SRA finally issues guidance on consumer credit

Practice Compliance analysis: Some two weeks after the new consumer credit regime came into force, the Solicitors Regulation Authority (SRA) has issued guidance for law firms. What does your firm need to do now?

Original news

Guidance: Regulation of consumer credit activities

Firms previously included under the Law Society’s group license for consumer credit work will need to check the licensing requirements used by the Financial Conduct Authority (FCA) to receive the correct authorisation, the SRA has said. The SRA has published this guidance to help firms identify how FCA authorisation will affect the way they work.

Why is consumer credit an issue for law firms?

Consumer credit activities were historically regulated by the Office of Fair Trading (OFT). Although firms may not have been aware of it, the OFT granted a group consumer credit licence to SRA, which covered any consumer credit activities law firm engaged in.

The OFT was scrapped on 1 April 2014 and the FCA became the new regulator for consumer credit.

The FCA has abandoned the group licence regime and the SRA's group licence has disappeared. This means firms that engage in consumer credit activities may (not must) need an individual consumer credit licence from the FCA.

This begs the obvious question—do law firms engage in consumer credit?

Why has it taken the SRA so long to issue guidance?

The SRA issued interim guidance before the new regime came into force although this raised more questions than it answered.

In approving recent consumer credit changes to the SRA Handbook, the Legal Services Board commented that there was a lot of confusion in the profession around consumer credit and said it expected the SRA to implement a robust communication strategy. This is what the SRA has now done, albeit nearly two weeks after the new regime came into force. To be fair to the SRA, there are inconsistencies in the primary legislation that have made it difficult to issue guidance, although this is still largely unresolved.

Do law firms engage in consumer credit?

Law firms might be caught by the consumer credit regime because of:

• their fee arrangements, and/or
• the type of work they do

The recent SRA guidance sheds some light on the SRA's likely approach to these two issues, but it certainly doesn't paint a clear regulatory picture.

What does the SRA guidance say on fee arrangements?

I need to set the scene before explaining the SRA's recent guidance.

Law firms will be caught by the consumer credit regime if they enter into fee arrangements that fall within definition of consumer credit under the Consumer Credit Act 1974 (CCA 1974) and ancillary regulations. This will depend on two questions:

• who is the client?
• is the firm giving credit by deferring payment of its fees?

If the client is an individual or small partnership and the firm is deferring its fees, it may be caught by the consumer credit regime. The first question is generally straightforward, it's the second question that causes problems.

Over the past few year, firms have become more creative with their fee arrangements—eg reducing fees for early payment or agreeing fixed fees for payment up front. Many firms are concerned about whether they are giving credit.

FSMA 2000, ss 326–327

On 1 April 2014, the SRA amended the SRA Financial Services (Scope) Rules 2001 to pull consumer credit activities into the existing Exempt Professional Firms (EPF) regime. The EPF regime allows firms to provide certain regulated financial services to clients without being authorised (licensed) by the FCA, so long as:

• those financial services are incidental to the firm's professional services
• the firm has registered on the FCA’s Exempt Professional Firm's register

SRA, Regulation of consumer credit activities Q&A, 10 April 2014

In mid April 2014, the SRA finally provided some guidance in the form of a short note and some basic Q&As. According to the Q&As, providing credit to clients (in the form of postponed or staged-payment of fees) is more than likely to fall within the EPF regime, meaning firms should not need a licence. However, this is probably not the main issue, because law firms will still have to comply with onerous requirements regarding the form, content and execution of consumer credit agreements with clients. Failure to comply could mean the firm needs a court order to enforce the agreement (which it isn't guaranteed to get).

This is because the EPF regime exempts firms from the requirement to be licensed by the FCA for consumer credit activities—it doesn't mean that consumer credit agreements entered into by such firms are exempt from CCA 1974.

The best solution is probably to avoid entering into fee arrangements that fall within the definition of credit, meaning firms will not be required to navigate the minefield of potential exemptions.

What does the SRA guidance say on ancillary consumer credit activities?

For most firms, their work type (rather than their fee arrangements) is more likely to stray into the territory of regulated consumer credit activities.

Again, I need to set the regulatory scene—most firms do some sort of work that falls within the definition of ancillary consumer credit business, eg:

• credit brokerage
• debt-adjusting
• debt-counselling
• debt-collecting
• debt administration

Firms could be caught by the definition because they do debt recovery work involving consumer credit agreements or because they negotiate with a matrimonial client's creditor to defer payment of a debt due under a consumer credit agreement pending the outcome of their divorce.

Just because a firm conducts work caught by the definition of ancillary consumer credit business, it doesn't automatically mean it needs a licence. There are two ways firms may be able to continue this work without licence, ie by relying on the:

• litigation exception—this isn't massively helpful as firms can only rely on the litigation exemption if proceedings are issued, which they generally can't know at the outset of a matter
• EPF regime (also known as the Part 20 exemption)—this allows firm to conduct ancillary consumer credit work (debt collection/negotiation etc) under the regulatory control of the SRA so long as the ancillary consumer credit activities are incidental to their professional services

The legislation is inconsistent about the meaning of 'incidental to your professional services'. The FCA appears to interpret 'incidental' by reference to the firm’s overall services—this can be justified under the Financial Services and Markets Act 2000, s 327(4) (FSMA 2000). The SRA believes any ancillary consumer credit activities must be 'incidental' to the work the firm is doing for the particular client—this is consistent with FSMA 2000, s 332(4). This makes a huge difference to law firms, as I'll come onto explain (see below What should firms do now?)

