The importance of being classic

Quite often the team are approached by the solicitor on one or other side of a transaction, sometimes both sides, asking whether a proposed undertaking will be covered under the Master Policy or if it will be a ‘classic letter of obligation’. In some cases, solicitors are seeking support for their stance that it is or isn’t ‘normal’ or that there is or isn’t any ‘requirement’ for an undertaking to be granted or on the grounds that the proposed undertaking is reckoned to be unduly onerous.

Nothing in this article should be read as implying that a solicitor must grant an undertaking in particular circumstances. Whether that is a matter of professional practice or a matter for negotiation, it is certainly beyond the scope of this article.  

This article is concerned solely with the Master Policy implications of granting undertakings and letters of obligation although the two perspectives may not be very different.

The bottom line is – avoid giving undertakings except for appropriate undertakings in appropriate circumstances. But what is ‘appropriate’ from the perspective of the Master Policy?

Master Policy implications – in a nutshell

The bottom line is that –

• with only one exception (see comments below regarding personal financial guarantees) there is cover under the Master Policy for undertakings granted by solicitors in the ordinary course of their practice as solicitors
• for reasons of risk management, the Society have sought to encourage solicitors to grant undertakings only in appropriate circumstances and in appropriate terms by identifying three distinct categories of undertaking for which there is cover under the Master Policy, each attracting different treatment for Master Policy purposes, ranging from the neutral to the penal -
• at one extreme, ‘classic’ undertakings, which create the least risk of claims, benefit from a nil excess (ie. no Self-Insured Amount) and do not impact on the practice’s Master Policy premium discount/loading position
• at the other extreme, non-‘classic’ undertakings attract a doubled Self-Insured Amount contribution as a discouragement to issuing non-standard undertakings and the amount paid by the insurers will be taken into account for Master Policy premium discount/loading
• between the extremes is the category of ‘failed classics’ which are ‘classic’ in their content and context but which fail to comply with one or more of the conditions described below. The amount paid by the insurers will be taken into account for Master Policy premium discount/loading

Let’s look at these categories in a bit more detail -

Master Policy implications – Undertakings (not) covered

Only very exceptionally will cover be excluded for undertakings granted by solicitors in the ordinary course of their practice as solicitors. Clause INSURANCE 2 of the Master Policy Certificate of Insurance states that ‘The Insurers will indemnify the Insured against loss…arising from honouring any personal undertaking (but excepting personal financial guarantees) or letter of obligation given by the Insured in the Insured’s professional capacity in the Practice’.

Note that there is no cover for undertakings which constitute personal financial guarantees. It cannot be a matter for the Master Policy to stand guarantor for the personal financial obligations of a client or any other party.

There may be a further category of undertakings which while not amounting to personal financial guarantees are so extraordinary that they fall outside the scope of Master Policy cover on account of being beyond what is customary for solicitors in Scotland.

Master Policy implications

‘Classic’ or not ?

Having identified that most undertakings are covered under the Master Policy, the next issue is to identify which will be ‘classics’, which ‘failed classics’ and which ‘non-classics’. That distinction turns on whether or not various conditions imposed by SPECIAL CONDITION 3 of the Master Policy Certificate of Insurance have been complied with. These conditions relate to the context in which the undertaking is given, the content of the undertaking, qualifications which are attached to the undertaking and risk controls which require to be observed with a view to minimising the risk of a claim arising.

Context

What’s meant by ‘context’ is the situation or type of transaction in which the undertaking is given.

One of the profession’s criticisms of the ‘style’ of ‘classic’ letter of obligation circulated by the Society in 1995 was that the terms of the style wording suggested that a letter of obligation could only be ‘classic’ if granted in the context of a sale/purchase transaction. That is not the case.

Undertakings granted in a very much wider range of scenarios may be ‘classics’ provided the various conditions in SPECIAL CONDITION 3 have been complied with. SPECIAL CONDITION 3 effectively defines as ‘appropriate’ any situation involving ‘the disposal for onerous consideration of any interest in property of any description or the granting of security over any such property by a client of that solicitor..’.

That ‘definition’ is intended by the Society to reflect the fact that it may be ‘appropriate’ to give undertakings in loan/security transactions; in leasing transactions; in corporate sale/purchase transactions; in the context of conveyance of matrimonial property on divorce.

Content

It is not considered ‘appropriate’ for any solicitor to give a personal undertaking to deliver Planning Permission, Listed Building Consent, Building Warrant, Completion Certificate. Such undertakings are treated for Master Policy purposes as non-standard and, being ‘non-classic’, they attract a doubled

Self-Insured Amount (excess) contribution as well as being taken into account for future premium discount/loading.

It is accepted as ‘appropriate’ to give undertakings, subject to conditions, in relation to clear property and personal searches, executed/recorded Discharges and redemption receipts in respect of ground burdens and also to give undertakings in, or substantially in, the styles of letter of obligation set out in the Registration of Title Practice Book. SPECIAL CONDITION 3 specifies the undertakings which will be treated as ‘classic’ provided they are expressed in appropriate terms and subject to appropriate qualification.  

Qualification

SPECIAL CONDITION 3 stipulates that a qualification or proviso must be attached to any undertaking in respect of clear searches/clear title before it will be treated as a ‘classic’. Such an undertaking must be time limited so that it is effective for no more than 14 days from the date of settlement.

If an undertaking is in all other respects a ‘classic’ but omits the 14 day time limit, it will be treated as a ‘failed classic’ and the standard self-insured amount (excess) will apply and the amount paid by the insurers will be taken into account for the practice’s future premium discount/loading position.

Risk Controls

The term ‘risk controls’ in this context refers to enquiries made and precautions taken to ensure that there is the very minimum of risk attaching to the granting of an undertaking. If all aspects of the enquiries stipulated in SPECIAL CONDITION 3 are carried out, the risk of a claim arising from granting an undertaking is minimised. In summary –

• Don’t give undertakings in respect of –
• Executed/Recorded discharges – unless you have control of sufficient funds
• Redemption receipts – unless you are aware of the identity/whereabouts of the party entitled to redemption monies and you have available sufficient funds to redeem the ground burden

Clear searches/discharges –

unless you -

• have seen clear ‘interim reports’ on searches as close to settlement as possible
• can provide evidence to the reasonable satisfaction of the insurers that you have made proper enquiry of your client regarding outstanding securities and
• are unaware of any outstanding security other than those which you are in a position to have discharged

If, in spite of these enquiries/precautions, a claim arises out of an undertaking which is ‘classic’ in terms of context, content and qualification, then there will be no Self-Insured Amount (excess) payable by the firm and the firm’s Master Policy premium discount/loading position will be unaffected.

If these enquiries/precautions are not observed but the undertaking otherwise complies with the requirements of SPECIAL CONDITION 3, then any claim will be a ‘failed classic’ for the purposes of the Master Policy. The standard Self-Insured Amount will apply and the amount paid by the insurers will be taken into account for Master Policy premium discount/loading purposes.

Action points –

• ensure everyone involved in drafting/revising undertakings is aware of the terms of SPECIAL CONDITION 3 and the implications of granting non-standard undertakings
• review the style undertakings used in the practice to ensure they comply with SPECIAL CONDITION 3.

The information in this page is (a) intended to provide guidance on matters of practical risk management and not on issues of law and (b) is necessarily of a generalised nature. It is not specific to any practice or to any individual and should not be relied on as stating the correct legal position.

Alistair Sim is Associate Director in the Professional Liabilities Division at Marsh UK Limited (e-mail: Alistair.J.Sim@marsh.com)