Breaches of the SRA Accounts Rules - Duty to correct breache...

Learning Outcomes

This article outlines the obligations under the SRA Accounts Rules regarding the correction of breaches, focusing on the requirement to remedy breaches promptly upon discovery and the distinct duty to replace client money shortages immediately. It covers common breach scenarios and their causes (for example, dishonoured cheques, posting errors, bank charges debited to client account, residual balances not returned, or impermissible “banking facility” use of client account), practical steps to safeguard client money and correct records (including the precise journal entries to restore the position), the distinction between correcting general breaches “promptly” and replacing client money shortages “immediately”, the respective responsibilities of fee earners, managers and the COFA for preventing, detecting and rectifying breaches (including deciding when a breach or pattern is material and must be reported to the SRA), and the interaction of Rules 2.4–2.5 (availability and prompt return of client money), 3.3 (no banking facilities), 4.1 (separation), 5.3 (no overdrawn client ledgers), 7 (interest) and 8 (records and reconciliations) when formulating a compliant remedy.

SQE1 Syllabus

For SQE1, you are required to understand the practical steps and principles involved when breaches of the SRA Accounts Rules occur, including the duty imposed by Rule 6.1, with a focus on the following syllabus points:

• The specific requirement under Rule 6.1 to correct breaches promptly upon discovery.
• The distinction between the prompt correction of general breaches and the immediate replacement of client money improperly withheld or withdrawn.
• The responsibility of the Compliance Officer for Finance and Administration (COFA) and the firm's managers regarding compliance and breach rectification.
• The necessity of robust systems and controls to identify and manage breaches.
• The potential consequences of failing to remedy breaches as required by the Rules.
• Typical breach fact patterns: dishonoured cheques leading to overdrawn client ledgers; bank charges wrongly debited to client account; paying business costs from client account; keeping residual client balances after a matter ends; using client account as a banking facility.
• The accounting entries required to correct shortages, reverse mispostings and move money between business and client accounts to restore compliance.
• Materiality and reporting: when isolated breaches, or patterns of breaches, trigger a report to the SRA and what factors inform that judgment.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Under SRA Accounts Rule 6.1, what timeframe applies to correcting a breach involving improperly withdrawn client money?
   1. Within 7 days of discovery.
   2. Promptly upon discovery.
   3. Immediately upon discovery.
   4. Before the next accounting period ends.
2. A firm accidentally pays a £150 supplier invoice from the client bank account instead of the business bank account, causing a client ledger to be overdrawn. Which SRA Accounts Rule is primarily breached regarding the withdrawal?
   1. Rule 2.3 (Paying client money in promptly).
   2. Rule 3.3 (Providing banking facilities).
   3. Rule 5.3 (Withdrawals not to exceed funds held).
   4. Rule 7.1 (Accounting for interest).
3. Which role within a firm has designated responsibility for taking reasonable steps to ensure compliance with the SRA Accounts Rules?
   1. The senior partner.
   2. The reporting accountant.
   3. The Compliance Officer for Finance and Administration (COFA).
   4. Each individual fee earner.

Introduction

Compliance with the SRA Accounts Rules is fundamental to maintaining client trust and ensuring the safety of client money. The Rules mandate strict procedures for handling funds, but errors and breaches can still occur. Rule 6.1 imposes a clear duty on authorised bodies, their managers, and employees to rectify any breach promptly upon discovery. This article examines this duty, focusing on the specific requirement for immediate action regarding client money shortages and the essential role of internal controls and compliance oversight. Understanding these obligations is essential for day-to-day practice and success in the SQE1 assessment.

Breaches arise in many ways. Common triggers include drawing against uncleared cheques that later bounce, misallocating mixed receipts, paying office expenses from client account, leaving residual balances after completion, or holding funds for convenience (contrary to the prohibition on banking facilities). Whatever the cause, the priority is to safeguard client money, restore compliance swiftly, correct the accounting records accurately, document what happened and prevent recurrence.

Key Term: Breach
In the context of the SRA Accounts Rules, a breach refers to any failure to comply with the requirements set out in the Rules regarding the handling of client money, operation of accounts, or maintenance of accounting records.

The Duty to Correct Breaches Promptly

Rule 6.1 of the SRA Accounts Rules 2019 is explicit: 'Any breach of these rules must be remedied promptly upon discovery'. This overarching requirement reflects the SRA Principles, particularly the duties to act with integrity (Principle 4), in the best interests of clients (Principle 7), and to protect client money and assets (Principle 10).

The term 'promptly' is not defined within the Rules and its interpretation depends on the specific circumstances of the breach. However, the SRA guidance suggests that firms should act quickly once a breach is identified. For minor administrative errors, prompt correction might mean rectifying the record or system issue within a few days.

