1. History of referrals

The history of introductions and referrals, in particular the payment of referral fees, is a long and chequered one that has for many years divided opinion within the solicitors profession.  The traditional argument was always that the payment or receipt of referral fees would jeopardise a clients’ ability to obtain independent advice, cause reputational damage to the profession and should thus be prohibited.  The preferred stance by many was that solicitors should be in the driving seat and that accepting, or being expected to make, any form of an inducement, financial or otherwise, would weaken the solicitors’ position.

That of course was very much the argument from those in a safe position.  The reality of the situation for many was that for many referral fees were a reality that existed – whether banned or not – and that firms who did not make them could not compete effectively with those who ignored the rules and did.  Many argued that the ban went further than was necessary for the purposes of ensuring independent advice and was in fact harming a solicitors ability to compete in a marketplace that was becoming ever more commercial.

Gradually, over the years, and in the face of increasingly commercial competition from licensed conveyancers and others, the referral of business rules were relaxed.  Thus by 1988 solicitors were permitted to enter into referral arrangements provided the introducer was not “rewarded” and then even this safeguard was swept away on the grounds that:

• no obvious link between payments for referrals and a solicitors’ independence could be conclusively proved;
• it prevented solicitors competing effectively with other legal services providers;
• it was almost impossible to enforce;
• many solicitors did it anyway – adopting a more “relaxed” interpretation of the word “reward” than their colleagues; and
• there was no real perception of public protection involved.

Much debate continued to ensue with payments for referrals still effectively prohibited until 2004 when payments, subject to conditions and safeguards such as full disclosure to the client, were officially sanctioned.

Since then, the position has been continually liberalised – first in Rule 9 of the Solicitors Code of Conduct 2007 and then in the SRA Code of Conduct 2011. However, we have subsequently seen further restrictions imposed in relation to the payment of referral fees for personal injury claims, through part 2 process of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (“LASPO”), which we may yet see applied to other types of referrals in the future.

2. The current position

Before we look in detail at the current position it is as well to clarify what we mean by “Introductions” and “Referrals” and to explain how they differ.

An introduction, for these purposes, is taken to mean an introduction of a client by a solicitor to a third party.  On the other hand, a referral is an introduction to the solicitor by a third party of a client.  In either case it can be with or without the payment of a fee or some other form of consideration.

Introductions are dealt with in the SRA Code of Conduct in Chapter 6 (Your client and introductions to third parties) (“the SRA Code”) and describes the conduct duties which arise when a solicitor wishes to refer his or her client to a third party, for example another lawyer or a financial services provider.  The overriding duty here is that the solicitor must retain their independence and act only in the client’s best interests.

Referrals, on the other hand, are dealt with principally in Chapter 9 (Fee sharing and referrals) of the SRA Code. This chapter is about protecting clients’ interests where the solicitor has arrangements with third parties who introduce business to them and/or with whom they share fees. Here it is stressed that the “relationship between clients and firms should be built on trust, and any such arrangement should not jeopardise that trust by, for example, compromising …. independence or professional judgement.”

The similarity of these two concepts often leads to confusion.  Yet, there are very different considerations to bear in mind.   Even the Lexcel standard appears to perpetuate this confusion when it states in section 6.4 (b) that:

“Practices must … advise the client where the practice will receive a financial benefit as a result of accepting instructions”

3. Introductions

First of all we will consider introductions – that is to say the position where a firm introduces or recommends one of its clients to a third party.

The current basics are to be found in the four outcomes in Chapter 6 of the SRA Code.  These provide:

O(6.1)	whenever you recommend that a client uses a particular person or business, your recommendation is in the best interests of the client and does not compromise your independence;
O(6.2)	clients are fully informed of any financial or other interest which you have in referring the client to another person or business;
O(6.3)	clients are in a position to make informed decisions about how to pursue their matter;
O(6.4)	you are not paid a prohibited referral fee.

Let us look in more detail at what these mean.

Outcome O(6.1)

The first of the Outcomes, O(6.1), provides that whenever a solicitor recommends that the client use a third party or adviser that recommendation should only ever be in the best interests of the client and the solicitor’s independence must not in any way be compromised by that recommendation. 

