The SRA Code of Conduct obliges law firms to ensure their fees are transparent to their clients. Firms must not be seen to generate secret profits. Jason Mitchell looks at how to maintain compliance
If regulators identify secret profits in a law firm, the firm can suffer significant damage to its reputation and potentially incur a financial cost. This article examines common areas where firms can be seen to generate secret profits, and how compliance officers for legal compliance and for finance and administration (COLPs and COFAs) can assist in maintaining compliance.
A bank charges, say, £10 to a law firm for processing a telegraphic transfer (TT) fee. The firm may then charge, say, £25 plus VAT to the client. The uplift of £15 is the firm’s administration fee for processing the payment. It is not unreasonable to apply this, but it is essential to ensure it is correctly communicated to the client.
If the firm only explains in its client engagement letter that a disbursement for a TT fee will be charged at £25 plus VAT, and then issues a bill of cost to the client showing a disbursement of the £25 plus VAT, it will potentially have created a secret profit.
The glossary to the SRA Code of Conduct defines a disbursement as any sum spent, or to be spent, on behalf of the client or trust. So if a firm simply passes on to the client the bank charge of £10, the transaction can be classified as a disbursement. However, if an administration fee is added, even the £10 element will not meet the definition of a disbursement, because the position to client would not be transparent.
To remain transparent, a firm must issue a client engagement letter which indicates the costs and disbursements to be incurred. Where the firm passes on to the client only the TT bank charge, it can reasonably be included within the anticipated disbursements within the client engagement letter. However, where the TT fee charged to the client will include the firm’s own administration fee, the whole charge (ie the bank charge plus the firm’s mark-up) should be clearly shown as a separate part of the firm’s costs, described as something like ‘Our administration fee’. The same principles apply to the bill of costs: any administration fee should be shown within the fee costs section, as opposed to disbursements, and be clearly marked as the firm’s own fee.
Some firms show the bank charge as a disbursement and the firm’s administration costs as a fee on the bill of costs. However, it has been confirmed that the more appropriate treatment is for the whole amount to be shown as a fee, because the bank charge it is not a third-party liability of the client. This treatment is then consistent with its treatment for VAT purposes.
The COLP and COFA should implement systems and monitoring processes to ensure everyone in the firm is aware of these requirements, if they are responsible for engaging and billing clients.
Where commissions are received by firms on behalf of clients for reserved activities, firms must do one of the following.
To meet the last two requirements, a client agreement must be in place in advance, and a record must be retained as evidence of that agreement. As part of the agreement, the client must be informed of either the amount of commission being received, or an estimate, where the exact amount is not then known.
Historically, a practice was permitted to retain any commission received, without agreement with the client, if the amount received was less than £20. This is no longer permitted.
A law firm which does not follow the above requirements will not be seen as transparent with its clients, and will be deemed to have received an unjust financial benefit.
The COLP should have a system to identify commissions received within the financial records, and to ensure these commissions are treated appropriately. Fee-earners and legal cashiers should be reminded of the requirements where applicable. The firm’s terms of business should also communicate to clients their rights to receive the commissions received.
Firms can now obtain a discount on Land Registry fees for registration of title, where an application is processed online.
The reduced cost must be passed on to clients to meet the definition of a disbursement. As with the TT fee scenario, if the standard Land Registry fee is charged to the client, the firm will be making a profit which, if not appropriately communicated, will be seen as a secret profit.
These points are clearly important. If COLPs or COFAs have any concerns, they should seek professional advice.