Raising the legal premium: law firms hunger for higher professional malpractice liability limits as they come under fire because of conflicts of interest, unscrupulous clients, complex deals and larger scale

Risk & Insurance, Oct 15, 2006 by Patricia Vowinkel

Attorney Ron Shechtman remembers a meeting he had with a client not long ago.

The meeting was to take place in the office of a law firm in Hartford, Conn., a convenient midway point between the client who was based in New Hampshire and Shechtman, a partner with the New York law firm Pryor Cashman LLP.

But before the meeting could take place, the Connecticut law firm first insisted on knowing the names of everyone who would be at that meeting so that it could do a conflict of interest check--even though it was only lending office space to Shechtman and was not representing anyone at the meeting.

"I was taken aback by this degree of care," Shechtman says. "But they explained they were part of this insurance group and this was one of the requirements under which they were bound to comply."

That's just one example of how seriously many law firms, and their insurers, are taking the threat of legal malpractice claims.

And it's no wonder. A series of headline-grabbing corporate frauds and multimillion dollar malpractice claims over the past few years have made it clear just how vulnerable law firms are to the individual mistakes of their partners.

Law firms have come under fire because of their relationship with companies involved in high-profile frauds, such as Enron, Tyco and WorldCom.

"The debacles of many of these corporate failures or frauds that marked the end of the last century and the beginning of this one created financial disasters for everybody around and associated with the corporate entities, Shechtman says. "And often financial disasters for the accounting firm and the law firms that were involved."

More recently, the legal profession has been battered by a controversy over tax shelter advice it gave to clients.

Many law firms, as a result, are appointing general counsels to handle their firm's risk management issues and are trying to protect themselves by buying larger limits on their professional liability coverage.

SIZE MATTERS

Although malpractice has been a longstanding concern for the legal profession, many firms face a growing risk because of their increasing size and the increasing complexity of their dealings.

A recent wave of merger activity in the legal profession means that law firms are bigger than ever and that means there are that many more opportunities for things to go wrong.

In addition, following a merger, the acquiring company has not only its own liabilities worry about, but the liability of the unknown acts of the target firm's lawyers.

And as the law firms grow ever larger, so do the size of the potential losses. Because liabilities can be so large, law firms are taking the risk very seriously.

"The professional insurance premium can be one of the single largest payments that a firm makes," says Rick Goshorn, general counsel for Akin Gump, a leading international law firm.

So firms pay close attention when it comes to the issue of malpractice.

For an example of just how costly mistakes can be, consider the case of Dallas-based law firm Jenkens & Gilchrist. Jenkens & Gilchrist has agreed to pay a total of $108 million to settle with clients who sued the firm over its tax-shelter advice. The $108 million includes an $85 million settlement with some 1,000 former clients who filed a class action against the firm and additional money to compensate clients who opted out of the class action. It is the largest reported settlement against a law firm, says Doug Richmond, senior vice president for Aon Risk Services.

The cost of settling a malpractice claim can run into millions of dollars and a firm with a poor claims history can have a harder time securing insurance and may have to pay higher premiums. But there are other costs as well.

"There's real cost in terms of distraction and time, and most policies have deductibles and retentions," Goshorn says. "There are also reputational costs," he says, noting that it makes good business sense to run a conscientious organization that is sensitive to the risks that it is taking on.

Aon's Richmond agrees.

"The real risk for firms, I think, in a lot of ways is not monetary, it's reputational," Richmond says. "In any business, you've got to be concerned about your good name."

And the rapid collapse of Arthur Andersen is an unsettling reminder of the fragility of professional service firms and how difficult it can be for a firm to survive a scandal.

CONFLICTS AND CLIENTS

The type of mistakes that get lawyers into trouble vary depending on the size of the law firm.

At smaller law firms, malpractice claims tend to arise from basic mistakes, such as missed deadlines, lack of competence and lack of due diligence, Richmond says.

At law firms with more than 100 attorneys, those kinds of mistakes are usually caught before they can cause a problem because there are so many people working and reviewing the cases.

Instead, at large law firms, the problems tend to come from two areas: conflicts of interest and dishonest clients.

Conflicts of interest can result in malpractice claims because of the potential for a breach of fiduciary duty by the law firm.