Thus, for example, a recommendation of a financial adviser should be based only on the ability of that financial adviser to provide the client with the advice needed and should not be based upon the fact that, whilst they may not be as expert in that particular area as another adviser, they are more likely to refer work back to the solicitor or pay the solicitor a fee for the recommendation.  Clearly if there are two advisers of equal ability with one being more likely to benefit the referring solicitor than the other then the solicitor may choose the more beneficial referral – but if that is the case then the referring solicitor would be well advised to record why they made the referral in question and of the solicitor’s belief in the ability of the adviser to provide the advice needed.

Indeed, where financial advice is concerned, attention should be given to Indicative Behaviours IB(6.1) and IB(6.2) which provide:

IB(6.1)	any arrangement you enter into in respect of regulated mortgage contracts, general insurance contracts (including after the event insurance) or pure protection contracts, provides that referrals will only be made where this is in the best interests of the particular client and the contract is suitable for the needs of that client;
IB(6.2)	any referral to a third party that can only offer products from one source is made only after the client has been informed of this limitation;

Outcome O(6.2)

The second Outcome specifically deals with the situation where the solicitor has an interest in making a particular referral – as opposed to simply referring to a third party able to undertake the work.  Outcome O(6.2) provides that the client must be fully informed of “any financial or other interest which you have” in making any recommendation in their matter. This goes wider than the mere payment of a financial “referral fee” and covers all forms of benefit which the solicitor might receive.  Thus, reciprocal referral arrangements, benefits in kind (for example the use of a holiday property), actual referral payments,  even personal interests such as the spouse of one of the principals being a partner, director or perhaps even an employee of the referred to firm, should be declared to the client.

Outcome O(6.3)

The third Outcome, O(6.3), is slightly more difficult to comply with and indeed, has been fundamentally amended since the SRA Code first took effect in 2011.  The original version of Outcome O(6.3), which remained in force until Version 6 of the SRA Code took effect on 1 January 2013, provided for the situation where a client required advice on investments, such as life insurance with an investment element or pension policies and where the solicitor was under a duty only to refer the client to  an independent intermediary.

This original Outcome O(6.3) has been removed entirely (following changes to the classification of such agencies by the then FSA ) and has been replaced with the amended  requirement that clients must be in a position to make “informed decisions about how to pursue their matter”.

It is not entirely clear what this means or indeed why a firm would not want the client to be in such a position – unless perhaps they were planning to take advantage of a vulnerable client.  The wording is undoubtedly vague and has attracted criticism from many in the financial services sector.  At the time of the change there were, in fact, three optional wordings which the SRA were considering.  These were:

Option 1 – to keep the main tenor of the wording but to replace the term ‘independent intermediary’ with another term consistent with the Retail Distribution Review that had led to the change being necessary in the first place.

 

Option 2 – to simply replace Outcome O(6.3) with a new indicative behaviour describing referral to an independent adviser.

 

Option 3 –  simply to amend Outcome O(6.3) so as to require the firm to ensure that clients could make an informed choice about referrals.

In the event, Option 3 was chosen which, in theory anyway, places upon the solicitor an obligation to carry out their own investigation into the suitability of any adviser – particularly a financial adviser – to whom the client is referred.  In reality it is suspected that it is a provision which is more observed in the breach.  Whilst this is not an unexpected result of the rather vague wording it could, from the firm’s point of view, be a dangerous one as it could leave the firm open to claims from clients to whom inappropriate referrals have been made.

Thus to comply, firms should consider implementing a procedure whereby those within the firm making referrals should only do so to pre-approved independent financial advisers and that the criteria by which they were selected be recorded .

Outcome O(6.4)

The fourth and final Outcome, O(6.4), was added in Version 7 of the SRA and took effect on the 1st April 2013.

It arose from the requirements of sections 56-60 of LASPO which had the effect of banning the payment of referral fees in personal injury work.  The SRA came under significant pressure at the time to provide guidance to firms on precisely what it would regard as  the payment of a prohibited fee and what would continue to be permissible marketing or other business expenditure.  Regrettably such guidance was not forthcoming and a rather limited provision incorporated into Chapter 6 was the SRA’s only offering at the time – a requirement that no authorised practice should be paid a prohibited referral fee backed up by two indicative behaviours at 6.3 and 6.4 to the effect that systems would need to be in place to determine what would be a prohibited fee and that records should be kept of all such deliberations and decisions.  The Glossary defines a “Prohibited referral fee” as a payment prohibited by section 56 of LASPO or “a payment made to or by you which appears to the SRA to be a referral fee for the purposes of section 57(7) of LASPO, unless you show that the payment was made as consideration for the provision of services or for another reason and not as a referral fee.”

