Client money - Repayment of client money to clients

Learning Outcomes

This article outlines the core obligations for solicitors regarding the repayment of client money held in a client account, including:

• The duty to return client money promptly when there is no longer a proper reason to hold it, and its interaction with the requirement that client money is available on demand
• Authorised bases for withdrawals for repayment and safeguards in Rule 5.2 and Rule 5.3
• Accounting for interest under Rule 7, including the common two-step method for sums in lieu of interest before final repayment
• Procedures for residual balances where clients cannot be traced, including prescribed circumstances up to £500 and SRA authorisation for amounts over £500
• Risks of inappropriate retention and the prohibition on using the client account as a banking facility (Rule 3.3)
• Correct journal entries for repayments and linked transactions, and records required by Rule 8

SQE1 Syllabus

For SQE1, you are required to understand the practical application of the SRA Accounts Rules 2019 concerning the handling and repayment of client money. This includes knowing when client money must be returned and the procedures involved. Your understanding will be tested through scenarios requiring you to apply these rules, with a focus on the following syllabus points:

• the duty to return client money promptly when there is no longer a proper reason to hold it (Rule 2.5)
• the circumstances in which withdrawals from a client account are permitted for repayment (Rule 5.1)
• the requirement to hold sufficient funds for the specific client before making a withdrawal (Rule 5.3)
• the procedures for dealing with residual balances where the client cannot be traced (prescribed circumstances and SRA authorisation)
• the connection between holding client money unnecessarily and the prohibition on providing banking facilities (Rule 3.3)
• correct accounting/journal entries for repayment and linked transfers, and record-keeping in ledgers and cash sheets (Rule 8)
• accounting for interest on client money (Rule 7), including sums in lieu and separate designated deposit client accounts

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 which SRA Accounts Rule must client money be returned promptly when there is no longer a proper reason to retain it?
   1. Rule 3.3
   2. Rule 4.1
   3. Rule 2.5
   4. Rule 5.1
2. A firm holds £450 in its client account for Client A after their matter concluded six months ago. Despite reasonable efforts, the firm cannot trace Client A. What can the firm do with the £450 without SRA authorisation?
   1. Transfer it to the firm's business account.
   2. Pay it to any charity.
   3. Keep it in the client account indefinitely.
   4. Pay it to a charity that provides an indemnity against future claims.
3. Before repaying client money, what is the key check required by Rule 5.3?
   1. Confirming the client's identity.
   2. Ensuring sufficient funds are held for that specific client.
   3. Obtaining written authorisation from the client.
   4. Reconciling the client account statement.

Introduction

A fundamental principle of handling client money is that it does not belong to the firm and must be safeguarded. Part of this stewardship involves returning the money to the client or rightful owner when it is no longer needed for the purpose for which it was held. The SRA Accounts Rules 2019 (the 'Rules') set out clear obligations regarding the repayment of client money. Understanding these obligations is essential for compliance and maintaining client trust. This article examines the key rules governing the timing, authorisation, and process for repaying client money.

Key Term: client money
Money held or received by a firm relating to regulated services, including money held for a client, on behalf of a third party, as a trustee, or for fees and unpaid disbursements prior to a bill being delivered (Rule 2.1).

Key Term: promptly
Not defined in the Rules, but treated as “as soon as reasonably possible” in the circumstances. Retaining funds beyond the point of need without justification is a breach.

Key Term: banking facilities
Use of the client account to receive or pay funds unconnected with the delivery of regulated legal services. Rule 3.3 prohibits using a client account to provide such facilities.

The Duty to Return Client Money Promptly

Rule 2.5 states: "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."

This rule establishes a positive obligation on firms to proactively return funds once the legal matter or the specific purpose for holding the money has concluded. “Proper reason” is linked to the delivery of regulated services. Examples include completion monies awaiting completion on a sale, proceeds awaiting distribution to estate beneficiaries, or sums on account pending disbursements in an ongoing matter. Once that need ends—such as after completion, approval of estate accounts and distributions, or cancellation of a planned disbursement—the firm should identify the balance due and return it.

