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Credit crunch seminar: new challenges, new risks

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"You should certainly expect the unexpected, however unexpected that is" said Adam Applegarth on his resignation as chief executive of Northern Rock.  
 
At our seminar with Baker Tilly speakers George Bull and David Blacher, Frank Maher from Legal Risk LLP reviewed some of the unexpected issues for solicitors that have emerged from the credit crunch. Francis Dingwall of Legal Risk explains:

  • Client risk

    At the best of times, it is a high-risk strategy to sue a client for unpaid fees. It so often leads to a counterclaim for professional negligence.
     
    When times become harder, it is vital to preclude the need to sue. Firms should limit their exposure to clients by giving them full information on the likely costs at the outset, by billing very regularly to keep Work In Progress under control, and by obtaining money on account where possible. Client solvency is now a significant issue, given that even major financial institutions can fail. You should take into account even the possibility of sovereign risk.
           
    'Client account' risk (the risk of liability for the loss of clients' money held in the firm's bank account) has become an issue which resulted in the Law Society hastily issuing a practice note, recently updated. The risk may appear to have receded with the government bail-out of banks, but it cannot wholly be ignored, and there are simple steps you can take to mitigate the risk.
     
    Where work is scarce, as it is now in some sectors, overdependence on a client or market sector can be a significant risk. Not only can the scarcity of work subject people to undue pressure to achieve financial targets, but overdependence can also cause lawyers to bend to client pressure to push compliance with ethical standards beyond the limit.

    Desperate clients may be applying pressure.  AIRMIC (the Association of Insurance Risk Managers) has warned that the credit crunch may be a 'breeding ground for fraud', and mortgage fraud has already emerged as a significant issue. The only brake may be the unavailability of mortgages.

    Equity release schemes also caused a substantial number of claims against solicitors in the 1990s property recession. Despite assurances that many of the schemes are now safe (particularly those accredited by SHIP), there are still complaints. They have been identified by mortgage brokers as a business opportunity to make up for the loss of other mortgage work, and we can expect inexperienced salesmen to be busy. The client should be told to get advice from a specialist financial adviser as to the scheme's suitability for his particular needs, and the solicitor should be alert to the fact that they are generally not suitable for a borrower who intends to move house again during his lifetime.

    There are other, murkier, financial products, including examples of loan sharks buying houses from debt-laden homeowners and renting them back; soon afterwards, the rent increases dramatically, while in other cases the money is never handed to the debtor/seller. These are already giving rise to claims against solicitors. Lottery schemes for selling houses have been the subject of a Law Society Practice Note.
     
    Unpicking complex financial instruments, particularly those relating to securitisation of subprime mortgages, will doubtless cause problems. For an early example of credit crunch litigation, see J P Morgan Chase Bank v Springwell Navigation Corporation [2008] EWHC 1186 (Comm), involving a failed allegation of a duty to provide investment advice in relation to investments in an emerging market.
     
    Pensions may give rise to a number of claims issues. Pension trustees may be concerned about the strength of the company's covenant where the pension is underfunded (and note the guidance from the Pensions Regulator in October 2008); equally, however, there may be no benefit in putting the company in peril.
     
    Clients' investments in emerging economies – where returns may appear better than at home – are already giving rise to claims. These cause particular difficulties because obtaining appropriate representation locally to defend the claims can be a problem. The odds may be stacked against you in some jurisdictions, too.

  • Regulatory risk


    Clients who channel investments through solicitors' client accounts pose other risks. Over a year has elapsed since the Money Laundering Regulations 2007 came into force on 15 December 2007. The profession's compliance is supervised by the SRA, and firms need to be able to demonstrate compliance.
     
    The anniversary raises two issues, assuming that a firm put in place policies and procedures to comply with the Regulations a year ago. First, the requirement to monitor Anti Money Laundering policies and procedures calls for a review at least annually, and that time for review has probably arrived. Second, regulation 14 requires ongoing monitoring in the case of non-face-to-face clients, Politically Exposed Persons, and other high-risk situations. Firms should not allow financial pressures to cause them to do less, rather than more, going forwards. Some of the larger firms are having external audits, including the testing of staff.
     
    There has been press coverage of the recent FSA fine on the Money Laundering Reporting Officer of Sindicatum Holdings Limited.
     
    The Solicitors' Code of Conduct will give rise to further issues sooner rather than later. Among issues which are in the Regulator's sights are:
    • Rule 2.03 requires solicitors to give their client the best information possible about the likely cost of a matter both at the outset and, when appropriate, as the matter progresses. This is an area where, time and again on inspections by the Practice Standards Unit of the SRA, firms are found wanting. As noted above, it is an issue which solicitors should particularly focus on at this time, and this is a good example of regulatory requirements chiming in with commercial imperatives
    • Rule 9 (referrals) has received much unwelcome publicity, mainly in the area of Personal Injury, Miners' Compensation claims and volume conveyancing. The recent striking off of two partners in Beresfords merited headlines in national newspapers, as did the extraordinary level of their earnings, Mr Beresford reputedly earned over £16 million in one year. However, the issue does not stop there. It has relevance to all firms. The rule does not only apply where an introduction fee is paid; it applies wherever there is a referral arrangement, even if no fee is involved
    • The Regulator has taken action where he has discovered 'secret profits' in relation to charging for what were described as disbursements. CHAPS fees are the most common culprit, but the same issue applies to internal photocopying charges described as disbursements. Transparency of charging is a developing issue, with several firms under investigation over their web quotations for fixed price conveyancing, clouded by additional charges
    • As more solicitors encounter financial difficulties, the obligation in rule 20.04 may become more relevant: the duty to report a solicitor if you have reason to believe s/he is in serious financial difficulty which could put the public at risk.
     
    The Legal Services Act 2007 will doubtless herald a number of changes. We may in due course see an increase in the level of awards from the new Office of Legal Complaints for Inadequate Professional Services from the current maximum of £15,000; some commentators predict that it will increase to £100,000.

  • Risk and insurance

    Recent fears as to the security of banks and insurers teach the lesson that no financial institution is safe. Although you may think you have ample professional indemnity cover now, you also have to safeguard against the risk that the insurers will be unable to pay claims by the time those claims come home to roost. It is therefore particularly important now to look at alternative ways of protecting yourselves.

    Prevention is better than cure, and partners are under an obligation to the Solicitors' Code of Conduct. The publication in October 2008 of BS31100, a code of practice for risk management, is timely: it provides a template for a risk-management system. 

  • Conclusion

    The challenges and risks are great, and it would be easy to see it all as negative. But one lesson that emerges out of the credit crunch is the importance of 'no'. As one commentator put it: 'If a risk manager said 'no', he was immediately on a collision course with the business line.  The risk thinking therefore leaned towards giving the benefit of the doubt to the risk takers.' If we identify and address the issues, we will develop better client relations as well as mitigating some of the economic problems which may otherwise affect us.

    Credit crunch webinar - Managing new risks during the credit crunch

    If you missed the credit crunch seminar, then on Thursday 26 March 2009, 4pm to 5.30pm, you can see Frank Maher of Legal Risk LLP along with George Bull and David Blacher of Baker Tilly once again join forces in a 90-minute webinar (external link) to break down the risks that have arisen out of the credit crunch.