Client money - Requirement to keep client money separate fro...

Learning Outcomes

This article examines the fundamental requirement under the SRA Accounts Rules to keep client money separate from money belonging to the authorised body. It explains the scope and purpose of Rule 4.1, the definitions that drive the analysis (what is client money and what is business money), and how the separation principle works in day-to-day practice through the operation of distinct client and business bank accounts. It explores how the principle applies to receipts and withdrawals (including mixed receipts under Rule 4.2 and withdrawals under Rule 5), the prohibition on using client account as a banking facility (Rule 3.3), the requirement that client money is available on demand (Rule 2.4) and returned promptly when no longer required (Rule 2.5), together with how breaches are identified and remedied (Rule 6.1), including common scenarios such as dishonoured cheques and mispostings. The article also integrates relevant controls and exceptions (for example, payments from the Legal Aid Agency and when business money may briefly touch client account to correct errors), and provides worked examples and journal entries that reflect how the separation principle is implemented in practice.

SQE1 Syllabus

For SQE1, you are required to understand the SRA Accounts Rules relating to the handling of money and the separation of client and business money, with a focus on the following syllabus points:

• The fundamental requirement to keep client money separate from money belonging to the authorised body (Rule 4.1).
• The definitions of client money and business money (Rule 2.1 and Glossary) and practical implications (for example, money received for unpaid disbursements before a bill is delivered is client money; reimbursement of paid disbursements is business money).
• The rationale for the separation requirement (safeguarding client funds, ring-fencing in insolvency, preventing misappropriation, maintaining public confidence).
• The basic operation of client accounts and business accounts (Rule 3), including naming, location, and the requirement that client money is available on demand (Rule 2.4) and returned promptly when no longer needed (Rule 2.5).
• How the separation principle applies to receipts, including mixed payments and prompt allocation to the correct account (Rule 4.2), and to transfers for costs after billing (Rule 4.3).
• The prohibition on using a client account to provide banking facilities (Rule 3.3), with practical indicators and risks.
• The consequences of breaching the separation rule, common breach scenarios (including dishonoured cheques and inter-client misallocations), and the duty to rectify breaches promptly by replacement from business funds (Rule 6.1).
• The limited circumstances when business money may be paid into or remain temporarily in client account (e.g., to open/maintain the account or to correct a breach), and when some firms need not operate a client account (Rule 2.2 and Rule 2.3(b) for LAA payments).

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. Which SRA Accounts Rule mandates the separation of client money and business money?
   1. Rule 2.1
   2. Rule 3.3
   3. Rule 4.1
   4. Rule 5.3
2. A client pays a firm £1,000. £600 is for a bill already delivered, and £400 is money on account of future costs. Which part is client money?
   1. £1,000
   2. £600
   3. £400
   4. £0

3. True or false? A firm can temporarily borrow from the client bank account to cover an unexpected business expense, provided the money is replaced within 24 hours.

4. What is the primary purpose of keeping client money separate from the firm's own money?
   1. To simplify accounting procedures.
   2. To maximise interest earned for the firm.
   3. To comply with HMRC requirements.
   4. To safeguard client funds and prevent misuse.

Introduction

A key element of solicitor regulation in England and Wales is the protection of client money. Central to this protection is the absolute requirement for authorised bodies (firms) to keep money belonging to clients completely separate from money belonging to the firm itself. This principle is enshrined in the SRA Accounts Rules and is fundamental to maintaining public trust and confidence in the legal profession. Failure to comply with this rule can lead to serious disciplinary action. Separation also protects clients if a firm fails financially: sums ring-fenced in a clearly designated client account do not form part of the firm’s assets available to creditors.

Misuse of client account—particularly using it as a conduit for general payments unrelated to regulated services—is treated seriously. The courts have endorsed the SRA’s stance that operating a banking facility through client account is objectionable, increases risks (including money laundering), and undermines regulation. Firms must therefore implement systems and controls that keep client money safe, segregated and traceable, and ensure any errors are identified and rectified promptly.

