This guest article was first published on Legal Finance Professionals.
There are very few firms of solicitors that do not have a problem, to a greater or lesser extent, with old residual balances on their clients’ ledger. For many, these balances may only be a few pounds or even a matter of pennies but, even so, they can create very real compliance problems under the SRA Accounts Rules 2011.
What the Rules Say
It may seem strange but until the old version of the rules, the Solicitors’ Accounts Rules 1998, were amended on 14 July 2008, there were no provisions within the accounts rules directly that required solicitors to return money to clients on the conclusion of a matter, even when those funds were not needed for any other purpose. However, those who failed to do so were taking a risk as the Solicitors Regulation Authority (SRA) always had the option of making a regulatory case against the solicitor or firm on the grounds of misconduct, usually for failing to act in the best interest of their client and/or bringing the profession into disrepute.
On 14 July 2008 various amendments were made to the accounts rules with the intention of making it easier for solicitors to deal with residual client ledger balances under £50 by allowing these, subject to satisfying certain conditions, to be paid directly to a charity without having to seek a waiver from the SRA in the first instance. But, as is often the case, there was a sting in the SRA‘s tail. Other changes included a provision which, for the first time, created a requirement to account to clients ’promptly‘ at the conclusion of a client’s matter.
Significantly, on 31 October 2014, the SRA amended the SRA Accounts Rules 2011 (Version 12) and increased the threshold for which old client ledger balances can be paid directly to a charity from £50 to £500. Notably, new SRA guidance, published at the same time as these latest rule changes, seeks to reinforce the message that, regardless of the amount involved, the SRA Accounts Rules 2011 require monies held for clients to be returned to the relevant client, wherever possible, in the first instance to avoid dormant client ledger balances arising.
In the SRA Accounts Rules 2011, introduced on 6 October 2011, the provisions governing residual client ledger balances are contained within Rule 14.3, Rule 14.4, Rule 20.1(j) & Rule 20.2 and are as follows:
Client money must be returned to the client (or other person on whose behalf the money is held) promptly, as soon as there is no longer any proper reason to retain those funds. Payments received after you have already accounted to the client, for example by way of a refund, must be paid to the client promptly.
You must promptly inform a client (or other person on whose behalf the money is held) in writing of the amount of any client money retained at the end of a matter (or the substantial conclusion of a matter), and the reason for that retention. You must inform the client (or other person) in writing at least once every twelve months thereafter of the amount of client money still held and the reason for the retention, for as long as you continue to hold that money.
Rule 20.1(j) and Rule 20.2
Rule 20.1(j) in conjunction with Rule 20.2 permits money to be withdrawn from a client account where the amount held does not exceed £500 in relation to any one individual client or trust matter and you:
a) establish the identity of the owner of the money, or make reasonable attempts to do so:
b) make adequate attempts to ascertain the proper destination of the money, and to return it to the rightful owner, unless the reasonable costs of doing so are likely to be excessive in relation to the amount held;
c) pay the funds to a charity;
d) record the steps taken in accordance with rule 20.2(a)-(c) above and retain those records, together with all relevant documentation (including receipts from the charity), in accordance with rule 29.16 and 29.17(a); and
e) keep a central register in accordance with rule 29.22.
Our experience indicates that, despite the fact the rule changes making it a breach of the SRA Accounts Rules 2011 have been in place for more than six years now, there remain many firms that have yet to grasp the nettle and do anything about the ongoing build-up of residual client ledger balances on their firm’s ledgers or, indeed, to clear historic dormant client ledger balances which predate July 2008.