This Outcome should also be read in conjunction with Outcome O(9.8) which requires that a solicitor “not pay a prohibited referral fee.”

Finally in relation to introductions, Outcome (1.15) of the SRA Code deals with the related issue of commissions received.  It states:

O(1.15) –    you properly account to clients for any financial benefit you receive as a result of your instructions;

Whilst not as common as they were, there may still be a circumstance where a firm might receive a commission for an introduction – for example an insurance commission payable to the firm or possibly a discount on search fees.

Under the former Code of Conduct 2007 firms were entitled to retain sums of up to £20 earned in this way without accounting for it to the client.  This rule was, however,  abolished by the SRA Code leaving firms with a strict liability to account in full for any benefit received as a result of the client’s matter with no de minimis exception.  This new stricter line is reinforced by the definition of what amounts to client money in the SRA Accounts Rules which states at Rule 12.2(f) that:

“Client money” includes money held or received ….. as a financial benefit paid in respect of a client, unless the client has given you prior authority to retain it (see Chapter 1, outcome 1.15 and indicative behaviour 1.20 of the SRA Code of Conduct);

4. Referrals from others

The other side of the coin, so to speak, from an introduction by the firm to a third party is  the referral to the firm by a third party.  The issue of referrals is mainly dealt with in Chapter 9, the preamble to which states:

This chapter is about protecting clients’ interests where you have arrangements with third parties who introduce business to you and/or with whom you share your fees. The relationship between clients and firms should be built on trust, and any such arrangement should not jeopardise that trust by, for example, compromising your independence or professional judgement.

The Chapter goes on to deal with Referrals in the eight Outcomes which state:

O(9.1)	your independence and your professional judgement are not prejudiced by virtue of any arrangement with another person;
O(9.2)	your clients’ interests are protected regardless of the interests of an introducer or fee sharer or your interest in receiving referrals;
O(9.3)	clients are in a position to make informed decisions about how to pursue their matter;
O(9.4)	clients are informed of any financial or other interest which an introducer has in referring the client to you;
O(9.5)	clients are informed of any fee sharing arrangement that is relevant to their matter;
O(9.6)	you do not make payments to an introducer in respect of clients who are the subject of criminal proceedings or who have the benefit of public funding;
O(9.7)	where you enter into a financial arrangement with an introducer you ensure that the agreement is in writing;
O(9.8)	you do not pay a prohibited referral fee

It is important to bear in mind when considering these that:

• there is no longer a distinction between referrals from other lawyers (which were formerly dealt with separately as “fee-sharing” agreements and not regarded as referral agreements at all; and
• the rule is not limited to paid-for referrals only and there are implications in less formal relationships too.

Let us look at these Outcomes in more detail.

Outcomes O(9.1) & O(9.2)

As with introductions, the principal concern of the SRA Code is that the interests of the client should be paramount. Therefore, no referral arrangement should be entered into where your  independence and professional judgement are in anyway prejudiced or where the client’s interests are not paramount. Thus, for example, if the referral arrangement is such that the advice given to the client is tainted in any way by a duty to the referrer, then that independence would not be achieved. This could include, for example, advising the client to take a particular course of action that would be beneficial to the referrer but harmful to the client.

This is backed up by the provisions of Indicative Behaviours IB (9.1) to IB (9.4) which require:

IB(9.1)	only entering into arrangements with reputable third parties and monitoring the outcome of those arrangements to ensure that clients are treated fairly;
IB(9.2)	in any case where a client has entered into, or is proposing to enter into, an arrangement with an introducer in connection with their matter, which is not in their best interests, advising the client that this is the case;
IB(9.3)	terminating any arrangement with an introducer or fee sharer which is causing you to breach the Principles or any requirements of the Code;
IB(9.4)	being satisfied that any client referred by an introducer has not been acquired as a result of marketing or other activities which, if done by a person regulated by the SRA, would be contrary to the Principles or any requirements of the Code;

In the commercial world these may not always be easy behaviours to abide by.

