Liability as an opportunity

The legal sector, perhaps more than any other, is where change is the norm and adapting to the constant flux of information received is not merely an objective, it is a necessity.

But while reactive strategy is often required simply to 'keep-up' with legislative changes and to ensure that best practice is maintained, it can also bring about significant opportunities.

Improving awareness of factors affecting the liability of senior management within private and public companies, and the subsequent insurance they require in order to protect themselves, is one such case. Legal practitioners who take the time to understand the ins and outs of corporate risk insurance, particularly directors and officers (D&O) liability, could reap the rewards in the current litigious corporate climate.

Revised Companies Act

So why is an understanding of this particular area so important now? The answer is down to the cumulative effect of several important legislative changes that have recently been, or are imminently to be, implemented. One such factor is the revised Companies Act, which finally received Royal Assent in November 2006.

Under the Companies Act (the vast majority of which comes into force by October 2008), companies are under greater pressure than ever before to self-regulate, with senior management figures being held more accountable for their actions and behaviour.

A legal requirement for greater transparency with regards to company information and proceedings, combined with a 'relaxation' on constraints surrounding business decision processes in order to allow faster paced corporate alterations, means that errors and omissions are both more likely and more visible to interested parties and shareholders.

On top of this, directors duties have been codified in the new Act, which has seen the addition of a new duty to 'promote the company's success', requiring consideration of numerous factors, ranging from long terms consequences to effects on staff. As well as increasing the bureaucracy burden on companies, this also leaves directors open to greater scrutiny, particularly as under the Act shareholders also now have a codified right to bring 'a derivative action against directors for negligence even if the directors concerned have not benefited from their negligence', and can sue if a 'breach of duty' is perceived to have occurred.

Changes to the Fraud Act

Another major factor affecting senior management liability, are the changes that have been made to the Fraud Act in 2006. As well as adding a new offence, with regards to obtaining services dishonestly and possessing, making or supplying equipment to commit fraud, the Act also expands the definition of 'abuse of power' to include exposing others to the risk of loss '“ it is not necessarily the case that an actual loss has to have occurred. The consequence of this is that actions can be brought against directors with 'less substantial' evidence than previously required.

The simultaneous arrival of these two key pieces of legislation, together with all the standard threats facing company directors and senior management, such as HR issues, breaches of customer/supplier contract, means that company director and senior management liability has never been greater. But what can they do to protect themselves?

D&O protection

Taking out D&O liability insurance is one important option. D&O insurance provides financial protection in the event of a legal case being brought against the policy holder. Importantly, particularly where accusations of fraudulent activity may be brought, this money cannot be withheld from the policy holder in the event of an assets freeze.

As well as protecting directors, D&O cover can also protect anyone within a company who operates at a managerial or supervisory level for example, who have some degree of internal corporate responsibility.

The protection can also be extended to incorporate a company as an individual entity, providing a valuable cash safety net in the event of prosecution.

An important point here is that while the financial 'pot' available through D&O insurance is primarily of use with regards to ensuring effective legal representation, it also protects a company should a key individual within the company be found guilty. For example, should a director be found guilty of fraud under the revised legislation and subsequently convicted, this could have a significant effect on company revenue. D&O insurance can offer financial support in this eventuality.

The benefit of D&O liability insurance to directors and senior managers is clear, given that legislative changes make being prosecuted increasingly likely, but why should legal practitioners care? The answer is cause and effect. Firstly, private clients that fall victim to this climate of liability, and that do so without insurance, may well not be able to afford the legal services they would wish for '“ a situation which is not good for business.

Secondly, and more likely given that companies are undoubtedly aware of the liability issues highlighted in this article, is the scenario whereby legal firms that either operate alongside a broker of have their own D&O scheme will simply hold greater appeal to potential clients than those who fail to address this issue.

A firm may display an impressive portfolio of corporate risk defence cases but that is worth little if the funds are not in place to secure those services.

Legal aid reforms

I could not cover this subject adequately without reference to the proposed legal aid reforms generating so much debate within the industry. By replacing hourly rates with fixed pricing, with the intention of 'rewarding efficient practice', the reforms (according to the Constitutional Affairs Select Committee) are likely to cause unsustainable cuts in solicitors' income' and will reportedly see the closure of around 800 UK law firms unable to operate successfully under the new pricing structure.

While consultation on the proposals has led to an admission that 'things aren't quite right' and consequently the current proposed changes are likely to be significantly modified, one thing that is for sure is that legal aid budgets will be slashed.

Therefore, with fewer legal aid cases possible, the volume of private client business is likely to increase '“ private client business for which financial defence costs are particularly important. A law firm which is able to advise and recommend appropriate insurance in such situations is well positioned against competitors. What is more, they also act in line with Law Society recommendations regarding best practice.

The short of it is, market conditions have created a climate of liability for UK businesses that has not been witnessed before. Law firms should be looking now to see how they can build insurance into their service portfolio, whether by taking matters in- house or, more likely, working with an established broker in the field to develop an appropriate package to target potential and existing clients. Those that do not could well be missing out.