How should you cap your liability to clients?
Published: Monday, 8 July 2024
Unlimited claims can sink your firm
Learn how to set an enforceable liability cap that will protect your business.
It is not enough to arbitrarily set a liability cap in your engagement letter and trust that this will protect you if a claim is made.
Client case study
We have been involved in a claim for one of our clients that started at a staggering £14m, 6 years ago, and was well over the Limit of Indemnity available to the client. It recently resulted in a settlement of just over £1m plus costs.
It is not often that we see claims reduce by that much. One of the main contributory factors that helped reduce the level of the loss, successfully claimed, was that the client had included a liability cap in their engagement letter. The cap was set appropriately for the work being carried out, it had been brought to the claimants attention at the outset of the retainer and the claimant had signed to say that they agreed the cap. It was therefore deemed enforceable and so our client’s exposure was successfully limited to the amount of the cap, despite the fact that the claim was much larger.
How do you set an enforceable liability cap?
We asked Karen Eckstein to comment on some of the key risks with liability caps and mitigating steps that can be taken.
Karen is a highly experienced solicitor who is dual qualified as a Chartered Tax Adviser and has specialised in defending claims against accountants and tax advisers for over 30 years. Her firm, Karen Eckstein Ltd, helps firms manage their risks particularly in relation to their engagement letters and liability caps.
High Value Claims and enforceable liability caps
The value of claims against accountants and tax advisers can be substantial irrespective of the level of fee charged.
For example, an adviser might help a client in relation to their tax returns and charge a relatively low fee. The liability cap might be set at a multiple of 5 x the fee. If, in completing the work, the adviser fails to include all of the income, or fails to make relevant claims for reliefs, the client can suffer significant losses, have to pay interest at penal rates and might lose the rights to claim losses that they would otherwise have been able to make. If the issue is not identified for several years, the ability to claim those losses might be lost (as the ability to correct past returns is time limited) and the client may suffer significant losses as a result. If the adviser does not hold a sufficiently high level of professional indemnity insurance then claims could exceed the limit of a tax adviser’s professional indemnity insurance, leaving the adviser potentially personally exposed.
I have dealt with cases where the claim that was made exceeded £2m; the fee charged to the client was £15k. The liability cap suggested in the letter was based on the fee charged. It is easy to see how that could be challenged by the client as unreasonable and struck out, leaving the adviser exposed to unlimited liability.
My advice to professionals is always to include a liability cap in the engagement letter, so that the maximum liability for which the professional can be responsible is restricted. The professional should be able to demonstrate the reason for selecting the limit put forward and the wording of any limitation should be clear, brought to the client’s attention, and understood by the client, to limit any successful challenge to the cap at a later date.
Many people say that they do not need liability caps because the claims against them are likely to be fairly small and that they do not charge high fees but, as mentioned above, this is a mistaken belief. Whilst liability caps can protect an adviser’s practice, certain steps need to be taken to ensure that the liability cap is valid and enforceable. If the cap is held by the Court to be unreasonable, it is not increased to a more reasonable level, it falls away in its entirety, meaning that there is no liability cap in place. (see Ampleforth Abbey Trust v Turner & Townsend Project Management Ltd - 2012).
The issue of whether any liability cap is to be imposed and the amount of such cap is something which needs careful consideration. The professional should be able to demonstrate the reason for selecting the limit put forward and the wording of any limitation should be clear, brought to the client’s attention, and understood by the client, to limit any successful challenge to the cap at a later date.
What is a reasonable cap?
There is no simple answer to this question, and it ultimately depends upon the facts of each individual case.
The following is a non‐exhaustive list of relevant factors, which the court may consider in weighing up whether a cap survives the statutory test of reasonableness:
- The strength of the parties’ respective bargaining positions. Would it have been practical and convenient to go elsewhere?
- Whether the client knew, or ought reasonably to have known, of the existence and extent of the terms
- (having regard to any previous dealings between the parties).
- The size of any limit compared with other limits in widely used standard terms.
- Whether the parties have negotiated the limit.
- The level of PI cover available.
- The resources that the professional could be expected to have available to meet any liability.
- The level of the professional’s fees. A common starting point is that a multiple of e.g. ten times the fee is a reasonable limit.
- We know of tax advisers however who use a limit of their fee plus 20% but this approach may not always produce an appropriate limit - each relationship is different and must be looked at on its own merits.
- Carefully consider the reasoning behind the limit so that it is not viewed as arbitrary and keep a clear record of this.
- Draw the limit to the attention of the client before the contract is entered into.
- Discuss/negotiate the limit with the client and explain to them how the cap has been reached. Make a record of these discussions, preferably in a letter to the client.
- In respect of repeat work for the same client, ensure that the cap is tailored to the particular work in hand and has been negotiated and agreed by the client.
Practical Guidance
To make it more difficult for a client to successfully challenge a liability cap, the professional should take the following steps if possible:
Conclusion
Whilst the court is obliged to have regard to the level of PI insurance, this will not necessarily be decisive as it is only one of a number of factors that the court will take into account in weighing up whether the liability cap figure was reasonable. If evidence can be shown to demonstrate that there was a logical explanation for the cap, this should go a long way to ensuring the clause works as intended.
For guidance on your own unique circumstances, you should always take professional advice.
Karen Eckstein
Director, Karen Eckstein Limited
07973 627039
Karen@kareneckstein.co.uk
Karen offers a review of liability caps and other key risks in her innovative Risk Insight report ™- the report considers 10 key risks which can derail a professional firm, looks at how these apply to your firm and provides practical prioritised recommendations on how to resolve them in a one page report. It takes up to 90 minutes in an online meeting and costs £1,850 plus VAT. For readers of this newsletter, if you buy the report by 15th August, quoting 'Ntegrity' then you can secure a £100 discount. There is a money back guarantee: if the report doesn’t find any areas to improve, you will get your money back, so there is no risk to you.
For more details about the Risk Insight report click on the link below. To book the report email risk@kareneckstein.co.uk – remember to quote 'Ntegrity' to secure your discount.