• What constitutes a “reputable third party” and how would you justify doing the best for a client even though the referrer was suspect. The two need not necessarily be mutually exclusive.
• How would you go about telling someone that the matter they were involved in was not in their best interests – especially if there is a chance that they will simply be referred to someone else if you don’t act? What about the situation when it is not in the client’s best interests but you can make it more so than someone else may do?  Are there shades of grey?
• If a referral agreement is particularly lucrative or is a mainstay of the firm, how do you justify to yourself, your partners, your creditors even your family terminating an introduction arrangement – especially when you know that the clients will simply be sent to another firm who may be less scrupulous? A difficult moral call.
• How do you go about finding out whether the marketing activities of the introducer are unacceptable? It would be easy to refuse a client if you knew that the marketing was unacceptable – difficult to prove a negative – i.e. that it was no unacceptable.

Indicative Behaviours IB(9.11) and IB(9.12) provide examples of where there would be a breach of these provisions:

IB(9.11)	allowing an introducer or fee sharer to influence the advice you give to clients;
IB(9.12)	accepting referrals where you have reason to believe that clients have been pressurised or misled into instructing you.

Outcome O(9.3)

This Outcome echoes Outcome O(6.3) and as such a fraught with the same difficulties.  It places a duty on the firm to ensure that they are aware of all of the factors influencing the referral to them and it also places a duty upon them to be sure that the client understands.  Again, as with the points covered above, instances will no doubt occur where the referral is not in the interests of the client or aspects associated with the referral and undertaken by the introducer are not in the best interests of the client.

Outcomes O(9.4), O(9.5), O(9.6) & O(9.7)

As was the case with Introductions,  the client must be informed of any “financial or other interest” that the introducer has in making this referral to you or of any fee sharing arrangements that is relevant to their matter.

In particular it should be noted that no payments may be paid in legal aid or criminal matters and any paid-for arrangement with any introducer of work must be in writing.

Again the phrase “other financial interest” is used meaning that any arrangement where there is a potential for someone to benefit comes within this.

Outcome O(9.8)

Finally, there is the counterpart to O(6.4) dealt with above which states that no prohibited referral fee may be paid for the introduction of work to the practice.

5. Separate Business

A final area of relevance here lies in the recently revised rule in relation to separate businesses.

Separate Businesses are dealt with under Chapter 12 of the SRA Code, the preamble to which states:

Clients of a separate business will not have the same regulatory protections as clients of an authorised body and it is important that this is clear to clients of the separate business particularly where they are being referred from the authorised body or cases are being divided with the authorised body.

Of particular relevance here is Outcome O(12.4) which states:

O(12.4) –    you only

1. refer, recommend or introduce a client to the separate business;
2. put your client and the separate business in touch with each other; or
3. divide, or allow to be divided, a client’s matter between you and the separate business,

where the client has given informed consent.

In other words, a higher duty of “informed consent” applies to the separate business referral situation.

6. Practical Questions

Rule 4.1(c) of the SRA Financial Services (Scope) Rules 2001 states that “A firm which carries on any regulated activities must ensure that …. the firm accounts to the client for any pecuniary reward or other advantage which the firm receives from a third party”

It would seem that if the figure can be determined then yes, you must tell the client under the provision in Outcome O(9.4).  Where this becomes more difficult is in relation to payment for an unspecified number of introductions or where some other form of arrangement exists.  In these cases the firm must use its best endeavours to ensure that the client understands the nature of any arrangement that exists.

Probably not, because the staff member is not a “third party” as referred to in chapter 9 but a part of the firm.

Outcome O(9.2) provides that a firm should ensure that the clients’ interests are protected “regardless of the interests of an introducer or fee sharer or your interest in receiving referrals”.

On the other hand, Indicative Behaviour IB(9.12) provides that you should not be “accepting referrals where you have reason to believe that clients have been pressurised or misled into instructing you.”

However, the Indicative Behaviour is only a suggestion as to how the firm should act.  Provided that your firm is acting strictly in the best interests of the client then this could well overreach any prior pressure placed upon the client to instruct you.  However, you are likely to need to raise this matter with the client, ensure that the client understands what has happened and that they are given the opportunity to place their instructions elsewhere should they choose to do so.  You will also need to raise the matter with the introducer and either ensure that the situation does not arise again or terminate your arrangement with them.  You would be advised to document fully the steps and considerations taken in regard to this matter.