FINANCIAL PROTECTION FOR CLIENTS IN THE BRAVE NEW WORLD OF LEGAL SERVICES

  “Your birth is a mistake you'll spend your whole life trying to correct.”  Chuck Palahniuk

As the small print and practical details of all the issues arising from the implementation of the Legal Services Act 2007 are thrashed out, it is becoming clear that this delivery will not be a simple natural birth.  The Legal Forums regularly include comments about the risks of non-professionals absconding with their client’s monies, (usually to “Fraudistan” while equally vociferously, other contributors declare that there are just as many stories of regulated solicitor’s firms cleaning out their clients monies. These differences are highlighted even further by the recent press releases from The Law Society, The Legal Ombudsman and the Solicitors Regulation Authority (SRA) setting out their own views on what levels of protection are required while trashing the other organisations solutions. 

With regard to Alternative Business Structures (ABS’s), the risks remain unclear but a key objection appears to be whether a normal business entity can undertake to provide reserved legal services with an even balance so that the commercial imperative does not act against the public interest. The Lord Chief Justice in his response to the CLC consultation paper on Outcomes Focussed Regulation states that “reserved activities must be regulated in the public interest and not merely in the consumer’s interest of reduced cost and greater competition”. 

The issue of whether all legal activities need to continue to be reserved, and whether there is actually a conflict between a better service for the client and the public interest is still not fully addressed, and a cynical observer might consider that for some specific types of legal service the public interest is merely a synonym for old fashioned protectionism.

What exactly is Financial Protection for Clients?

Client Financial Protection encompasses business processes, risk management and internal controls, but in the final resort the protection comes from Insurance. Professional Indemnity Insurance (PII) is an accepted necessity for all Service Providers, especially for professional services where the consequences of bad or inaccurate advice can be costly. Legal Services are inherently intangible and a private consumer can struggle to assess the quality of the service; there is a disparity between the level of technical and factual knowledge and understanding between the consumer and the service provider – this is known as “information asymmetry”. Buy a kettle from a department store and you know within hours whether the product works or not. But with Legal Services, the consumer can be disadvantaged because very often the outcome will not be known until many years later – for example the Trust written today may not be shown to be ineffective until many years later.

The current compulsory insurance arrangements for solicitors are set by the SRA.  All Solicitors in private practice are required to have in place an insurance policy through a panel of qualified insurers providers (QIP) who are authorized to conduct insurance business in the UK and have signed an agreement with the SRA. The agreement specifies that the policy must comply with specific minimum terms and condition (“MTC”). The Financial Services Authority regulates insurers that are authorized to conduct insurance business in the UK and, accordingly, regulates all qualifying insurers.

One of the key objectives of this system is to have in place insurance to protect clients. However the recent Charles River Associates Report commissioned by the SRA (The CRA) which considered the different structural models that could be used to deliver professional indemnity insurance (PII) as well as the detailed terms and conditions of that insurance, concludes that although Insurance may be critical for private individuals, there is no reason why any intervention is needed to support clients where there is no asymmetry of information – for example Corporate Clients who are repeat purchasers and can ensure for themselves that their supplier is adequately insured. The Law Society have aggressively come out against this recommendation.

A further key element of this insurance scheme is the Assigned Risks Pool (ARP) which will provide qualifying insurance for a limited time to those firms who are unable to obtain cover from the market. These policies are underwritten by the panel of QIP who are also prohibited from avoiding or repudiating a claim on any normal exclusion clauses (for example non disclosure of material facts or non payment of the premium) and additionally have to provide run off insurance for 6 years if a firm ceases within having a successor in place. The SRA are now proposing that the time that an ailing law firm should be allowed to stay in the ARP should be cut. The Law Society state that this would simply hasten firm’s closures and again are adamant in their opposition.

