In the course of managing an accountancy practice; attracting new clients, handling your standard business or developing strategies for expansion, it would be understandable if the arrival of a legal claim against the firm took you by surprise.

It would, perhaps by definition, be somewhat unexpected.
And when relations with clients are broadly good, and you are frankly thinking about other things, the prospect of shifting into a mentality of ‘who did what and when,’ ‘was it negligent’ and ‘what are the damages’, is enough to throw anyone.

So what should you do when you receive a claim? How do you deal with the culture shock? And what are the key things to remember?

At the outset, you will tend to become aware of a claim not so much when the lawyers’ letter arrives, but when a client gets in touch, says Richard Farnhill, an associate in Allen & Overy’s litigation practice.

‘A client becomes aware there is an error, and raises it with the contact partner, or you may receive a letter. Lawyers are not involved right at the outset. You often find that while the client might think something is wrong, they don’t maybe know something is wrong,’

John Trotter, a partner in Lovells professional indemnity practice, says that the key thing to do at that stage is not to admit anything at the outset.
‘Never admit anything without telling your insurers. You may think “Something has gone wrong”, but even if you appear to be absolutely bang to rights your insurance policy will say you should not admit that without clearing it with them first,’ he says.

That can be a difficult thing to manage with your client.
‘Your first instinct will be to want to keep the relationship, to say “I am sorry. I don’t know how this has happened,” which could be taken as an admission,’ says Trotter.

Once your insurer has heard about the facts it may say there’s no point in fighting this case. Just because a mistake has been made does not mean that has caused the client a loss, so you should consider all the issues. There are two elements to any claim, says Farnhill. One is fighting it, and the other is the indemnity.

He pinpoints a whole series of issues that you could have with your insurer, quite apart from deciding whether the claim is right or wrong.

There is an inherent conflict of interest at times. ‘In fighting the claim, what you are looking to do is secure a win. You want to exit with the minimum cost to you, and the minimum cost to your reputation.’

The insurer, on the other hand, is purely attempting to minimize the financial impact.

There will be several kinds of claim you could face.
If it is the client suing you it could be that they are saying you got the audit advice wrong. They may be suing you for breach of the retainer, or the failure to provide services to an adequate level.

And it may not be just your clients who come after you, warns Farnhill. ‘The second class of claimants are third parties who have in some way seen or relied on the accountants advice. There were a lot of these sorts of claims in the 1980s and the 1990s, people saying we bought shares based upon the audited accounts.’

But it is harder to bring those sorts of claims, he argues.
‘The courts have taken a policy decision restricting the duty
of care, and accountants tend to make it clear that accounts are prepared for the benefit of the client and nobody else is allowed to rely on them.’
You can’t rule it out, though. ‘The disclaimer may be missing, or not wide enough,’ Farnhill says.

Where the relationship with the insurer comes in is when you have an issue over reputation, and the accountant wants to settle to avoid damage to their name.
‘There will be cases where we will want to settle to protect your reputation. There’s also a client relationship issue where you just want to settle it. This is where the question of insurance comes in,’ says Farnhill.

Often an insurance policy will contain in it clauses that restrict an insurers ability to settle the claim.
If you want to settle, and your insurers don’t, the insurers are restricted by the fact that although they have to give their consent to a settlement, that consent cannot be ‘unreasonably withheld.’

All policies will prohibit settlement without insurer’s consent.
‘Once you get lawyers involved, if a claim was to be made, you would expect to see correspondence right up to a formal claim letter. Some detail of what the claim was and the basis for the claim. That’s an important stage in proceedings. If you are claiming a quite considerable sum of money one of your accountants has the right to know why. Running parallel to this process you come back to the insurance policy,’ says Farnhill.

One golden rule, he says, is you must tell your insurer, often a difficult issue since most accountants will be worried that notifying them will just push up premiums for the next year.

‘If you don’t tell them, however, you are storing up two problems,’ he says. ‘The 2006 policy may require you to notify. When you do notify, the insurer will say “why didn’t you tell me about this earlier?”’

Farnhill asks, why give insurers the argument? ‘The second problem is that when an insurer grants an insurance policy, it is entitled to full disclosure of all material facts.’ In short, not telling your insurer risks jeopardizing both the 2006 claim and the 2007 policy. At a certain level the insurer’s interest is the same; you both want the claim to go away.

‘Involve them early, make them feel a part of the process they are much more likely to be reasonable when it comes to claims settlement or control,’ Farnhill advises.

Be careful about e-mails. E-mails to lawyers are covered by legal confidentiality says Lovells’ Trotter. E-mails around the office saying: ‘I think we haven’t got a chance on this claim, so and so was negligent,’ can be discovered, and are unlikely to look good in court.
If a claim comes in and the managing partner of the firm starts saying we really must find out what went on, those things are also not protected under disclosure.

As the case goes forward, if they are in line for paying out damages they may want to appoint the lawyers.

A lawyer will act for both the accountants and the insurers.
‘That can mean problems if there is a difference of opinion about whether the case should be fought. In the US, you almost always have one firm of lawyers fighting and another firm advising the insurers,’ Trotter says.
If there is a difference of opinion, the insurance policy will have some sort of mechanism to resolve that. QCs are instructed as if they are a judge deciding the matter.

You should also be careful to ensure that people do not go round shredding material. ‘You must preserve all your documents,’ says Trotter. ‘There’s an obligation to do that as soon as any claim is threatened against you. You have to give away in disclosure any documents that are relevant to the matter, in particular documents that help the other side. Obvious gaps will draw an adverse inference and possibly contempt of court. If it was shown that you deliberately and knowingly destroyed documents then that is a contempt of court.’

If you do so you could, at most, be fined. ‘You could forfeit the case or the judge could take a poor view.’

Trotter’s last tip is about PR: ‘Be prepared for bad publicity. Prepare a PR statement to give to interested media if it all goes public.’

Should you go to court or opt for arbitration?

Even with the prospect of facing court action, you might want to think about arbitration.

‘Arbitration is entirely possible if both parties submit to it. The advantage of arbitration is that it’s confidential and that limits the reputational damage,’ says Allen & Overy’s Richard Farnhill.

Going to the High Court is likely to be extremely expensive, he adds. ‘Litigation is not a cheap option. A High court trial with witnesses, disclosure and everything can cost £1m/£2m a side.’

However most feel that the key advantage of arbitration is confidentiality. It may be that the claimant would quite like to retain the option of going public with their complaint against you, but there are reasons why they would wish to do things privately as well.

Lovells advises that there are various contexts in which arbitration might be preferred with times where court procedures are likely to be lengthy and expensive being the main one.

In arbitration, parties are able to agree their procedures, in particular as to the level of representation in the arbitration and the extent to which oral argument is involved.

Arbitration will also most likely give a final decision with no right of appeal.