SRA response: Financial Conduct Authority consultation paper—detailed proposals for the FCA regime for consumer credit, 5 December 2013SRA, Regulation of consumer credit activities, 10 April 2014

As early as December 2013, the SRA asked the FCA to provide urgent guidance on the Part 20 exemption. On 10 April 2014, the SRA said it would continue to work with the FCA and update its information when further guidance and details were received.

SRA, Regulation of consumer credit activities Q&A, 10 April 2014

It's therefore unfortunate that, in the meantime, the SRA has issued a Q&A document dated 10 April 2014 firmly adopting the more restrictive approach:

'The SRA's view is that firms that carry on, for example, debt collecting activities for clients...will be carrying on regulated activities and will only be able to rely on the Part 20 exemption where those activities "arise out of, or are complementary to" another service provided to that client.'

The only concession allowed by the SRA is that firms can make an assessment on a case–by–case basis but not necessarily on a matter by matter basis, eg if a firm provides various debt collecting services to a client where some matters involve regulated consumer credit activities and other matters do not, it would be reasonable to argue that the consumer credit element of the work is incidental to the overall services the firm is providing for that client (and can therefore be conducted under the EPF regime).

The SRA further states that its interpretation accords with the FCA's in that the regulated activity must be incidental to the professional services offered to each client rather than the overall professional services offered by the firm. The SRA does not, however, provide any authority for this statement, which appears to conflict with PROF 2.1.14 of the SRA Handbook.

This places firms in an invidious position. According to the SRA, firms will have to cease any ancillary consumer credit work they cannot conduct under the EPF regime until they have been granted authorisation by the FCA.

Isn't it simpler to just get a licence?

Getting an individual consumer credit licence has two main disadvantages: cost and increased regulatory burden.

Cost

Firms can also expect to pay around £1500 for a licence plus an annual fee to maintain their licence.

Increased regulatory burden

Law firms are already heavily regulated by the SRA. Any firm which gets a licence from the FCA to conduct consumer credit activities will submit itself to the oversight of a second regulator, the FCA.

FSMA 2000, s 327(7)
SRA, Regulation of consumer credit activities Q&A, 10 April 2014

Firms might also get more than they bargained for—any firm that becomes licensed (ie authorised) by the FCA for consumer credit activities will eventually be regulated by the FCA for all incidental financial services, including those it currently conducts under the wider EPF regime, eg insurance mediation. This is because firms cannot be simultaneously authorised and exempt from the FCA regime, ie they cannot be authorised by the FCA for consumer credit and exempt for other incidental financial services under the EPF regime. According to the SRA, once a firm is authorised by the FCA in relation to consumer credit it will have to cease other activities carried under the EPF regime and should apply to the FCA for permission to undertake such activities.

What should firms do now?

Let's be clear on this—it's a criminal offence to engage in consumer credit activities without a licence, if a licence is needed. The question is whether firms need a licence.

SRA, Regulation of consumer credit activities Q&A, 10 April 2014

The SRA has said that providing credit to clients (in the form of postponed or staged-payment of fees) is more than likely to fall within the EPF regime, meaning firms should not need a licence for funding agreements, although they will still have to comply with CCA 1974 on the form, content and execution of the agreement.

Firms will therefore only need an individual FCA consumer credit licence if they provide ancillary credit services that fall outside the scope of the EPF regime and/or litigation exception.

It's estimated that over 8,000 firms conduct debt work among other services and in many cases this is likely to involve debts due under consumer credit agreements. It's difficult to imagine the FCA wants to become the mainstream consumer credit regulator for thousands of law firms, which are already heavily regulated by their industry regulator, the SRA. Unfortunately, despite stating that it is seeking further FCA clarification, the SRA has now said that firms can only conduct ancillary consumer credit work under the EPF regime that is incidental to the professional services offered to each client rather than the overall professional services offered by the firm. The SRA also says firms will have to cease any ancillary consumer credit work they cannot conduct under the EPF regime until they have been granted authorisation by the FCA.

The current, unsatisfactory, position can be summarised as follows:

• if a firm specialises in debt work that relates to consumer credit agreements, it should certainly consider applying for an individual consumer credit now
• firms will not need a licence if:
  • their only exposure to consumer credit work is incidental to one or more non-consumer credit services it provides to particular clients, eg where the main service to a client is personal injury or divorce and the firm is simply helping that client to defer debts due under consumer credit agreements pending the outcome of their matter
  • the service provided to a particular client is exclusively debt related but it involves a range of consumer credit and non-consumer credit matters—eg the firm is recovering a book of debts that includes some consumer credit matters

The difficulty lies where the firm offers a range of services (including consumer credit) and a client instructs the firm solely on a consumer credit matter or a range of matters all of which relate to consumer credit. According to the SRA, firms will need a licence for this situation.

Firms will have to make a judgement call on whether to wait to see whether further clarification is forthcoming from the FCA or SRA, bearing in mind that getting authorised by the FCA for consumer credit work means they will eventually be excluded from the EPF regime for all incidental financial activities.

Firms should also review their fee arrangements to ensure they are not entering into any arrangements that stray into the definition of consumer credit agreement.

Finally, firms should consider amending their Terms of Business to explain the regulatory basis on which they are conducting any consumer credit work—see Template: Terms of business.

Allison Wooddisse, solicitor and head of the Lexis®PSL Practice Management and Compliance team.