Law ambiguous if client money gets lost in the crunch

Trawling through the Solicitors Account Rules (SAR) is not fun, even for a hardened managing partner, general counsel or director of risk. But that is exactly what most of them have been doing in the past few weeks in an attempt to deal with the possibility that the money held by law firms in client accounts could be unprotected in the event of a bank insolvency.

Last week the Government extended its guarantee for private and small ­business savings held in banks to £50,000. Amounts of more than the £50,000 threshold or money held for large corporate clients remain ­completely exposed.

The Law Society estimates that more than £3bn is held in lawyers’ client accounts. Firms have been left to figure out for themselves whether they would be held responsible if a client’s money was to disappear down an Iceland – or otherwise – shaped hole.

A City partner responsible for risk management says: “What’s happening is that the use of client accounts is diminishing. Previously clients would be happy to leave all the money in there because they’d get the interest. But now, unless you really need it, the client may feel it has more control if it holds the money.”

One firm even received a request to turn a client’s money into gilts, but ­solicitors can only hold client money in a bank account where the bank has a branch in England or Wales.

Firms have been reacting to the ­problem in a variety of ways. One risk management partner says: “We have one main client account and we have another small account with another bank. For historical reasons this was not much used, but since the events of last week we’ve opened two more.”

This risk limitation measure has also been taken by several other large firms.
One magic circle firm now informs clients which bank will be holding their money before accepting any cash. Although that firm said it was not examining all cash currently held on account, another firm is telling all clients with significant deposits where their cash is held.

Another firm has reviewed its policy of giving undertakings, which are almost impossible for solicitors to get out of.

“We’ve changed our approach over the last month,” says the firm’s risk ­management partner, adding that the firm has now banned all undertakings to pay cash, choosing instead to instruct banks to make payments.

The Law Society published a practice note on the subject last week, responding to firms’ calls for industry guidance on the issue. After seeking advice from counsel, the Law Society decided it would be “unlikely” that law firms would be found negligent if client money was lost in accounts of insolvent banks, unless they were negligent in their choice of bank (TheLawyer.com, 9 October).

But there are additional concerns that, if a firm was negligent in its choice of bank account and a client lost millions, the standard terms of firms’ professional indemnity insurance explicitly exclude “trade debt”.

Law Society director of legal policy Mark Stobbs states: “We can’t stress too strongly that the situation is unprecedented and that the law is untested. Ultimately it’s for individual solicitors to assess where the risks lie.”

But the legal liability is, perhaps, the least of a firm’s problems. As one ­managing partner says: “If HBOS or one of those banks goes down, then you probably wouldn’t be negligent if you had your money there, but try explaining that to the clients.”