Friday, September 25, 2009

Professional negligence: The risks of globalisation - Legalweek

Professional negligence: The risks of globalisation - Legalweek
Over the last 20 years, the process of integrating economic activity across international borders, or 'globalisation', has achieved a heightened significance in the business strategies of companies and professional service firms. Globalisation has come to be regarded as an unstoppable force; in the words of former US President Bill Clinton, speaking in November 2000, "the economic equivalent of a force of nature". However, concern at the rapidity with which the financial crisis spread throughout the world has prompted calls for greater caution. The current reappraisal of globalisation is echoed in issues confronting international professional service providers relating to their exposure to liability risk across multiple jurisdictions.
The variety of structures
A key factor at the heart of the issues with which international service providers must grapple is the legal structure of their operations across separate countries. This directly affects the ability of claimants to access assets in countries distantly located from the scene of the work which is the subject of their allegations. Some of the larger international law firms operate as a single partnership or LLP throughout the world, albeit with some services being provided by locally incorporated subsidiaries. Other international law firms operate as a single partnership/LLP in much of the world but as separate partnerships in a small number of jurisdictions such as Japan, often for reasons connected with local regulatory requirements. Many national law firms of all sizes have joined international associations or networks, within which clients are referred to "preferred" correspondent or member firms in other countries.
Some, but relatively few, of the larger international legal practices have followed the traditional model adopted by the biggest networks in the accountancy profession, involving legally separate LLPs/partnerships in each country, all of which are members of a network administered by a non-trading entity. This model was adopted by the accountants before most of today's international law firms had travelled very far down the road of cross-border expansion. The network structure meant that profit shares of partners in the larger member firms were not diluted but it was still possible to assimilate existing local firms without requiring them to surrender all of their autonomy.
Another significant benefit of this model was that it offered some protection for each national partnership from professional liabilities incurred by other member firms, particularly small-scale practices in territories where skills and experience were in short supply and justice was somewhat random in quality if not occasionally biased.
The decision taken by the larger law firms to adopt more unified structures has been attributed to a number of factors, including (it has been suggested) a comparatively greater significance being attached by them to operating according to a partnership model, a relatively lesser concern about liability avoidance, and a tendency to expand through a deliberate strategy of seeding overseas development by opening new offices rather than through a long series of deals between existing local firms.
Comparisons between the legal and accountancy markets can be instructive in this field, notwithstanding their points of divergence. It is useful to consider the experience of accountancy networks, given that similar issues will affect law firms which are members of such structures, and also because decisions about restructuring options may appear on the agenda of other firms from time to time in connection with specific proposals for international expansion or with general organisational reviews.
A number of the larger accountancy networks have revised their structures in recent years, bringing more closely together their national member firms within particular continents. Some have established a new layer of non-trading entities in which ownership is shared between individuals drawn from all of the national firms in that region. However, as yet there is little sign of a general consolidation of trading operations or that the accountancy networks will dismantle the barriers between European and North American member firms.
Liability risk
Numerous commercial factors will influence the legal structure chosen by an international professional services brand. Mitigation of liability risk may not be a predominant consideration but will nevertheless feature in the inevitable balancing exercise. Although network structures sacrifice some of the cohesiveness and opportunities for quality control and oversight available in a fully integrated international organisation, they may be effective in preventing liabilities from jumping across the firebreaks established between their legally separate member firms. They are not a guarantee of total protection, as 'holding out' risk, for example, is difficult to control, not least because a firm in the UK can have little direct influence on a firm in, say, South America and is unlikely to have detailed knowledge of holding out law in every relevant jurisdiction. Individuals may fail to "live the structure" by referring to "my American partners" and "our Chicago office" although the US firm is legally separate. But the use of text explaining the legal relationship between member firms has become more effective with the increasing role played by email in business communication throughout the world, making holding out claims ever more difficult.
Unsurprisingly it is in the US that accountancy networks have faced their most serious challenges to ring-fencing liabilities attaching to the work of individual member firms. In the 1990s, claimants tended to argue that the relationship between member firms amounted to a partnership in law, or that the facts of a particular engagement established that the US firm had been standing behind its local fellow member (say in the Caribbean) in a principal-agent or alter ego relationship, referring to evidence of instructions given or influence over the local firm. Such claims tended not to survive motions for summary dismissal, although there were some exceptions. It is as yet unclear whether the new semi-integrated regional structures will be more vulnerable to 'partnership' claims.
Stepping stone claims
Having experienced mixed success with those arguments, US claimant lawyers have recently favoured a different approach. Claims have been brought against the non-trading 'international' entities which license network member firms, on the theory that the member firm is a mere agent of that entity. Such a claim is now pending in the Southern District Court of New York against the non-trading international entities of the Deloitte and Grant Thornton networks, arising from audits by Italian member firms of Parmalat, the failed dairy giant. Significantly, the US member firms of each network have also been sued, on the theory that the international entity is the agent or alter ego of the US firm. The claimants seek to rely principally on evidence of general influence exerted over the international entity by board members drawn from the US firm, and evidence of general control by the international entities over firms' professional practices (for example through inspection visits and the prescription of engagement procedures). It is possible to imagine such arguments being deployed in other cases against a UK firm sued as a co-defendant with its fellow US firm.
The US firms and international entities in Parmalat failed to obtain summary dismissal of the claims and now face a jury trial. Their resolve will have been strengthened by the verdict of a Florida jury in June this year, dismissing a similar "agency" claim against BDO International involving an allegation that it controlled its US member firm.
Ring-fencing liabilities and the future
Given the significance of services provided by offshore professionals with limited assets, it is unsurprising that the financial crisis has generated new attempts by US claimants to attach liability on other parts of a network. Attempts to ring-fence the liabilities of individual member firms can exact a high price in legal costs, but this has to be weighed against the vast amounts which may be at stake. The fact that the fences remain in place within the largest accountancy firms is indicative of their relative success in the courts in defending these boundaries, although legal separation did not save member firms in Andersen Worldwide from the outflow of business following the collapse of Enron.
UK law firms that are influential members of international networks will follow with interest developments in the Parmalat litigation. In particular, they may wish to consider distancing themselves further from direction of the administration of their international network. They may need to consider whether their insurance cover provides appropriate protection for claims based on engagements performed by other member firms, and involving allegations of holding out, partnership, or agency/alter ego connected with other member firms or the network's international entity.
Law firms that practise as a single worldwide unit may regard the US liability issues confronting networks as having no direct impact upon them, because by definition they would be unable to confine claims liabilities to their local offices which performed the relevant work. Nevertheless, if any of the major international law firms were exposed to major US litigation risk in the wake of financial crisis, any damage limitation provided by the network model may look more attractive if and when firms come to take a fresh look at their legal structures and the risk/reward balance, either in the course of expanding into new territories or as part of a periodic general review.
James Roberts is a partner and Andrew Forsyth associate director in Barlow Lyde & Gilbert's professional and financiel disputes team.
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