Client Money and Business Money

Understanding the distinction between client money and business money is essential before applying the separation rule.

Key Term: Client Money
Money held or received by a firm relating to the regulated services it provides (Rule 2.1). This includes: money held for a client; money held on behalf of a third party in relation to those services (e.g., money held as agent or stakeholder, or to the sender’s order); money held by the firm as trustee or holder of a specified office or appointment (e.g., donee of a power of attorney, Court of Protection deputy, trustee of an occupational pension scheme); and money held in respect of fees and any unpaid disbursements received before delivery of a bill for the same.

Key Term: Business Money
Money belonging to the firm. Examples include payments of billed fees (and VAT), reimbursements of disbursements already paid out of business funds, interest earned by the firm on general client money (subject to paying clients a fair sum of interest), and capital injected by the owners. It is the firm’s own working capital.

Key practical points from these definitions:

• Money on account of costs and unpaid disbursements before billing is client money. It must be paid into client account and cannot be moved to business account until a bill (or written notification of costs) is delivered under Rule 4.3.
• Reimbursement of a disbursement already paid out of business funds is business money. That element must be paid into business account, not client account.
• Money held as stakeholder is client money; from exchange to completion it does not belong to the seller. Money held as agent for the seller is also client money but belongs to the seller from exchange. This status influences who can give instructions and when funds may be released—but it does not change the need to keep it separate from business money.
• Money held to the sender’s order is client money. The firm must hold it in client account pending instructions or return.

The Separation Requirement: Rule 4.1

SRA Accounts Rule 4.1 explicitly states: “You keep client money separate from money belonging to the authorised body.” Operationally, this requires:

• Distinct bank accounts—client and business—together with accounting records that clearly identify to whom each sum belongs.
• Prompt banking of client money into a client account (Rule 2.3), and prompt removal of business money from client account and vice versa (e.g., after mixed receipts under Rule 4.2, or after billing under Rule 4.3).
• Immediate correction of any mispostings or improper withdrawals (Rule 6.1) by replacing funds from business money.

Limited exceptions exist. Business money may touch client account only where permitted by the Rules—for example, to open or maintain the client account, or to replace money withdrawn in error or due to a dishonoured cheque. Conversely, client money must not be left lingering in business account: where mixed payments are first banked to business account, the client element must be transferred promptly to client account (Rule 4.2).

The rationale behind strict separation is safeguarding: ensuring client money is neither inadvertently nor deliberately used to meet the firm’s own obligations and remains ring-fenced in any insolvency. The approach also deters and detects misappropriation and supports transparent, auditable records.

Key Term: Banking Facility
The use of client account as a general money transmission service for clients or third parties, unconnected to the delivery of regulated services (Rule 3.3). This is prohibited even if the client consents; there must be a proper connection to a matter on which the firm is providing legal services.

The SRA’s published warning notice and case law confirm that paying school fees, settling unrelated invoices or circulating large sums through client account without a relevant legal transaction fall foul of Rule 3.3. The fact that a firm has a retainer with the client is not, by itself, a justification for funds to pass through client account.

Client Accounts and Business Accounts

To facilitate the separation required by Rule 4.1, firms must operate distinct bank accounts with appropriate titles and controls.

Key Term: Client Account
A bank or building society account held in England and Wales, in the name of the firm, which must include the word “client” in its title (Rule 3). It is used exclusively for holding client money and must not be used to provide banking facilities.

Key Term: Business Account
An account held by the firm for its own money (business money), sometimes called the “office account”. All receipts of business money (e.g., billed fees) go here, and business expenses are paid from here.

Important operational points:

• Client money must be available on demand (Rule 2.4), unless a different arrangement is agreed in writing with the client or third party (for example, a separate designated deposit client account that requires notice but yields higher interest).
• Client money must be returned promptly when there is no longer a proper reason to hold it (Rule 2.5). Holding funds “just in case” or for client convenience risks breach of both Rules 2.5 and 3.3.
• Some firms do not operate a client account under Rule 2.2 (e.g., where the only client money received is money on account of the firm’s own costs/disbursements and certain conditions are met), or where payments come solely from the LAA for costs.

