Published: Tuesday, 14 December 2021
How to turn a high risk, non-profitable client into a low risk, profitable one.
Karen Eckstein explains why the scope of your engagement letter matters
There has been a lot of discussion recently in the legal press about the case of Manchester Building Society v Grant Thornton LLP  UKSC 20.
In 2006, Grant Thornton, who were Manchester Building Society’s auditors, advised the MBS that the Society could have its accounts prepared using a method known as hedge accounting. MBS relied on that advice, entering into interest rate swap agreements to hedge against interest rate changes which could adversely affect its central lending and mortgage business. Unfortunately, the use of hedge accounting obscured the volatility in the Society’s capital position and a significant mismatch arose between the negative value of the swaps and the value of the mortgage loans against which the swaps were supposed to hedge.
In 2013 Grant Thornton advised the Society that its advice about the use of hedge accounting had been incorrect. As a result, the accounts had to be restated and the substantial deficit in regulatory capital came to light. MBS had to cancel the swap accounts early and a £32 million loss arose.
The substantial legal arguments and subsequent discussion in the legal press focused on the Important issue of whether the loss which arose could be recoverable from Grant Thornton.
When Grant Thornton were appointed as the Society’s auditors, I presume that the initial engagement letter did not specifically cover advice on hedge fund accounting. I do not know if a separate engagement letter was issued in that regard, or whether Grant Thornton had within their engagement with the Society to enable them to give ad hoc advice. But at first sight, this situation could be the sort of situation that arises within retainer creep.
What is retainer creep?
Retainer creep arises where work is carried out for a client outside the defined scope of what has been agreed will be carried out for that client. For example, an advisor has agreed to advise in relation to transaction A, and a client calls and asks a quick question about a potential transaction/ mentions an event that is forthcoming and asks for advice /receives a letter from HMRC or other third party and asks for advice.
It is always flattering when a client turns to the adviser for advice beyond that for which the advisor is being instructed to act. But it can be dangerous, if advice is given which falls outside the terms of the agreed engagement with that client.
Why does ‘retainer creep’ matter?
If the work being carried out is outside the terms of the agreed engagement letter, then the protections included within that engagement letter and terms of business may not apply including:
- any liability caps
- restricting the scope of advice to the client only, not third parties
- clarifying that the firm is responsible for advice given, not individuals
- requiring the client to rely only upon written advice given (reducing ambiguity and risk).
Without a formal engagement letter, there can be difficulties in recovering fees as well as potential breaches of professional and legal regulatory issues. The firm may be exposed to significant unlimited claims by clients and third parties. It is also unfair to the client - the ambiguity prevents the client from clarifying the terms of the retainer and seeking advice elsewhere, if appropriate.
To prevent retainer creep, firms need to have a process in place to enable all staff to know what is in the terms of the existing retainer at all times. They need to understand the scope and purpose of the work and who has authority to give instructions.
It is worth including an ‘ad-hoc clause’ into engagement letters, to enable additional work to be carried out without the need to issue a new engagement letter for every additional inquiry.
Firms will also need an ad-hoc policy, which will advise the staff on how to apply the ad-hoc clause, and in what circumstances. For example, some firms may consider that up to three hours work can be carried out under the terms of the clause but longer matters or riskier matters will require a new engagement letter.
The policy should also include a process for giving advice under the terms of the ad-hoc clause. The policy needs to be practical, so that it is followed rather than avoided. This should include confirming with the clients before advice is given that the advice is to be given ‘under the terms of the clause’ and then confirming the use of the clause, the facts, the purpose for the advice and the advice in writing to the client.
Clients often ask additional questions during an engagement. Taking practical steps to pre-empt this (the inclusion of the ad hoc clause, the inclusion of a process to ensure staff know what is in every retainer, the drafting of an ad hoc policy and training staff on how to apply it) can substantially de-risk a firm’s practice and enable them to charge additional fees for the work.
Claims are extremely expensive; I estimate that even a straightforward claim that doesn't go to mediation or trial can cost a firm tens or hundreds of thousands of pounds. A little work in prevention can avoid that pain and increase fees at the same time.
The DeRisk© service undertakes a review of the processes and systems relating to problem areas in a firm, examining the overall exposure to risk from a risk and legal perspective, including estimating the likelihood and value of such claims. https://kareneckstein.co.uk/