tough but it doesn’t. There can be delays of several indemnity years before they do anything.”
He adds that PI insurers want those firms at fault to be dealt with quickly so that they do not inadvertently take a firm onto their books, or renew their cover without knowing of a potential problem. The Law Society’s decision to review the underlying principles governing referral fees and to crack down on firms breaching the rules is likely to be controversial, and it could divide those who perceive such ‘bungs’ as murky from others who regard them as a necessary commercial decision. Solicitors must act in their clients’ best interests and independently of commercial arrangements with third parties but the issue of whether they should be allowed to pay referral fees to those putting work their way has a highly contentious regulatory history.
The original ban raised competition issues, and was lifted by the Law Society in 2003 to be replaced by a regime permitting their payment but with safeguards. Research by the society’s practice standards unit, however, has unearthed widespread and systematic breaches relating to non-disclosure of the referral fee arrangement, and failures in the supervision of introducers’ compliance with the introduction and referral code. The unit’s final report stated that a mere 6% of the 135 firms surveyed were fully compliant, while 39% committed significant – and 55% minor – breaches.
Finding a solution that combines professional integrity with commercial realism will be tricky. Lord Falconer, Secretary of State for Constitutional Affairs, has let it be known that he views referral fees as “trafficking” in personal injury cases; and Mark Boleat, the government’s new head of claims management regulation, has said regulation of the claims management sector is necessary only because of solicitors’ own breaches of the referral fee rules.
The issue is certainly damaging to the profession’s reputation, coupled with the risks – real or perceived – of jeopardising clients’ ability to obtain independent advice from a lawyer who may have a potential conflict of interest.
Anthony Hughes, managing partner of Ricksons Solicitors, comments: “A lot of personal injury claims in the past were hijacked by claims management firms that spotted a commercial opportunity and exploited it on the basis that law firms were frightened work would not come to them if they didn’t pay ‘marketing costs’.
“Referral fees have been around for a long time, dressed up as marketing costs, but the profession has known this and realised laws have been flouted. Unfortunately, someone is going to be made an example of, with several firms potentially going to the wall,” he explains.
Mr Hughes is aware of firms paying fees of up to £650 per case from claims management companies, and says that the cost of these cases can be laid firmly at the door of market forces. “If you have a demand for them, then it’s an age-old business principle that you tailor prices to what the market will stand. Unfortunately, a lot of smaller firms paid the price because they believed that if they didn’t then the work would dry up,” he explains.
The report’s findings will no doubt result in increased numbers of solicitors’ disciplinary tribunal actions, so would such action impact on a firm’s risk profile? Angus Turner, a partner at Mills and Reeve, comments: “A firm that has an increase in disciplinary actions will find itself under fire when it comes to renewal terms. Risk management within law firms has played a major role in keeping firms’ premiums in check, and evidence that full substantive risk management systems are in place is required by most insurers. Such systems include conflict checks as well as compliance checks, so individuals facing disciplinary proceedings are likely to be seen as evidence that the risk management in place at the given firm is not sufficiently robust.”
Mr Maher takes a slightly different view: “The insurance impact is likely to be low on its own but if the future of the firm were put in peril, then that would be a major concern to insurers because under the Law Society’s minimum terms they have to provide compulsory run-off cover if the firm folds – even if the firm fails to pay the extra run-off premium.”
Insurers would also be concerned if a firm is dependant largely on referrals for their income because this can raise issues of credit worthiness and financial stability. “It affects the integrity of the firm and, when answering the question of whether a firm relies on one client for more than 20% of its work, some firms are not seeing the introducer as one client,” comments Mr Nickels.
He finds the 6% compliance figure worrying because it poses the question of ‘what else is going on’, and he says it impacts on the effectiveness of the monitoring of the conflict of interest rules. The report highlights one element where the Law Society is clearly not enforcing the rules but, he observes, if the status quo is to be maintained with no change in the referral fee rules, the Law Society needs to educate some of its members “given that some breaches are so systematic that schemes have apparently been devised with the sole purpose of circumventing the rule”.
