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Why is professional indemnity insurance beneficial for the consulting business?

Jul 7, 2020.

While protection against claims for damages has long been part of everyday professional life for lawyers and notaries, many business, real estate and financial advisors continue to tread on thin ice. Find out how you can better hedge against contractual risks – and protect yourself and your customers from unpleasant surprises.

The real estate buyer who requests a full refund because he was not aware of plans for a nearby landfill. The taxpayer whose right to a tax refund has lapsed. The company that is misled into making a costly decision on the basis of a poor recommendation. Consulting services repeatedly lead to claims for damages – and it is not uncommon for large amounts to be involved.
 
So it’s best to be protected: with sufficient cover, professional indemnity proves to be a reliable safety net in many cases. For certain professional groups such as doctors or self-employed lawyers, it has long been a legal requirement. “But for other professions too, it is advisable to take out professional indemnity insurance,” emphasises Generali expert Ali Avci. “Business consultants in particular could face legal action by a customer after the completion of a project – often seemingly out of the blue.”
 
Read in our interview what the legal basis for liability is and what that means for financial loss.

 

Professional groups with risks in the consulting business

Lawyers
Notaries
Mediators
Accountants
Tax consultants
Business consultants
Trustees
Auditors
Insolvency administrators and liquidators
Real estate brokers
Real estate managers
Real estate trustees
Construction trustees

 

“Contractors who have sufficient insurance cover for possible liability claims can concentrate on their core task with confidence.”

Ali Avci, Operational Lead Financial Lines, Generali

What service providers should know about their liability risk

Medical malpractice, botched construction, a fire caused by  carelessness – this kind of personal injury or property damage is part of everyday life for many insurers. Pure financial loss, on the other hand, is all too easily forgotten about. It involves “real” financial loss, such as loss of (value of) money, investments or financial claims against third parties.
 
Freelance consultants are quickly identified as the cause: “In Switzerland, there are roughly a hundred thousand self-employed people in the legal and business consultancy professions. Many of them work in areas where there is neither a licence requirement nor compulsory professional indemnity insurance,” explains Ali Avci.
 
For this reason, both freelancers and owners of larger management consultancies should ensure that they are adequately protected. Ali Avci: “In the event of financial loss, Swiss legal practice stipulates that it is up to the contractor to prove that he has exercised due caution. This is not always easy, and without professional support they can quickly fall into legal traps.”
 
Professional indemnity insurance helps in two ways: by organising and paying for the defence against unfounded claims, and by paying compensation if the damage or loss was in fact caused by the action of the contractor. Failure to take action – such as not informing a customer about facts relevant to the consultation – can also lead to claims for damages in practice.

Common pitfalls for independent consultants

“If a trustee forgets to claim deductions, for example, he could be liable to the customer for irretrievable expenses. This is often referred to as contractual liability,” explains Generali expert Ali Avci. “However, the content of the contract is not the only decisive factor. In accordance with the applicable law, the contractor may be responsible for numerous obligations, regardless of the provisions of the contract, and a breach of these obligations could also justify a claim for damages.”
 
Here are the most important regulations in the service business, which also apply to all consulting services:
  • Each contractor is liable to the customer for the contractually compliant and careful performance of the work assigned to him.
  • According to the law, he must perform this work with the same care as an employee in an employment relationship.
  • He has both a duty of loyalty and a duty of care and must also comply with the will of the customer.
  • Also important: the contractor must collect the instructions necessary for the performance of the work himself if such instructions have not been provided.
  • The duty of loyalty also means that the contractor must check the instructions received and warn the customer if they appear inappropriate or could potentially result in damage or loss.
  • The contractor must therefore provide the customer with comprehensive advice and information. In order to perform his consulting services competently, he should actively make appropriate enquiries beforehand.
These all constitute “secondary contractual obligations” – and this is precisely where the most dangerous pitfalls for professional consultants lie.
 
Ali Avci: “In the event of a claim, contractors cannot simply use their ignorance of a particular matter as an excuse. Because the issue is not their individual competence, but the generally accepted level of knowledge that a hypothetical specialist of the relevant profession should have in order to be able to practice this profession at all.” In the end, the court will often say that the contractor should have known better. 

Claims from practice

A real estate manager is commissioned by a landlord to rent an apartment. The new tenant may stay until the daughter of the landlord wants to move into the apartment after a stay abroad. The real estate manager draws up an agreement for an unlimited period, but forgets to provide the tenant with notice of termination in good time. The tenant can stay for another six months. The landlord must find another apartment for his daughter for this period. The landlord claims these rental costs as damages. The insurer of the real estate manager assumes payment.
 
 
 
A trustee advises farmers on government subsidies and helps them manage their businesses. One of his customers owns a large farm. The customer enters into a joint venture with a smaller neighbouring establishment. A change in the applicable legal provisions ultimately leads to a significantly lower government allowance for this type of cooperation. As a result, the two farmers receive around CHF 60,000 less in subsidies in the year in question. They then merge into a single legal entity, which means that the government allowance can be raised to the previous level. The trustee’s insurer reimburses both farmers for the subsidy losses previously incurred due to inadequate advice.
 
 
The treasurer of an association embezzles around CHF 240,000 during his five-year term. This is only fully discovered after his dismissal. Although an auditor previously criticised irregularities and pointed out suspicious transactions on a number of occasions, no further investigation was initiated and so the treasurer was able to continue his fraud. The association subsequently sues the auditor for damages. The professional indemnity insurer decides to settle the claim.
 
 
An independent interior designer permanently transforms a room of his home into a studio, which he uses exclusively for his job. However, his tax advisor only deducts the construction costs of the studio as professional expenses and repeatedly fails to deduct the running costs associated with the studio as professional expenses in the following years. The tax advisor tries to argue that the designer did not explicitly draw his attention to this and that all known circumstances for the tax deduction were therefore taken into account. In out-of-court discussions, the insurer agrees with the designer that it was actually the tax advisor’s duty to request these types of details specifically and regularly. The insurer agrees to pay CHF 15,000 after the deductible amount, as a legal dispute would have quickly become more expensive.
The expert
Ali Avci works at Generali as Operational Lead Financial Lines. He focuses on all issues relating to pure financial loss, such as professional liability, cyber insurance and D&O liability.

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