Carry On Consulting: Potential Compensatory Reform

Published 6 April 2020

In 2014 the SRA began a series of consultations designed to ‘reduce the regulatory burden’ upon law firms and practitioners, whilst preserving the necessary protections for clients. We now take a look at the progress made, the reforms that have been rejected, and the latest consultation period.

The primary focus was a review of Professional Indemnity Insurance (PII) cover, aiming for what was described as proportionate and targeted regulation to more closely align insurance cover with perceived business need. The ultimate intention was to reduce the costs of insurance and at the same time to open up the market to increase the choice of legal services providers for consumers

The second limb of the review has been about the SRA’s Compensation Fund (the Fund), the discretionary fund of last resort designed to operate as a safety net for people owed money by regulated firms but which for various reasons will not otherwise fall within the mandatory PII cover.

Some five years later, the potential reforms of PII have been abandoned amidst a general consensus that the proposals were unworkable and/or would not achieve the intended benefits. However, and perhaps to demonstrate that the process has not been entirely fruitless, we are now within a further 12 week consultation period about the provisions relating to the Fund.

PII reforms – a summary

The SRA had been keen to remove the ‘one size fits all’ approach to PII, to be more representative of increasingly diverse business models and the actual risk profile for each regulated firm. A key driver was the fact that some areas of work are inherently more likely to result in negligence claims (particularly conveyancing and commercial), and with a higher potential quantum, thus requiring increased protection for the consumer and yet the Minimum Terms & Conditions demand the same minimum level of cover.

The proposed changes met with fierce opposition, including from The Law Society, insurers and the profession itself. In December 2019, the SRA announced that, despite being convinced that its data was “robust” and that a large number of firms could have benefitted, the anticipated reluctance of firms and Insurers to embrace the proposals would effectively mean that the benefits would never materialise. As a result, none of the changes are being introduced, with the SRA instead saying it will keep insurance arrangements under review, to attempt to understand the challenges faced by firms during a time of hardening markets.

The Compensation Fund

The SRA has, though, concluded that it is still worthwhile looking at the operation and sustainability of the Fund, which is financed by the profession. The Fund is the final potential safety net once other avenues have been discounted or exhausted, to assist those who have lost money via a regulated firm due to the absence of insurance cover (or a policy that will respond), the dishonesty of a regulated firm or individual, or a failure to account for monies received. Between 2014 and 2019, it paid out £95.2m in discretionary grants, more than 70% of which was in respect of conveyancing and probate matters, consistent with the main risk areas for PII claims.

The revised proposals include:

• Making it clear what will be expected of applicants to mitigate loss, whilst restricting the circumstances in which the Fund will pay mitigation costs. This places more emphasis upon applicants recouping losses via other avenues of redress, rather than relying upon the Fund.
• For applications concerning firms that have failed to obtain the required insurance cover, to only respond if those firms were authorised by the SRA in the first place.
• To reject applications arising from the insolvency of an insurer. This will inevitably leave some clients with no recourse, but the SRA justifies this by reference to resources being finite and a focus upon dealing with the ethical failures of those that it is regulating, presumably as distinct from the financial failings of insurers.
• To reduce the maximum grant from £2m to just £500,000, subject to a discretion to pay a higher sum if deemed “in the public interest”. This is said to be ‘fair and proportionate’, although the SRA acknowledges the significant impact it will have on those who have suffered much greater losses yet are otherwise eligible to claim.
• To exclude applications for unpaid fees from barristers and third-party professionals, who can protect themselves through terms of business and/or the debt recovery process.
• To only accept applications from the recipient of legal services, thus direct clients or else beneficiaries or others for whom the service is being provided. This is to prevent claims from parties for whom the regulated firm was not acting, such as a property buyer losing money due to theft or dishonesty by the seller’s solicitor. The justification is that whilst infrequent the losses are usually large, and that there would be a cause of action against the other party, who in turn could pursue the solicitor. However, this potentially will just transfer the problem to another client / consumer of legal services.
• To pay closer attention to the conduct of the applicant, including whether they could have prevented or reduced any losses, with an explicit requirement for full and frank disclosure in support of any application. This means a closer analysis of the key components of an actual negligence claim, in assessing causation, contributory negligence and failure to mitigate.
• To relax the restrictions on eligibility so that individuals, small businesses, small charities and small trusts (small meaning turnover or assets of less than £2m) being able to claim without needing to demonstrate either wealth or “hardship”. Larger business will, though, continue to be excluded, as the “overarching purpose” is said to be the protection of smaller consumers.
• Capping payments relevant to any “single or connected event” at £5m. This is premised upon the dangers of huge losses stemming from failed investment schemes and the like, which could threaten the viability of the whole Fund.

The priority in the consultation is to control and reduce expenditure, albeit the SRA is keen to emphasise that these revised proposals would still mean the Fund compared favourably to similar schemes for other professions and jurisdictions.

The most significant step from a financial perspective is the proposed quartering of the grant limit to £500,000. Between 2010 and 2018 there were 32 grants at £500,000 or above, totalling £30m. This represented 21.3% of the grants made, in respect of just 0.4% of the successful applications. A £500,000 cap would apparently have reduced payments by £14m. It therefore suggests the possibility of marked saving in the future, but these would clearly be at the expense of the same consumers that the Fund is designed to protect, and potentially harmful to the reputation of the profession.

The consultation is due to run until 21 April 2020.