Applying the John West test – how to prevent disasters with fishy clients

[Australasian Law Management Journal,Compliance & Risk Management,Finance & Accounting,General Management,Strategy & Leadership] March 27, 2019

Sometimes the most valuable decision you can make when running a law firm is to not take on a client, so putting in place robust processes to determine which clients you accept or reject can save firms many future problems, writes Peppy Mitchell.

How many times have you been in a difficult situation with a client and realised that you ‘smelt a rat’ from the very start?

With the benefit of hindsight, you would never have accepted their retainer or their money. While much of the effort in law firm risk-management goes into minimising a loss after a client has failed to pay their bill or made a complaint or claim, it may well be more efficient for firms to focus on prevention rather than a cure. This means saying ‘no’ to a potential client at the outset to avoid future problems.

Solicitors are not obliged to accept every potential client. This is in contrast to barristers in the United Kingdom and other countries where the ‘cab-rank rule’ obliges the barrister to accept any work in a field in which they profess themselves competent to practise, at a court at which they normally appear, and at their usual rates.

Solicitors, on the other hand, can screen their clients at the outset and so weed out many future problems, such as complex communication breakdowns, time-consuming costs recoveries, trust account irregularities and even unfounded negligence claims.

Assess your clients

Good client intake processes start with knowing your client. This requires doing reasonable due diligence so that you understand who they are and who controls them. Reasonable due diligence means making your own independent enquiries.  Do not simply rely on the due diligence of another entity, such as a big bank, another law firm or an accountant. When considering control, you need to understand who is the beating heart behind a non-individual client, known as ‘beneficial owner/s’. Austrac defines a beneficial owner as an individual who controls and either directly or indirectly owns 25 per cent of an enterprise.

Next, you need to independently verify the identity of the client/s and beneficial controller/s. Clients may be local or foreign individuals, companies, groups, trusts, associations or government entities. To know what checks to do for different kinds of clients, most regulators offer guidance on minimum recommended verification of identity. For Australian clients, we are fortunate to have well-developed, centrally regulated and reliable company and business name registers such as ASIC.

Ask about the potential client’s legal structure and intentions. It makes sound business sense, after all, to know with whom you are dealing. So, getting to know them helps you to improve your client service and ensure that your advice is appropriate for their particular circumstances. You may also identify further opportunities to do business with that client or its associates.

Of course, the other reason for doing your own due diligence and verifying the identity of a new client is to identify and refuse bad eggs from the outset. This is vital for your business reputation, whether or not the jurisdiction/s in which you operate are subject to the full ambit of anti-money-laundering legislation. As the ad says, “It’s the fish John West rejects that make John West the best”.

If you are not reasonably satisfied about the identity or control of a potential client, ask the client to explain. There may be a perfectly reasonable explanation. Keep asking for more information until you understand. If there is any reluctance to give you identity information – such as a refusal to provide a licence or passport, consistent failure to meet or talk in person, always communicating via agents and an unexplained willingness to make upfront payments into your trust account – be very cautious. These are all red flags.

Beware of money rorts

Law firms are perhaps most exposed to money-laundering risk when they accept money into their trust accounts. The firm’s role in holding money on behalf of others, and then paying that money to third parties in accordance with directions, can be exploited by criminals who have made their money through illegal or unethical means and want to ‘churn’ the dirty money before ‘placement’ into a legitimate bank account. To avoid this risk, it is important to know the payer/s; to understand, as far as possible, the source of funds; and to have robust processes so that you keep trust account records of the payor/s and payee/s.

Before engaging with a new client, make it your business to learn as much as possible about their business – their activities, locations and associates. Try to visit the client at their premises and meet as many representatives as possible. Investigate unusually complex structures and be alert to activities and success stories that are atypical for a client with their skillset, in their sector and industry. Be alert to inexplicable urgencies and unexplained sudden changes in plans. All these things may have explanations, but they can also be red flags. If things do not add up or do smell right, then you may well be avoiding a world of pain by refusing their instructions.

Less sinister, but often more time-consuming, are clients whose identity is clear but who display other warning signs. Situations where solicitors, from sole practitioners to large commercial firms, repeatedly find themselves in hot water include:

  • Taking on bad credit risks

To stay in business, you need clients who pay their bills. It goes without saying that you should not act for a client with solvency issues, unless there is upfront payment assurance from a liquidator or administrator. This is another reason to do your own company searches before you start work. For new clients who run smaller enterprises and family business clients, it can be useful to have a firm policy requiring not just personal guarantees but upfront money in trust for new SME clients. Before opening further matters for existing clients, you need a process to ensure that you check their payment history. Even large organisations can get into financial difficulty. So, if a client, big or small, stops paying their bills on time, promptly meet with them to seek an explanation and, if necessary, do not be shy in tightening your credit arrangements. Some Australian law firms learned this lesson the hard way with the collapse of their client and Australia’s then second-largest insurer HIH, which had a liquidator appointed on March 15, 2001.

No matter how big the client or how interesting the work, if that client is not going to pay their bills and you are not interested in doing their work pro bono, then it may well be wiser to send your staff to the beach so they are well rested and ready to work hard for a paying client.

  • Assisting multiple clients

Another scenario in which it pays to be wary is where there are multiple clients, such as joint ventures, inter-company loans, family businesses and estate planning.  At the outset, inter-client relationships will be harmonious and the interests of the multiple clients appear to be aligned. Yet things may change during the course of the matter. When interests of multiple clients diverge, a conflict of interest may arise. At that point, a solicitor must cease to act for any of the clients. This can damage client relationships and leave the solicitor with unpaid costs. So, it makes good sense to understand the interrelationships between multiple clients before you start an engagement, decline some instructions, or at least discuss the risks with the clients and limit your retainer.

  • Accepting locust clients

Locust clients are those with a history of changing legal and other professional advisors. Occasionally, there is good reason for this, but more often than not it represents a red flag for a client that is prone to communication breakdowns, irrational expectations of legal services and payment defaults. To screen out unwanted clients from the get-go, it helps to have a client intake process that includes finding out about their history with previous lawyers. Capture relevant information from potential clients as early as possible – from the first phone or website enquiry and before you decide to engage with them.

For law firms, good claim prevention starts at the outset of client engagement, with the very intake of the client. The best way to deal with a difficult client is to not accept them as a client. This frees you up to focus your efforts on enhancing and developing good client relationships.

Peppy Mitchell is a senior lawyer and risk manager with 25 years’ experience in commercial law firms, both as a practitioner and in practice management. She drives strong risk management cultures, solid corporate governance and robust compliance programs. She can be emailed at peppy.mitchell@gmail.com.