Held to account

In 1979 when I began at the College of Law in Lancaster Gate, we were allocated a specific seat in the classroom and woe betide you if you changed places. The idea was that the tutor could see at a glance who was present and who was not. A daily register was taken and attendance monitored. 

Accounting for solicitors was a subject totally alien to us. We had studied law at university so the legal topics, although more practical, were not strangers to us. Accounting, however, was a different story. The Accounts Rules 1967 were in force at the time plus the Trust Account Rules 1967 and the Accountants Reports Rules 1967 as well as the Deposit Interest Rules 1965. To add to our trials, we were also taught double-entry bookkeeping 

Needless to say, my mind wandered away from this fascinating subject. I scored 12% in the mock accounts exam in December 1979 but by the spring mock exams everything clicked and I scored 96% to be top of the class. As a result of my sudden and dramatic improvement, I was hauled up before the senior tutor to enquire if I had been cheating because of the vast discrepancy between my two marks. I had not been cheating but I had done some work, read my books and everything had fallen into place. It was one of those subjects where once you learnt the rules by rote you were away. It was prescriptive and repetitive but a very important skill for those new to the profession.

Introduction of flexibility

Moving to the present day, the Solicitors Regulation Authority (SRA) introduced into the current Accounts Rules elements of professional judgment and flexibility. It did so on the basis of shortening the rules (13 rules as opposed to 52 rules in the 2011 rules) as if brevity would somehow simplify things. As we all know, it is impossible to confine the Accounts Rules to 13 rules without accompanying pages of guidance. There are presently 11 SRA Guidance notes for the Accounts Rules so that the plethora of documents that need to be referred to in connection with the implementation of the 2019 Rules makes the claim that ‘shorter is best’ a somewhat unconvincing one. 

Finance professionals are more accustomed to prescription and repetition of process as the foundations of accurate financial management. Solicitors’ accounting processes are of course more of a science and less of an art form and are not suited to flexibility if client money is to be protected. 

The guiding principle is set out in Law Society v Weston CO/0225/98 [1998] The Times, 15 July, in that “the tribunal had been at pains to make the point, which was a good one, that the Solicitors’ Accounts Rules existed to afford the public maximum protection against the improper and unauthorised use of their money, and that because of the importance of affording that protection and assuring the public that such protection was afforded an onerous obligation was placed on solicitors to ensure that those rules were observed”.

Breaches and discipline

Breaches of the Accounts Rules have traditionally formed the bulk of the cases dealt with by the Solicitors Disciplinary Tribunal (SDT), often linked to an allegation of dishonesty related to a client account shortage. Many of the more serious allegations arise because of mistakes or omissions by fee-earners or partners as opposed to the accuracy or otherwise of the financial records and the work undertaken by the accounting personnel. Examples range from using client account as a banking facility or failures by fee-earners to deal with residual balances to keeping cheques drawn for professional disbursements in the desk drawer pending an improvement in the firm’s finances. In Philip Browell SDT 12271-2021, a sole practitioner used £140,000 of residual balances to pay salaries and VAT bills. In Christopher Messenger SDT 12282-2021 a veteran solicitor’s carelessness and ignorance of the Accounts Rules led to multiple breaches and a client account shortage. In Karen Todner SDT 12209-2021, nearly £100,000 of unpaid professional disbursements were retained in the firm’s office account when the client ledgers for the three matters under scrutiny erroneously showed that they had been paid to counsel. 

This link between the conduct of fee-earners and partners, and the more serious breaches of the Accounts Rules can only be reversed by training and an emphasis on the financial management of files being as important (almost) as the legal issues.

Handling client money

The SRA Guidance Note “Taking money for your firm’s costs” (14 September 2020) is a classic example of the SRA’s mantra for flexibility and professional judgment and warrants close scrutiny, especially as the economy is on the brink of recession. The note is linked to the SRA’s stated aim of permitting greater “flexibility which is taken to refer to the ability to hold client money outside client account.”

The Guidance note acknowledges that firms may request payment of their costs in advance of the work being done and that “cashflow issues are a common challenge which many firms have to deal with on a daily basis”. Where the only client money that a firm holds falls within rule 2.1(d) (such as fees and unpaid disbursements held or received prior to delivery of a bill) –then this is not required to be held in client account (rule 2.2) but is still classed as client money. Historically, we would have described this as a payment on account of costs and disbursements which would automatically be paid into client account.

In addition, the SRA acknowledges that billing for anticipated fees and disbursements in advance is permissible under the current Accounts Rules in order to provide further flexibility for firms.

