Originally published in Legal Week on 2 April 2009

Recent media stories suggest that the current recession will trigger a huge increase in disputes, including claims against lawyers. This article explores the likely exposures and some risk management solutions.

Recessionary pressures

Commercial lawyers tend to be very active in an economic boom generating more contracts to litigate over in the subsequent "bust", and also creating the risk of cutting corners in attempts to meet increased client demand.

Not only do recessionary pressures induce people to commit fraud, but sharply reducing asset prices, together with increased redemption demand by investors, also lead to its increased detection. High profile examples, from which professional liability claims will inevitably flow, include the Madoff scandal and some recently reported scams in the UK "buy-to-let" property market.

Solicitors are often perceived to have deep pockets due to the mandatory professional indemnity insurance they must carry. Moreover, law firms typically do not seek extensively to limit their liability when agreeing terms of engagement with clients, in contrast to some other professionals.

Even where solicitors are not initially seen as primarily responsible for a loss, it seems inevitable that, as credit crunch disputes increase, solicitors will get drawn into them, particularly given the extreme complexity of some of the contracts generated in the financial services field.

Whilst little credit crunch litigation has been reported in the UK so far, consistent with the 1990s recession we have already seen a noticeable increase in real property and dishonesty-related claims, while the historical data suggests that we can expect a time-lag of a year or so before a general increase in claims occurs. At present, the top priority amongst corporates is understandably business survival and stability. Once this has been secured, experience shows that boards of directors will turn their focus to the past conduct of their professional advisors, often just as the economy is beginning to recover. Alternatively, claims will come from the liquidators of companies which fail due to the recession.

Sources of claims

Common sense suggests looking to the market sectors hardest hit by the recession, where losses will be greatest. A "sector vulnerability analysis" conducted by PwC indicates that the most vulnerable sectors are manufacturing (especially of metal products such as motor vehicles), financial services, hotels and restaurants, engineering, transport (the shipping market has been particularly hard hit), telecoms, construction, textiles, and oil and gas. To these market sectors, past experience tells us that we should add real estate (residential and commercial) and fraud, wherever it occurs, to make our list complete. Law firms acting for clients involved in these sectors are therefore at greater risk of claims being made.

Amongst this list, "financial services" is wide-ranging in scope, including not just sub-prime lending and associated credit derivatives but also other areas in which serious loss has been suffered, such as private equity, the hedge fund industry, and pension funds. Increased regulatory exposure of clients in the financial services sector may cause knock-on problems for the lawyers advising those clients.

Types of claim

We can expect many claims against lawyers to be brought in the context of a broader dispute in which one party to an agreement seeks either to enforce or escape from obligations under it. Claims against lawyers will plainly be fact-specific but, among others, we can expect to see arguments along the following lines:

  • inadequate "due diligence" in the broadest sense (for example regarding the target company of a private equity transaction, in relation to opinion letters or generally concerning the issue of prospectuses);
  • the agreement does not do what the client (or possibly all the parties) intended;
  • the client was not advised as to the full effect of the agreement;
  • the agreement does not adequately protect the client's interests in circumstances which have subsequently materialised.

The last of these arguments may frequently come close to a contention that the solicitor should have advised as to the commercial wisdom of the deal. With hindsight, "covenant-lite" transactions may no longer seem as acceptable as once they did! This argument may be thought to have taken a battering in cases such as Football League v edge ellison (2006) but it will not go away so long as solicitors offer commercial advice to their clients, effectively assuming the role of general "trusted advisor", and/or fail to document the terms upon which they are instructed in an engagement letter.

In the property field, lenders typically claim that they would not have lent (either at all or so much) but for their advisor's negligence. However, the outcome of such claims may be a little different from those in the '90s because judicial authorities established at that time with regard to causation, contributory fault and dishonesty have developed the law, and the CML handbook has further clarified the scope of solicitors' duties.

Litigation landscape

Procedurally, the legal landscape has also changed since the last recession, with concern at the cost of litigation promoting a major rise in mediation and attempts to streamline the conduct of large cases. The funding of litigation is also different now, with Conditional Fee Arrangements increasingly commonplace and the rise of after the event insurance and third party litigation funding. Lord Justice Jackson's current review of the costs of civil procedure is likely to lead to further major changes in this area.

One would need a crystal ball to predict the combined effect of all these changes upon the bringing of claims against lawyers and their outcome. However, it can safely be predicted that, if the recession is severe and prolonged, the volume of such claims is likely to increase significantly.

Risk management

Where claims against solicitors relate to work already done, it may be argued that the die is substantially cast. However, a review of sample files in identified problem areas can still provide benefit. This should not only help to develop a firm's risk management model going forward but can also assist to preserve evidence relevant to potential claims. Early identification of a problem can sometimes also lead to the mitigation of loss. Even where that is not possible, it may assist with the management of client relationships.

Finally, some potential claims may be avoided altogether by enhanced risk management. Points to consider here include the fact that the issue of large and unexpected bills without prior discussion with the client often generates unwelcome counterclaims in negligence. Poor vetting of new clients or instructions typically causes a range of future problems including conflicts of interest. And work done by lawyers without appropriate expertise, whether because they have been redeployed from a less busy practice area or as a result of "hoarding", carries obvious risk.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.