Large fines are, therefore, on the cards. The recent Solicitors Disciplinary Tribunal case of Mendelson resulted in fines of £9000 for referral fee breaches and £2500 for accounting breaches. In addition, the solicitor was ordered to pay a £25,000 contribution to the Law Society’s costs of £50,000 plus VAT. Law firms cannot insure against any fines but would any of the legal fees be covered under a solicitors’ PI or a directors’ and officers’ policy?
Defence costs
Mr Maher points out that there is no restriction on insuring the defence costs of disciplinary action. “There is a provider for such costs cover for accountants but I have not seen one for solicitors,” he says. “Compulsory Law Society cover includes some cover for these defence costs but only where there is likely to be a related, insured claim for damages – usually by the client – but that would not always be the case on referral fee complaints.”
The result is that solicitors have no real incentive to do anything other than fight disciplinary proceedings all the way, according to Eamon Mooney, who leads the professional indemnity team at DLA Piper and is chairman of the Forum of Insurance Lawyers’ professional negligence group. “If the Law Society comes good on its threat to crack down,” he warns, “the result might well be that insurers’ defence costs increase considerably. It is interesting to note that the Solicitors Disciplinary Tribunal has itself commented that recent cases have tended to last longer and be contested to a greater extent than previously. It is, perhaps, a sign of things to come.”
When it comes to D&O insurance, most law firms do not purchase it but if they did, says Sandra Neilson-Moore, European practice leader for law firms’ PI at Marsh, such insurance would cover the wrongful acts of members of the firm in connection with its management: “D&O insurance covers the individual liability of the members for those acts. Any fine would most likely be against the firm itself, and not against any individual.”
In any event, Mr Mooney says it is usual for fines to be excluded “because of the basic insurance principle that insurance is intended to cover unforeseen events and not to condone any breach of regulatory rules”.
Another difficulty for insurers is likely to be the less predictable outcomes of hearings. While judges make the occasional controversial decision, there is usually a fair degree of legal analysis and rigour. Consumer-oriented proceedings on the other hand can be prone to subjectivity.
Mike Willis, a professional risks partner at the Leeds office of Beachcroft, sees the Law Society crackdown as evidence of the government prioritising consumer interest. “This is a new area of risk, and solicitors will have to be on their mettle and know that if they transgress regulatory matters, it will have an impact on their claims record,” he says.
He also points out that there is a difference in approach between regulatory and civil matters: “The former is not governed by the same rules of evidence as civil cases, and a claimant with a sympathetic case has more chance of winning. It represents a departure as there are fewer defences in the new tribunal scenario.”
Court penalties
Consequently, solicitors could find themselves liable for penalties they would not be liable for in a court, which, according to Mr Nickels, is a concern for insurers.
As to the wider implications of the crackdown, insurer claimants in The Accident Group litigation are seeking reimbursement of several millions of pounds of referral fees made by panel solicitors in breach of the rules effective at that time. Ms Neilson-Moore comments: “My understanding is that insurers are universally saying this is not covered. Their rationale is that this is money the firms should not have had in the first place. It is the return of that wrongfully given money, and is not a loss to the firms in fact.” Mr Maher notes the Law Society “has gone rather quiet on The Accident Group referral fees”, and reports there is a group challenging insurers on their refusal to cover the referral fee claims.
This adds some interesting twists from the insurance viewpoint, notes Mr Mooney, adding: “The Law Society’s minimum terms also specifically exclude debts and trading liabilities. It seems likely that any orders to reimburse referral fees will also be excluded under the policies. That creates its own challenges with the firm being sued needing to secure separate advice in connection with that part of any claim against it. There may be differing tactical considerations in connection with those separate elements, and that is a potential minefield for defendant firms instructed by insurers.”
He warns that if disciplinary proceedings increase radically in numbers, and solicitors firms fight more cases, the market will become less attractive to some insurers. This, in turn, might lead to an overall increase in premiums across the legal profession.
Story Credit: Post Magazine