It is evident that a number of those responsible for managing firms within the legal sector continue to view this as a low risk area. However, this is not a view shared by the SRA as is evident from the published outcomes of a number of cases dealt with by them. For example, one regulatory settlement published by the SRA clearly highlights the importance of dealing with these residual balances properly. In summary, the firm in question had an historic issue with residual balances and held such balances in a suspense account on their clients‘ ledger. When the SRA visited the firm in January 2010, the balance on this suspense ledger amounted to just under £20k. The firm had failed to deal with the balances as and when they arose and, in the SRA’s view, inadequate attempts had been made by the firm to distribute these funds to clients. The partners were required to give an undertaking to deal with the matters properly, in accordance with the SRA Accounts Rules, and have had to pay fines and costs totalling £12,000.
Given the current regulatory climate and the prominence of the role of the Compliance Officer for Finance and Administration (COFA) within firms, this case only seeks to highlight the importance of having robust internal accounting controls and procedures designed to prevent residual balances occurring in the first instance.
Prevention is Always Better than Cure!
The single most effective control that a firm can introduce to avoid residual client ledger balances arising in the first instance is likely to be ensuring that details of the client’s own bank account are recorded as part of the standing client data obtained when a client matter file is opened. Whilst some clients may change their address on a fairly regular basis making it difficult to return residual client ledger balances to them, they are much less likely to change their banking arrangements meaning that monies can be returned to the client electronically without too much trouble even after they have moved.
Of course, it is crucial that either the COFA or other person responsible for SRA Accounts Rules compliance ensures that appropriate accounting procedures and internal controls are in place to prevent residual balances arising. Typically, these might include:
- The production of regular exception reports for fee earners showing any matters with a balance on the client ledger which hasn’t moved for, say, three months.
- File closure procedures which do not allow for client matter files to be closed and archived until the balance on the ledger is nil and any cheque payments from client bank account have cleared through the client bank account.
- Internal audit procedures which check that client money is being returned to clients promptly on the conclusion of their matter.
Frequently, problems with residual balances arise in those firms where there has been a lack of appropriate SRA Accounts Rules training provided to appropriate staff. Firms are usually very diligent in ensuring that members of the accounts team receive SRA Accounts Rules training whilst sometimes overlooking the needs of fee earning staff.
Dealing with Residual Balances of £500 or Less
Residual client ledger balances are likely to arise for one of two reasons. Commonly, residual client ledger balances are caused by client account cheques which have been issued and sent out to the client or, perhaps, to a third party to pay a disbursement on behalf of the client which are never presented for payment by the payee. Alternatively, it may simply be the case that there is a balance due to the client which, for whatever reason, hasn’t been returned to the client. The treatment of the balance will vary slightly depending upon what caused the balance in the first place.
Residual Balances Caused by Unpresented Cheques
In these circumstances the firm will have already made a reasonable effort either to return monies due to a client or to use the money for the purpose for which it was provided, such as discharging a disbursement on the client’s behalf. There is no specific guidance from the SRA but our view is that where the amount of the cheque is £25 or less, and a client account cheque has already been issued but remains unpresented, a firm would be justified in paying small balances of this nature directly to a suitable charity.
For unpresented client account cheques between £25 and £50, the amount involved would suggest that additional steps should be taken to confirm the validity of the client‘s address. A search of the popular social media websites (Facebook, Twitter or LinkedIn) may be sufficient to track the client or a subscription service such as those offered by 192.com or peopletracer.co.uk, provides a quick and cost effective method of checking a client’s details against the electoral roll, official telephone directory and Companies House records. If this search reveals a different address for the client concerned, the original cheque should be cancelled and a replacement cheque sent to the newly discovered address. However, if a more up-to-date address cannot be found and the cheque is not presented within a reasonable period of time, the cheque should be cancelled and the balance paid over to a charity.
For balances above £50, more effort is going to be necessary to demonstrate to the SRA that you have complied with the SRA Accounts Rules and the relevant Principles within the SRA Handbook before releasing funds to your preferred charity. Where the client is a private individual, we would suggest that the next step would be to use the Department for Work and Pensions (DWP) letter forwarding service. If no match is found or the client does not make contact and the residual client ledger balance is less than £250, the balance held can, in our view, safely be paid over to a suitable charity.
