Introduction
No matter how well managed your practice, and no matter how diligent your accounts staff, it is inevitable that at some point you will acquire a residual client balance that needs to be dealt with. However, how you manage your accounts and how you deal with those residual balances can make life considerably easier for you.
Residual client balances are balances that remain in client account following the conclusion of the matter to which they related. They are balances of money that should have been refunded to the client but, for some reason, were not. Rule 2.5 of the Accounts Rules specifically requires that “You ensure that client money is returned promptly to the client, or the third party for whom the money is held, as soon as there is no longer any proper reason to hold those funds”. However, with the best will in the world there will always be situations that arise that mean that this is not always possible or is overlooked.
The Solicitors Regulation Authority (SRA) recognises that this will inevitably occur from time to time and permits firms to withdraw those residual balances provided that certain steps have been followed. The requirements are set out in a “mandatory statement” relating to this entitled “The prescribed circumstances in which you can withdraw client money from client account to pay to a charity of your choice”[1]. Thus, withdrawals that are neither for the purposes for which the sum in question was held nor following instructions from the client, can be made without the prior written authorisation of the SRA. These circumstances are limited to withdrawals of £500 or less on any one client matter and the balance must be paid to a charity. The mandatory statement also sets out other steps that must have been taken before the withdrawal occurs. Sums over £500 require SRA approval.
How can residual balances arise?
Residual balances can easily arise through no fault of the firm and may even come to light after a file has been closed. There are many ways in which such balances can arise. These include:
- refunds or payments received by the firm after the matter to which they relate has come to an end,
- balances acquired by a successor practice – often where the original fee-earner is not available to provide further information,
- interest has been earned or a dividend declared,
- the firm has attempted to return money but the cheque has not been cashed,
- the client has failed to give instructions as to how funds are to be dealt with,
- the client has disappeared without leaving a forwarding address before funds could be remitted,
- the client has died during or shortly after the end of the transaction and details of executors/administrators are unknown,
- disbursements have been misapplied and sent back after the end of the matter,
- retentions have not been claimed, and
- the money has been held on an undertaking to pay to a third party and the specified act to which it relates either does or does not occur.
They can, of course, also arise from simple bad accounting practices – of which more later.
Avoiding balances arising
Clearly there are always going to be situations over which the firm has no control, for example, clients that will not cash cheques. However, with a small amount of effort, firms can help to prevent residual balances arising.
Before we look at this, it is worth mentioning, however, that even if the balances cannot be avoided it is VITAL that they are dealt with as quickly as possible and that firms do not allow such balances to accumulate. In 2020, a four partner firm was fined a total of £32,500 by the SDT and ordered to pay £10,000 in costs for allowing 979 residual balances totalling over £468,000 to accumulate. More recently, just last month a north London firm was fined over £14,000 by the SRA and agreed to pay £600 costs for allowing almost £105,000 of residual balances to build up.
This latter example, in particular, is a salutary warning to all solicitors to address the issue of residual balances. Here the SRA commented that the firm did not have procedures in place to deal with these residual balances, and its systems did not identify receipts in the client account.
So, what should firms do to avoid such residual balances?
The simple answer is to be proactive. Accounts, even the accounts of files that have closed, need to be monitored regularly and steps taken to identify any sums that appear in client account at the point at which they arise. Dealing with residual balances can be a time consuming and complicated problem for firms. Tracing clients so that funds can be repaid to them not only uses up valuable time, if enquiry agents need to be appointed or adverts placed in the media, it can also result in the expenditure of funds. Far better, therefore, not to allow such balances to arise in the first place and to contact clients as soon as they do – before they have a chance to move house.
COFAs and other partners responsible for financial issues should be alert to the potential for such balances. Steps that can be taken to help avoid residual client balances arising include:
- arranging for the accounts department or manager to provide fee earners/principals with a list showing all client balances over a certain age (1 to 3 months) and requesting that these be reviewed, and an explanation provided as to why those balances exist. This should be done for all sums – even de minimis amounts;
- reviewing all closed files on which a client balance appears as soon as the balance is posted;
- having a file closure system which prevents files from being closed whilst ever there is a client balance and a review of any files that have not been, but should have been, closed;
- setting up automated procedures within accounting systems to warn about sums left in accounts;
- checking with clients on a regular basis that they are still at the address originally given when the file was opened – especially where money is held or expected to be received – or asking them as part of your terms of business to keep you updated of any change. This might appear time consuming but can be far less onerous than having to search for clients at a later date;
- taking care to estimate correctly disbursements, to pay the correct amount and to ensure that refunds to the client are processed promptly.
