Editors' Blog

Beware those cap-wearing Trojan horses

Posted 4/05/2007 by Deal Comment

Interesting to hear of ‘revelations’ concerning the shock use of liability caps. Perhaps it was slightly less revelatory three years ago, when Legal Week established that Eversheds was using such limits on potential negligence claims in its standard terms, at the time becoming the first law firm to admit using a tactic that had already become common among accountants.

That same year, a spread of firms as diverse as Linklaters, Allen & Overy, Pinsent Curtis, Simmons & Simmons, Ashurst, Lovells and Bird & Bird indicated that they had used similar arrangements, albeit occasionally.

Unusually, the practice was pioneered by mid-tier law firms across a range of commercial disciplines, though projects was clearly one of the early focal points. In some cases, caps were as low as £1m.

The initial debate was whether such tactics could be deployed by top City firms, especially on corporate work, given the potential brand damage to high-end advisers and (rather hypocritical) resistance from the banking community.

That question was soon answered when three magic circle firms - Clifford Chance, Slaughters and Freshfields - in 2005 conceded that they were regularly capping on vendor due diligence reports (see story) in corporate auctions.

Given that lawyers in these situations were often under pressure from vendors and advising banks to produce the reports - often on tight fee structures and timeframes - and were being asked to assume third-party liabilities, the use of caps was understandable. Indeed, most lawyers instinctively recoiled at the inherent contradictions of such reports.

Not that the issue wasn’t sensitive. Legal Week’s then City editor, Paul Hodkinson, was privately thanked on several occasions for getting a debate going about a subject that no-one else was touching and that the Law Society had shown little interest in.

But attitudes change quickly in the City and what was once considered risky from a client perception viewpoint is now common. As such, a Legal Week poll of senior lawyers earlier this year found that a quarter of firms regularly or always attempt to limit their exposure on individual instructions, often through initial engagement letters. Likewise, only 13% said that they ‘never’ deployed liability caps.

The auction issue is also a red herring. The popularity and oddities of the auction process created an environment for capping to enter the mainstream of transactional practice. Partly this is because private equity houses don’t care about caps and partly because of the ambiguities of the vendor DD process.

But that has nothing to do with buy-side or sell-side; it was only a matter of time before capping snuck into the corporate mainstream - vendor DD just proved the most comfortable Trojan horse going.

Perhaps the key issue is not about capping itself but the impact that sponsor-driven auctions are having on advisers. As Deal Week recently noted (see comment), this brand of corporate disposals have already made the concept of multiple bid roles acceptable.

How long before that - and other controversial innovations - are translated into traditional public M&A?

alex.novarese@legalweek.com