Limiting liability

The idea of limiting a law firm's exposure to a negligence claim from a disaffected client is not new. However, it has taken some time for the concept to catch on throughout the profession. While up to 75% of firms perceive the need for limiting liability, only around 30% routinely cap their financial exposure, according to figures from PricewaterhouseCoopers.


The resistance often comes from partners, who are more concerned about how their clients will react to their lawyers telling them that they want to introduce a liability cap than the clients themselves. Anecdotal evidence suggests that many clients are not the slightest bit concerned and many are familiar with liability caps imposed by their accountants and other professional advisers.


Liability capping makes sense as part of a comprehensive risk management programme and, indeed, many professional indemnity insurance underwriters now look for capping as evidence of prudent risk management. However, firms should take care that they set limits sensibly and have a clearly thought-through procedure for setting and imposing those limits. A liability cap that fails when challenged could arguably put the firm in a worse position than it may have been if it had not chosen to limit its liability at all.


First, bear in mind that liability caps are only permitted for non-contentious work - so a firm-wide diktat that a set form of words should go into all engagement letters would not be a good start. Secondly, ensure that any cap would meet the test of reasonableness from the Unfair Contract Terms Act 1977. As ICL v St Albans City & District Council, The Times, 11 November 1994, tells us, a liability cap set well below the commercial risk inherent in a contract is bound to fail.


Also, consider the cap in terms of the firm's overall limit of professional indemnity insurance. Different solutions will suit different firms, but one school of thought argues for setting the liability cap at a figure that matches the firm's limit of indemnity, while another says the limit of indemnity should be set at a higher level to provide comfort if the cap is set aside for any reason. In any event, do not set the liability cap above the total limit of indemnity as this defeats the original objective.


Firms also need to exercise caution when setting a client-specific limit, particularly if this is set at a level above the firm's normal cap. In this event, ensure that the limit of liability of professional indemnity insurance cover matches or exceeds this figure not just for the term of the contract, but until any possible claim of negligence in relation to that work is time-expired. Professional indemnity cover is written on a 'claims-made' basis - so the liability will be borne by the insurer providing cover when the claim is made, rather than when the negligence is committed - even though this may be many years after the event.


This column was prepared by AFP Consulting, a division of Alexander Forbes Risk Services UK