Recovering costs and payments from third parties
We have published separate guidance on recovering the costs of regulatory action against those we regulate. This guidance covers how we decide whether to try to recover these costs against other parties, in certain circumstances. In doing so, we recognise that it is important to maximise recoveries to help minimise our costs and therefore the cost of regulation for individuals and firms which is ultimately passed on to consumers.
This guidance should be read in the context of decision making at the SRA and other guidance. It is a living document and will be reviewed and updated as appropriate. It reflects our approach to our regulatory role. Any departure must be capable of justification on the individual facts of the case.
Who is liable?
Where an intervention is into a partnership, all partners in the firm at the time of intervention are jointly and severally liable for the costs, which we can enforce directly against them.
Under legislation, we are also able to apply to the High Court to require a former partner, or a manager or former manager of an authorised firm which is a body corporate to pay intervention costs. This power can only be exercised where the person’s conduct contributed to the need to intervene. This means we are able to recover costs from those directly responsible. In some circumstances this allows us to take action where a perpetrator within a firm anticipates the intervention and resigns from the partnership before we intervene.
Where we intervene into a firm, the entity itself is liable for the costs. However, individual solicitors can have a practice within the corporate entity and those practices can themselves be subject to intervention. In that case, the individual will be liable for the costs of intervention. The way we deal with those individuals is covered in the separate cost recovery guidance. This guidance deals only with where those individuals are not specifically subject to the intervention and how as managers of the entity, they can be made liable for the costs.
The statutory test
In order to succeed, we will need to satisfy the court that the conduct within the firm which made it necessary for us to intervene was "carried on with the consent or connivance of, or was attributable to any neglect" by the person we intend to bring the claim against. This wording is broad. We will examine all evidence in our possession to assess the conduct of the individual concerned.
In a two partner firm, Mr A deals mainly with conveyancing and Mrs B deals with wills and probate. We receive complaints from clients that they have not received sale proceeds due to them after completion. We find there have been a number of misappropriations by Mr A of client money on conveyancing transactions. These have been hidden by false entries in the accounts (which Mr A maintained). Mr A resigns from the practice.
Mrs B tries to replace the missing money but she does not have the personal resources to do so. The firm is now a sole practice of Mrs B and she therefore faces full liability for the intervention costs whereas Mr A, whose actions prompted our action, is not automatically liable. We decide to make an application to the court for Mr A to be made liable jointly and severally with Mrs B for all costs of the intervention. We provide evidence to the court that it was Mr A’s activities which led directly to the intervention. The court is satisfied and makes the order. We can then pursue Mr A for the costs of the intervention.
We intervene into an incorporated practice and into the practice of its sole director, Mr A, on the ground that they failed to comply with the accounts rules. Mr B had also been a director of the company, and majority shareholder, but resigned and sold his shares three months prior to the intervention. The breaches of the Accounts Rules which led to the intervention were committed when both Mr A and Mr B were directors. We commence proceedings against Mr B on the basis that the intervention was as a result of both Mr A and Mr B’s conduct at the firm. Mr B settles our proceedings by paying a significant proportion of the outstanding intervention costs.
Deciding whether to use these powers
Our guidance on recovering costs explains that, where an individual is liable to pay the costs of intervention, we will examine their ability to pay by considering their assets, income and liabilities. If they cannot pay in full, we may accept a reduced lump sum in full settlement or payment by instalments. We may also accept a charge over property to secure our debt. The guidance also explains that we will take enforcement action against anyone who does not cooperate with us, for instance by refusing to complete a financial statement or by providing misleading, false or inadequate information.
We will take the same approach when considering whether to seek an order against a former partner or manager, above, or a current manager or a body corporate. In particular, we will not wish to bring unnecessary proceedings before the court, for instance, succeeding in a claim only to find out the individual has neither assets nor income and so has no prospect of paying the debt. Therefore, usually, we will try to engage with the individual and ask if they will complete a financial statement. We will also, where appropriate, carry out our own investigations into their financial position.
If an individual cooperates and provides us with satisfactory evidence that they would not be able to pay the debt if the court ordered it, then we are not likely to proceed with that action.
Where it is clear that an individual could pay the debt, we are willing to reach an agreement with them at that stage to avoid the need and costs of court action. Assuming they accept that they are likely to be found liable for the costs, we will treat the potential debt due from them as we would from those automatically liable and consider instalments, charges and other mechanisms.
If an individual refuses to provide information or tries to mislead us, then we are likely to proceed to court to obtain an order which will open up the full range of enforcement action to us, for example issuing a statutory demand in bankruptcy.
Further information is found in our guidance on recovering costs.
Liability for Compensation Fund Payments
Managers – Indemnity Insurance
The liability of current managers is highlighted in the guidance on Recovering Costs. If the Compensation Fund makes grants to those clients whose money has gone, it will inherit the rights those clients had to take action against the firm, or its managers.3 This is called subrogation.
However, if these individuals were not involved in the wrong doing which led to the payment, they may have the protection of indemnity insurance against that wrong doing. All firms are required to have insurance that meets certain minimum terms and conditions. In the case of an incorporated practice, the minimum terms state that an insurer can only decline an indemnity if all members/directors committed or condoned the dishonest activity. The burden is on the insurer to justify their refusal (called a declinature) and not on the insured to justify why they should have cover.
