This article is intended to be informative only; it does not contain any legal, insurance, risk management, accounting, or other professional advice or create any professional relationships. You should seek the advice of a licensed professional in these fields in your state regarding any of the topics contained herein.
Malpractice Insurance and COVID-19 Related Cashflow Issues for Small Law Firms
Author: David W. Collins, Esq., Vice President, Synergy Professional Associates, Inc.
These are uncertain times for everyone, but we will get through them. While our primary focus as a nation is rightfully on our collective health, there is no doubt a lot of corollary concern for our financial futures as well. Small law firms may be uniquely vulnerable to a temporary economic downturn or a potential recession, but there are two steps that small law firms can take now to help bridge any economic skid and to protect both the firm and its employees financially:
(1) DO NOT LET YOUR LEGAL MALPRACTICE INSURANCE LAPSE; and
(2) Anticipate and address CASHFLOW issues immediately.
It is imperative to engage this second step without jeopardizing the first. Letting a firm’s malpractice insurance lapse should never be one of the steps taken to improve a firm’s cashflow. Here’s why:
1. DO NOT LET YOUR LEGAL MALPRACTICE INSURANCE LAPSE!
This point can’t be emphasized enough. While immediate cashflow may become a concern for many small law firms over the next many months, the downside of letting a firm’s legal malpractice insurance lapse could be catastrophic and far exceeds any temporary cashflow issues a firm may be facing. Most temporary cashflow issues can be addressed and remedied in some way, as further discussed below, while a claim against a firm operating without legal malpractice insurance could result in the firm’s outright collapse. Cashflow issues are temporary; a law firm’s collapse is forever. A firm must not be shortsighted when deciding whether to maintain the firm’s legal malpractice insurance.
1.1. Claims
The cost-benefit ratio of legal malpractice insurance is massively in favor of the law firm. Recall that insurers work on the concept of large numbers and pooled risk, so any individual firm participating in that pool is going to be getting a lot for their premium dollar. A typical one or two attorney firm can usually purchase hundreds of thousands or even millions of dollars’ worth of malpractice insurance coverage for just a few thousand dollars – maybe less depending on their state.
While this may seem like an unnecessary cost to a firm experiencing temporary cashflow issues, it is important to remember that cashflow issues are indeed temporary; a firm’s bankruptcy is forever. It is likely that the cost of responding to and defending just one claim, one bar complaint, or one subpoena for records/testimony will far exceed the premium that could have been paid to cover such an occurrence. Any indemnity obligation owed by the firm on top of this could be catastrophic for an uninsured firm.
Firms should also take very seriously the financial implications of the “claims made and reported” language in almost every legal malpractice policy. In the event that a “claim” is first made against a firm during the policy period, but the firm does not report that claim to the insurer prior to letting its malpractice policy lapse, it is very unlikely that the firm will have any coverage for that claim whatsoever. Claims made after a policy lapses are generally not covered at all, regardless of when the legal work was done for the client. Firms considering letting their malpractice policy lapse need to understand this reality.
1.2. Informing Clients / Competitive Disadvantage
In many states (like California, Colorado, and Pennsylvania, for example), law firms are required to inform their client and potential clients if the firm is uninsured. In a climate where competition for clients is already fierce and likely to get tougher, a firm should seriously consider the competitive disadvantage it will have to face if it chooses to let its malpractice insurance lapse. Why would a client want to work with an uninsured law firm when there are plenty of competent, insured law firms to choose from? It is hard to think of anything worse for a cashflow problem than a lack of clients.
1.3. Gaps in Coverage and Loss of Retroactive Date
The final major concern for a firm letting its malpractice insurance lapse is the gap in coverage the firm will have created for itself when the cashflow issues have passed and the firm is once again seeking to purchase malpractice insurance. This gap in coverage will either be totally irreparable (limiting the firm’s retroactive date coverage, as discussed below) or extremely expensive for the firm to repair.