In practice, “promptly” means:

• immediately safeguarding client money (for example, pausing further withdrawals from the affected client ledger until the cause is known);
• making the necessary accounting entries without delay to put client money in the correct place (for example, transferring business money to client account where other clients’ money has been used inadvertently);
• evidencing the correction on the cash sheet and client ledger(s), and capturing the breach in the firm’s breaches register;
• investigating root cause and implementing a proportionate remedy (training, amendments to authorisation controls, or more frequent checks) to reduce recurrence risk.

For general record-keeping errors where no client money is at risk, “promptly” will be measured in days rather than weeks. Where client money has been displaced, “promptly” is superseded by a higher standard: immediate replacement.

Key Term: Material breach
A breach that, judged on factors such as client detriment or risk of detriment, scale, persistence, pattern and impact on confidence, is sufficiently serious to be reported to the SRA as soon as reasonably practicable. A series of smaller breaches can be material in aggregate.

Immediate Replacement of Client Money Shortages

A critical distinction exists within Rule 6.1 concerning breaches that involve client money being improperly withheld or withdrawn from a client account. The rule states: 'This includes the replacement of any money improperly withheld or withdrawn from a client account'. The SRA expects such replacement to happen immediately upon discovery.

Key Term: Client Money Shortage
A situation where the amount of money held in the client bank account for a specific client (or across all clients in aggregate) is less than the firm's liability to that client (or all clients), often resulting from an improper withdrawal or failure to deposit client money correctly. This includes situations where a client ledger account shows a debit balance.

This requirement for immediate action emphasizes the absolute priority placed on safeguarding client funds. It means that the firm must use its own resources (ie, business money) to make good any shortfall on the client account without delay. Failure to do so constitutes a serious breach.

The duty to replace shortages immediately captures a wide range of scenarios, including:

• a cheque received from a client is dishonoured after the firm has already paid a disbursement from client account for that client;
• a bank error (for example, charges deducted from client account) creates a shortfall;
• a posting error leads to an overpayment from a specific client ledger;
• a business invoice is paid from client account in error.

The correct approach is to transfer business money to the client account at once to correct the shortage, then investigate and reclaim from the bank or other third party where appropriate. Waiting for the client to resend funds or for a supplier to re-credit is not acceptable.

Worked Example 1.1

A trainee solicitor accidentally authorises payment of a £250 counsel's fee from the client bank account for Client A, believing sufficient funds were held. Later that day, the accounts department discovers Client A's ledger only held £100, meaning £150 of other clients' money was improperly used.

What action must the firm take?

Answer:
The firm has breached Rule 5.3 (withdrawals not to exceed funds held for the specific client) leading to a £150 shortage. Under Rule 6.1, the firm must immediately replace the £150 improperly withdrawn from the client bank account. This requires an immediate transfer of £150 from the firm's business bank account into the client bank account. Waiting for Client A to provide funds is not acceptable.

Worked Example 1.2

A client sends a £500 cheque on account of costs. The next day the firm pays a £200 court fee from client account for that client. Two days later, the bank advises the £500 cheque has bounced.

What must be done, and what entries are required to rectify the breach?

Answer:
There is a client money shortage because £200 was withdrawn without sufficient cleared funds for that client, so other clients’ money was used. The firm must immediately replace the £200 by transferring £200 from the business bank account to the client bank account. Journal entries:

• DR cash sheet client account £200; CR cash sheet business account £200 (reflects the inter-bank transfer).
• DR client ledger business account £200; CR client ledger client account £200 (reflects the restoration of the client’s funds position). The breach is recorded and the root cause addressed, including a control to avoid drawing on uncleared funds.

Responsibility for Compliance and Rectification

Responsibility to remedy breaches does not rest solely with the individual who noticed or caused the breach. Under the SRA regulatory framework, the authorised body is responsible for compliance, managers must ensure effective systems and controls, and employees must comply with those systems. The obligation to protect client money is collective. If a shortage arises, the firm must make it good immediately from its own resources. Managers should ensure the firm has the liquidity to do so and, if necessary, escalate to arrange short-term business funding so that client money is protected.

The Compliance Officer for Finance and Administration (COFA) plays a central role. Designated under the SRA Authorisation Rules, the COFA must take all reasonable steps to ensure compliance with the Accounts Rules and record any failures. They are central to overseeing the identification and prompt rectification of breaches.

Key Term: Compliance Officer for Finance and Administration (COFA)
An individual approved by the SRA within an authorised body who is responsible for taking reasonable steps to ensure compliance with the SRA Accounts Rules.