Rule 2.4 complements this duty by requiring client money to be “available on demand” unless an alternative arrangement is agreed in writing. Holding money in a deposit account that requires notice is permissible only if the written agreement is reached before funds are placed there.

Holding client money without a proper reason can also risk breaching Rule 3.3, which prohibits using a client account to provide banking facilities. If money is retained long after the matter has concluded, the firm may be seen as offering a banking service rather than holding funds incidental to legal services.

Typical triggers for prompt repayment include:

• completion of a conveyancing transaction, with sale proceeds or buyer surplus identified after completion statements reconcile
• conclusion of a litigation matter, including receipt and allocation of damages and costs
• approval of estate accounts in a probate matter with final distributions calculated and agreed
• abortive transactions or cancelled instructions, where funds on account no longer serve any pending regulated service

Firms should have file-closing procedures to review ledger balances, identify residual funds, and trigger repayment. Where client contact details are outdated, reasonable steps must be taken to trace clients. If clients cannot be traced, the residual balance procedure applies (see below).

Worked Example 1.1

A firm acted for Client B in a litigation matter which settled two months ago. The firm received settlement funds into the client account and, after deducting its billed fees, a balance of £5,000 remains for Client B. The client has not provided instructions on where to send the funds despite requests. Can the firm continue holding the £5,000 indefinitely?

Answer:
No. Under Rule 2.5, the firm must return the £5,000 promptly as there is no longer a proper reason (related to the concluded litigation) to hold it. The firm should continue efforts to obtain payment details from Client B but cannot hold the funds indefinitely. Prolonged retention could breach Rule 2.5 and potentially Rule 3.3.

Worked Example 1.2

A conveyancing purchase completes. The buyer’s solicitor holds a surplus of £2,150 in the client account after apportionments and disbursements. The client asks the firm to retain the surplus “for a few months” to help pay private rent while they organise their finances. Is retention appropriate?

Answer:
No. After completion there is no proper reason to hold the surplus for private living costs. Retention for convenience risks breaching Rule 2.5 and Rule 3.3. The surplus should be returned promptly. If the client later instructs the firm on a new matter, fresh client money arrangements can be made for that matter.

Authorised Withdrawals for Repayment

Repaying client money involves withdrawing it from the client account. Rule 5.1 governs withdrawals and permits them only under specific circumstances:

• for the purpose for which it is being held: for example, paying the client or a third party the sums due under the transaction or matter.
• following receipt of instructions from the client, or the third party for whom the money is held: the usual basis for returning the client’s balance at the end of a matter.
• on the SRA’s prior written authorisation or in prescribed circumstances: relevant mainly to residual balances where the client cannot be traced.

Importantly, Rule 5.3 states: "You only withdraw client money from a client account if sufficient funds are held on behalf of that specific client or third party to make the payment." Before making a repayment, the firm must check the specific client ledger to ensure the balance covers the repayment amount. Using funds held for Client X to make a repayment to Client Y is a serious breach, even if the overall client account bank balance is positive.

Rule 5.2 requires withdrawals to be appropriately authorised and supervised. Firms should ensure only appropriately trained personnel authorise withdrawals and that documentary evidence of the purpose and amount is retained.

Key Term: client ledger
An accounting record maintained by the firm for each individual client (and often for each matter for that client) showing all the transactions involving client money and business money relating to that client/matter.

Key Term: COFA
Compliance Officer for Finance and Administration. Responsible for ensuring compliance with the Accounts Rules, including systems that safeguard client money.

Worked Example 1.3

A firm holds £1,500 for Client C in its general client account. The client requests the return of this money. The firm’s cashier checks the client ledger and confirms the £1,500 balance. However, due to an accounting error last week, £200 belonging to Client D was accidentally withdrawn from Client C's ledger balance (though this hasn't been corrected yet). The ledger shows £1,500, but the actual money held for Client C is only £1,300. Can the firm repay £1,500 to Client C?

