Ceiling liability

Hugh Price explores the case for capping liability and asks how brokers can implement this

In a recent article, Tony Cornell of Cornell Consulting asked the question: "Are brokers still as safe as houses?" (Insurance Age, March 2009). The point he was trying to make was that in the recessions of the 1980s and 1990s, 98% of brokers survived and lived to prosper, but conceded that the conditions today are rather different.

But what steps, if any, can insurance brokers take to protect their business from a catastrophic claim?

Brokers invariably protect themselves against claims by taking out professional indemnity (PI) insurance. While liability cannot be excluded nor restricted for damages relating to personal injury, the contracting parties can agree to limit their liability to each other for breach of contract and/or negligence.

It is well established that recovering damages from a limited company is largely restricted to the extent of PI cover and/or the assets of the company.

Where the defendant to a claim is an individual or partnership (not a limited company) then, in practical terms, recovery will be limited to the value of the assets belonging to the individual or partner. It could be said that a cap gives clients a degree of certainty that they will not otherwise have.

Meeting criteria

Any limitation of liability must satisfy the 'reasonableness' test under the Unfair Contract Terms Act 1977 (UCTA) and this will depend upon the circumstances of each case.

This means, in effect, that great care needs to be taken when drafting liability capping clauses because if the extent of the clause is subsequently disputed then it will be construed against the party that seeks to rely on it.

So, how does a financial cap work? Basically it limits the amount of damages payable to an agreed amount. The extent to which the cap applies will depend on the contract itself and ordinarily will be either an each and every claim limit, an aggregated basis or a total limit.

The broker will need to consider its total potential exposure to the client. There is no such thing as 'one size fits all' cap figure. The nature of a client's business and any potential liability to third parties must be taken into account when considering the reasonableness test.

The financial cap is not necessarily the same as the limit of indemnity under a firm's PI policy. The level of indemnity is simply what the insurer is exposed to. Thereafter, a firm will be liable for any additional amounts payable, exposing it to an 'uninsured loss'.

There is sense, therefore, in capping liability at the same figure as the limit of PI cover. In this way the broker's exposure to uninsured loss claims is minimised.

The UCTA reasonableness test is that the term must be "fair and reasonable having regard to the circumstances, which should have been known to or in the contemplation of the parties when the contract was made".

Furthermore, the Act requires reassurances that resources be available for the purpose of meeting any liability and in regard to the extent to which the position could be protected by insurance.

It is also essential that any liability cap is drawn to the specific attention of the client and discussed. A failure to do so could lead to a successful challenge later.

Keeping track

For obvious reasons it would be sensible to include the cap in Terms of Business Agreements so that it remains effective for any repeat business. In order to ensure that the reasonableness test can be satisfied, it is sensible to keep a note on the client's file as to how the level of cap has been calculated and of any discussions with the client on the subject.

In calculating an appropriate cap, various issues need to be taken into account, including the extent of risk, its size and complexity, plus an assessment of the damages potential in the event of a claim, the resources available to the broker in meeting any liability as well as the amount of cover under the PI policy.

Unfortunately claims by third parties (usually in negligence) cannot be excluded or restricted in the absence of a contract.

The Solicitors' Code of Conduct, by way of example, allows solicitors to limit their civil liability provided such limitation is not below the minimum level of cover required by the solicitors indemnity insurance rules - £2m for sole practitioners and £3m for LLP and corporates. Any limitation must be brought to the client's attention and evidenced or confirmed in writing. The guidance notes to the Code suggest it would be "inappropriate to include the limitation in Terms of Business without specifically drawing the client's attention to it".

Until recently, it was felt that capping damages in this way would affect the individual firm's professional reputation - an issue that will also be of concern to insurance brokers. A recent survey of over 100 senior commercial lawyers revealed that 80% felt that capping liability in order to prevent costly negligence claims made no difference to the perception of quality. Evidence suggests that liability capping is now becoming an accepted safety net for law firms.

A fairly straightforward example of where things can go wrong would be where a broker wrongly issues a motor cover note outside the terms of the insurer's authority, such as an unacceptable profession or the age of the driver. If a vehicle is subsequently involved in a serious road accident, which results in multiple claims say exceeding £5m, then the insurer will have to pay the claim. However, it could well seek to recover its outlay from the broker for the negligence and/or breach of contract. If the broker's PI cover limit is £2m, as is often the case, then the exposure will be for £3m uninsured loss.

The need for brokers to treat customers fairly is enshrined within the Financial Services Authority's Code. Provided brokers pass the reasonableness test set out in UCTA, there are good and sound commercial reasons for exploring the possibility of capping liability. n

Hugh Price is partner at Hugh James Solicitors