Finally there is a dishonesty exclusion within the MTC whereby no compensation will be paid by a QIP if all the principals of a firm have been dishonest and client monies have been lost. For an Insurance Company, it is untenable that they should be forced to cover individuals who have taken out the policy, carried out the fraud, and are then able to claim successfully against the policy. This risk is very specific to Solicitors and the way that their businesses are structured and is covered by the Solicitors Compensation Fund which is the final safety net for consumer. Most claims against the Compensation fund are made as a result of problems caused by small legal businesses where there is a sole practitioner or 2 partners who have created the problem.

The balance between protecting the consumer while supporting a competitive market has been increasingly hard to maintain in recent years and it is clear that the current arrangements are not sustainable, with growing concern, particularly, about the numbers of firms entering the Assigned Risks Pool (ARP), the substantial increase in claims and as a result the increasing costs.

What is the position for Alternative Business Structures?

The client protection arrangements for ABS’s are currently non mandatory and existing businesses will have in place their own Indemnity Insurance Arrangements. 

However for ABS’s there are some unanswered questions including:

1. Will ABS’s will be required to use a QIP to obtain Professional Indemnity Insurance? The terms under which an Insurance provider can qualify are unusual – for example they cannot repudiate or avoid a claim that in a normal market would be excluded? The MTC requirements need to be carefully reviewed and adapted to reflect normal market conditions. For example, non-payment of a premium should result in cancellation of the policy and there should be no artificial arrangements to allow an entity to continue trading without insurance.  They should be forced to explain to all their clients that they have no insurance in place and in a very short time the market would decide whether that business survives or dies.

2. Will there be a situation where an ABS has to enter the Assigned Risk Pool? The ARP is in place principally to deal with the rehabilitation of firms who are in difficulty, providing temporary cover where there are problems in renewing insurance or where an existing policy does not give sufficient protection. However the lion’s share of all claims made against the ARP arises from conveyancing claims and from firms that have closed down and enter a run-off period. It is no co-incidence that these disorderly run downs arise in firms that should have been prevented from trading much earlier on in their lives and that better oversight and prompt action from the Regulator could have prevented these losses.

3. Will an ABS have to contribute into the Solicitors Compensation fund?  The sole purpose of the Compensation Fund is to protect clients who have lost client monies and to provide cover for own fraud. This is a specific risk for the Solicitors market, and for any other professions who trade as Sole Practitioners or in partnership. This risk is excluded from their policies. However in most commercial entities trading through a Corporate Body and for some other professions including the Accountants, fraud is covered by their insurance. Regulation can be applied to ABS’s to ensure that insurance is in place and to take action if it is not. ABS’s have access to Insurance Policies that cover fraud and should not be penalized by having to pay into the Compensation fund

Conclusion

The experience of Kings Court Trust Corporation is that Insurance should not be seen as a cost but as a business enabler. Risk Management needs to be part of the attitude and culture of a service provider coupled with systems and procedures, technical ability and accountability to staff and clients and adequate protection if the worst happens, with the Insurance Policy as the backstop.

The argument presented by some legal firms is that to provide full client protection, there needs to be a level playing field for all organizations offering legal services. The reality is that there is a fear of commercial disadvantage if new entrants are not subject to the same restrictions as Solicitors. A shake up of the Indemnity Insurance Rules for Solicitors is timely and must be completed before ABS’s can be forced into this bracket. This must include shifting the focus from the conduct of individual lawyers towards the regulation of the entity providing the legal services.
 
More importantly the disagreements between the representative body, the complaints body and the regulator must be resolved; this can only demonstrate to the interested consumer that the key players still have no consensus. With the deadline rapidly approaching at which time the regulatory landscape is meant to be fully in place, these discussions can only confirm once more the lack of clarity on what are the risks of opening the market to ABS’s

Kings Court Trust Corporation plc is a leading Independent Probate and Estate Administration Provider which expects to be regulated as an Alternative Business Structure.

William Feeny is a Director at Kings Court Trust Corporation. You can reach him on 01225 787107 or at william.feeny@trustcorporation.com.