Does the cap fit? Liability for law firms

Given the double-digit premium increases experienced by many firms at the October 2020 Professional Indemnity Insurance renewal, it is very likely that risk managers and insurance buyers are considering their options for the future. The upward premium trend looks set to continue, with the impact of COVID-19, Brexit and related concerns all highlighted in our recent article¹ on the renewals season.

One option for worried firms is how best to limit liability, and how this might be undertaken whilst complying with the obligations imposed by the Solicitors Regulation Authority (SRA) and the SRA Standards and Regulations (StaRs).

In this article we look at whether limiting or capping liability is possible for law firms, how this might be achieved and what might be appropriate steps to take.

Why limit liability?

Law firms, like other professional service organisations, are offering a service at a cost. The impact of getting something wrong can be significant and so it makes sense to try and limit or cap liability in someway.

Other sectors have used liability caps more readily. It makes commercial sense to link risk with reward, and this is a concept that clients should understand and appreciate. Equally to insurers it demonstrates a sound understanding of risk, and risk management.

The SRA’s approach

There are three main regulatory and legislative areas for firms to consider. The SRA Indemnity Insurance Rules (‘the Rules’)², (including the accompanying Guidance Note³), the Unfair Contract Terms Act 1977⁴, and the Consumer Rights Act 2015⁵. In considering whether to limit liability it would be prudent to consider those areas of legislation thoroughly. In this article we discuss solely the SRA’s approach to limiting liability.

The StaRs require that clients are treated fairly, and that ‘you do not abuse your positionby taking unfair advantage of clients or others.’

The StaRs require that clients are treated fairly, and that ‘you do not abuse your position by taking unfair advantage of clients or others.’ This is arguably the key underlying requirement for law firms and is further embedded in the Code of Conduct for Solicitors requiring that ‘you give clients information in a way that they can understand⁶.’

The SRA is a consumer focused regulator, hence clarity of advice to consumers is a central plank of their approach to regulation.

In addition, the Rules require firms to:

1. ‘take out and maintain professional indemnity insurance that provides adequate and appropriate cover,’ and
2. not exclude or limit liability below the minimum level of cover (Rule 3.2) which is £3million for a relevant recognised body or a relevant licensed body and £2 million for an Alternative Business Structure. Under Annex 1 of the Rules limits on liability can only be used on amounts over the minimum level of cover.

The SRA Guidance requires that any limit or cap: -

• Is fair and reasonable to the specific circumstances, further embedding the requirement under the StaRs
• Reflects the power and knowledge of the transaction or relationship
• Takes into account the best interests of the client; supporting SRA Principle 7 that solicitors ‘act in the best interests of each client’⁷
• Is communicated to the client so that they can understand the impact

The SRA makes the clear statement that they “would not expect to see caps put on liability to clients as a matter of course”.

What is an appropriate limit?

Liability can never be excluded entirely, and we have already looked at the minimum levels the Rules the SRA require.

Equally, under the Rules, the SRA require that any limitation must be fair and reasonable. To this purpose we have historically seen limits set at the Professional Indemnity Insurance limit or as a multiplier of fees. Perhaps to avoid the appearance of capping liability as ‘a matter of course’, any limitation should be a reasonable appraisal of the probable loss on a negligence claim.

How to limit liability

Firms should consider the following points when they are considering limiting liability. All points should be clearly documented:

Why are you limiting liability in this particular matter?

The onus is on the firm to clearly lay out why this matter warrants a different approach. File notes and records of internal discussions will assist in this respect.

Power and knowledge of the transaction or relationship

As a consumer protection focused regulator, the SRA is unlikely to favourably consider requests to cap or limit liability for consumer clients. There is likely to be more consideration given to limiting liability for commercial clients.

Make it clear and obvious to the client

Overtly draw the client’s attention to the limitation, make it explicit and outside of your standard Terms of Engagement. This will help support the requirement to communicate to the client in a way that they can understand the impact.

You may go further and suggest to the client that they contact you to discuss, and again if they do then you must fully document that discussion and what was agreed with the client on the file.

Conclusion

This article discusses the considerations when looking at limiting liability and the steps required to comply with the SRA requirements.

We have already referred to the more frequent incidence of limiting liability across many professions which contrasts with the approach taken within legal services. Whether this is due to a sense of ambiguity over the regulator’s stance is unclear.

It is possible to use liability caps and stay on the right side of the regulatory tightrope but, in order to do so, the SRA will want to see that client interests are protected and that clients are given sufficient information to make informed choices.