Key Term: Legal Aid Agency (LAA)
A public body that pays solicitors and counsel for legally aided work. Payments from the LAA for the firm’s costs may be paid directly into the business account (Rule 2.3(b)).

Worked Example 1.1

A client provides your firm with £5,000. £1,000 is to pay your already delivered bill, and £4,000 is to be held for a property purchase deposit. Your firm’s policy is to pay mixed receipts into the client account initially.

What immediate steps must be taken regarding the £5,000 received?

Answer:
The entire £5,000 should initially be paid into the client bank account. £4,000 is client money (deposit) and £1,000 is business money (payment for the bill). Under Rule 4.2, the firm must promptly allocate the funds correctly. This requires transferring the £1,000 of business money from the client account to the business account. Leaving the firm’s money in the client account beyond the time needed for allocation would breach Rule 4.1.

Dealing with Receipts and Payments

The separation principle dictates how receipts and payments are handled.

Receipts

• Client money must generally be paid promptly into a client account (Rule 2.3). Typical examples: deposits, settlement monies, sale proceeds, money on account of costs before billing.
• Business money (for example, payment of a billed fee) should be paid into the business account.
• Mixed receipts must be allocated promptly to the correct accounts (Rule 4.2). Firms may receive a single bank transfer (or cheque) comprising both client money and business money; the firm can bank the whole into either account but must promptly transfer the other element to the correct account.

Key Term: Mixed Payment
A payment received by a firm that includes both client money and money belonging to the authorised body (business money). Rule 4.2 requires prompt allocation to the correct accounts.

Journal entries help test application:

• Mixed receipt first into client account: CR client ledger (client account) for the client element; CR client ledger (business account) for the billed element; DR cash sheet (client account) for the full amount; promptly transfer the billed element to business account (DR cash sheet business; CR client ledger business).
• Mixed receipt first into business account: DR cash sheet business for the full amount; promptly transfer the client element to client account (DR cash sheet client; CR client ledger client).

When disbursements are involved:

• If the third-party invoice is in the client’s name (agency method), pay the VAT‑inclusive total and record a single VAT‑inclusive client‑side entry; there is no VAT entry on the firm’s VAT ledger for that payment.
• If the invoice is in the firm’s name (principal method), it must be paid from business account (recording input tax in the VAT ledger) and later recharged to the client on the firm’s bill; before recharge, the cost is business money.

Withdrawals

• Withdrawals from a client account may be made only for the purpose for which the money is held, on client/third-party instruction, or with SRA authorisation (Rule 5.1).
• A withdrawal can be made only if sufficient funds are held for the specific client or third party (Rule 5.3). Using Client A’s balance to pay Client B’s obligation is a serious breach of separation and trust.
• Business expenses must always be paid from the business account. Money to settle the firm’s fees may be transferred from client to business account only after a bill (or written notification of costs) has been delivered and to the specific amount billed (Rule 4.3).
• If the firm paid a disbursement from business funds and holds client money on account for that purpose, client money can be transferred from client to business account to reimburse the firm when the disbursement has been incurred.

Worked Example 1.2

A trainee solicitor accidentally pays a £150 business utility bill using a cheque drawn on the general client account. The firm’s COFA discovers this the next day during reconciliation.

What action must be taken?

Answer:
This is a breach of Rule 4.1 (keeping money separate) and Rule 5.3 (withdrawing client money only when sufficient funds are held for the specific client/purpose). The firm must immediately correct the breach under Rule 6.1 by transferring £150 from the business account into the client account to replace the improperly withdrawn funds. The root cause should be addressed through systems and training.

Worked Example 1.3

On Monday you receive a client’s cheque for £500 on account of costs and bank it into client account. On Tuesday you pay a £100 court fee from client account for that matter. On Thursday the bank informs you the cheque has been dishonoured.

How do you remedy this while preserving separation?