Answer:
No. Despite the ledger showing £1,500, the firm only holds £1,300 for Client C. Repaying £1,500 would involve using £200 of other clients' money, breaching Rule 5.3. The firm must first correct the accounting error by replacing the £200 improperly withdrawn (Rule 6.1), likely from the business account, before repaying the full £1,500 to Client C.

Practical steps before repayment

• confirm the balance on the client ledger and verify there are sufficient funds on behalf of that specific client
• ensure any uncleared receipts (e.g., cheques) are cleared before making payments
• check bills and agreed disbursements are correctly recorded and transferred, to avoid misallocations
• obtain the client’s repayment instructions (bank details or postal address) and verify them through appropriate controls
• where appropriate, calculate interest due and complete the linked business-to-client transfer prior to repayment (see below)

Accounting entries for repayment

Where repayment is a payment out of the client account to the client:

• DR client ledger (client account): the client ledger reduces as money leaves the client account
• CR cash sheet (client account): payment out of the client bank account

If the repayment includes a sum in lieu of interest first transferred into client account from business account, record the business-to-client transfer in two pairs:

• DR client ledger (business account); CR cash sheet (business account)
• CR client ledger (client account); DR cash sheet (client account)

Accounting for Interest Before Repayment

Before making a final repayment to a client, the firm must ensure it has accounted for any interest due on the client money held, in accordance with Rule 7. Rule 7.1 requires firms to account for a fair sum of interest unless agreed otherwise in writing (Rule 7.2). The firm’s interest policy will determine the amount and method. Any interest due must be calculated and paid (often by transferring it from the business account to the client account) before the final balance is repaid to the client.

Where money was held in the general client account and the firm pays a sum in lieu of interest:

• record the interest payable expense as business money:
  • CR client ledger (business account)
  • DR interest payable ledger (business side)
• transfer the sum from business to client account:
  • DR client ledger (business account); CR cash sheet (business account)
  • CR client ledger (client account); DR cash sheet (client account)

Where money was held in a separate designated deposit client account (SDDCA), the client is entitled to the interest arising in that account. When closing the SDDCA, transfer the total (principal plus interest) back into the general client account and then repay as appropriate.

Key Term: separate designated deposit client account (SDDCA)
A deposit account designated for one client’s money, typically used when a large sum is held for a period. Interest arising is usually paid to that client.

Key Term: interest payable
An expense ledger for sums in lieu of interest paid to clients for money held in the general client account.

Worked Example 1.4

Firm Z held £90,000 for Client E for three months in the general client account. Under its interest policy, it calculates £120 as a fair sum in lieu of interest. Before returning the balance to the client, how should Firm Z account for the interest and the repayment?

Answer:
First record the interest payable expense (CR client ledger business side £120; DR interest payable £120). Next transfer £120 from business to client account (DR client ledger business side £120; CR cash sheet business side £120, then CR client ledger client side £120; DR cash sheet client side £120). Finally, repay the client (DR client ledger client side with the total repayment; CR cash sheet client side). All entries should be supported by the firm’s interest policy.

Dealing with Residual Balances

Sometimes, usually at the end of a matter, a small balance of client money remains, and the firm cannot trace the client despite reasonable efforts. The Rules provide mechanisms to clear these residual balances.

• Balances up to £500: without SRA authorisation, firms may withdraw the money and pay it to a charity if they have made reasonable attempts to trace and return the money, and they keep detailed records. Many firms keep a central register and retain evidence of tracing attempts and the charity receipt.
• Balances over £500: prior written authorisation from the SRA is required before withdrawal. The SRA may impose conditions, commonly that the money is paid to a charity which provides an indemnity against future claims.

Reasonable attempts to trace may include checking the file, contacting last known addresses/emails/phone numbers, electoral roll searches for the last address, and using low-cost letter forwarding or tracing services where proportionate to the amount. Firms should be mindful that prolonged retention of residual balances risks breaching Rule 2.5.

Exam Warning

Be clear on the distinction between the procedures for residual balances under and over £500. Note that for balances under £500 paid to charity, no SRA authorisation is needed, and no indemnity is required from the charity. For balances over £500, SRA authorisation is mandatory.

