Case study: Improper use of client account as a banking facility
6 August 2018
The following case studies concentrate on setting out our views on the application of rule 14.5 of the SRA Accounts Rules 2011 to the facts presented rather than attempting to cover all the other considerations or risks. We have picked up on some issues where we think it appropriate, but this is not a comprehensive review of all of the potential regulatory issues involved. Full consideration should be given in each case to all existing legal and other requirements. The case studies should be read in conjunction with our warning notice on improper use of client account as a banking facility, issued on 18 December 2014 updated on 6 August 2018.
We would expect law firms to understand (and document where necessary) all relevant risk factors involved in a transaction such as, amongst other matters, conflicts of interest or acting by implication for any unrepresented parties. Law firms will also need to comply with other regulatory and legal requirements for example, undertaking appropriate client and other due diligence.
A law firm has been instructed by a client to advise on a transaction involving government bonds in a foreign jurisdiction. The lead solicitor has advised the client that the firm will need to instruct lawyers in the foreign jurisdiction to provide specialist advice. The client has asked the firm to project manage the transaction and proposed that money could be paid to the firm so that it can pay the foreign lawyers’ fees.
Where there is an underlying legal transaction on which the law firm is acting (for example, provision of advice on the terms of the bond) and the firm engages the foreign law firm, we do not consider that this scenario gives rise to a breach of rule 14.5.
A law firm acts for an energy board and a partner at the firm is also a clerk to the board. The board holds fluctuating cash deposits, which could be more than £2 million at any one time.
At present the board receives bank interest at 0.05% per year. If this money was held in the firm's client account, the firm’s bank would pay 0.7% per year. The partner’s view is that this would be of great benefit to the board to hold money in the firm's client account and the firm agrees to accept the funds on that basis.
The firm is carrying out or facilitating banking activities which are prohibited by rule 14. 5.
The law firm is not acting on any underlying transaction or providing any service other than holding the money. There are clear risks that would need to be considered here, that rule 14.5 is intended to prevent, such as involvement in fraud, money laundering and possible insolvency issues. If a firm’s client account is used improperly, they may also be in breach of the SRA Principles.
A law firm acts for a developer who intends to enter into a development agreement with a buyer of land. The buyer is to make payments in instalments, but it has a weak covenant strength. Buyer and seller have agreed that the total price will be paid up front to the buyer’s solicitors and held by the firm. Instalments will be released when they are payable.
The development agreement will be exchanged before the monies are paid to the firm and the firm will continue to advise the client about the performance of its obligations under the development agreement while the money is held. This will include the negotiation of construction documents and utility easements and advising generally on the terms of the development agreement. The firm will also on the interpretation of the payment provisions in the agreement as the development progresses.
On these facts, the firm had advised (and continues to) on the development contract and other related matters. Provided there is a proper connection between holding the money and the advice being given (for example, a continuing requirement on the firm to advise on whether the payments are triggered) this scenario is unlikely to breach rule 14.5.
In all such cases where money is being held in their client account, we would also expect the firm to question whether there is a proper reason for the funds to be held by them, rather than paid directly between the parties. The circumstances should also be kept under review to make sure that holding the money remains proper and justifiable.
A law firm acted for a property development company. The original retainer related to a redevelopment of a block of flats, the creation of separate leasehold interests and sale of the individual leases.
When the flats were sold, the client asked the firm to retain the proceeds in the firm’s client account. The company then asked the firm to make a series of payments from client account, using the proceeds of sale from the first development to pay a building contractor, architect and council tax in relation to another development site, and to pay £56,000 to a consultant for his services as a sales agent.
The consultant then asked the firm to split the payment to him - paying £9,000 to a car dealership as a deposit on a new car and the balance to another firm of solicitors as a deposit on a property he was purchasing. The firm was not instructed to provide legal advice about the second development site. Its role was limited to making the requested payments.
The firm later found out that the consultant was in the process of going through a divorce.
There is a clear risk here that in making the payments the firm would be in breach of rule 14.5.
Making prompt payments on behalf of a client to third parties connected with a conveyancing transaction on which a law firm acted, such as to sales agents, is unlikely to breach rule 14.5. However, the less connected the payments are to any such transaction, the higher the risks are that the firm may breach rule 14.5.