Many insurers (especially those in the admitted, and usually, cheaper market), may not even consider offering a policy to a firm that does not have current malpractice insurance. If the firm is lucky enough to find an “admitted” carrier to offer it coverage, the insurer will very likely only do so on grounds that it will not cover any work that the firm did prior to the inception date of this new policy (i.e. “retroactive date inception”). This means that the insurer will only agree to consider coverage for work that the firm does after the date that this new malpractice policy went into effect and will not even consider coverage for any claims arising from work done by the firm prior to that date.[1]
Depending on the length of time a firm has been without malpractice insurance and the previous retroactive date the firm has now lost by creating a gap in its coverage, the firm could be facing the reality that weeks, months, years, or even decades of work the firm has done for clients is now totally uncovered in the event of a claim, even with a current policy in place! This could be especially devastating for firms with long-term clients, as the work the firm did for those clients over the years will likely now fall outside of the firm’s malpractice insurance coverage simply because the firm made a shortsighted cashflow decision to let the firm’s malpractice policy lapse.
Even firms with only a small gap in coverage will pay the price – literally. There are some “excess & surplus / non-standard” carriers who will “repair” a short gap in coverage between malpractice policies for a law firm and reinstate the firm’s old retroactive date. However, this is typically quite costly to the firm, which would almost always have been better-off financially had it simply just maintained its malpractice insurance without letting the policy lapse in the first place.
2. Anticipate and address CASHFLOW issues immediately.
In any financial environment, anticipating and ensuring cashflow is important to any business. This is perhaps doubly true for small law firms in an uncertain financial climate. But, do not fear! Cashflow issues are often temporary and can usually be addressed with proper anticipation and action. Below are a few key steps that small law firms can take to ensure that their malpractice policies never lapse as a result of cashflow issues. This is especially important in times of financial uncertainty when these malpractice policies are one of the most valuable assets a small law firm can hold.
2.1. Premium Financing
Cash-strapped firms should consider financing the premiums for their malpractice insurance policies. This will obviate any short-term cashflow issues by allowing the premium due to be paid in installments over time.
2.2. Billing Procedures
Retainers – help avoid collection issues, increasing cashflow.
Flat Fees – provide certainty to both the firm and the client (may be welcome by both parties in uncertain economic times).
Regular Billing – clients expecting a bill at the same time each month may be more likely to timely pay as a matter of routine. Bills can be “null” if no work was completed that month. This billing arrangement should be discussed with clients so they know what to expect.
Clear Billing Entries – will reduce the likelihood of client push-back. The fewer questions a client has about what they were billed for, the more likely they are to timely pay. Entries should be very specific and denote the value-added to the client.
Accelerate Bill Collection – avoid aged accounts receivable. Follow-up on late payments. Advise clients of payment timelines in advance and stick to them.
Payment Methods – accept as many payment methods as your state allows (cash, check, credit card, PayPal, Venmo, online payment portal, etc.). Make it simple for clients to pay.
2.3. Accounting
Monitor cashflow and non-trust account capital at least weekly. Be able to anticipate firm expenses (like insurance premiums) and cashflow; budget months in advance.
2.4. Lines of Credit
Can be established now and utilized to overcome a short-term cashflow issue in the future. Current interest rates are at record lows.
3. CONCLUSION
These are trying times for us all. For a variety of reasons, including prospective staffing issues, possible lack of IT infrastructure, and a potential slowdown in client activity, small law firms are likely to be especially vulnerable to the ongoing and anticipated economic impacts of COVID-19. We hope that this brief article provides some perspective on how to rationally approach the coming uncertainty as well as a few guideposts to help firms make sound and reasoned decisions in unprecedented times. Stay safe! And please let Synergy know how we can help.
[1] Example: A law firm was founded on 1/1/2005 and had malpractice insurance with a 1/1/2005 retroactive date (i.e. this firm was covered for legal work the firm did after 1/1/2005). On 1/1/2018 the firm let its malpractice policy lapse. The firm was uninsured until 3/25/2020 when the firm purchased new coverage with a new retroactive date of 3/25/2020. The firm has now lost its 1/1/2005 retroactive date and has no possibility of coverage for claims arising from any work that the firm did for clients prior to 3/25/2020. The last 15+ years of the firm’s work is now uncovered simply because it wanted to save a few dollars by letting its malpractice policy lapse!