Imagine this scenario: you are working in a City firm and have been given your own deal to run. You have been at work for 20 hours poring over hundreds of documents for your client, a businessman who wants you to negotiate an agreement between some of his companies and an investor.
After 10 hours of coffee and Pro Plus, your sight is going blurry and you fail to notice a crucial line in the contract drafted by the other side's lawyers which states that the investor has the right to remove your client from the companies' boards. The other side goes away and celebrates your mistake, the deal is signed, and your client is subsequently removed as a director and loses his stake in the companies and millions of pounds. The result? The client brings a professional negligence claim against your firm, suing it for a large part of its annual turnover.
The firm is protected by its professional indemnity insurance. However, under the same principle that if you crash your car your motor insurance goes up, a hike in its premium could really hurt the firm. Especially this year.
Since September 11 2001, insurance companies, which invest a large chunk of their clients' money on the equity markets, have been doing about as well out of the recession as Iain Duncan Smith at a Gay Pride march. When insurers lose money they pass the losses onto clients, in what is known as a 'hardening market', and the price of insurance goes up. Like any other insured business, law firms are exposed to this.
Until 2000, law firms were insured by the Solicitors' Indemnity Fund (SIF), their own mutual insurer run by the Law Society. But the profession has since moved on to the open market and firms now buy their cover from a group of around 27 insurers, the largest being Zurich and The St Paul.
Firms buy this cover in tranches. They have to be insured for at least £1m, although many of the top City firms are indemnified for several hundreds of millions. This year, for the first £1m tranche alone, the profession saw the total cost of premiums rise sharply, by £55m to £221m.
But the real crunch for any firm comes when a client sues for more than the firm's insurance cover. As the firm's owners, partners are personally liable for any excess and a major claim could put their houses, holidays and life savings on the line.
Sixteen-partner City firm Maxwell Batley recently faced this situation, but mercilessly escaped unscathed. The firm was sued for £45m by a former employment adviser of its client Sita. Sita had sued actuarial consultancy Watson Wyatt for £45m, which in turn tried – unsuccessfully – to pass the claim on to the law firm. This was the largest negligence claim brought against a firm since SIF's demise. As the firm was insured for only £20m, there are no prizes for guessing what would have happened should it have lost the case.
However, a preventative solution is now on offer: limited liability partnerships (LLPs), which ringfence partners' potential liability. Most US firms already have LLP status, but they have only recently become available to UK firms. There is almost universal interest but few have made the conversion, largely due to fears that firms with international offices – particularly in Germany – will be subject to adverse tax treatment. Clifford Chance is now set to lobby the German tax authorities on behalf of the UK's largest firms and, if successful, there could well be an explosion in the number of UK LLPs.