Protecting clients' financial interests

The Solicitors Regulation Authority (SRA) has invited discussion on reform of the Compensation Fund (CF) run by the Law Society and the associated impact this might have for firms on their professional indemnity insurance (PII). 

Most CF payments are necessary as a result of intervention by the SRA on the grounds of suspected dishonesty, breach of accounts or other rules, and financial difficulty. The fund also makes grants where the authorised individual or firm has failed to take out qualifying insurance. 

The SRA disclosed that 1,699 claims, valued at £56.73m, were made to the CF in 2014. The majority related to firms’ failure to account, payment of conveyancing costs (in particular, failure to pay stamp duty and land tax), and probate matters. 

Three main areas of potential change to the minimum PII requirements, which the SRA discussion document highlights and which could impact on the CF, are:

• The level of protection for clients;Potential removal of the requirement to cover partner fraud; and Potential removal of the obligation on insurers to provide extended cover.

• ??Potential removal of the requirement to cover partner fraud; and ???

• Potential removal of the obligation on insurers to provide extended cover. 

The minimum PII cover requirements are:

• Cover for all clients regardless of size or sophistication; and

• Cover of at least £2m per claim for a partnership and £3m per claim for a limited company or LLP.

These minimum requirements represent a disparity with the CF, which last year removed (subject to some limited exceptions) the right to claim on the fund for any business with an annual turnover of more than £2m.

The question therefore arises: should the minimum requirements for PII match the eligibility of claimants of the CF?

Who is covered?

The SRA has previously recommended that minimum PII requirements should only be set for clients that are individuals, small and medium-sized micro-enterprises, trusts, and charities.

This proposal was met with much opposition, not least because there was a lack of clarity about precisely who would be covered under the proposals.

Current requirements mean that PII covers the liabilities of principals arising from the fraud of others. This means that as long as at least one principal was not involved in the fraud or dishonesty, any related claim will be dealt with under the firm’s insurance policy. 

There is consideration now about whether the removal of this element of compulsory cover will encourage better internal management, and whether it will open up a wider choice of products and insurance rates should a firm choose to take out such insurance independently. The risk for the CF is that as a result of removing this mandatory requirement, there will be more claims on the CF that would previously have been covered by insurers.

Extended policy

Insurers are required to provide a policy that includes an extension for up to 90 days beyond the renewal date – the first 30 days (the extended indemnity period (EIP)) in which a firm can carry on its practice while it seeks replacement insurance, followed by 60 days (the cessation period (CP)) in which the firm cannot take on any new work and should simultaneously prepare for an orderly closure. If insurers were released from this obligation to provide cover in the EIP and CP, then inevitably the cost of PII would go down and firms would perhaps look at their renewal options far earlier. 

However, removal of a buffer period could carry an increased risk that firms would continue practising without insurance,  and there is concern that this could have a knock-on impact upon the use of the CF. 

Clearly, any changes in the minimum PII requirements are likely to impact the cost of PII for firms, and changes to PII that impact the CF are, in turn, likely to change the contribution fee to the CF (currently an annual flat-rate fee contribution of £32 for all practising certificates and £548 where that firm holds client money). 

As part of this discussion, there needs to be consultation between the SRA and insurers as to the likely impact upon PII costs that any changes might have, so that they can be adequately weighed up against any potential downside of such changes to both PII and the CF. 

The legal market has moved on significantly since 2010, when client protection arrangements were last considered in detail. New entrants to the market, such as multi-disciplinary practices and alternative business structures, must be considered as part of this exercise to ensure that the rules are not prohibitive or cumbersome for such practices, all while maintaining a level playing field for legal service providers and the protection of their consumers. SJ

Jennifer Williamson is a business services partner at accountancy firm Kreston Reeves @KrestonReeves