Few of us can escape the cost-of-living crisis which is having an impact on almost all areas from fuel to basic shopping prices. The climb in inflation, which is at a 30 year high, will affect business as well as us individually. Under monetary policy, the Bank of England has adopted regular incremental increases in interest rates, which at the time of writing sit at 1.75%. Such rises may be passed on to all businesses that are borrowing, including law firms, but there is also the issue of legal practices accounting for interest under Rule 7 of the SRA Solicitors Accounts Rules.
From a commercial point of view, interest rates increases can have damaging cash flow and profit implications. Where properties are mortgaged, and not on a fixed rate, repayments may increase. Where firms have borrowing obligations coming to an end or need to borrow, for example to fund Professional Indemnity insurance or partners tax payments, they are likely to see higher rates. This will be especially true if, in recent years, practices have taken advantage of the COVID government borrowing schemes.
Inflationary pressures may also result in demands from the work force of law firms. If prices and mortgage rates are going up for staff, a review of their remuneration package may become a far trickier conversation then previously anticipated. With good staff being in short supply, it is difficult for firms to navigate such problems.
On top of this, law firms have an extra issue to address when it comes to rising interest rates – Rule 7 of the SRA Accounts Rule 2019. Rule 7.1 states “You account to clients or third parties for a fair sum of interest on any client money held by you on their behalf”. The key words in this sentence are “fair sum.” In recent years interest rates have been so low that these words never needed to be dissected. In fact, it was little over a year ago that the possibility of negative interest rates became a real possibility and some banks were considering charging law firms for holding funds.
Many firms will have a de minimis amount below which interest will not be paid to clients. This is normally detailed in the client care letter or terms of engagement. This should be reviewed regularly to ensure it remains “fair.” In addition, accounting systems must have controls in place which calculate when interest becomes payable to clients. If this is not the case, there is a breakdown in the control mechanism and the client might not receive the interest they are owed.
Rule 7.2 does offer a degree of flexibility by stating “You may by a written agreement come to a different arrangement with the client or the third party for whom the money is held as to the payment of interest, but you must provide sufficient information to enable them to give informed consent”. The real test here is ensuring there is “sufficient information” in order for a decision to be made.
One point to consider as reporting accountants is that Rule 7 is not one of the rules we need to carry out work on. However, if we come across a client where their interest policy or accounting for is not in line of Rule 7, we should consider the overall impact. Where interest should be paid to a client and is not, client money may be being held in the business account.
For law firms, it is therefore apparent that a rise in interest rates may have an even more profound impact than on other businesses and economic uncertainty ahead will only add to this.
*The views expressed are the author’s and not ICAEW’s.