The History of Upfront Payments
Historically the concept of upfront payments emerged to establish trust and mitigate risks in business transactions. It was also used to secure goods or services in advance. In the modern world it became even more essential as it provides businesses with necessary capital to initiate production of goods and delivery of services.
While upfront payments have existed for thousands of years and grew organically as an instrument of the free economy, some Industries seem to be more sensitive to upfront payments than others.
Upfront Payments in the Service Industries
Let’s have a quick look at some other Service Industries. There are a large number of them which use upfront payments as a standard approach. The Insurance industry is a prime example. Have you ever tried to get Insurance for anything without paying upfront?
The Courier Industry is somewhat similar. Customers are normally expected to pay in advance for Royal Mail or DHL type of services. There are occasional exceptions, where for example, corporate clients may be invoiced for delivery services at the end of the month or where the recipient at the point of delivery.
Is there a common theme in these examples? The behaviour of the Service Providers and of the Customers are driven mainly by the dynamics of the free market, and by competition rather than by a Regulator.
Are there examples in any other Industries where the Regulator has introduced bans on advance payments? Surprisingly, there are few. I came across one example, where in 2009, talent agencies faced a ban on receiving advanced payments. The rationale was to protect aspiring Actors and Models who were charged hundreds of pounds in “Registration Fees” to cover the cost of their portfolio in order to find lucrative show business contracts, which on many occasions never materialised.
We found another example in the Retail Industry. Manufacturers were required to pay fixed fees to Retailers to obtain access to shelf space and to support downstream promotional activities. The upfront payments in these cases were found by the Competition Authority to potentially inhibit small manufacturers from obtaining adequate distribution for their products. The rationale behind this being that small manufacturers can be disadvantaged relative to large dominant manufacturers because they lack adequate access to capital markets, and cannot therefore afford to pay the large upfront fees that are often demanded by Retailers, and could therefore be deemed to be an anti-competitive strategy.
Upfront Payments and Intervention
It is easy to notice that in both cases intervention by the Regulator could be justified by the need to protect the interest of the weaker players in the market and to support competition.
So why is the proposed Regulation required in the Legal Services Industry, and who will benefit from this?
On the face of it, it would seem it aims to protect the interests of the client. If we were to accept that such protection is required, we must also accept that the clients are at a disadvantage in relation to the Law Firm. This, in our view, is a very stretched assumption. The Legal Services Industry is a clear example where the customer King. Returning customers and a good reputation are the ‘bread and butter’ of any Law Firm. As a result, it is often the case that negotiation power is on the side of the client.
If a particular client doesn’t want to accept upfront payments, it can easily negotiate with the law firm different payment terms or just find another Service Provider. Even the bigger Law Firms would rarely have leverage to insist on upfront payment terms as a standard, unless there are upfront fees which the law firm must make on behalf of the client (e.g Court filing fees).
While the positive effect of the proposed change is questionable, the positive effect of upfront payments is obvious.
Upfront payments can help to ensure financial stability, maintain positive cash flow and investment in growth opportunities. It also provides comfort that the clients is committed to the Law Firm, and so the Law Firm can expend money on resources of its Lawyers to work on client matters, knowing they will be reimbursed for that time without delay, which can bring about a sense of security when it comes to assessing financial projections and spending money on additional resources.
Reducing Financial Risk
Another positive aspect of upfront payments is reduced financial risk. For example, by not having to chase payments or recover late or missed payments, Lawyers can focus better on their client’s needs. With upfront payments, both parties have a better understanding of the payment terms, which promotes clearer communication, better financial accountability, and can reduce the likelihood of disputes.
In addition to ensuring financial stability, upfront payments encourage stronger client commitment, leading to better collaboration and smoother project execution. When the client feels that they are invested in the process by contributing upfront payments, they are more likely to remain engaged and provide timely feedback throughout the project lifecycle. This can lead to increased satisfaction by clients and a better reputation for the Law Firm.
This advantages are particularly pertinent to the smaller Law Firms, which may find themselves in a disadvantageous position, should upfront payments be prohibited.
Negative Impact of Prohibiting of Upfront Payments
It could have a detrimental impact on the client as well as the Law Firm. In a statement from the Law Society it said there was no evidence of problems arising under the existing rules. “We are aware of several firms, particularly High Street Practices, which legitimately operate in this way. This approach lowers risk on both sides,” the statement read: “The result may be poorer value for clients who may pay more for a case if charged by the hour, and may have adverse economic effects on Solicitors’ Firms,” it added.
The Balance
While upfront payments are an important economic instrument, if not used carefully they can be damaging both for clients and law firms.
Upfront payments can alienate potential clients who require flexible payment terms. This might lead to a limited pool of clients, thereby thwarting business growth.
To avoid this, Service Providers may consider accepting staggered payments or negotiating payment options that align with the financial capability and preferences of the client.
Upfront payments could also raise red flags about possible unethical practices and perceptions of improper payments, in contravention of the Bribery Act 2010. Service Providers must therefore uphold strict anti-bribery measures, conduct due diligence on clients, and maintain transparency in their financial dealings.
When clients are not satisfied with the Service provided or the project is terminated prematurely, disputes commonly arise concerning refunds, leading to loss of trust, revenue, and possible legal action.
Our Conclusions:
We would like to offer several conclusions from the research we have conducted:
• The Regulator needs to be extra cautious when deciding to interfere and regulate the relations of the parties, which should normally be regulated by the rules of the free market economy, and by competition.
• In our opinion the introduction of restrictions on upfront payments is neither justifiable, nor beneficial for the Legal Services Industry.
• Clients, when requested to make upfront payments, need to clearly understand the benefits such arrangements bring and the alternatives.
• Services Providers should clearly communicate payment terms, expectations, and deliverables in written agreements or contracts. This ensures transparency and avoids misunderstandings.
• Additionally, whilst upfront payments may be preferred, offering flexible payment options, such as partial payments or milestone-based payments, can accommodate the preferences of different clients whilst still addressing cash flow needs.
• Maintaining open lines of communication with clients throughout the project lifecycle is crucial. Regular updates, progress reports, and addressing concerns promptly can foster trust and mitigate any potential issues related to upfront payments.
This Article was written by our Ethics and Compliance Director, Evgeny T, who is a leading expert in managing compliance and instigating anti-corruption programs within the pharmaceutical industry.
We will be exploring in a future Article, the measures which pharmaceutical companies must put in place to combat corruption, and adherence to the Bribery Act 2010.
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