Answer:
Reverse the original receipt entry (to remove the apparent client funds) and recognise that the £100 court fee used other clients’ money. Under Rule 6.1, immediately transfer £100 from business account into client account to restore client funds. When the client later pays validly, treat the receipt as a mixed payment (business money of £100 reimbursing the firm, plus any further client money) and allocate promptly under Rule 4.2.

Worked Example 1.4

A developer client asks you to retain net sale proceeds from development A in client account and settle unrelated invoices for development B (contractor, architect, council tax). You are not instructed on development B.

Can you make these payments from client account?

Answer:
No. This would be using client account as a banking facility contrary to Rule 3.3, as the payments are not sufficiently connected to regulated services you are delivering. You should return the sale proceeds promptly (Rule 2.5) and advise the client to pay third parties directly from their own account.

Exam Warning

A common error tested is the misuse of client money. Never assume it is permissible to borrow client funds for business purposes, even temporarily. Rule 4.1 requires strict separation. Rule 5.3 prevents using one client's money for another or for the firm. Similarly, avoid using client account as a banking facility (Rule 3.3); having a retainer does not justify unconnected money movements.

Breaches of the Separation Rule

Mixing client money and business money, or using client money improperly, constitutes a breach. Rule 6.1 mandates that any breach must be corrected promptly upon discovery; this usually involves replacing money from the business account into the client account to restore the correct position, followed by swift removal of any business money wrongly left in client account. Typical breach scenarios include:

• Paying business expenses from client account (misuse of client account).
• Taking more for a client than is held for that client (breach of Rule 5.3), often caused by posting errors, timing differences, or a dishonoured client cheque previously credited.
• Leaving business money in client account longer than necessary after a mixed receipt (failure to allocate promptly under Rule 4.2).
• Retaining residual client balances where there is no proper reason to hold them (breach of Rule 2.5); small, unreturnable residual balances may be cleared to charity in prescribed circumstances, subject to record‑keeping.

Key Term: COFA
Compliance Officer for Finance and Administration. The individual responsible for ensuring compliance with the SRA Accounts Rules within the firm and for reporting material breaches. The COFA should set up and monitor systems and training to minimise risks to client money.

Breach identification and rectification rely on accurate, contemporaneous, and reconciled records. Firms must keep dual‑column client ledgers (business and client sides) and perform client bank reconciliations at least every five weeks. These controls ensure that any anomalies in separation are detected quickly and corrected in line with Rule 6.1.

Revision Tip

Understand the flow of money. Ask: Whose money is it? Where should it be held? Was it paid into/out of the correct account? Was there authority? Was there sufficient client balance for that client? This structured approach helps identify compliance issues relating to separation.

Key Point Checklist

This article has covered the following key knowledge points:

• Rule 4.1 is the core rule requiring client money to be kept separate from business money.
• Client money (Rule 2.1) belongs to clients/third parties; business money belongs to the firm.
• Separation protects client funds, prevents misuse, and maintains trust; monies in client account are ring-fenced in insolvency.
• Firms must use distinct client accounts (Rule 3) and business accounts; client account titles must include the word “client” and be held in England and Wales.
• Client money must be available on demand (Rule 2.4) and returned promptly when no longer required (Rule 2.5).
• Client money must generally be paid into client account promptly (Rule 2.3); in limited cases LAA payments can go to business account, and some firms may rely on Rule 2.2 not to operate a client account.
• Mixed receipts require prompt allocation to the correct accounts (Rule 4.2); journal entries should reflect the client and business elements accurately.
• Withdrawals from client accounts are strictly controlled (Rule 5). Money cannot be used for the firm or other clients; funds for costs can be transferred only after billing (Rule 4.3).
• Using client account as a banking facility is prohibited (Rule 3.3); ensure a proper connection to regulated services before receiving or paying funds.
• Breaches of separation must be corrected immediately (Rule 6.1), typically by replacing any shortfall from business funds and addressing root causes through systems and training.

Key Terms and Concepts

• Client Money
• Business Money
• Client Account
• Business Account
• Mixed Payment
• Banking Facility
• Legal Aid Agency (LAA)
• COFA