Reasonable steps by the COFA and managers include:

• ensuring reconciliations are completed and reviewed at least every five weeks (Rule 8.3) and that discrepancies are investigated promptly;
• maintaining a breaches register and monitoring patterns so that repeat issues are treated as material even if individual instances are minor;
• specifying and enforcing authorisation limits for withdrawals from client account (Rule 5.2), and requiring pre-payment checks that the relevant client ledger is in sufficient credit;
• training fee earners and cashiers on mixed receipts, correct use of client versus business accounts, and the prohibition on providing banking facilities (Rule 3.3);
• ensuring there is a tested process to make immediate business-to-client transfers when shortages are discovered, including out-of-hours escalation.

Where a breach or series of breaches is material, the COFA should ensure the SRA is notified as soon as reasonably practicable, setting out the breach, its impact, how it has been remedied, and what the firm has done to mitigate recurrence.

Identifying and Recording Breaches

Effective systems and controls are essential for identifying breaches promptly (Rule 8.3 requires reconciliations at least every five weeks). Firms must maintain accurate and up-to-date accounting records (Rule 8.1). Regular reconciliation of client accounts against bank statements is a key control for detecting discrepancies that might indicate a breach, such as an incorrect withdrawal or a client ledger being overdrawn.

Core record-keeping controls include:

• a dual cash account (business and client columns) to record all receipts and payments clearly and contemporaneously;
• separate client ledgers for each matter, with running balances on both business and client columns, updated for every transaction;
• a central, searchable record of bills and other written notifications of costs (Rule 8.4);
• a system to flag potential breaches automatically (for example, warning if a proposed payment would overdraw a client ledger, or if a posted bank charge reduces the aggregate client balance).

Once a breach is discovered, firms should maintain a record of it, detailing:

• The nature of the breach.
• The date of discovery.
• The corrective action taken and the date.
• Reasons for the breach (if known).
• Any steps taken to prevent recurrence.

This record assists the COFA in monitoring compliance patterns and deciding whether a breach (or series of breaches) is material and requires reporting to the SRA.

Key Term: Banking facilities
Using the client account to hold or move money where there is no associated regulated legal service requiring it. Rule 3.3 prohibits providing banking facilities to clients; payments in and out must relate to the delivery of regulated services.

Key Term: Material breach
A breach that, because of client detriment or risk of detriment, scale, persistence, pattern or impact on confidence, must be reported to the SRA promptly. A number of smaller breaches can be material when considered together.

Materiality is a question of judgment. Factors include the actual or potential risk to client money, how long the breach persisted, the amounts involved, whether clients suffered detriment, whether the breach indicates a widespread weakness, and whether similar issues have arisen before (pattern). A series of “small” issues within a department over a short period may be material in aggregate and must be reported, even if each individual instance was promptly rectified and caused minimal risk.

Examples of matters that commonly surface through reconciliations and routine reviews include:

• uncleared funds used to make a payment and the original cheque is later dishonoured (creates a shortage);
• bank interest or charges incorrectly applied by the bank to client account (creates a shortage or surplus);
• a payment for office costs posted from client account in error (specific client ledger debit balance);
• large client balances retained after completion without a proper reason (contrary to Rule 2.5 and at risk of breaching Rule 3.3);
• mixed receipts left wholly in client account or business account contrary to Rule 4.2, resulting in misallocation.

For residual client balances where the client cannot be traced, the SRA recognises that, after reasonable attempts to locate the owner and return funds, firms may be able to pay small residual balances to charity. Under current SRA guidance, balances below a modest threshold (often referenced as £500) may be paid to a charity without prior SRA approval if the firm has taken reasonable steps to trace the owner and keeps full records; larger balances generally require SRA authorisation. These are exceptions to the general duty to return client money promptly (Rule 2.5) and must be handled carefully and transparently.

Worked Example 1.3

A firm's cashier reconciles the client bank account and discovers a £50 bank charge has been incorrectly debited to the client account instead of the business account. The COFA is notified.

What accounting entries are needed to correct this immediately?

Answer:
The firm must immediately replace the £50 in the client account. This requires a cash transfer from the business bank account to the client bank account. The journal entries would be:

1. Transfer out of business account: DR Client Ledger (relevant client or suspense) Business Account £50; CR Cash Sheet Business Account £50.
2. Transfer into client account: CR Client Ledger (relevant client or suspense) Client Account £50; DR Cash Sheet Client Account £50.

The COFA must ensure this is done immediately and the breach is recorded.

Worked Example 1.4

A secretary mistakenly pays a £180 stationery invoice (addressed to the firm) from client account against Client B’s matter. The error is spotted the same day and Client B’s client ledger shows a £180 debit balance.

