Skeletons in the closet

Before the economic downturn, the failure
of a large, high-profile
firm was virtually unheard of. However, over the past couple of years, we have not only witnessed a significant number of smaller firms being unable to secure professional indemnity insurance (PII) cover but we have also seen some large, longstanding firms shut up shop. With the challenges facing firms not about to let
up any time soon, it is likely
that we will continue to witness firms desperately trying to make their business more attractive to insurers by considering expansion, mergers, acquisitions, and
so on.

However, while a merger may solve the problem of securing
PII cover, merging in a panic without doing your homework often leaves a bitter aftertaste. This was undoubtedly the case in McManus Seddon Runhams (a Firm) v European Risk Insurance Company [2013] EWHC 18, which concerned a claim by McManus Seddon Runhams (MSR) for a declaration from the court that a blanket notification to the firm’s insurers, European Risk, was valid.

Merger mistakes

Runhams, a high-street
practice in Bradford, acquired the practice of Sekhon Firth in 2010.

McManus Seddon, also a well-regarded high-street
firm, which had a previously unblemished PII record, then merged with Runhams in 2011, creating MSR – a successor practice to Sekhon Firth and Runhams.

After Runhams’ acquisition
of Sekhon Firth, three former members of Sekhon Firth
were subject to disciplinary proceedings before the Solicitors Disciplinary Tribunal, and one of the former members admitted creating false documents and misleading clients.

MSR later received a claim from a former lender client of Sekhon Firth alleging, among other things, a breach of fiduciary duty. Then came the influx, and by May 2012 a further 17 claims had been notified to European Risk. All related to conveyancing transactions conducted by Sekhon Firth (pre-Runhams acquisition).
MSR decided to raid the archives to see what other skeletons were lurking, and a ‘consistent pattern of breaches’ by Sekhon Firth was identified, as well as evidence suggesting that some of the case handlers at Sekhon Firth did not have sufficient expertise to conduct transactions.

In 2012 MSR sought to make a blanket notification of all cases conducted by Sekhon Firth and Runhams (some 5,000) as circumstances that could
give rise to a claim.

In the notification, MSR acknowledged that the due diligence carried out for the Runhams’ acquisition now appeared ‘grossly inadequate’, and that staff who had arrived from Sekhon Firth had confirmed, when interviewed independently, that the ‘practices exemplified in the files giving rise to claims…were indeed endemic in the firm’.

Invalid notification

European Risk rejected the notification, stating that simply listing Sekhon Firth’s files
did not constitute a valid notification as there was a lack of particulars concerning, for example, the act or omission giving rise to the claim.

What followed was a series of events which had a devastating effect on MSR. European Risk refused to renew the firm’s cover. The firm was unable to secure other insurance and so, in October 2012, entered the assigned risks pool. MSR was effectively uninsurable. The firm was under threat of losing its Legal Services Commission contract (representing 36 per cent of its work) and faced
the prospect of closure.

Complete crisis was, it seems, averted (but at what cost?)
when the High Court ruled that European Risk’s rejection of
the notification was wrong. Although the High Court refused to grant declaratory relief
(a point upheld on appeal), it found that European Risk had been wrong to accept some
of the claims and reject others. Instead, the court decided that issues regarding the limits of
the circumstances notified were better left to be considered
if (and when) a claim arose.

The MSR decision serves
as a salutary reminder of the importance of undertaking constructive due diligence before becoming a successor practice. Firms considering such a move should always ensure that their due diligence exercise involves, at the very least, a thorough analysis of the claims and complaints history of the firm being acquired (and its predecessors). Even evidence
of a clean record is not always enough – that won’t show what a rogue partner has been up
to, for example. Therefore, conducting sample file reviews across the different departments and getting to know the firm’s culture and working practices
by talking to staff is essential.

If the intention is to become a successor practice (and run-off cover isn’t an option), then PII insurers should be involved at the outset of talks, particularly given the PII implications (possible increased premiums, issues with renewal, etc.).

In MSR’s case, the firm did enlist outside assistance from compliance specialists, but that was when the claims came to light – by which point it was too late. Perhaps, had they done so at the outset, they could have avoided much of what transpired. SJ

Jennifer Haren is a solicitor at Weightmans

@Weightmans