Preparing for alternative business structures (archived)
Ensuring that clients are protected
Guidance issued by the SRA's Rules and Ethics Committee
This guidance was issued in January 2009. The guidance does not form part of the rules and is not mandatory, but the SRA may have regard to it when exercising its regulatory functions. Solicitors who do not follow the guidance may be required to demonstrate how they have nevertheless complied with the rules.
Who should read this guidance?
1. This guidance on solicitors' core duty of independence is for all solicitors and in particular:
- solicitors who have commercial arrangements with third parties (e.g. introducers and lenders); and
- solicitors, and those dealing with solicitors, who may be considering steps to prepare themselves for the time when alternative business structures (ABSs) are introduced.
Why is there a need for this guidance?
2. The Legal Services Act 2007 (LSA) offers opportunities for the development of legal services in ways which can benefit clients through the delivery of more flexible and competitive services, and offers attractive commercial opportunities to lawyers and others working with lawyers. This year, legal disciplinary practices (LDPs) will enable groups of lawyers, and some non-lawyers, to work together in firms delivering legal services. From a date yet to be determined by the Legal Services Board (LSB) ABSs, with external investment and ownership, will be permitted.
3. The SRA welcomes these developments, and encourages solicitors and others to consider how they will respond to these challenges and opportunities. The purpose of this guidance, which has been prepared in response to requests from solicitors, is to ensure that, in the interests of clients, solicitors protect their independence, particularly in the period between now and the date on which the new regulatory safeguards — without which LDPs and ABSs cannot be permitted — are introduced.
Summary
4. This guidance highlights some of the legal and regulatory requirements which apply:
- now;
- after March 2009, when we expect LDPs and firm-based regulation to be introduced;
- when ABSs are permitted (the LSB is considering 2011 as the starting date).
5. It emphasises the key importance of the core duty of independence.
6. It also suggests some steps which might be appropriate for solicitors who are considering being involved in the setting up of an ABS.
Introduction
7. The SRA's regulatory powers are almost entirely based on statute. Our powers and the client protection we provide are limited to those individuals whom and types of organisations which we are permitted to regulate under statute.
- Until March 2009 when changes to our powers under the LSA come into force, we can regulate only solicitors, registered European lawyers (RELs), registered foreign lawyers (RFLs), and firms which are owned and managed by solicitors, RELs and RFLs.
- From March 2009 the amendments made by the LSA will allow us also to regulate legal disciplinary practices (LDPs), i.e. practices which may include different types of lawyers as managers, and with up to 25 per cent (carefully defined) non-lawyer managers. Non-lawyers who intend to become managers will be subject to approval to ensure they are fit and proper, and we will be able to regulate all managers and employees in the firms that we regulate. These LSA amendments do not give us any regulatory powers over external owners or investors.
- From about 2011 firms will be able to operate as ABSs. Regulators such as the SRA will be empowered (subject to approval by the LSB) to regulate such firms and their external owners and investors in the public interest. The LSA contains a number of regulatory safeguards to ensure that ABSs and their external owners and investors behave appropriately. It is clearly Parliament's intention that practices which have the features of an ABS should only be permitted when they can be properly regulated in the public interest. For that reason, we shall apply our current and post-March 2009 powers and rules until we are permitted to regulate ABSs.
8. If you are considering restructuring your firm or making commercial arrangements with external interests (for example with lenders or introducers of business), you should take care to ensure that you comply with your professional obligations and the rules as they currently stand. You must not "jump the gun" and create what would amount to an ABS until the regulatory structure which will give proper client protection is in place.
Client protection and "regulatory reach"
9. Remember that the Solicitors' Code of Conduct (the Code), and the legal framework which underpins it, exist to maintain proper standards in the public interest. Clients are entitled to instruct solicitors safe in the knowledge that their solicitor is responsible for the conduct of the retainer and the client will be protected because the solicitor is properly regulated and, should things go wrong, there are proper safeguards in place. For this reason, for example, rule 8 prohibits you from sharing your fees with an unregulated person (although there are limited and defined exceptions to the general rule). The purpose of the rule is to protect your independence and your professional judgement. This means your own and your firm's independence, and not merely your ability to give independent advice to a client. Without this prohibition an unregulated person would be able to use a solicitors' practice as a front behind which to operate as a provider of legal services.
10. The LSA changes come into force in an incremental way. The new structures which the Act permits will allow solicitors to practise through entities co-owned with, and in due course entirely owned by, persons who are currently (i.e. before March 2009) beyond the SRA's regulatory reach. That is not permitted under the present rules. The Act sets up a structure and safeguards to protect the public interest by extending the regulatory reach of the SRA and other regulators.
11. There are a couple of additional points to note:
- Section 9A of the LSA sets out the structural requirements of a "legal services body" – these being the only kinds of structures which are capable of being recognised by the SRA as "recognised bodies" under the arrangements for LDPs (i.e. from March 2009). It will be permissible for the SRA to recognise a body with a relatively complex structure, involving various tiers of ownership. You should note, however, that any company etc. that owns a share in a recognised body must itself be a "legally qualified body"–i.e. it must itself be a recognised body, an authorised non-SRA firm or a European corporate practice. In addition, at least 75 per cent of the ultimate beneficial ownership in the recognised body - and in the "legally qualified body" - must be in the hands of lawyers (to include e.g. solicitors, barristers, licensed conveyances, RELs and RFLs).