Therefore, where the evidence shows that there is a manager who was not involved in the wrong doing at the firm, we may bring a subrogated claim against them for any payments made out of the Compensation Fund, knowing that they should be indemnified. If we conclude that the person is entitled to an indemnity, we will write to the insurer direct to explain our position including details of payments made from the Compensation Fund and why we think the person is entitled to an indemnity.
An incorporated practice has four directors. Three of the directors report to us that they have discovered that the fourth director has been committing probate fraud over a period of months and that a significant amount of client money has been misappropriated. The three directors have not been able to replace the missing money and while they hope that the insurer will provide an indemnity to them, this has not yet been confirmed and the matter won’t be resolved for some months. The three partners accept that the only option is for us to intervene. We do so and the Compensation Fund makes payments to replace the stolen money. We pursue the culpable director directly for liability for these payments. However, our investigation shows that the other directors were not involved in the wrong doing at all. We therefore bring claims against them, which they refer to their indemnity insurer. The insurer accepts that the three directors are not implicated in the fraud and confirm they will indemnify them. The insurer therefore makes a payment to the Compensation Fund to replace the payments made.
Just as an innocent manager at the time of intervention is liable for losses which arise during their time in that role (albeit with the protection of indemnity insurance), similarly liable is someone who was in that role in the past. However, in the same way, if they were not involved in the wrong doing, they will have the benefit of indemnity insurance. We are able to bring a claim against them for the funds if they were a manager at the time of the loss which led to the grant from the Compensation Fund. The individual concerned will refer the matter to the indemnity insurer.
We intervene into a sole practice because the principal has been stealing client money for a number of years. Although a sole practice at the time of intervention, the firm was a partnership until the resignation of a partner two years ago. The Compensation Fund makes a number of grants covering money which was stolen at various times over the last few years. A number of these losses were incurred when the partnership was in place. We bring a subrogated claim against the innocent partner who refers it to the indemnity insurer. The insurer confirms they will provide an indemnity against the claim.
Most firms are required to obtain an annual report prepared by an independent accountant, and deliver this to us if it identifies any breaches of our Accounts Rules or risks to client money (otherwise known as a "qualified" report). The Solicitors Act 1974 imposes an obligation4 on a firm’s reporting accountant to notify us immediately if the accountant: discovers evidence of fraud or theft in relation to money held by a solicitor for a client or any other person (including money held on trust) or money held in an account of a client of a solicitor, or an account of another person, which is operated by the solicitor obtains information which the accountant has reasonable cause to believe is likely to be of material significance in determining whether a solicitor is a fit and proper person to hold money for clients or other persons (including money held on trust) or to operate an account of a client of the solicitor or an account of another person.
The Court of Appeal has confirmed that reporting accountants owe us a duty of care5 which is breached, firstly, when in the course of preparing the report, the accountant identifies something which is urgent and high risk, and does not report this to us immediately; or secondly, where the report is not qualified and does not therefore raise issues which they were or should have been aware of.6
In either case, the risk is that any prohibited activities will remain undetected and the loss to the clients and ultimately the Compensation Fund, will be greater.
Therefore where we make payments from the Fund on the basis of a shortfall in the client account or other risks to client money, we will review the accountant’s reports for the firm to see if these issues were identified, and if not whether they should have been and when. We will also consider whether the issues identified were sufficiently serious that the accountant should have reported them to us immediately.
If the Compensation Fund grants all relate to losses caused in the period since the last accounting report, then clearly there is nothing the accountants could have done to notify us of that. However, if we have evidence of long standing problems with the client account of the firm such as ongoing shortages on the account or suspicious transactions taking place over a period of years, then we will assess whether the accountants should have noted this and if it should have been reported to us. If so we can make a claim against them for breach of their duty to us.
We intervened into a two partner firm on the grounds that we had reason to suspect dishonesty. It became clear to us that the two partners had been committing fraud for a number of years and misusing the client account to assist in the fraud. Despite this, the firm’s reporting accountants had prepared unqualified reports for each of the periods when the frauds were committed. Significant payments were made to clients from the Compensation Fund.
We commenced proceedings against the accountants, claiming damages on the ground that they had been negligent in preparing the accountant’s reports and, as a result, we had not intervened as quickly as we could have done had we known earlier of the serious problems in the firm and risks to client money. That would have reduced the losses and the amount paid out of the Compensation Fund. The accountant’s insurer settled the claim and the payment was transferred to the Compensation Fund.
- Paragraph 13A of Schedule 1 to the Solicitors Act 1974; Schedule 2 paragraph 35(g) AJA; Schedule 14 paragraph 18 LSA.
- Schedule 2 paragraph 35(g) AJA; Schedule 14 paragraph 18 LSA.
- Rule 18.1 SRA Compensation Fund Rules 2011.
- Section 34(9).
- Law Society v KPMG Peat Marwick & Others  4. All ER 540.
- Since November 2015, it is no longer necessary for firms to send to us their annual accountant’s reports if unqualified.