You should be on your guard whenever you hear the word ‘escrow’. Law firms are prohibited from providing pure escrow services through the client account.
Why? Because pure escrow accounts are primarily banking facilities and a serious compliance risk, according to the Solicitors Regulation Authority.
The SRA says:
“Money passing through the client account can be entirely legitimate where there is a clear legal service being provided, but we will continue to take action against those who cannot justify their actions, put their clients at risk and undermine public trust in the profession.”
The prohibition and SRA Warning Notice
This is enshrined in the Standards and Regulations. Rule 3.3 of the SRA Accounts Rules says that:
“You must not use a client account to provide banking facilities to clients or third parties. Payments into, and transfers or withdrawals from a client account must be in respect of the delivery by you of regulated services.”
The SRA takes this prohibition very seriously. There is a clearly worded Warning Notice. The SRA only issues Warning Notices when the softly-softly approach fails to land with the profession.
The Warning Notice states that there must be a ‘proper connection’ between the money and the legal services:
“Whether there is such a proper connection will depend on the facts of each case. The fact that you have a retainer with a client is insufficient to allow you to process funds freely through the client account. You need to think carefully about whether there is any justification for money to pass through your client account when it could be simply paid directly between the clients.”
And don’t forget the Solicitors Disciplinary Tribunal regularly sanctions solicitors for breaching the rules (e.g. see this recent Agreed outcome resulting in £15,000 fine plus £15,000 costs for the solicitor).
The commercial reality of escrow
However, as any commercial lawyer will tell you, escrow services are a vital part of the transaction process. It bridges the trust gap between contracting parties.
Law firms regularly act like an escrow agent in legal transactions by holding funds in the client account until completion.
The vital difference is that the solicitor holding those funds will be acting for one of the parties on the transaction itself. There is nothing wrong with that in principle. So long as the money relates to the legal service being delivered, the prohibition in 3.3 of the Accounts Rules does not apply. It’s similar to conveyancing solicitors holding deposits pending completion.
You can get into trouble when the client asks you to hold money and you are not also providing legal services. That would be classed as a banking facility and is caught by the prohibition. The thinking is that these arrangements are high risk for side-stepping the regulated banking sector, hiding assets (e.g. from an insolvency process), facilitating financial crime and money laundering.
Fundamentally, law firms are not in the business of providing banking services. Use of the client account must be incidental to the legal services provided.
What is the alternative?
The only alternative option is to use a trusted third party escrow service.
Contact us if you have any questions or would like a recommendation for escrow account providers.