Where the balance is less than £500 but more than £250, you would need to consider what further steps may be appropriate. This could take the form of placing an advert in a local newspaper or instructing an enquiry agent. However, you would have to take into consideration the costs involved and the likelihood of success. The SRA’s recent guidance from Ethics on residual client ledger balances states, “where the costs of placing an advertisement or instructing a tracing agent are unreasonable when compared with the balance in question, it is likely to be considered to be appropriate to withdraw a balance under £500 from the client account and pay the money to a charity.”
Other Residual Balances
As has been said already, in the first instance, you should always try to return funds to the client to whom they belong. The Law Society has issued guidance suggesting that for balances of less than £4, amounts due to the client should be repaid by sending postage stamps of the appropriate value to the client‘s last known address. If the client’s address is unknown, reliance can be placed on rule 20.2(b) which provides a ‘get out’ clause where the reasonable costs of ascertaining the whereabouts of a client and returning clients‘ money to the rightful owner is excessive in relation to the amount held. Where the balance held is less than £4 and you do not know the client’s current address, the costs of trying to trace the client would certainly be considered to be excessive and the balance can be paid to a suitable charity.
For residual balances between £4 and £25 in amount, we would recommend that a firm send a client account cheque for the amount of the residual balance to the client’s last known address. Where a cheque has been issued but remains unpresented after a reasonable period, say, three months, the cheque should be cancelled and the balance paid over to charity.
Where the residual balance exceeds £25, as before, a client account cheque for the amount of the residual balance should be sent to the client‘s last known address. However, in this instance should the cheque remain unpresented, the amount involved would suggest that additional steps should be taken to confirm the validity of the client’s address. As outlined above, an online search should be undertaken to validate the client’s address. If this search reveals a different address for the client concerned, the original cheque should be cancelled and a replacement cheque sent to the newly discovered address. However, if a more up-to-date address cannot be found and the cheque is not presented within a reasonable period of time, for amounts up to £50, the cheque should be cancelled and the balance paid over to a charity.
Where the value of the unpresented cheque exceeds £50, the Department for Work and Pensions (DWP) letter forwarding service should be used to try and trace the client in the first instance. If the DWP search is unsuccessful, where the residual balance is less than £250 we would suggest that the balance held can be paid over to charity. If the amount of the residual balance is more than £250 then, as previously described, the firm would need to consider the merits of a newspaper advertisement or employing the services of an enquiry agent.
Do I Need an Indemnity?
Strictly speaking, it is not necessary for payments to a charity under Rule 20.1(j) of the SRA Accounts Rules to be covered by an indemnity against any future legitimate claim by a client or third party in the same way that is required for residual client ledger balances in excess of £500. However, it must be remembered that the firm remains liable to account to the client for any monies due to them even if the sum has previously been paid over to a charity. Given that the value of the individual residual client ledger balances being paid over to charity will have increased substantially from 31 October 2014, we would always recommend that firms only make payments to charities which are prepared to offer an indemnity against future legitimate claims by a client or third party. The SRA maintains a register of charities which are prepared to offer an indemnity as described above.
Record Keeping Requirements
Other considerations to bear in mind include the requirement to ensure that a central register is maintained which details the name of the client or other person/trust on whose behalf the money is held, the amount, the name of the recipient charity and the date of the payment. Additionally, copies of receipts from the charity should be retained.
Balances over £500
Once the amount of the residual balance exceeds £500, there is no option other than to seek a waiver from the SRA prior to withdrawing the funds from your client bank account under rule 20.1(k) of the SRA Accounts Rules.
Do you Need Further Help?
If your firm has an issue with residual client ledger balances but lacks the time and resources to tackle the problem why not speak to Legal Finance Professionals? We have experience in distributing residual client ledger balances and making waiver applications to the SRA under Rule 20.1(k) of the SRA Accounts Rules. To find out more about the training and consultancy services we can provide to support your firm please contact Richard Lane on 0845 6500 112.