Here, the payments relate to other transactions on which the law firm was not acting. Developers also frequently use different companies as special purpose vehicles for each development and solicitors must be very wary of the risks in receiving funds that belong to Company A and paying them to Company B or to pay a liability of Company B.
Firms should also ask themselves why the money cannot simply be paid to the client which can then make payments itself. Even if the liabilities are all the clients, it remains very risky to pay these when there is no reason the client cannot do so itself. The client's convenience is not a legitimate reason. We would expect the firm to be able to explain fully why the payments are being made and to have fully considered the risks involved – for example, involvement in money laundering, avoiding money being caught in an insolvency, or the hiding of assets.
A law firm was instructed to act as “execution only escrow agent” in a proposed investment transaction and was also referred to in the contracts used as the “Paymaster”. The retainer was purportedly limited to reviewing the terms of an “escrow agreement” and to release funds in accordance with it.
The retainer letter excluded any advice on the supposed underlying transaction and the firm made no attempt to understand it; it simply received and distributed more than £650,000 in accordance with the terms of the “escrow agreement”. The client told the firm that the matter involved investment in bearer bonds.
An investigation showed that there was no genuine legal transaction and circumstances disclosed several of the signs from the SRA's warning notice on money laundering. An “investor” who lost money complained that he thought the investment must be safe because the contracts had the name of a solicitors’ firm on them and he relied on the firm being the “Paymaster”.
The law firm received and paid out money without advising on or even understanding the purported transaction. It had no real knowledge of the transaction and made no attempt to establish its legitimacy or the money’s source. In our experience, the use of “limited retainers" of this kind is often in itself a red flag because the firm is seeking to avoid addressing the suspicious nature of the transaction. There is a clear risk here that the law firm is in breach of rule 14.5. The risks inherent in acting in this way were in fact borne out by subsequent investigation.
To act in an “escrow” capacity a law firm must identify and understand the transaction and there must be good reason why it is the appropriate for the law firm to hold the money.
A law firm administers family or other trusts, mainly for longstanding, UK-based private clients. For some of the trusts the solicitor is the trustee, in others they are acting on the trustees’ instructions.
The firm’s work may involve collecting trust income (for example, from investment managers and rental income generated by properties which are trust assets) and making trust payments, such as distributions to beneficiaries and payment such as school fees and trust asset maintenance payments (ie payments to surveyors), on their trustee clients' instructions, using client account.
In some cases, the firm may be instructed to carry out transactional work, using trust funds to buy or sell real estate. In other cases, the firm’s role will be more administrative in nature, documenting the sale or purchase of other assets e.g. cars or artwork, receiving receipt of investment income and paying out trust distributions to beneficiaries (on the trustees’ instructions). Firms will also arrange for the drawing up of trust accounts, using either internal or externally sourced accountancy resource.
Where the solicitors are acting as trustees (for example, as trustees under a discretionary trust, or as an executor), they will be providing a regulated professional service. In this situation, receiving trust income into client account and making payments out of it, would not give rise to a breach of rule 14.5.
The situation is different when the law firm acts for trustees, rather than as trustees. Here the firm’s role is more limited to undertaking routine trust administration services, such as collecting income, preparing accounts and possibly checking the terms of the trust arrangement. On the basis that this type of work is part of the normal and longstanding regulated activities of law firms, we do not consider that this type of work, of itself, will breach rule 14.5.
However, allowing clients to place what might be significant funds in a law firm’s client account gives rise to risks in relation to potential money laundering or other breaches of the law. The firm will need to be fully satisfied that the arrangements are proper, and the trust is genuine. They will also need to be satisfied and able to demonstrate to us, if required, as to the legitimacy of their instructions and the source of the funds being administered.
In certain situations, it may be more appropriate for the law firm to agree to operate the client’s own account rather than allow its client account to be used in this way. That does not however remove the need for firms to make sure that they are not facilitating impropriety in any way.
A law firm is instructed by the landlord of a new development of commercial properties to prepare the lease agreements. The firm is also instructed to receive, and hold in client account, the rental deposits that are paid by the tenants. These will be held the lease comes to an end and any conditions eg dilapidations are met.
The receipt and holding of commercial rent deposits in client account would not, in itself, breach rule 14.5. This is providing that the deposit properly relates to an underlying transaction on which the firm is acting, such as advising the landlord, preparing and completing the lease or drafting any rent deposit deed. We expect firms to promptly release the deposit once the work has been completed. This is, of course, a requirement in the SRA Accounts Rules.
