PracticeAccounting FirmsProfessional indemnity: handling a claim

Professional indemnity: handling a claim

Our reporter looks at how you should respond when a client claim comes out of the blue

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

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

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

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

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
‘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

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

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 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

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