Mergers can leave a sting in the tail. Frank Maher explains the problems arising from successor practice provisions

Paying your own bills can at times be disappointing, but being forced to pay someone else's bills is rather more so. Yet it can happen, often unintentionally, with lateral hires and mergers.

A recent survey of the top 100 law firms' professional indemnity and risk management by Legal Risk reveals that even some top firms are still failing in their due diligence.

Horror stories abound, with firms caught up in other practices' money-laundering problems, major claims and more besides.

Firms can become practically uninsurable in the process, ending up in the Assigned Risks Pool sin-bin, where the premium for a firm with £10m turnover would be an astonishing £1.4m - just for the basic £2m cover.

The problem arises under the so-called 'successor practice' provisions in the Law Society's Minimum Terms and Conditions of Insurance.

This sets out the terms required for the compulsory insurance required of all firms in England and Wales - £2m, or £3m for limited liability partnerships (LLPs) and other incorporated practices.

These have the laudable aim of protecting the public and practitioners alike, by ensuring that as far as possible, when a firm ceases practising, there will be another firm whose insurers pick up the tab for any future claims.

The problem, however, is the burden of this does not always end up where one expects.

Firms which are splitting cause particular problems and several have caught a cold to the writer's knowledge.

A simple fictional but typical example: the partners in Walter Charles are splitting up.

There are two departments, corporate and litigation. The corporate partners are joining Capon & Co, and the litigation partners are joining Larks. The partners agree among themselves, and with the firms they are joining, that Capon & Co will be successor practice for any Walter Charles corporate department claims, and Larks will be successor for any litigation department claims.

However, they fail at the first hurdle - because the successor practice provisions in the Minimum Terms and Conditions take precedence over anything they may have agreed between themselves.

The rules are written in difficult language, which makes the rules hard to apply and open to conflicting interpretation. Trying to achieve the partners' objective through indemnities is difficult.

So which is the successor? Depending on additional facts, it could be either, neither or both. The simplest way to end up with successor liability is by holding out as successor.

The obvious example would be if, say, Capon & Co added "incorporating Walter Charles" on its notepaper - without more, that would make it successor for all purposes under the rules, not just corporate department claims but litigation too.

If Larks also put "incorporating Walter Charles" on its notepaper, both firms would jointly be successor. But this would not achieve the objective of making Capon & Co liable for corporate claims and Larks liable for litigation. Instead, both firms and their insurers would share all claims liability.

Firm rules
There are many other ways of holding a firm out as successor. The rules make clear that it can be expressed or by implication and contained in notepaper, business cards, electronic communications, publications, promotional material or otherwise, or contained in any statement or declaration by the successor firm to any regulatory or taxation authority.

So one stray email by an uninformed member of staff may suffice to land a firm with the liability. Even using the initials of a previous firm could be enough to cause a problem.

If neither firm holds itself out as successor, then other rules apply based on a variety of factors, such as the number of partners, but even these provisions cause difficulty in interpretation.

Some hard cases have arisen under these provisions. In several cases, firms took a course of action years ago when the demise of Solicitors Indemnity Fund was never foreseen.

The different rules which apply now change the consequences of that course of action.

In one case, a retired partner in a small firm sold his practice to a large firm and found himself liable for multiple £50,000 excesses on claims by mortgage lenders who were trawling through files long since closed. These he could ill afford to pay.

Rogue partners
In two cases, top 100 firms took on people from firms where other partners were later struck off for money laundering and similar transactions. Even though the firms had been careful not to take on the rogue partners, they found themselves on the wrong end of substantial claims for successor practice liability arising from the rogue partners' activities.

Yet Legal Risk's survey found that 23 per cent of top 100 firms are not checking successor liability when doing lateral hires. Better, though, than last year's 47 per cent.

Other firms have found themselves caught up in the massive £100m group action brought by insurers of the failed Accident Group. One medium firm took over a small Accident Group panel firm, only to find itself facing six-figure claims. Whatever the outcome of the case, defendant firms have had to throw massive resources at file reviews and co-operating with insurers.

The problem is compounded by the mechanism for resolving disputes, which is by arbitration between insurers. The insured is not a party, and the result is not necessarily binding on a firm's future insurers.

There are many steps firms can and should take when considering lateral hires and mergers. They should check they insurance position carefully before committing themselves, and should not assume that they have understood the provisions correctly if they are not used to dealing with them.

Careful thought needs to be given to the position on top up insurance, which is not bound by the same rules, and whether the firm intends to provide cover to a prior firm.

In some cases, transactions can be structured either to minimise the problems, or even to avoid them altogether as there are several devices which can assist given the right circumstances. IT

' Frank Maher is a partner at Legal Risk, a firm specialising in risk management and professional indemnity for law firms and insurers

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