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The question often raised is whether it is permissible, practicable and effective to include in Terms of Business Agreements (“TOBAs”) with clients, a clause which introduces a financial limit on the exposure of a regulated firm to the client. The answer to this question is broadly yes, but it is subject to a number of qualifications. This note considers the question from the following four points of view: risk management considerations, the regulatory regime, the common law and statutory regime, cost/benefit and other commercial considerations.

Risk Management

The issue is that insurance brokers have exposures to clients for negligence and breach of duty. The scale of the exposure is related to the limits placed by the broker. This clearly varies enormously from broker to broker. Good practice would suggest that a broker should compare the limits placed for clients with the limit of professional indemnity insurance purchased to consider whether enough protection has been secured in the event of a claim against the broker by a client. Although, it has to be borne in mind that an insurance policy is not a guarantee and may not, for various reasons, respond to a claim. In those circumstances, a contractual limitation is particularly helpful.

The Regulatory Regime

The FCA does not prohibit the introduction of clauses limiting the financial exposure of a firm to the firm’s client, although the FCA does not mandate such a clause. ICOBS 2.5.1 prohibits a firm from excluding a duty or liability which arises under the regulatory system e.g. a firm could not contract out of its disclosure requirements.

In so far as the FCA takes exception to any limitation clause (whether financial or relative to the firm’s duties), it has to refer to the Unfair Terms in Consumer Contracts Regulations 1999 (the “Regulations”) – see paragraph 3.3 below, and the Consumer Rights Act 2015.

The FCA does prohibit a firm from purchasing insurance to cover regulatory fines (see GEN 6.1).

The FCA also mandates certain provisions in contracts, such as the disclosures in ICOBS, the terms of outsourcing contracts in SYSC 8, and the terms of appointed representative agreements in SUP 12.

The Common Law and Statutory Regime

When considering the effectiveness of any limitation clause, there are four considerations which should be borne in mind:

Has the clause has been incorporated into the contract?
This is an issue for the whole TOBA: either it forms the basis of trading or it does not. Whether the TOBA is binding is a matter of fact in each case. On the whole, if it can be shown that the client was sent the TOBA and continued to trade with the broker, then a court would likely find the TOBA set out the basis of their relationship. It is clearly easier to prove with longer-established clients. It is nevertheless a risk that a client which finds the TOBA clauses inconvenient will challenge the TOBA’s applicability.

Is the clause effective?
This is a question of fact and there will always be a risk of interpretation by the courts under common law.

Is the term unenforceable?
The Regulations are, for the FCA, the most important set of requirements governing the content of contracts, although apply only to consumers. The effect of finding that any term is unfair under the Regulations is to render it unenforceable. The FCA, in its drive to improve conduct standards, is routinely expecting firms to treat SME businesses as if they were consumers.

Clients of any size should expect to be treated fairly under Principle 6 and ICOBS prohibits a firm from contracting out of the duties imposed in the regulations and expects limitation clauses generally to be reasonable. It would therefore be prudent to judge the fairness of any limitation clause relative to the size and sophistication of the client. It follows that the limitation clause may have to be adapted to cater for consumers/SME businesses on the one hand and larger commercial clients on the other hand.

At common law some exposures cannot be excluded.
Death and personal injury are examples, although likely not particularly relevant to brokers. More relevant is the inability to exclude or limit the consequences of fraud and deceit.

Commercial Considerations

This is a matter for speculation, and is likely a combination of:

  • the broker’s assessment of the potential exposure;
  • the broker’s failure to recognise the exposure;
  • the broker’s anxiety about and/or the client reaction.

More often than not the larger brokers have no option but to introduce a limitation clause as failure on their part to do so would expose them unnecessarily to shareholder suits if they did / were not seen to take every possible step to protect shareholder value and assets.

So it is a matter of weighing the client profile, the exposure, the insurance purchased, the asset base of the company, the cost of introducing and maintaining a limitation clause, and the likely reaction of the client base to the change. And the firm’s own risk appetite will determine how these factors are assessed. The fact remains that, in the absence of an effective limitation clause, a large enough claim will threaten the continued existence of the business.

For more information please contact Sara Ager at EC3 Legal LLP.

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Birketts and EC3 Legal announce merger

David Coupe, Senior Partner at EC3 Legal, said of the union: “The focus of EC3 Legal has always been on serving our clients' businesses. Following the merger with Birketts, I am confident that our clients will continue to be the biggest beneficiaries, as the two practices will be able to expand and develop the range of services on offer to new and existing clients.”


Posted 1 May 2020

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