Key Term: residual balance
A client money balance remaining at or after the end of a matter which cannot be returned because the client cannot be identified or traced, despite reasonable efforts.

Worked Example 1.5

Client F’s conveyancing matter concluded a year ago. A residual balance of £280 is on F’s client ledger. The firm has emailed and posted to the last known address, attempted phone contact, searched the electoral register, and used a letter-forwarding service without success. How may the firm deal with the £280?

Answer:
Provided the firm records its reasonable attempts and keeps the evidence (including the charity receipt and entry on a central register), it may withdraw the £280 from the client account and pay it to a charity without SRA authorisation. It cannot transfer the funds to the business account. If later traced, the firm should reimburse F.

Worked Example 1.6

Client G’s probate matter concluded with a residual balance of £1,350. Despite reasonable attempts, the firm cannot trace Client G. What should the firm do?

Answer:
Apply to the SRA for prior written authorisation to withdraw the residual balance. The SRA may require payment to a charity that provides an indemnity against future claims. The firm should keep full records of attempts to trace and of the SRA authorisation and payment.

Client Money Available on Demand and Avoiding Banking Facilities

Under Rule 2.4, client money must be “available on demand” unless an alternative written arrangement is made with the client or third party. If client money is placed in a notice deposit account, obtain the client’s written agreement in advance and document the reason (such as a better interest rate while funds are legitimately held for a period connected to the matter).

Rule 3.3 prohibits using the client account to provide banking facilities. Keeping client money after the matter has ended, or making payments unrelated to the regulated legal services, risks breaching this prohibition. SRA warning notices emphasise that convenience is not a justification. In borderline cases, ask whether a payment could be made directly by the client from their own bank account. If the answer is “yes” and there is no good reason relating to the legal work to hold the funds, do not use the client account.

Worked Example 1.7

A firm acts on a sale and receives the net proceeds for Client H. The client instructs the firm to pay £7,000 from the proceeds to their child’s school for next term’s fees. May the firm make the payment from the client account?

Answer:
No. There is no connection between payment of private school fees and the delivery of regulated services in the sale. Using the client account in this way risks providing banking facilities contrary to Rule 3.3. The firm should return the sale proceeds to Client H promptly and advise the client to make any personal payments themselves.

Record Keeping

All repayments of client money must be accurately recorded in the firm's accounting records in accordance with Rule 8. This includes entries on the relevant client ledger and the cash sheet, showing the purpose, amount, date, and payee. The firm should:

• maintain accurate, contemporaneous client ledgers for each matter and a cash sheet covering both client and business sides
• retain evidence supporting withdrawals (authorisation, invoices, client instructions, bank details, etc.)
• perform regular bank reconciliations for client accounts (typically at least every five weeks), investigating any discrepancies promptly
• keep a readily accessible central record of bills and written notifications of costs, and apply controls to ensure transfers from client to business account occur only when permitted

Robust systems help prevent breaches such as paying out more than is held for a client (Rule 5.3) or retaining balances beyond the point of need (Rule 2.5).

Key Point Checklist

This article has covered the following key knowledge points:

• Firms must return client money promptly when there is no longer a proper reason to hold it (Rule 2.5).
• Client money must ordinarily be available on demand unless a written alternative arrangement exists (Rule 2.4).
• Holding client money unnecessarily long may breach Rule 3.3 (prohibition on providing banking facilities).
• Withdrawals for repayment must be authorised under Rule 5.1 and supervised appropriately (Rule 5.2).
• Before repayment, firms must ensure sufficient funds are held for that specific client (Rule 5.3).
• Interest due under Rule 7 must be accounted for before final repayment; use the correct ledger entries for sums in lieu of interest.
• Specific procedures apply to residual balances where the client cannot be traced: up to £500 may be paid to charity without SRA authorisation with records kept; over £500 requires SRA authorisation.
• All repayments must be accurately recorded in the accounting records (Rule 8), with reconciliations performed regularly and supporting documentation retained.

Key Terms and Concepts

• client money
• promptly
• client ledger
• banking facilities
• separate designated deposit client account (SDDCA)
• interest payable
• residual balance
• COFA