International expansion may bring huge opportunities for a law firm, but it also brings risk. Sandra Neilson-Moore assesses the professional liability hazards of expanding a network overseas

In today's hectic world, constantly growing one's business is often an important and necessary evil. In a globalised economy, this perceived need for continual growth will, for major commercial law firms, often involve international expansion. As members of the executive and administrative teams of any business know, growth of any kind demands considerable management skill and attention. Growth into foreign jurisdictions can be especially daunting, expensive and fraught with the risk of 'getting it wrong'.

When faced with the choice of how best to branch out into the international legal marketplace, the management team of a law firm might decide to expand the firm's business into foreign jurisdictions in a variety of ways. Each has its advantages and disadvantages.

For example, the firm might seek to grow its international presence organically. The first step of such organic growth will often be the seeding into target foreign jurisdictions of key partner and senior associate ex-pats who have suitable backgrounds and language skills to successfully work there. This would be followed at appropriate intervals by a gradual build-up of local resource and capability. This is the slow and easy 'keeping an even keel' approach.

Conversely, the firm might choose to grow more rapidly, by directly acquiring active and already engaged local resource through the hire of key laterals and teams or via the acquisition of entire indigenous firms in order to immediately establish a locally acceptable working presence. This will usually be combined with the involvement of seeded partners as in the organic approach and with so-called 'valve' or 'structural' partners in order to ensure the firm's culture is integrated with that of the local newcomers.

Finally, the firm might choose to form formal or informal international networks with organisations already operating in the target jurisdictions, but without making the local firms a legal part of the global firm structure. In many places throughout the world this is the only option available because local regulations prohibit foreign lawyers from practising in partnership with, or acquiring the assets of, local firms or practitioners.

Many of the largest firms have used all of the above methods to support their global expansion at one time or another, and as circumstances have dictated.

However, even for multinational corporate organisations that are (rightly or wrongly) lauded for their skill in business acumen and management prowess, expansion into previously unknown locales is perilous. It requires time, attention and, most importantly of all, investment. Getting it wrong can be a very costly endeavour indeed.

The risks are loss of investment, people, clients, revenue and reputation, as well as the spectre of professional liability claims through exposure to new people, culture, practices and legal systems. Once a firm has failed in such expansion efforts, competitive pressures may mean that its time will not come again. However, too rapid expansion can lead to greater risk and even more dire consequences.

It is generally accepted that organic growth carries the least amount of risk. It is slow, typically well-controlled and normally increases the likelihood that the global culture of the firm will be successfully transplanted into the firm's local presence. The firm's values will be universally adhered to and the firm will be in control of the face it shows to its market. Its brand will be safeguarded and it will be better able to maintain its collegiality and professional standards. It is not the least expensive method, but it is less expensive and certainly less risky than rapid acquisition of local resources.

The rapid and senior lateral hiring of indigenous teams and/or the acquisition of entire local firms is inherently more risky. It is more difficult to integrate these autonomous clusters of people, systems and culture into the firm all at once. For that reason, it is essential that the fit between the firm and its new senior resources be correct and that their goals and values are shared. Otherwise there is a danger that an almost anachronistic environment will result, with the potential for dangerous consequences. This is also usually the most expensive option, both to implement and to unwind if it does not perform to satisfaction. In some jurisdictions there are additional employment law pitfalls to be wary of, with local legislation more generous than the home jurisdiction and more supportive of the rights of the employee.

International networks, whether formal or informal, can be either the best or the worst of situations, depending on a number of factors.

International networks do not involve anything like the same amount of cost to the firm that direct investment in any particular jurisdiction will. The local firm remains separate and there is no need to integrate people, systems, culture or costs. No management time needs to be devoted to the day-to-day management of the local firm – it will manage itself. However, the local firm is clearly then not part of its partner firm and does not share its goals in the same way as it would if it were truly part of the overall organisation.

When a major commercial firm (for example in the UK) enters into a network with firms in other jurisdictions, these relationships are usually of a variety of types. In some cases these are loose referral systems. In others, the arrangements are more formal.

However, even where informal relationships are concerned, the larger firm may often act as 'lead' or 'prime', with work sub-contracted out to the local firm. The client engagement in such cases is usually with the lead/prime only and not directly with the firms actually doing the work. Often the client does not even know the other firm is involved or, if the client does know, it resists engaging directly with the other firm. Sometimes the client insists on the larger firm taking full responsibility for the acts of the other firms through indemnification agreements.

