Residual Client Balances – an unavoidable problem?
No matter how well we manage our practices, our work and most importantly, our client accounts, inevitably there will be cases where we are left with a residual client balance.
It is a fundamental element of most solicitors’ practices that they will need to hold money for their clients – whether it be in relation to buying or selling a house, obtaining compensation following an accident, buying or selling a business or gathering funds on the administration of an estate. Whilst the majority of any funds held by the solicitor will be used during the course of the client’s retainer, some funds will inevitably be left over. In the normal course of business, those excess funds must be returned to the client as soon as is possible.
Indeed, Rules 14.3 and 14.4 of the SRA Accounts Rules 2011 provide that:
14.3Client 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.
14.4You 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.
Thus, as soon as a transaction or matter has been completed, any moneys still held by the solicitor must be returned promptly to the client once there is no longer a need for the solicitor to retain them.
The specific duty to return funds is a fairly recent introduction to the accounts rules – as recent as 2008 when, following the “Residual client account balances” consultation, the rules were amended so as to introduce:
- a specific obligation to return surplus funds to a client once there is no longer any proper reason to retain those funds (eliminating the need to specify a period of time);
- a requirement to inform clients at the end of a matter if funds are retained and for what purpose, and to report to clients on an annual basis if funds continue to be held;
- a new system for the withdrawal of residual client account balances by a hybrid system of self-certification, subject to safeguards, for amounts of £50 or less, and continued prior SRA authorisation for larger amounts.
Interestingly, 38% of those solicitors who responded to the consultation did not support the introduction of a specific obligation to return surplus funds to a client within a reasonable time of concluding a matter – apparently because they “anticipated practical difficulties in complying with such a rule.” Perhaps that is best left without further comment!
Despite these provisions, and despite the fact that many solicitors are assiduous in ensuring that surplus funds are returned to clients, nevertheless from time to time, solicitors find that they are, possibly through no fault of their own, holding money for clients which was not returned at the end of a matter.
The reasons for there being a residual balance are numerous, and can include:
- refunds received by the firm after the matter to which they relate has come to an end,
- 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,
- 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.
It might, however, simply be as a result of bad book-keeping and accounts practices – a topic we will come on to later.
Whatever the reason for the residual balance, as soon as the solicitor realises that surplus funds are held, steps should be taken to ensure that they are returned. This applies however small the sum in question. It is never appropriate for the firm merely to pay the balance into office account, to prepare a “fictitious bill” or to put the money against miscellaneous disbursements. Neither is it an option just to leave the sums on the client’s account.
If the whereabouts of the client is known then the funds must be returned to them as promptly as possible.
Where the sum in question is small – probably less than £3 – then it may be acceptable in certain circumstances for the firm to send postage stamps to the last known address for the client rather than going to the expense of drawing a cheque. Note, however, that despite what has been erroneously claimed elsewhere on the web, postage stamps are not legal tender and it is entirely up to the client whether or not they chose to accept them. If they are to be sent, however, it is suggested that some attempt be made to check whether stamps are acceptable and that they be either standard first or second class stamps. In this case the firm can assume, unless it receives information to the contrary, that the matter is dealt with and the firm need not require that a receipt be given.
Where the sum exceeds £3 and you know the whereabouts of the client then you should return the funds to the client as soon as possible – normally in the form of a cheque. If the cheque remains unpresented after a reasonable length of time, then the account must be treated as one where the whereabouts of the client is not known.
Clients whose whereabouts are unknown
It is not unusual for residual balances to arise or the firm to become aware of their existence in circumstances where the whereabouts of the client is not known or there is some doubt as to that clients whereabouts. This might be, for example, because they have moved house or changed premises without leaving a forwarding address or because they have died and a personal representative or next of kin cannot be found.
If the sum in question is less than £50, then Rule 20.1(j) of the SRA Accounts Rules 2011 permits the money to be withdrawn from client account provided that the provisions set out in Rule 20.2 of the those rules are followed. Otherwise, Rule 20.1(k) provides that money can only be withdrawn from the account “on the written authorisation of the SRA” and the SRA “may impose a condition that you pay the money to a charity which gives an indemnity against any legitimate claim subsequently made for the sum received.” We shall look at those cases where SRA authorisation is required shortly.
Rule 20.2 provides:
20.2 A withdrawal of client money …… may be made only where the amount held does not exceed £50 in relation to any one individual client or trust matter and you:
- establish the identity of the owner of the money, or make reasonable attempts to do so;
- 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;
- pay the funds to a charity;
- 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
- keep a central register in accordance with rule 29.22.
Thus, two separate sets of scenario are created.
