Frank Maher says firms must prepare now for possible property-related claims in the future
This writer's last article, Life of PI, reviewed the past year in the field of solicitors' professional indemnity. This article looks at anticipated claims trends in property-related matters going forward over the next few years. Residential and commercial conveyancing account for over a third of claims against law firms, though the precise figure varies from insurer to insurer.
I commented in the previous article that in the absence of a downturn in the property market, conveyancing claims should not increase; that remains the case. It is unlikely that the property market will turn significantly enough this year to have any immediate impact on claims, as it takes time for a collapse in property prices to filter through into claims statistics.
Many steps generally have to take place before the claim comes in - borrower default, possession proceedings, and sale of the property with a shortfall.
It is probably not this year's insurers therefore who will feel too much of the pain for any errors made now, with the possible exception of those covering firms which go into run-off over the coming year. Claims numbers have been low in recent years, perhaps helped by anti-money laundering compliance which has forced firms to focus more on Know Your Client issues.
Daily we see offers of loans based on ever higher multiples of earnings - as much as five times or more - loans of 100 per cent of the value of the property, and generous offers of finance on buy-to-let. These are all cases where the lender may be heavily dependent on the value of the borrower's covenant to repay.
Any fall in the property market could be fatal to the repayment of loans such as these. Speculation has of course continued year after year that there will be a property crash and, with perhaps the odd local exception, it simply has not happened so far.
Perhaps the strongest warning yet came with the report from leading economist David Miles, chief UK economist of Morgan Stanley and former adviser to Gordon Brown, on 22 November 2006 advising that a housing market collapse is likely because house price growth has been fuelled by unrealistic expectations of double-digit annual rises.
A collapse in house prices should not make claims against lawyers inevitable: if they have not breached their duties to lenders, they should not face claims. But history relates that the reality is often different. And how can those who insure the legal profession be so confident that the lawyers are doing a better job than they were doing before the raft of property claims in the 1990s?
With the conveyancing world being cut-throat, lawyers paying estate agents to buy the work in, tight margins and legions of unqualified staff doing the work, in many cases with inadequate supervision, there may be no overwhelming reason to believe that anything is better than it was 15 years ago.
A few examples of firms that have undergone testing with Legal Risk's web-based system, Desktop, illustrate the point. Claims where firms have purported to act for a couple but one party has been defrauding the other are not uncommon. Yet there were mixed responses on whether fee earners took instructions from both at all times or ensured they had written authority from one to take instructions from the other.
Nor are staff always considering the Law Society's Warning Card which contains valuable guidance on lessons learned from the thousands of lender claims in the 1990s. Lack of partner supervision was also highlighted, and this is set to become a bigger problem with the increasing use of email and other risks associated with it, with claims coming in already. Some staff were even giving oral undertakings which is highly risky.
Even if firms have given the right advice, will the evidence be there on file to prove it? Again, test results from Desktop reveal a significant number of lawyers, even in the largest firms, have still not bought in to the need to keep attendance notes.
Environmental claims may also be an area of future exposure to large claims. I have defended a property claim 40 times the purchase price. In one firm tested with Desktop, half the respondents confessed that they were not confident in advising clients on contaminated land searches and indemnities.
Fraud claims are another area of concern, and these predominantly arise in property matters. A notable example was the lawyer who opened an account in the name of Ian Revue. He then stole £800,000 in stamp duty cheques intended for the Inland Revenue, but made out instead to 'I Revue' in sloppy handwriting. In one recent analysis of large claims against solicitors by leading law firm insurer St Paul Travelers, 10% of claims of over £1m involved fraud.
An alleged major property fraud centring on a firm of valuers has already had an impact on law firms. The first claim to hit the headlines related to an alleged £10m fraud on the Cheshire Building Society, but others appear to be emerging and the FSA issued a probably unprecedented warning of its type on 2 April 2006.
Equity release is a potential minefield. These are schemes where the elderly, who may be asset rich but cash poor, are encouraged to mortgage their houses to finance the continuation of their lifestyle in their existing homes; perhaps also funding improvements, holidays or purchases that they would not otherwise make.
Those with longer experience of the solicitors' professional indemnity market will remember the thousands of claims against several hundred solicitors in the 1990s; the writer acted for several of the defendants. It has taken a decade for the claims to meet their equal with the litigation arising from the collapse of The Accident Group.
Many in the financial services industry will seek to reassure us that the equity release products on the market now are very different from those which gave rise to the litigation in the 1990s, which is of course true. But the reassurance comes from those with a vested financial interest in selling the products and should be regarded with healthy scepticism.
Certainly, many of the schemes are far, far better than those set up in the late 1980s and early 1990s, which were in many cases doomed from the start. Many proponents of the new schemes speak as though a no-negative equity guarantee is the panacea for all ills. Yet even with no-negative equity guarantees there can still be no or insufficient equity (especially if there are exit penalties) to fund the next stage in the borrower's life, which may entail moving to more suitable accommodation, perhaps single storey or sheltered housing. The schemes carry real risk of post-transaction remorse.
A letter to The Times in 2004 contained a typical tale of woe. The correspondent was sorting out his mother's financial affairs following the recent death of his father. His parents had taken out a scheme to buy a car and help put his niece through university. Up until his father's death, his parents had received less than £25,000, but on sale of the property, the scheme provider would receive 75% of its value, then about £185,000. His 80-year-old mother continued to receive £100 per month for life but it was not index-linked. Solicitors had advised against the scheme but his parents had been desperate to help his niece following the death of his sister.
While the involvement of independent financial advisers should lessen the risk of liability on solicitors, it does not exclude it altogether, particularly where the solicitors have been lax about limiting the scope of their duty contractually. The Law Society of England and Wales has issued guidance to solicitors but its existence may not be well known and it is in any event far short of what is really required. Other law societies overseas have issued far more detailed guidance to their members.
Mystery shopper investigations into equity release mortgages have been done twice by the FSA. After reading those, it would no longer be safe to assume, if it ever was, that clients have received adequate financial advice.
The message? Firms need to be getting their 'ducks in a row' now - risk management will be rather less use when the conveyancing claims start coming in. IT
Frank Maher is a partner in Legal Risk Solicitors, specialising in professional indemnity, risk management and anti-money laundering. www.legalrisk.co.uk