From a professional liability point of view, the insurers providing protection to large UK firms are aware that some of the firms to which they provide this insurance protection may enter into these types of arrangements. However, insurers are universally concerned that the larger firm in such circumstances is too often taking full responsibility for anything done by the smaller, local firm – at least from the client's point of view.

The professional liability insurers would very much prefer that the client knows of the existence of the local firm and, indeed, that the client engages directly with the local firm by referral through a best friends' network rather than through a prime and sub-relationship.

Professional liability insurance needs to be carefully examined to ensure there is full coverage at both primary and excess layer levels for claims arising out of the acts of others. In today's soft insurance market it is usually possible to secure protection for even contractually-assumed liability for the acts of others, but the wording used is critical. The recent well-publicised experiences of Grant Thornton International in respect of its own professional liability insurance arrangements illustrate how dangerous an improperly-prepared policy language can be.

However, even if the professional liability insurance does cover the liability, there remains considerable danger in situations where the larger firm is liable for claims caused by smaller firms actually doing the work because:

l the firm is responsible for the payment of the excess under its professional liability insurance policy, often a significant amount;

l the firm's premium for professional liability insurance will increase if a claim is paid under its policy; and

l the firm's reputation and relationship with its client will suffer to its detriment.

Some of the things that the larger firms might consider doing to attempt to protect itself from liability for the actions of the local firm include:

l attempting to have the client engage directly with the local firm (admittedly, the client may not agree to this);

l ensuring that the local firm has reasonable limits of professional liability of its own (or insisting that it secure these); and

l retaining the subrogation rights of its insurer against the other firm (indeed, this may be a condition of the firm's professional liability policy).

Firms that are entering into such relationships should always consider their duties of disclosure to their professional liability insurance carriers. Failure to disclose material facts at the appropriate time can result in the firm being unable to take full advantage of the protections that it has arranged for itself, and can even result in a full avoidance by the insurer of any responsibility to indemnify the firm.

Although there are considerable risks involved in informal relationships, they are quite common and for that reason would normally not need to be disclosed to the firm's professional liability insurer during the policy period, unless the firm is accepting much greater liability than would be usual for a similar firm in similar circumstances.

Regarding formal relationships, unless the nature of the risk being assumed by the insurers has changed fundamentally, there is no absolute duty to disclose material changes mid-term. These would normally only need to be disclosed at renewal, unless the terms of the policy indicated otherwise.

However, such a relationship would almost certainly have to be disclosed at renewal as a material fact for the purposes of negotiating the renewal terms. For that reason – and to enhance the relationship between the firm and its insurers – it is sensible to tell insurers about such a formal arrangement prior to entering into the relationship if at all possible, providing as much information as practical.

Useful information that could be provided includes:

l background information about the network – how it will work, who will be prime and under what circumstances;

l details of any indemnification agreements between the firms;

l the names of the firms and any other information about them and their practice that is readily available;

l a copy of any formal agreement(s) that have been or will be entered into; and

l future plans for greater integration, so far as these are applicable and possible to divulge.

In addition, and for its own protection, the firm may need or want to consider the following – will the UK firm (for example) want the insurers to waive their rights of subrogation against the foreign firms in the event that the UK firm is found liable for a loss that is really the fault of one of the foreign firms?

Some things that the UK firm might consider in this context are:

l whether the foreign firms' insurers are likewise willing to waive these rights;

l the effect on the UK firm's insurance claims experience and premium of bearing claims that are the responsibility of the foreign firms under its own policy and in respect of which the insurers would have no recourse;

l whether waiver of subrogation is a good idea or if it would be better to leave whatever insurance the foreign firms have available to them completely unencumbered and accessible through the insurers' rights of subrogation;

l the limits of coverage carried by the foreign firms. Often the limits of liability carried by firms in other jurisdictions are very low by comparison to that carried by the larger UK firm. If the limit of protection carried by the foreign firm is too low, the UK firm may wish the foreign firms to purchase more, either singly or in a 'basket' group policy, to bring them closer to the limits that the UK firm carries and to avoid the UK firm being perceived as the 'deep pocket'; and

l marketing and how to accomplish the aim of promoting the 'network' to clients without introducing, or increasing, holding out liability for the UK firm.

Although it might seem surprising, many firms do not explore these issues in enough detail before entering into formal networks. Major commercial firms normally put considerable effort into their examination of the positive business aspects of such ventures, but sometimes do not concentrate as much effort on the analysis of the risks. However, failure to properly address the risks inherent in such ventures could result in financial and reputational consequences that could not have been anticipated at the outset. n