Residual balances of less than £50
If the residual balance is less than £50 then the first criteria to be looked at is whether the identity and whereabouts of the owner of the money is known. If it is, or if it can be ascertained by making reasonable attempts to do so, then the process set out above for stamps and cheques should be followed.
However, the question needs to be asked as to what is a reasonable attempt. 20.2(b) states that attempts are to be made “unless the reasonable costs of doing so are likely to be excessive in relation to the amount held”.
No guidance is provided in the Accounts Rules themselves as to what is “reasonable” or “excessive” and so ultimately it is up to the firm to ascertain what those costs would be, how they relate to sum in question and whether or not they are reasonable. The view currently taken by the SRA appears to be that some effort must be made to trace the client in all cases – even if it is only checking the file and/or looking on the web to see if the whereabouts are obvious. In their as yet to be updated guidance “Rule 22(1)(h) – general advice for applicants“ they state that there can be a withdrawal of client money “after making adequate attempts to identify the owner and repay those monies.” This may be seen as being at odds with the statement in 20.2(b) – the firm must make a judgement as to what it regards as being adequate attempts .
In practice, anything other than the most preliminary of enquiries will often result in fairly substantial costs being incurred. Simply retrieving a file from storage, going through it to find an address, writing to that address and dealing with any response that might come back from such an enquiry could easily account for a substantial proportion of the £50.
Certainly if the sum is less than £10 and it has been held for a period in excess of 12 months then it may be regarded as reasonable in most cases simply to send the money to a charity after a basic search has been made as to the whereabouts of the client.
If the money in question is more than £10 then it is likely that the SRA would expect the firm to have made some basic enquiries. These steps could include:
- searching online for the client using Google, Bing or Yahoo,
- looking the client up using free online services such as those provided by BT using the last known town in which they lived or the town to which they moved if known,
- using www.freefindpeopleuk.co.uk
- using 192.com to search the electoral register, or
- carrying out a search at Companies House.
A guide to tracing people is provided by the British Library and can be found at www.bl.uk/reshelp/findhelprestype/offpubs/electreg/traceliv/tracinglivingpeople.pdf
As the sum approaches the limit of £50, then those enquiries would be expected to be more thorough including, in appropriate circumstances, using the Department of Work and Pensions (DWP) letter forwarding service. This may be useful when unable to trace clients or beneficiaries. Please note that the DWP will not forward on bills of costs to clients. For more information see www.gov.uk/government/publications/pensions-and-insurance-tracing-and-letter-forwarding-service/bulk-letter-forwarding-service-detailed-guidance. There is a cost involved which must be paid in advance and every effort must have been made to trace the person concerned before asking the DWP to forward any letters.
If as a result of enquiries an address for the client is found then, as before, a cheque should be sent to that address. If it is not presented within three to four months then it can be assumed that the client is not at that address. The firm must then make a judgement as to whether to continue enquiries to find the client or simply to pay the money to a charity. If a further cheque is to be issued and a cheque has already been sent to a previous address, that first cheque should be cancelled prior to the second cheque being sent.
Where the sum is less than £50, the charity to whom the cheque is sent does not need to be one which provides an indemnity against any legitimate claim subsequently being made for the sum sent to them – as would be the case for sums in excess of £50. However, the firm must keep a clear record of the steps that were taken to find the client, the decision processes leading to the decision to send the money to charity and where the money was sent.
Note also that there is no implied authority within the rules for the cost of tracing the client to be deducted from the sum sent – even where this is a specific sum paid to a third part such as 192.com or the DWP. You would need to approach the client, if found, for such a deduction to be agreed. The charity receiving the money cannot agree that deduction.
If in doubt, a firm can apply to the SRA for authorisation even though the sum is less than £50.
Residual Balances of More than £50
Where a residual balance exceeds £50 then the provisions set out in Rule 20.2 of the Accounts Rules do not apply and authorisation from the SRA must be sought. Rule 20.1(k) provides that such money may only be “withdrawn from the account on the written authorisation of the SRA. The SRA may impose a condition that you pay the money to a charity which gives an indemnity against any legitimate claim subsequently made for the sum received.”
Although the rules do not specifically state that it must be done, there are a number of steps that firms must go through before the SRA will grant an authority for moneys to be withdrawn. The only reference to the fact that criteria exist is to be found in note vi(a) to the rule which states: “Applications for authorisation under rule 20.1(k) should be made to the Professional Ethics Guidance Team, who can advise on the criteria which must normally be met for authorisation to be given.”
Fortunately, however, there is still previously issued guidance to be found on the SRA web site as to what the SRA expect and, helpfully, the Rule 20(1)(k) Application/Information Form can also be found on the SRA web site.
