Which law firms should be FCA regulated?
The CJC report had a number of proposals for funding and law firms. Unfortunately, much of the report is quite difficult to understand, but it includes a proposal that portfolio loans to law firms be regulated by the FCA. The background to it is that there have been a number of major law firm failures that have caused harm to consumers, and we don’t want this to happen again.
We have been asked if a loan to a law firm against a portfolio of cases will be regulated.
It’s a really interesting question, and it goes to the heart of consumer protection, contingent fee agreements and no-win-no-fee arrangements.
In a typical no-win-no-fee arrangement, the lawyer offers to take on the case on a fully contingent basis i.e. the client does not pay. On the face of it this is not a regulated activity: the client is not taking on any potential liability. However, in the UK there are cost-shifting rules - the loser of a case pays the costs of the other side.
If clients are worried that they will have to pay costs if they lose, then they are less likely to sign up, particularly if they didn’t know they had been harmed i.e. a lawyer is signing them up for a case.
To get around this problem, the lawyer will offer to indemnify the client in the event the case loses i.e. the lawyer will pay the costs of the other side. The effect of the arrangement is that the law firm is offering insurance to the client. That’s why the firm needs to be regulated.
What has happened in the past is that, to offset that risk, the lawyer has taken out an ATE policy.
All of that makes sense, until it fails. If the client acquisition is too aggressive and clients are not properly vetted, then the adverse cost risk is increased, and the cover provided by the insurer will not meet the aggregate claim. The firm folds and the client no longer has insurance… and the client ends up being on the hook.
First, society wants to stop over-aggressive client acquisition, particularly where the clients are vulnerable, but second, the insurance should be constructed in the right way - each client should be insured, and the insurance should be independent of the financial structure of the law firm. That way the client will not be left uncovered, and the law firm shouldn’t need FCA regulation.
Rather than FCA-regulated law firms, perhaps it would be much simpler just to prohibit law firms insuring their clients. They can’t lend to them, so we should they be able to insure them?