Imagine advising a client to place their funds at your disposal and to warn them that all will be lost if the firm goes under financially. There is no advantage to the client whatsoever. The financial advantage lies entirely with the firm. It is a classic “own interest conflict”

However, the SRA emphasises in the note that there are clear risks to your client if you bill for and then pay into your firm’s business account money for legal work that you have not yet done or for disbursements that have not yet been incurred. These risks include termination of the retainer by the client; an abortive transaction; or a sudden closure due to death or incapacity. In all three cases, the SRA questions whether the client can be repaid immediately by the firm. In the fourth example of risk, the SRA highlights a firm being subject to an insolvency event and the client’s money being absorbed into the insolvent’s estate as it is not held in a ringfenced account. The hapless client would not be able to progress their case or pay any disbursements because these monies would be withheld by the insolvency practitioner in the firm’s business account. 

The SRA shamelessly concludes that “you need to make sure that your client is fully informed of the risks connected to their money being received into your firm’s business account”. 

What an astonishing conversation to have with a client. Imagine advising them to place their funds at your disposal and to warn them that all will be lost if the firm goes under financially. There is no advantage to the client whatsoever. The financial advantage lies entirely with the firm. It is a classic “own interest conflict”. How the SRA has countenanced this arrangement which cannot ever be described as being in each client’s best interests, contrary to Principle 7, or even the wider public interest, defies understanding.  

We have not as yet seen SDT cases involving this new flexibility but with anticipated economic challenges they will be coming down the pipeline. Any firm that requires payment of costs from clients in advance of work being undertaken in order to ease cashflow is likely to constitute a risk to clients and to the reputation of the profession. More generally, it is predicted that the likely downturn in the economy and the hardening professional indemnity market will result in an increase in breaches of the Accounts Rules as firms struggle to survive.

Disbursements and cashflow

Another area where client money has historically been used to ease cashflow has been the payment of professional disbursements. Disbursements were paid by clients or by the Legal Aid Agency for counsel or experts. Monies were transferred to but were never paid out of office account. The overdraft facility of the firm was often perilously close to its limit so there was never a time when finances permitted that these disbursements could be paid out. 

Under the current rules (rule 4.3) you must provide a bill of costs or written notification of costs before transferring money from client to office account to pay disbursements. Rule 4.3 does not refer to “disbursements” but to “costs”. However, the SRA glossary defines “costs” as “your fees and disbursements”. Rule 4.3 has been interpreted to mean that you cannot transfer funds to cover disbursements until those disbursements have already been paid out from office account. You are therefore reimbursing office account for monies already expended. This is reinforced by the SRA Guidance note referred to above which states that “We would expect you to make sure that the bill sets out only those fees and disbursements that have been incurred” (emphasis applied). You should also note that there is no longer a distinction between professional and non-professional disbursements.

Timescales

A further benefit claimed in support of the more flexible approach was the removal of “arbitrary timescales”. In the 2011 rules there were a few specified time limits but under the 2019 rules, firms are required to take certain steps “promptly” and to prescribe their own time limits within internal office procedures. My soundings reveal that most firms, fearful of challenge by the SRA, have merely adopted the same time limits as provided by the 2011 rules.

Role of the COFA

Finally, compliance officers for finance and administration (COFAs) must have a much greater understanding of the Accounts Rules and how the finances of the firm are managed than has traditionally been the case. For example, reconciliations must be signed off by a COFA or a manager (rule 8.3). This is a sensible requirement and gives the management a chance to head off any problems at any early stage. COFAs or managers should make sure that they understand the mechanics of reconciliations and that they can effectively monitor the correction of any unreconciled balances. Also note that client’s own accounts (rule 10.1(b)) also need to be included in the reconciliation. 

A defence of delegating financial matters to someone else more junior or subcontracting to an accountancy firm will no longer succeed with the SRA or the tribunal. COFAs should ensure that they understand how their accounting software works (especially in a small firm so they could operate it if the bookkeeper is away for a prolonged period). Knowledge of the accounting mechanics also helps in spotting suspicious transactions and heading off fraud. In SRA v Harmail Gill SDT 11914-2019, Mr Gill as COFA admitted in an SRA interview that he was not aware “of the intimate details of dealing with a client account”. The tribunal accepted the SRA allegation that Mr Gill had acted with “manifest incompetence”. Don’t be like Mr Gill – make sure that you have a real grip on your firm’s finances.