For a few nightmare days in early October 2008, law firm managers and risk officers worried about their firms’ exposure if a major bank failure meant that they could no longer access their client-account funds. Such was the level of concern that the Law Society was moved to rush out an interim practice note on the subject, and then within twenty-four hours to amend it. Of course, the immediate crisis soon passed and the danger of a major bank collapse is now much reduced – although still present. This may, therefore, be an opportune time to reflect on the lessons to be learned.

A couple of points are important to a clear understanding of the firm’s and clients’ positions in the event of a bank collapse. The first is that solicitors’ client accounts are trust accounts. In theory, at least, there should be a greater prospect of these accounts being paid out swiftly and in full than those of ordinary depositors. The second is that a firm ought, in principle only, to be liable to compensate clients for lost or delayed funds if the firm has been negligent. Negligence might arise if a client account were to be set up with an obviously inappropriate institution or if a firm were to assume obligations to individual clients to advise them where their money might be best placed. Firms would be well advised to implement procedures designed to discourage individual partners and fee-earners from offering such advice. Outside these obvious situations, however, the likelihood of negligence being established would seem low.

More concerning, potentially, is the risk of being exposed on unqualified undertakings if bank failure were to prevent or delay compliance. More carefully qualified undertakings will now be prudent, with financial promises limited to the giving of instructions to bankers rather than absolute confirmation of payment. Unhelpfully, the Law Society’s interim practice note appears to discourage sensible limitations of this nature in routine conveyancing transactions: hopefully this will be changed.

Many firms will now have contingency arrangements in place to move client-account funds to another institution should this appear necessary. Some firms, however, have gone further and now actively operate more than one client account at different banks. Whether this is worthwhile may be debatable. While in most instances spreading risk is a wise policy, it would be an administrative nightmare to have to split each individual client’s money between different accounts and maintain separate records for these. In practice, each client’s money will most likely still be placed at a single bank and so the potential risk to clients will arguably not be reduced. Moreover, if anything, the firm will be increasing its own risk that if a bank failure does occur the firm will have some of its client money in the wrong place.

More straightforward steps to consider with a view to minimising exposure include a clause in terms of business confirming that the firm is not liable for the consequences of bank failure and a documented prompt for clients placing large funds with the firm to be able to specify, if they wish, where the funds should be held (but on the basis that the firm will not provide advice).

With the safeguards mentioned above in place, the risk of law firm exposure if the banks start to creak again should hopefully be much reduced.

Andrew Scott is a partner at Barlow, Lyde & Gilbert. He can be contacted at ascott@blg.co.uk