- Service companies – these will always have to be wholly owned by the regulated firm, whether under the current rules, or as from March 2009 or, almost certainly, under the eventual ABS regime. A regulated firm cannot invite an outside investor to buy into the firm's service company, because it will then no longer be a service company within the rules but will be an unregulated business improperly providing legal services.
12. If a solicitors' firm or a currently unregulated business shows that it fails to pay proper regard to regulatory obligations by breaching or encouraging others to breach the current rules, the SRA will take that into account when considering an application to set up an LDP—or eventually, perhaps, an ABS.
13. For more help about what the LSA changes will mean for you, please see our frequently asked questions and answers.
The key current regulatory requirements
14. Key rules you need to bear in mind are:
- Rule 1 – Core duties
- especially rule 1.03: Independence "You must not allow your independence to be compromised."
- Rule 2 – Client relations
- especially rule 2.02 (2)(e): Client care – duty to explain to your client limitations or conditions resulting from your relationship with a third party.
- Rule 3 – Conflict of interests
- Rule 8 – Fee sharing
- especially rule 8.02: Fee sharing with other non-lawyers.
- Rule 9 – Referrals of business
- especially rule 9.02: Financial arrangements with introducers.
- Rule 14 – Incorporated practice
- especially rules 14.04(4) and 14.05(5): Prohibition on creating third party interests over companies and LLPs.
- Rule 21 – Separate businesses
- especially rule 21.02: Services which may not be provided through a separate business.
Applying the rules
15. In helping you to decide whether any particular arrangement would be proper under the current rules, you should take account of the guidance which appears with the Code.
16. Note that the Solicitors Disciplinary Tribunal (SDT) has stated in a recent case:
"The Tribunal considers that it is incumbent upon solicitors to have proper regard for the principles which lie behind the written rules or codes of conduct and not to seek justification for their actions by dissecting the letter of such rules. Because the rules are in place to protect the public, a solicitor has always to bear those fundamental principles in mind when applying the letter of the rules to his own situation."
What sort of circumstances might put my independence at risk?
17. There is a variety of situations which might put at risk your ability to comply with the fundamental principles, i.e. the core duties. For example:
- finance agreements/loans to your firm with particular strings attached;
- financial arrangements which suggest dependency upon an outside body, such as could, at that body's discretion, effectively put your firm out of business;
- contractual conditions in agreements with referrers of business or funders which effectively cede control of your firm to the outside body;
- granting options to purchase your interest in your firm for nominal value;
- allowing a third party access to confidential information concerning your clients;
- a relationship with an outside body which is not at arm's length, and/or which suggests that your firm is more akin to a part of or subsidiary of that body, rather than an independent law firm;
- fee sharing arrangements which go beyond what is allowed under rule 8.02;
- any arrangement for a third party to fund legal actions which lays constraints on the conduct of the matter which go beyond the legitimate interests of a funder.
18. A lender (typically a bank) will lend funds to a legal practice only on certain conditions. Provided these conditions do no more than aim to protect the lender's legitimate commercial interests in securing the loan, they are very unlikely to cause a breach of the rules. If the conditions go beyond this, then there is a danger of breach.
19. Over-reliance on a single source of work, or a close relationship with another entity which provides your firm with finance, may put at risk your ability to comply with your duty of independence. The Code and guidance provide some safeguards to help you ensure that the core duties are not compromised. Before making any arrangement which may conflict with the core duties, you should identify the risks and consider what safeguards you can put in place to eliminate these risks. You should also document your risk analysis and the safeguards which you have identified. In carrying out this process, it may help you to consider the following issues, some of which have been highlighted in cases before the SDT.
Am I allowing my solicitors' practice to be used as an "umbrella" or "front" for another person or organisation?
20. Ask yourself: Who really is in control in my practice? Is it the principals in my firm, or is someone else outside my firm pulling the strings? Have I allowed a third party (e.g. an introducer or funder) to become a "shadow director" of my practice? Remember that the SRA and the SDT will look behind the appearance of a solicitor's relationships with third parties, and will consider the reality of the relationship rather than how it may be presented on paper.
Can I make arrangements to prepare to set up an ABS?
21. The SRA encourages responsible preparations for the setting up of ABSs, and these can include discussions with potential business partners. It should be possible to come to a non-binding agreement, or even to enter into flexible contractual arrangements to be activated once the regulatory requirements have been relaxed, but in either case you must not enter into an arrangement which would in reality:
- compromise your firm's independence;
- compromise your ability to give independent advice to your clients;
- involve selling your ownership interest (whether legal or beneficial) in your legal practice or any part of it (or its service company) before any such outside ownership can be permitted;
- put your future business partner in control of decisions about your business;
- allow your future business partner, or even the existence of the relationship, to affect the way in which you act for your clients;
- put your firm in the position of acting as a "front" for another organisation;
- put any outsider in de facto control of any votes in a partnership meeting, members' meeting or directors' meeting;
- involve you in co-ownership structures which put you in breach of the separate business rule; or
- set up a premature ABS, in disregard of the extensive safeguards constructed by Parliament in the LSA.
For further guidance on the rules please contact the SRA's Ethics Guidance Team.