How should this be rectified?

Answer:
A payment for the firm’s business expense should never have been made from client account. There is a client money shortage attributable to Client B’s ledger. The firm must immediately transfer £180 from the business bank account to the client bank account to remove the debit balance on Client B’s client ledger. Journal entries:

• DR cash sheet client account £180; CR cash sheet business account £180.
• DR client ledger business account £180; CR client ledger client account £180. Record the breach and implement a control to restrict payments from client account to authorised disbursements only.

Worked Example 1.5

After completion of a conveyancing sale, £420 remains on the client ledger. No further legal work is required. Two months pass and the funds are still on the ledger because the client has not replied to emails asking for bank details.

What is the compliant course of action?

Answer:
Under Rule 2.5, client money must be returned promptly once there is no proper reason to hold it. The firm should take reasonable steps to contact the client and return the £420 (for example, to the originating account). If the client cannot be traced after reasonable attempts, the firm should follow SRA guidance on dealing with residual client balances, which may allow paying small balances to charity without prior authorisation, provided the firm keeps full records of tracing steps and the donation. Holding the money indefinitely risks breaching both Rule 2.5 and Rule 3.3 (banking facilities).

Consequences of Non-Compliance

Failure to remedy breaches promptly, especially those involving client money shortages, is viewed seriously by the SRA. Potential consequences include:

• Disciplinary action against the firm and individuals (including managers and the COFA).
• Regulatory sanctions, such as fines or conditions on practice.
• Requiring a remedial plan and additional reporting (for example, more frequent reconciliations or external oversight).
• Qualification of the reporting accountant’s report due to risks to client money.
• Damage to the firm's reputation and loss of client trust.
• In severe cases, intervention by the SRA into the practice.

Replacing missing client money is non-negotiable. The SRA expects shortages to be made good immediately; delay increases the risk of intervention. Rectification after discovery does not necessarily avoid sanction if the original conduct (for example, using client account as a banking facility, or widespread ledger weaknesses) indicates wider risk.

Misuse of the client account to provide banking facilities can be an aggravating factor, particularly where funds are moved for convenience unrelated to regulated services, or in circumstances suggesting attempts to circumvent insolvency or anti-money laundering controls. Firms should always ensure that receipts into and payments out of client account are directly linked to the delivery of regulated legal services and supported by clear instructions and file notes.

Exam Warning

Pay close attention to the distinction between 'promptly' for general breaches and 'immediately' for replacing improperly withheld or withdrawn client money. SQE1 questions may test your understanding of this specific requirement under Rule 6.1. Failing to recognise the need for immediate replacement of client money is a common pitfall.

Also watch for:

• scenarios where a cheque has bounced after a disbursement was paid from client account;
• payments of business expenses from client account;
• the improper retention of residual balances;
• prompts to use client account for a client’s personal payments unrelated to the matter.

Revision Tip

Focus on the practical application of Rule 6.1. Consider scenarios like dishonoured cheques leading to overdrawn ledgers, accidental use of client funds for office expenses, or delays in transferring funds. Understand the steps required for rectification and the COFA's role in ensuring these steps are taken immediately where necessary.

To prepare, memorise the key journal entries for:

• immediate business-to-client transfers to make good shortages;
• reversing mispostings between business and client sides of the client ledger;
• inter-client transfers where money was wrongly credited to the wrong matter (paper transfer on ledgers only).

Key Point Checklist

This article has covered the following key knowledge points:

• SRA Accounts Rule 6.1 mandates the prompt correction of all breaches upon discovery.
• A critical aspect of Rule 6.1 is the requirement for immediate replacement of any client money improperly withheld or withdrawn from a client account.
• 'Promptly' applies to general breaches, while 'immediately' applies specifically to rectifying client money shortages.
• The firm's managers and the COFA share responsibility for ensuring breaches are remedied and for monitoring patterns of non-compliance.
• Effective accounting systems, controls, and regular reconciliations are essential for identifying breaches quickly and accurately.
• Typical breach scenarios include dishonoured cheques, bank charges wrongly debited to client account, paying business expenses from client account, retaining residual balances, and banking facility misuse.
• The precise journal entries to correct shortages and mispostings must be understood and applied without delay.
• Materiality depends on client detriment or risk, scale, duration and pattern; material breaches must be reported to the SRA promptly.
• Failing to correct breaches, particularly client money shortages, can lead to severe regulatory consequences, including qualified accountant’s reports and, in serious cases, intervention.

Key Terms and Concepts

• Breach
• Client Money Shortage
• Compliance Officer for Finance and Administration (COFA)
• Material breach
• Banking facilities