Clyde & Co's Richard Harrison and Jim Taylor ask if the rise in claims against solicitors signals a permanently riskier environment

For a long time there have been gloomy predictions of avalanches of claims against professionals – including solicitors – arising from the economic downturn. Yet it continues to be the case that the deluge has not arrived, although there has certainly been a very notable increase in claims in specific areas. So has the danger now passed?

The statistics released by the High Court show a significant peak in claims against solicitors issued in the Chancery Division (the only division that breaks down claims in this way). The figures went from 80 claims issued in 2008 to 210 claims in 2009, then fell back to 144 in 2010 and 125 in 2011. This suggests that the peak is over.

However, as the adage says, history repeats itself. The statistics, provided by the Solicitors Indemnity Fund after the early 1990s recession that ended in March 1991, reveal a peak in claims in 1991-92 and a second peak in 1994-95. Claims activity remained high until 1997-98. This suggests that if the pattern is repeated we may see a second wave of claims in the next 12 months.

However, there are some key differences this time around compared with the last recession, which means that claims activity may be significantly greater. We have seen a global credit crunch and financial crisis, a prolonged period of economic slowdown and a double-dip recession at the same time as economies are facing difficulties worldwide with serious and continuing issues in the eurozone. The double-dip recession may itself set off a whole new wave of claims in the next year or so.

In such difficult economic conditions litigation, which is inherently expensive and uncertain, may not be the priority of businesses which may be dealing with more immediate issues such as focusing on staying afloat or dealing with difficulties in maintaining their borrowing facilities and in trading with the eurozone.

However, if and when the economy stabilises potential claimants may then take steps to pursue lawyers in respect of earlier matters they had put on hold. We have seen an increase in claimants wishing to enter into standstill agreements, effectively halting the limitation period for claims, and this may be an indication that claimants are biding their time rather than forgetting about claims altogether. After all, the primary limitation period is six years.

Another key issue is that the size of the economy, and with it the turnover of law firms and the number of lawyers practising, has increased significantly since the early 1990s. Law Society figures show that in 1991 there were approximately 57,000 solicitors with practising certificates, but in 2011 this figure had grown to about 122,000.

Put simply, if there is more work being carried out by more solicitors then, without asserting better controls, there will inevitably be more claims. It is possible, therefore, that claim levels will remain at an increased level permanently.

Risky business?

An additional reason why levels of claim might continue to increase is that the prolonged economic downturn may produce behaviours in law firms that are more likely to lead to claims in subsequent years.

Clients across the board are putting pressure on the law firms they instruct to provide an even better service for a reduced reward in real terms. A number of consequences flow from that. Firms are taking on work for lower or fixed fees, or even extra work or risk for no fee at all. In order to make the work profitable it tends to be pushed down to junior lawyers with less and less supervision. Junior fee earners in these circumstances may be more inclined to make mistakes such as inappropriate use of previous deal documentation in a subsequent matter, or failure to carry out adequate checking.

Where it can be, work tends to be commoditised to reduce cost (for example in the field of commercial property) but this can mean that a mistake in one precedent can be catastrophic if that precedent is then used many times.

Fee earners also become spread more thinly when departing lawyers are not replaced and are more prone, for example, to spend less time testing the drafting of contractual documentation, and so mistakes are made.

What are we seeing?

Where are the claims currently coming from and where might we expect an increase?

• There has been an increase in lender claims against solicitors for some time. These have comprised claims in respect of negligence and claims where a borrower was fraudulent and either the solicitor was involved or negligently failed to provide the lender with information that would have uncovered the fraud.

At the moment, interest rates remain at a historic low, but should interest rates rise then the number of repossessions may increase significantly and there could well then be a knock-on effect on house prices.

This may lead to a further wave of claims or, at least, the current high levels remaining for sometime.

• As with every economic downturn, we have seen a number of fraud claims come to light, as transactions and funds dry up and the fraudster can no longer mask what they have been up to. This has included a number of high-profile instances of law firm partners defrauding their own firms and/or clients.

•Again, with every recession, there has been an increase in the number of companies entering into administration or liquidation. A number of high street chains have collapsed or reported significant difficulties in recent times. The administrators/liquidators will always undertake a critical review of past transactions entered into by the company. Problems commonly emerge in relation to inadequate guarantees, rent reviews, and employment contracts, all of which can trigger claims against the lawyers involved.

• There has been an increasing number of claims arising from failed corporate transactions, where the acquisition of a company has not run smoothly. In addition, there are some claims being advanced by financial institutions against their legal advisers.

• We have also seen increased numbers of claims by pension trustees and employers, often arising out of drafting errors, failures to properly implement changes to pension schemes or to spot that past advisers have not implemented changes correctly.

• In future, we expect to see an increase in the number of claims brought by disappointed beneficiaries of wills and trusts as they discover that the value of the estate or trust is no longer what they had hoped as the value of property and investments falls.

• The difficulties in the eurozone may have knock-on effects for claims against lawyers. There is the possibility of direct claims, for failure to advise in relation to hedging against the euro. In addition, the economic turmoil may in turn give rise to a situation where there are likely to be more claims – for example, there could be adverse effects on the housing market if lenders are less willing to lend due to the turmoil, leading to a situation ripe for more lender claims. There may also be an effect on the damages payable in respect of claims, for example, if the cost of UK bonds rises due to their perceived safety compared to certain European bonds, then the cost of annuities may rise, meaning higher damages may be payable in certain pensions-related claims.

Conclusion

For some time the predictions of high levels of claims against solicitors have failed to materialise, although there has been a very significant increase in claims, particularly in certain areas. Given the severity of the current economic conditions, it is unlikely that the danger has passed.

In light of the pressures being placed on law firms, installing good risk management practices is likely to be more important than ever.

For example:

• Partners should be clear that if further work is carried out beyond the scope of the original retainer it should be documented in a revised retainer letter to avoid the risks of mission creep.

• If work is carried out for free, fee earners need to be aware that the duty of care is unlikely to be any less than if the work were carried out for a fee. If there are any limitations on the scope of the work because it is being done on a gratuitous basis, then this needs to be made apparent to the client in writing.

• It can be difficult to change the behaviours of partners in a recession, but the importance of ensuring that partners do not take on work outside of their skill set and experience and that the work of junior fee earners is properly reviewed cannot be over-emphasised.

Even though all law firms have to purchase professional indemnity insurance, a catastrophic claim above the level of cover is not impossible. Even if a claim is fully covered, the excess will still have to be funded by a firm and reputational damage arising from a claim can be significant. Partners may need a reminder that the cost of proper risk management does not look so great when put next to the potential costs of a claim.

Richard Harrison is the head of and Jim Taylor is a partner in the lawyers' liability group at Clyde & Co.