PI Insurance | Renew Legal

Professional indemnity insurance issues

Renew Legal specialises in renewables, construction, engineering and technology projects

August 2024

Scenario: A sponsor engages a consultant lawyer to negotiate a document the contracts for a $250 million construction project. The consultant’s fees are $100,000.

During contract negotiations, a high profile climate change case has been working its way through the courts. The outcome of the case is relevant to the project, but wasn’t known by any of the parties.

Before board approval to enter into the contracts is sought, the case is granted special leave to appear by the High Court. After the contracts are signed, the company becomes aware of the case and the project is put on hold. If the appeal is successful, the project will be unviable and the company will lose its costs to date, and the opportunity costs, which it values at $40 million. While the project is on hold, the company is incurring delay costs of $1 million per month. The board would not have given approval if it had been advised of the special leave application.

A year later, the company’s losses are $15 million. The lawyer’s engagement letter states:

We hold professional indemnity insurance required by the Legal Practitioners Liability Committee in the amount of $2 million, renewed annually on 1 July. Our total liability to you is limited by a scheme approved under Professional Standards Legislation and includes liability for legal and other fees, costs and disbursements, in respect of any and all claims relating to this matter is limited to the higher of fees paid to us and the amount recovered under a responding insurance policy.

No one considered the engagement letter limitation of liability at the time of engaging the lawyer.

Professional indemnity insurance

There are many one-sided consultancy agreements such as with an architect: no times for completion, no liquidated damages and liability is limited to the fee. But the client wants that architect so the contract terms are take-it-or-leave-it. Typically, the consultant will have appropriate professional indemnity (PI) insurance cover for the project, up to say $5 or $10 million.

A lawyer’s involvement is often at a more fundamental level of the project, touching on all agreements and decisions the client may need to make. So what risks are the client exposed to?

In Victoria, all legal practitioners must hold or be covered by PI insurance before engaging in legal practice in Victoria. The minimum level of cover is $2 million and there is no obligation to hold top-up cover.

PI insurance covers damages for errors and omissions associated with the advice and services provided to clients. This is usually legal liability for claims arising out of an actual or alleged breach of professional duty.

A lawyer’s liability may arise from breach of: contract, obligation / duty to exercise duty care and skill, duty of care to a third party, fiduciary duty, or statute (such as in misleading or deceptive conduct claims under the Australian Consumer Law).

The coverage of the PI policy will vary, for example:

Is the policy type ‘occurrence’, ‘claims made’ or ‘claims made and notified’?

‘Occurrence’ covers any event which occurs during the term of the policy. ‘Claims made’ covers any claim first made during he currency of the policy. ‘Claims made and notified’ covers claims during the currency of the policy provided the insurer is notified within the same period.

What causes of action are covered? Are statutory claims covered?

Breach of contract has been found by courts to be covered “against any claim for which the insured is legally liable arising out of negligence” (Walton v National Employers Mutual General Insurance Association Ltd (1973) 2 NSWLR 73) and not to be covered “in respect of any act of neglect, default or error” (West Wake Price & Co v Ching [1957] 1 WLR 45), and for “liability imposed by law” (Canadian Indemnity Co v Andrews General Insurance Co [1953] 1 SCR 19). Claims for misleading or deceptive conduct under section 18 of the Australian Consumer Law should be included.

What is the scope of the coverage? Are there exclusions?

A policy is designed to cover typical work within the profession. For example, a policy covering an accountant for any act or error “on his part in the conduct of his business as an accountant” did not cover a fraudulent scheme by an agent sharing an office with the accountant (Whitworth v Hosken (1939) 65 Lloyd’s Rep 48). Solicitors syndicating purchases of commercial property in order to achieve tax advantages, while not providing any legal services, did not come within “the private practice of a solicitor” (Solicitors Liability Committee v Gray (1997) 77 FCR 1). A typical policy contains exclusions for things such as dishonesty, fraud or criminal acts. A firm’s insurance policy stated that it did “not indemnify the Assured in respect of any liability … brought about by the dishonest or fraudulent act or omission of the Assured including any Partner or former Partner of the Assured”. A misappropriation of $8 million by a partner came within this exclusion and the policy did not respond (McCann v Switzerland Insurance Australia Ltd (2000) 203 CLR 579).

Failure to advise

In Heydon v NRMA Ltd (2000) 51 NSWLR 1, NRMA sued two law firms and a barrister for failing to advise that an appeal to the High Court might have reasonable prospects of success and thus adversely impact upon a proposed corporate restructure. Ultimately, the Court found that (i) the risk posed by the High Court appeal was outside what a competent solicitor at the time would regard as being within the traditional issues associated with the restructure, and (ii) the High Court’s decision was not reasonably foreseeable.

Leaving aside the issue of whether one of the most senior commercial barristers and top tier law firms should tackle difficult questions, this happened in 1993 (and public case law reports were not even available on the internet until 1995). The law is always developing and it is possible that is 2023, with easy access to all court decisions, lawyers may be held to a higher standard of when they should know about a case within their area of specialisation.

Back to the scenario: The company eventually sues the lawyer for $15 million and the court finds the lawyer to be liable for 60% of the client’s loss, $9 million, but that the lawyer’s limit of liability was capped at $2 million as per the terms of the engagement letter. The insurer pays out to the cap of $2 million under the PI policy but deducts its defence costs of $220,000 from the payment. The client’s legal costs of $300,000 are excluded form the policy.

From $2 million, the lawyer only has $1.78 million left to pay the client, being 19.7% of the award, and 11.8% of the client’s total loss.

Under the terms of the engagement letter, the limit of liability is the higher of the fee and the amount recoverable under an insurance policy, the client is left $7.2 million out of pocket from the lawyer and $13.2 million out of pocket overall.

The court didn’t ignore the contract limit of limit of liability, but it has been reached and the client is left bearing the loss or trying to figure out how to bring a further claim against a possibly insolvent consultant.

What can be done?

A lawyer is no different from any other consultant and clients should carefully consider what service is being sought. This means if your lawyer doesn’t hold appropriate insurance, you may need to find another one, or convince (or pay) them to increase their cover. This means a careful review of the engagement letter limit of liability and understanding the risks being excluded by the consultant and therefore taken on by the client.

Law firms often will hold much higher cap PI insurance. If the lawyer is performing the role a firm would normally perform, then the client should ask about the level of insurance held, the type and the exclusions. A clearly defined scope of work helps to protect both parties from insurers who will always try to limit their own exposure in the event of a claim.

The client should consider whether to require the consultant to obtain top up cover for the particular project and try to understand what could be the flow-on losses arising from the consultant’s work in the event of a disaster.

This article is a summary and general overview of matters of interest. It is not comprehensive and does not constitute legal advice.

Liability limited by a scheme approved under Professional Standards Legislation