Often, residual client balances will arise because of sloppy book-keeping practices, lack of file and ledger reviews, inadequate safeguards or even fraud. For this reason, the existence of a large number of residual client balances – or even a small number of large residual client balances – may be seen by the SRA as being an indicator of other underlying problems. These could lead to the SRA wanting to undertake a more thorough investigation. As with the North London firm referred to earlier, this led on to the SRA becoming aware that the firm had been holding and transferring funds in relation to rent and rent deposits which breached the rule that firms may not provide a banking facility through the client account.
Even if such a system is not implemented, firms should certainly consider dealing with any residual client balances sooner rather than later – if only as an indicator to the SRA that they are managing the financial aspects of the firm adequately. In appropriate cases it may also be used as a means of sweeping up (genuine) unbilled costs and disbursements. However, in relation to this bear in mind that if the reason that a residual balance has arisen is because you cannot locate the client then you will also, for the same reason, not be able to deliver to them a bill for costs. Therefore, if the bill for the additional costs has not been delivered you would not as a firm be entitled to withdraw those additional costs without consent from the SRA.
Firms may also wish to pre-empt potential problems by dealing with issues in advance of them arising. For example, taking detailed instructions on how funds should be dealt with, keeping a record of the client’s National Insurance number (for use if using the Department of Work and Pensions letter forwarding service) or including information about residual balances in the firm’s terms and conditions.
The firm may also, when dealing with sophisticated clients on a number of matters, agree with the client to retain small amounts and then either account to the client at agreed intervals or pay the sums to charity. Regular checks should be made that the client continues to be happy with this arrangement.
Finally in relation to preventative measures, the firm should always bear in mind that if it is taking over or merging with another firm, it should not agree to take on residual balances without also taking over the file to which they relate and they should in any event try and get the firm they are taking over or with whom they are merging to deal with all residual balances before the takeover or merger.
Some final thoughts
Rule 12.1(b) of the SRA Accounts Rules requires that you deliver an accountants report to the SRA if it is qualified to show a failure to comply with the Accounts Rules such that client money is or has been or is likely to be placed at risk. There is an argument for saying that in some circumstances – for example where the firm has simply failed to account to the client correctly at the conclusion of a matter, the very existence of a residual balance could constitute money which is placed at risk. However, this might not be the case if the balance has arisen after a matter was concluded – for example as the result of an unpresented cheque or a refund – and the client has subsequently disappeared. Note that your accountant is not expected to judge the adequacy of the steps taken to establish the identity of, and to trace, the rightful owner of unclaimed client money.
You should also note that your inability to be able to return money to the client could be deemed to be a serious breach worthy of being reported to the SRA. This would particularly be the case where the lack of client details on the file arose as a result of deficiencies in the management of your firm, as required by paragraph 2 (compliance and business systems) of the SRA Code of Conduct for Firms.
Another situation which might arise is where you have succeeded in tracing the client but they refuse to accept the sums in question. Here, you would not be able to satisfy the SRA that the client could not be traced. This might arise, for example, because the client is in receipt of welfare benefits and believes the payment will take them above the savings threshold and so does not wish to accept the money. In extreme circumstances this could mean that the solicitor is assisting the client to do something improper. Because the firm will remain liable to pay the money to the client in full should the client change their mind at a later date, they may simply be using it as a means of holding money somewhere where it is not accountable.
In the event that this does occur and the firm cannot come to an arrangement with the client for payment of the monies to them, then the SRA may decide that is in the public interest for them to grant an authority to the firm to withdraw the balance. The SRA will normally suggest to the firm that they should write to the client warning them that they intend to apply to the SRA for such authority and to make it clear that, if the SRA agrees, the money will go to charity.
It should also be noted that the residual balance route is not the appropriate one for the firm to take where the money held belonged to a company that has been dissolved. Section 1012 of the Companies Act 2006 provides that “When a company is dissolved, all property and rights whatsoever vested in or held on trust for the company immediately before its dissolution (including leasehold property, but not including property held by the company on trust for another person) are deemed to be bona vacantia and … accordingly belong to the Crown, or to the Duchy of Lancaster or to the Duke of Cornwall”. Thus money held in a client account belonging to a dissolved company incorporated in England and Wales vests in the Crown and therefore the SRA cannot authorise any withdrawals of residual balances that previously belonged to a client that is now a dissolved company. Instead, the money should be paid to the Treasury Solicitor. Similarly, for companies incorporated overseas, the Treasury Solicitor is also of the view that residual balances should be paid to the Crown.
Finally, where a firm has been acting in the administration of an estate and there is money left in client account that is payable to a beneficiary who cannot be traced, but the firm is still in contact with the lay executors then the SRA will not give authority to pay this money to charity. Instead the firm must take instructions from the executors who are ultimately responsible for administering the estate. If the beneficiary cannot be traced, the executors can instruct the firm to pay this money elsewhere.
[1] https://www.sra.org.uk/solicitors/standards-regulations/withdraw-client-money/