As at the time of writing (January 2014) the guidance in question is to be found hidden away in the “Pending Review” section of the Guidance Page (www.sra.org.uk/solicitors/code-of-conduct/guidance.page) under the heading Solicitors’ Accounts Rules: guidance and forms. The two guidance documents are Applications to withdraw money from client account – notes for applicants and Rule 22(1)(h) – general advice for applicants (which were last updated in November 2009 and therefore predate the current Accounts Rules) and the checklist is in the form of a Word document and can be found at Rule 20(1)(k) Application/Information Form (DOC 1 page, 552K). Bizarrely, both the guidance and the checklist do appear to have been updated in part – despite being in a section marked pending review – and the fact that it contains the SRA’s current Birmingham address would seem to indicate that they can be relied upon.
Before making an application to the SRA, firms will need to have taken a number of basic steps to locate the whereabouts of the client. These will include (although the circumstances themselves will dictate what is reasonable):
- checking the file thoroughly and writing to the client at all known addresses and/or telephoning the client on all known telephone numbers
- carrying out the various searches recommended in the “less than £50” section including:
- Searching the internet, telephone directories, electoral registers, companies house lists, social networking sites and similar and
- Using the Department of Work and Pensions letter forwarding service.
- attempting to make contact through third parties – for example relatives, employers, banks etc. if known,
- placing an advertisement in a newspaper, and
- instructing an enquiry agent.
Bear in mind that if the money is due to a dissolved company then it may be bona vacantia and payable to the Treasury Solicitor under the provisions of the Companies Act. You will need to clarify if this is the position with the Treasury Solicitor’s Department before you make an application under Rule 20(1)(k).
When you make the application to the SRA – which will need to be made to the Professional Ethics department who are at The Cube, 199 Wharfside Street, Birmingham, B1 1RN or DX 720293 BIRMINGHAM 47 or email firstname.lastname@example.org – you will need to supply the following information:
- the name of the client,
- how long the money has been held,
- the steps that you have taken to locate the client (you may need to supply proof of the steps taken),
- if there are steps that you have not taken – the reason for this – e.g. costs would be excessive in comparison with the amount of money being returned.
In some circumstances it may also be necessary for you to supply a letter from your accountant in support of the application, although this may not always be required if, for example, the circumstances do not appear to warrant it, or the cost of the accountant’s letter is excessively high in relation to the money held.
Finally, you will need to give the SRA some indication of what you plan to do with the money – i.e. to which charity it is to be paid. Bear in mind that the SRA is likely to impose a condition that the money is paid to a charity which gives an indemnity against any legitimate claim subsequently made for the sum received. Remember also that even if SRA grants an authority, you will nevertheless remain liable to account to a rightful claimant, if such a claimant reappears or is traced and that if authority is granted such that it allows you to close your client account, you must continue to deliver accountants’ reports up to the date you cease to hold client money.
Being proactive about residual balances
It will be clear from that which we have said so far that dealing with residual client balances can in many cases prove to be a time consuming and complex problem. Far better, therefore, not to allow such balances to arise in the first place or, since sometimes events are outside of the firm’s control, to monitor the position to help ensure that such balances do not arise.
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.
It is a duty of the Compliance Officer for Finance and Administration (COFA) to take all steps reasonable necessary to ensure compliance with the accounts rules and this includes awareness of the problems that can arise around residual client balances.
There are a number of steps that can be taken to avoid these balances arising – some more basic than others.
The simplest system is for the accounts department or manager to provide fee earners/principals with a matter listing 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. This should also be built into the file closure system so that files remain current for as long as there is a client balance. By adopting a short review period such as 1 month, firms can help to minimise the effects of clients moving to an unknown address. Whilst it might appear time consuming, reviewing the client balance at this stage is far less onerous than having to search for clients at a later date. This will also help to highlight if there have been any accounting errors – for example where a residual balance appears on a file where it was believed that all outstanding monies had been remitted to the client.
Alternatively, a number of automated systems for alerting fee earners and accounts managers to residual balances exist – usually as part of the firms accounts package or practice management software.
Even if such a system has not been implemented, firms should 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.
The duty upon solicitors to return unwanted client funds to the clients and to 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 places a responsibility upon firms which should not be taken lightly.
Residual client balances are a nuisance – especially since they are often for amounts sufficiently small that any amount of effort in tracing the rightful recipient is out of proportion to the value of the sum held.
The simplest solution is to take steps to make sure that they do not arise in the first place – or that the circumstances in which they do arise are only those which are outside the control of the firm.
If you would like more assistance with dealing with residual client balances or you are experiencing problems with the SRA in connection with them then contact the Lawyers Defence Group.
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