Where, for example, services are being provided relating to advice on dilapidations that arise during the term of the lease or other professional services that relate to the management of the lease, this may mean that firms retain such rent deposits in client account for some time; even until the end of the lease when the funds may be distributed according to a specified scheme or provision. Firms need to be mindful that their obligations under the SRA Accounts Rules continue for the period they hold the deposit. They will need to make sure that they, for example, keep records, account for interest and promptly return monies to the client.
This can be contrasted with the situation where firms are holding rent deposits indefinitely and there is no reason for the money to be held in the client account, other than for the client’s convenience. This would amount to a breach of rule 14.5.
In residential lease cases, most deposits taken by landlords and letting agents must be held in one of three government backed tenancy deposit schemes. There is therefore no reason why a law firm would need to hold residential rent deposits in their client account.
A law firm is acting as attorney under a lasting power of attorney (LPA) for a client who cannot manage their own affairs due to their mental and physical incapacity. The firm is unsure whether it can hold the client’s money in their client account in order to make payments for the client’s personal living expenses or medical care.
Where solicitors are acting as attorney under an LPA (or enduring power of attorney), they act on the instructions of the donor and in the specific circumstances set out in the power of attorney. In this situation, receiving or holding the donor’s money into client account and making payments out of it, would not give rise to a breach of rule 14.5. You should always act in the best interests of your client (the donor) which may mean operating the client’s own account as signatory or placing money in a designated deposit account.
Solicitors must also comply with any other legal requirements. For example, for Court of Protection appointed deputies, the Office of the Public Guardian (OPG) has issued guidance which advises that law firms should not use client account to hold money and should instead use a designated deposit account or use the Court Funds Office account.
Miss X, a potential client and newly arrived in the UK, has approached a law firm asking if it will hold monies on her behalf. She says that she does not have a UK bank account but is applying to open one. Miss X tells the firm that, although she is not instructing the firm for any legal advice at present, she will do so in the future once a business opportunity she is working on comes to fruition.
We would expect the firm to refuse to receive this money. There is no transaction or matter on which the firm is providing legal advice or assistance. To accept the money would be a breach of rule 14.5.
A law firm is acting for the seller (a private equity house) which is taking a leading role on the sale of a target on behalf of several other sellers. The firm collates all the funds due from the buyer on completion and holds these in its client account. Following completion, the firm pays the money to their client (the seller) and to the other represented or unrepresented sellers (subject to carrying out due diligence checks).
The funds received on behalf of, and paid out to, the client for which the law firm is acting (the lead seller) would not breach rule 14.5. The funds belong to that client and are received in connection with a transaction on which the firm is advising.
However, receiving money into client account, from or on behalf of, and to be paid to the other sellers does raise risks of a breach of rule 14.5. The law firm will need to be satisfied that there is a proper reason for these funds to be received into client account (for example, to facilitate completion of the sale and purchase of the assets, and that would not be feasible if the firm could not act in this way).
A law firm acts for one of several debt or equity investors involved in acquiring a target investment. The firm is instructed to receive the aggregate collated investment funds into its client account. This is so that one firm is responsible, in accordance with an undertaking to be given, to complete the proposed investment out of hours. The completion of the investment is not subject to formalities which need specifically to be checked by a solicitor.
If the payments were to be made piecemeal (from the various represented and unrepresented investors) into a target investment, none of the investors (including the solicitors' client) would have comfort that the full amount of the investment would be invested, and the deal could be lost if there was no ability to complete and make payments out of hours.
The funds received from the client for which the law firm is acting (the lead investor) would not breach rule 14.5. The funds are that client’s money and are received in connection with a transaction on which the law firm is advising.
However, receiving other money into client account, from or on behalf of, the other investors, that the firm is not acting for, does raise risks of a breach of a rule 14.5. The law firm will need to be satisfied that there is a proper reason for these funds to be received into client account. In this instance, there is a risk that the transaction would not be completed without one firm taking control and receiving into its client account the investment funds – and being able to complete out of hours and to give the necessary and appropriate undertakings.
The law firm needs to understand the nature and propriety of the underlying transaction on which it is acting, and the source of any funds received. There are clear risks of being involved in money laundering when non-client funds are received into a firm’s client account and then paid out.