In brief

Dewey & LeBouef was the product of the biggest merger of New York law firms, back in 2007.  As a combined firm, it could boast a corporate client list most firms only dream of, and partners in the 1300+ lawyer firm were amongst the highest earners in the market.  Yet five years on, the firm lay in ruins, and last week saw the indictment of a number of the firm's top officials, who, in a desperate bid to avert financial meltdown following the global economic crisis, allegedly mislead not only partners, but also the firm's creditors and investors.

Where previous proceedings against partners or law firm managers have typically been a consequence of fraud or embezzlement, the case against the Chairman, Chief Financial Officer and an Executive Director of Dewey & LeBeouf is unusual, in that the criminal charges arose out of the attempt by these individuals, in the course of their duties, to avoid the financial melt-down that the firm was facing.

Managers in current and recently collapsed UK law firms must be looking on with concerned interest, as so often what starts on one side of the pond makes its way over here before too long.  As the SRA continues to report significant numbers of high profile firms in financial difficulties, it also highlights the importance of management liability cover for firms, who could well find themselves on the wrong side of court action following a collapse.

How Dewey & Lebeouf unravelled

Apparently, following the downturn, the firm found itself unable to comply with a number of banking covenants (it appears that this was exacerbated by the firm having guaranteed partners a certain level of payments).  The indictment suggests that the firm's managers sought to use 'accounting tricks' to disguise the real situation, and raised funds via a $150m bond offering that overstated revenues by millions of dollars.

The particular circumstances of the Dewey & LeBeouf indictment may be unusual, and there is a clear morality tale that one would hope could not be applied to the majority of law firms.  However, there is a wider lesson that can be taken, of relevance to a large number of law firms, who recognise the purpose and value of Professional Indemnity cover, but do not see the rationale for comprehensive management liability cover.   And those firms that do have management liability cover may find that they are underinsured for the worst-case scenarios.

Management Liability repercussions

Claims against a firm's management, particularly a collapsed firm, may arise from staff, partners, suppliers, creditors, or indeed regulators.

For Dewey & LeBeouf, settlement of the numerous claims in bankruptcy came close to exhausting the liability limits of the firm's management liability insurance cover.  These latest regulatory and criminal charges may prove the ultimate test of the adequacy of the firm's cover.

Management Liability policies typically provide cover for criminal proceedings, but only up until a final adjudicated finding adverse to the Insured (including cover for defence costs up to that final adjudication).  Where your management liability policy includes 'entity cover' in addition to cover for individual managers, because the policies are severable, innocent insureds are unlikely to have their rights withdrawn under the policy, unless fraud is sufficiently widespread to justify rescission of the policy.   It is important to look at incorporation of 'non-rescindable' language in these instances, which is not always provided as standard within an ML form, as these issues are fortunately rare.

How Lockton can help

Insurance and Risk does not stand still - and it is important to review your firm's risk exposure and risk controls regularly.  We can help you review your risk exposures, and identify gaps in your insurance covers, as well as identifying practical risk controls which should form part of a holistic risk control programme.

If you already have Management Liability cover, either arranged through Lockton or another broker, we can review the programme adequacy for your current needs.  For smaller firms, we offer a unique and affordable Regulatory Risk Insurance product for fixed low premiums.

We also provide a range of risk audits and other consultancy services.

For more information about the Dewey & LeBeouf case, read Alison Frankels blog about the charges against the firm's managers.  For a fascinating account of the lead up to the firm's collapse, read James Stewart's October 2013 article in the New Yorker.

About the authors

Alison Hollern is Senior Vice President in Lockton's Financial Risks team, and Calum MacLean is Risk Manager for Professions clients at Lockton.