Law firms failing to pay clients 'fair' interest on monies held may come under regulatory scrutiny

With the base rate soaring from 0.1% in 2021 to 5.25% on August 3 2023, some law firms are likely to be earning significant sums of interest on client money. It is common for lawyers, particularly conveyancers, corporate lawyers and those specialising in personal injury, to hold substantial funds belonging to clients for varying amounts of time.

• SRA requires firms to pay clients ‘fair’ interest on money held on client account
• Rising interest rates means client accounts are earning substantial sums that law firms may be tempted to keep

Graham Reid, Partner at RPC, who advises law firms on regulatory issues, says that although firms do not necessarily have to pay clients the full value of interest earned, they are bound by the SRA to account to clients for a ‘fair’ sum of interest on client funds (under rule 7.1 of the SRA Accounts Rules). He adds: "Given the regulatory pressures being applied to banks and investment platforms to pay more generous interest rates to customers, it’s only a matter of time before law firms face similar scrutiny from their own regulator, the SRA."

Some law firms are paying out as little as 0.5% or 1% of interest on client accounts.

Graham Reid explains: “Many law firms have earned large amounts from interest on client monies since the Bank of England started pushing up rates. For some, this interest is likely to be making a significant contribution to profits.

“Law firms will need to consider carefully whether the way they pass on to clients interest earned on their monies is 'fair' or not. They will also need to be able to justify their reasoning to the SRA.

“As an alternative to accounting to the client for fair interest, it is possible under rule 7.2 of the SRA Accounts Rules for firms to reach an alternative arrangement with clients for the payment of interest, but clients must give informed consent. 'Informed consent' is a high hurdle to meet. Firms will need to be absolutely clear in their explanations to clients about options and implications.

“With new enhanced powers to fine firms and a vigorous approach to rule enforcement, the SRA can be expected to take a very dim view of those that do not pay fair interest and thereby cause client detriment.

“The key messages are: Is it fair? Is it properly explained? Can you fully justify your decision-making to the regulator?”