Covered by the terms?

Updated guidance published by the Law Society of Scotland highlights that: “A well drafted letter of engagement is a useful risk management tool which can have real benefits for solicitors and their firms… and help to minimise the risk of complaints at a future stage”.

In light of this recently updated guidance, it is an appropriate time to consider the scope for improving the effectiveness of terms of engagement in reducing the risk of claims. This article and next month’s will comment on the experience of Master Policy intimations where more effectively framed terms of engagement could have helped avoid misunderstandings leading to potential claims.

1. Who is the client?

Who is the practice representing? That sounds completely straightforward, and often it is. However, sometimes the circumstances surrounding the instruction are more complex, requiring careful consideration of who the practice is and is not representing.

Consider the following example:

A firm was instructed by a lender to prepare a standard security by a company in relation to a commercial loan transaction. The firm also acted for the company. A guarantee was to be granted by one of the company’s directors. The firm had previously represented the director individually in relation to other commercial matters.

Following default and calling up of the security and guarantee, the director alleged that the firm had been negligent in failing to advise him in relation to the onerous terms of the guarantee. The firm was clear that it was not advising the director.

The director’s allegations would have been more readily answered if the terms of engagement and other communications had been more explicit about who the firm was and was not representing.

2. Scoping the engagement

The importance of documenting and communicating clearly what is included, and what is not included, in the scope of the engagement sounds obvious. Again, this very often is straightforward – but the Master Policy experience includes examples of situations where a lack of clarity caused or contributed to misunderstandings.

As an example, when defining the scope of the engagement, consideration needs to be given to whether taxation advice is or is not included. If not included, the safest approach is to state that expressly. Where terms of engagement are silent, there is a risk that advising on tax matters will be deemed to form part of the practice’s responsibilities.

Even where the client is known to have the services of accountants or tax advisers, it is not necessarily safe for the scope of the engagement to be silent on this point.

In one case, a practice handling a commercial transaction, aware that accountants had been engaged, assumed that the clients had had the benefit of advice on the tax efficiency of the structure of the transaction. After the clients incurred a substantial and avoidable tax liability, it became apparent that this assumption had been incorrect. The accountants’ remit was very narrow and excluded tax advice. This had been agreed with the client and clearly defined in the accountants’ terms of engagement. The solicitors’ terms of engagement were silent with regard to responsibility for tax advice, leaving the solicitors exposed to allegations of negligence.

Scope for such misunderstandings is not confined to responsibility for tax advice. Similar considerations might equally arise where clients’ transactions involve input from, for example, financial advisers, estate agents, insurance brokers or surveyors. Their activities could potentially overlap with solicitors’ responsibilities. If the scope of the practice’s role and responsibilities is left unclear, there is the risk of misunderstandings which could leave the practice at risk of a claim, particularly if the other professionals have explicitly excluded responsibility in their terms of engagement, or in the event of insolvency of other professionals who are therefore unable to meet any claim against them.

Risk management points

A blanket exclusion of responsibility for tax advice might seem a sensible approach. In certain areas, however, taxation matters cannot be avoided, for example inheritance tax in relation to trust and executry work, and land and buildings transaction tax in property work. If the practice is acting in a corporate transaction, tax warranties and indemnities may need to be drafted/revised. In all of these scenarios, limitation of the scope of responsibility for tax advice would need to be addressed with care. For example, in relation to drafting of contract terms it should be made clear if the drafting is being undertaken on the basis of advice given by the client’s tax advisers (ideally named in the terms of engagement).

3. Payment instructions

Tackling payment instruction frauds has been the subject of previous articles. In perpetrating these frauds, criminals take advantage of misunderstandings about the security and reliability of email communications, targeting payment instruction emails by clients to solicitors, by solicitors to solicitors, and by solicitors to clients.

Risk management points

Some solicitors have adopted a practice of eliciting their clients’ payment instructions and bank account details at the outset and hardcoding them into the terms of engagement. As well as providing a record of the client’s payment instructions, such provisions serve to alert the client to the fact that any change of instructions, e.g. in an email, will require the solicitors to take steps to verify to their satisfaction the authenticity of the new instruction. This may result in a delay in funds being remitted to the client.

It is apparent that criminals are not just targeting funds transfers by solicitors. They are also targeting transfers arranged by clients. Criminals are known to have sent emails in which they masquerade as solicitors and advise clients, falsely, of changes in the solicitors’ banking arrangements. The objective is the same – to trick clients into remitting funds (e.g. the deposit for a property purchase) to the criminals’ bank account, believing it to be the solicitors’ client account.

Some firms are including reference in their terms of engagement about the arrangements for clients remitting funds by direct transfer and warnings about the risk of payment instruction fraud. If this approach is adopted, the firms’ terms of engagement typically include details of the client bank account and a statement to the effect that clients should not act on any email received, purporting to be from the firm, advising of a change to those account details. For completeness, some firms have chosen to include a brief explanation of payment instruction fraud together with a warning to be alert to these fraud risks.

Why not complete the Marsh eModule on terms of engagement, available at www.marsh.co.uk/login/lawscot?

All e-learning on the website is free and qualifies for CPD. Please contact nada.jardaneh@marsh.com if you require a reminder of your firm’s login details or are having any difficulty logging on.

Nada Jardaneh and Marsh

Nada Jardaneh is a former solicitor in private practice, who works in the FINPRO (financial and professional) Practice at Marsh, a leading global insurance broker and risk adviser.

Statements concerning legal, tax or accounting matters should be understood to be general observations based solely on our experience as insurance brokers and risk consultants and should not be relied upon as legal, tax or accounting advice, which we are not authorised to provide.

The information contained in this article provides only a general overview of subjects covered, is not intended to be taken as advice regarding any individual situation and should not be relied on as such. Insureds should consult their insurance and legal advisers regarding specific coverage issues.

Marsh Ltd is authorised and regulated by the Financial Conduct Authority.