A failure to communicate, or inadequate communication, lies at the heart of many complaints and claims against solicitors. Even when a claim appears to have a well defined primary causative factor, it is often the case that the underlying risk issue is rooted in communication failure. For a more detailed explanation of communication risks, see our risk management article (Journal, April 2019, 44).
In all corporate and commercial transactions, the solicitor is dealing with an individual. They may be the client or simply the representative of the (corporate) client. It is worthwhile bearing in mind that a key part of managing communication risks is to understand the audience (i.e. the recipients of the advice). Although this should not be surprising, there are many clients who, while sophisticated businesspeople, are not experts in corporate law. This lack of knowledge may not be apparent from initial discussions and it is a mistake to overestimate the level of knowledge that even an apparently experienced purchaser of legal services may have.
It may not be necessary to establish some type of formal checklist system, but it is important to make sure that key elements of communication are present in every transaction. This could mean a thought process along the following lines:
- Have we explained the key provisions of the draft document, particularly drawing the client’s attention to unusual conditions or transaction specific conditions?
- Have we explained any negative outcomes that could result from the execution of the document?
- Has the client given some level of feedback to us indicating that they appear to understand the key terms of the document and the outcomes which will be delivered by the document?
- Has the client seen and reviewed a final draft of the document prior to signature?
A client maintained that they had never been properly advised on the desirability of adding certain events of default in relation to a vendor loan arrangement. The solicitor maintained that discussions had been undertaken between the parties to the transaction directly and, for a variety of commercial reasons, the advice from the client (who was an experienced businessperson) had been to take a “light touch” approach to the loan arrangement. The solicitor recalled that a discussion had been undertaken with the client about default events additional to non-payment which would trigger early repayment of the loan, but that the instructions had been not to add these. There was no supporting file note or email regarding the position.
Although the lack of recording of the instructions was problematic, the solicitor appeared to have regarded the client as having a much better understanding of the risks in the transaction than the client actually possessed. An email acknowledging the instructions and explaining the potential downsides would have assisted the solicitor’s position. Whilst that approach could be categorised as “back covering”, it is really simply a further strand of the communication process.
Perhaps through pressure of time or the need to finalise commercial aspects of the deal, there can be situations where verbal advice is lost in the noise of the transaction. Setting out some reminders in writing can often be a helpful trigger to clients to consider the position further.
It is obviously critical in any corporate/commercial transaction to understand what the client wants in terms of outcomes. This is such a basic point that it can be overlooked.
Where the engagement letter failed to explain adequately to the clients the limits of the tax advice being given by the solicitors in connection with the transaction, the firm in question was left exposed to a claim in relation to matters which the client had understood were within the firm’s scope of work and had therefore not been referred for review to the accountants which the client had engaged to advise on other tax matters.
This can often be exacerbated by confusion as to the client. In corporate matters particularly, there is the possibility of inadvertently acting for the same client in different capacities (shareholder, director, employee, trustee), all of which may have different interests in a particular matter. Failing to understand what the desired outcome is for that client in their particular capacity can lead to risk exposure.
Solicitors were instructed by company directors to document a buyback of shares. That buyback would have allowed one of the directors/shareholders to exit the business. Initially, the terms of exit had been agreed and documentation was duly drafted. It then became apparent that the exiting shareholder wished to renegotiate the terms of the deal. This was, in part, due to a difference of opinion as to the value contributed over the years by the exiting director. Eventually, this resulted in the company solicitors indicating the terms of a new deal based on a revised position resulting from alleged breaches of director’s duties by the exiting director. That director then made an allegation of conflict of interest. Although not directly leading to a claim, it serves as a useful reminder that such issues still arise.
All practice areas generate large amounts of paperwork (whether actual physical paperwork or the electronic variety). Corporate transactions are no different and can generate significant amounts of paperwork in a fairly short space of time. It can be difficult to manage a process with multiple strands without having a disciplined approach to file management. There are a variety of ways to accomplish this, either through document management systems or utilising strict version control outside of such systems. All practices will have their own preferences and requirements. It is, however, essential to understand that from a risk management perspective, managing the file is key to reducing risk exposures.
This can be challenging in a corporate transaction where much negotiation can be at the last minute and there is a temptation to let administrative matters such as file notes slide. In most corporate transactions there are last-minute negotiations and changes to agreed terms, some changes only being agreed during the course of the completion meeting. By their very nature, some of these amendments may be needed “on the hoof”. Recording the reasons for these and the advice given to the client may be essential in defending any subsequent claim. Obviously, some consideration has to be given to the practicalities, but a post-completion wash-up meeting where these points are recorded before memories become clouded can be beneficial.
A disposal by way of share sale had been undertaken. The solicitor acting for the sellers, in the absence of the assistant who normally dealt with this, had managed the process of disclosure against the warranties which the buyer had sought in the share purchase agreement. A significant amount of documentation had been produced by the sellers in a piecemeal fashion. All of this had been delivered electronically. The sellers’ solicitor had been unable to keep abreast of the information being produced and had overlooked a number of disclosure items.
Whilst there are a variety of electronic systems which can be utilised in a disclosure exercise, the fundamentals of the process remain the same, namely that there must be a review process in a structured manner. Even where there are no sophisticated electronic systems, there has to be a methodology to ensure that all documentation is reviewed, classified as to relevance and actioned accordingly.
Conflict of interest
Conflicts of interest can, of course, arise in corporate and commercial matters. In relation to the drawing up of shareholder agreements, for example, unless the shareholder rights and obligations are equal, the same firm should not act for all of the shareholders. In other words, if shareholders are to be treated differently in a shareholders’ agreement, they should be separately represented. The firm might be able to take instructions from one of the shareholders on the terms of a draft agreement, but should make it clear to the others that they should take separate independent advice on the agreement before signing it.
As touched on earlier, conflict issues may also arise in relation to shareholders, directors and the company, particularly in small private companies, where it may be difficult to differentiate between the interests of the three parties. Solicitors should be clear, from the outset, who they are acting for, be it the company or the individual shareholders or directors.
It is worth noting that where the prime cause of the claim is, or is attributable to, the fact that the insured acted in breach of the conflict of interest rules (B2.1.2 and B.2.1.5), the self-insured amount will be double the standard amount.
A corporate client acquired the share capital of a separate client company. Following the acquisition, the former shareholders of the acquired company raised a claim against the practice, alleging that the firm was in a conflict of interest. The claim was successful. It is a clear conflict to act on both sides of an acquisition of share capital. Where one client of a firm wishes to acquire the share capital of another client, the same firm should not act for both – even in formalising the terms of an agreement reached by the parties themselves. The firm can act for one of the parties, but the other party should be told in writing to take separate legal advice before signing any documents issued by the solicitors.
In a share acquisition, it is also worth considering whether the firm has previously acted for the target company, or for one of its directors, as in these circumstances the firm may possess confidential information which is relevant to the acquisition.
Matthew Thomson is a client executive in the Master Policy team at Lockton. In part two, next month, he will look other types of risk for solicitors dealing with corporate and commercial work, such as drafting errors and acting outwith core competencies.
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