UK: The Risks Of Recession

Last Updated: 15 December 2009
Article by Sarah Clover

A recession imposes unique pressures upon professionals, including solicitors' firms. The professionals' response to this pressure gives rise to the risk of negligence and good risk management can therefore be crucial.

There are at least three sources of pressure in recessionary times, mainly relating to the need to preserve profitability and which can prompt problematic behaviours by solicitors' firms. They are: (1) pressures from within the firm; (2) pressures from clients; and (3) pressures from regulators.

Pressures from within the firm

Suing for fees is a classic risk management problem which solicitors bring upon themselves. Clients who are going through difficult times can often be unreasonably tardy in paying fees. However, due to pressures on firms' finance departments to recover unpaid fees, often there is insufficient thought before issuing proceedings, and perhaps without reference to the fee earners involved in the matter in question, which can result in a counterclaim from the client. These counterclaims are often a spurious attempt to avoid paying but are nearly always expensive, require notification to PI insurers, and regularly end up with the original fees being written off.

There is a temptation for firms to redeploy individuals into areas which remain buoyant and away from those aspects of their businesses where work is scarce. For instance, there is a fall off in financial derivatives and capital markets work whilst regulatory, insolvency and litigation practices have tended to remain busy, which might tempt firms to redeploy individuals into busier departments. However, given the high degree of specialisation that has occurred in the last decade, this is a dangerous practice. If a firm markets itself as having a particular specialism in a particular field, it will owe its clients a standard of care commensurate with that claimed specialism.

Further, pressure to bring in new work when work is scarce often leads firms to bend the rules about what work and clients they ought to be taking on, and might, for example, lead to the acceptance of work that the firm does not have the requisite expertise to carry out, or in conflict of interest.

Recessions often highlight the deficiencies in professional practice that arose during the boom time which preceded it. When professionals are extremely busy, there can be a tendency to take too much on and seek increased efficiency by cutting corners. Securitisation, for example, was a very popular way of raising capital in the period before this recession. Legal work relating to securitisations became entirely commoditised and conducted by junior fee earners using precedents. Carelessness which can set in, is often not uncovered until there is an economic downturn and problems emerge. Another example of this is the huge amount of work done in the property boom by solicitors in the buy to let residential property market. This is an area in which a large amount of fraud is being uncovered as a result of the downturn in the market and consequent repossessions, which has a knock on effect for professionals.

Another danger of recession is that there will almost inevitably be redundancies. Unless such a process is managed carefully, there is a danger of things being left unfinished on client engagements. For example, it is very easy for a lawyer to depart without leaving files in good order, and it may be that details such as arranging for stamp duty to be paid on a property transaction or registering a charge at the Land Registry will be missed, with claims likely to follow. Redundancy will also present problems for the firms in obtaining evidence to defend subsequent claims if the relevant fee earners have left the firm.

Risk management personnel can also be the victims of redundancy programmes. Peter Williamson, the Chairman of the Solicitors' Regulation Authority (SRA) recently warned, in the Law Society Gazette, that: "As firms make staff redundant there will be fewer people left to carry out the necessary compliance tasks."

If one puts this issue against the potential background of recessionary fraud and the added risks which a recession brings, it is easy to see how a reduction of risk management staff could become a serious problem.

Pressures from clients

The announcement made recently by the mining company Rio Tinto that it is to outsource its legal work to India is typical of clients' desire to find new, cheaper ways of obtaining professional advice. On all assignments involving external law firms, Rio Tinto will ask those law firms to pass to the lawyers in India such tasks as can be done by them at lower cost. This trend, prompted by recessionary forces, is clearly here to stay, even in better times, and the legal press regularly reports further instances of outsourcing by large firms. In terms of risk, this gives rise to a different set of problems. For example, a law firm asked by its client to outsource some of its tasks to their agent in another country needs to ensure that proper instructions are given, and that the law firm and the outsourcing agents both clearly understand the extent of what they are agreeing to do. There also arises the question as to who is responsible when things go wrong.

One way in which costs can be saved is to have professionals working at home or elsewhere in cheaper locations. The IT forensic investigator Kroll Ontrack has highlighted the serious exposure to potential data loss resulting from the increase in remote working. The cost of ensuring data security can be considerable and is a necessary expenditure that some firms may seek to avoid in an attempt to keep overheads low.

Clients might also take advantage of the need of professionals to keep clients on side in hard times and ask them to take on more risk than they would normally wish to, without the reward of an additional fee to compensate. For example, the professionals on a project might be asked to accept joint and several liability, or lawyers asked to give opinion letters on documents which they may not even have drafted.

Finally, working for unrealistically low fees can be a problem, and there are obvious dangers from work being pushed down to junior lawyers or even trainees or paralegals working at lower rates with decreasing levels of supervision.

Pressure from regulators

Even before the recession, the SRA was increasing its regulatory grip on the solicitors' profession and is even more determined to regulate on a risk basis now. Lord Hunt recently published his review of the regulation of legal services which recommended, among other things, the implementation of principles based regulation and "Authorised Internal Regulation", a form of self-regulation for firms with sufficiently robust risk, compliance and governance processes. This will undoubtedly be part of a much more rigorous approach to regulation by the SRA in the future.

Conclusion

Although these are difficult times for many solicitors' firms, it is important to be alive to the particular risks that a recession can present. Otherwise, just as a firm starts to recover from the difficulty of an economic downturn, it might find itself with a hangover in the form of claims arising from the way it has conducted its business.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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