Merchant banks and other professional advisers are facing a waveof court cases involving claims for professional negligence arisingfrom the takeover boom of the 1980s.

Samuel Montagu has already been found liable in a case broughtagainst it by the administrators of British & CommonwealthHoldings, although it is appealing against the decision. The Irishleasing company, Yeomen International, is reported to be suing SGWarburg alleging professional negligence in relation to thetakeover of CLF Holdings and US and Asian affiliates of Schrodersare being sued in separate actions relating to ill-fatedacquisitions.

Although claims arising from a billion pound deal couldpotentially wipe out a bank's resources, the scope of their legalliability remains unclear. Neither is professional indemnityinsurance the panacea it at first sight appears.

The question of an adviser's liability in negligence essentiallyhinges on the concept of "proximity" - the closeness of therelationship between the adviser and the person who relies upon hisstatement or advice. If there is a relationship of sufficientproximity between the two parties then the adviser will owe a dutyof care to the party who relies upon his statement and if he failsto take sufficient care in these circumstances he may be foundliable in negligence.

It is clear that an adviser owes a duty of care to his ownclient. For example, an auditor may be liable in negligence to thecompany whose accounts it audits. But the situation is less clearwhere the relationship between the adviser and the person relyingupon its statements is not that of adviser and client.

In a landmark decision in mid- 1990 the House of Lords decidedthat auditors of a public company are not generally liable toinvestors, including bidders, who deal in the company's shares inreliance on negligently audited accounts (Caparo Industries vDickman [1990] 2WLR 358, ).

PLC, 1991, II(5), 46The decision on the amount of damages recoverable by British andCommonwealth is expected by early Autumn but the bank could beordered to pay up to £250 million. The case illustrates theextent of potential liability faced by banks in large acquisitions.Although it related to a "private acquisition" the reasoning can beextended to a public bid. The Code contains provisions expresslyrelating to the care to be taken by financial advisers in makingstatements about the availability of funds of bidders.

Advisers wishing to rely on professional indemnity insurance mayfind it increasingly difficult to obtain adequate cover. Further,failure to notify a circumstance which may lead to a claim canresult in loss of cover.

Insurance may be taken out against claims for damages for breachof professional duty, not only to clients but to all third parties.But the cost of such policies is soaring and insurers areincreasingly imposing ceilings on the cover available. Banks maytherefore find it increasingly difficult to obtain adequate coverfor large transactions.

Where a policy holder becomes aware of a circumstance which hebelieves may subsequently lead to a claim for breach ofprofessional duty (but no formal claim has yet been made againstit) then that matter should be notified to its current insurer andwill be dealt with by the insurer to whom the circumstance isnotified even if a formal claim is made against the bank in a laterinsurance year.

At each renewal a proposal and warranty is signed by the policyholder to the effect that all claims have been notified, as haveall circumstances of which the policy holder is aware which maylead to a claim at some time in the future. Failure to warrant thisaccurately can lead to insurers avoiding the policy and returningthe premium.

Banks proposing to rely on professional indemnity insuranceshould therefore carry out a vigorous analysis of any circumstancewhich may lead to a claim, before each renewaldate..SMF