Client money - Requirement to keep client money separate from money belonging to the authorised body

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. After reading this article, you should understand the definitions of client money and business money, the rationale behind the separation requirement, the core principles of SRA Accounts Rule 4.1, and the implications of breaching this rule. This knowledge is essential for applying the SRA Accounts Rules correctly in practice and for answering SQE1 assessment questions.

SQE1 Syllabus

For SQE1, a core understanding of the SRA Accounts Rules relating to the handling of money is required. You must be able to apply these rules practically. This article focuses specifically on the separation of client and business money. As you revise, ensure you understand:

• 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).
• The rationale for the separation requirement (safeguarding client funds, preventing misappropriation).
• The basic operation of client accounts and business accounts as distinct entities (Rule 3).
• How the separation principle applies to receipts, including mixed payments (Rule 4.2).
• The consequences of breaching the separation rule and the duty to rectify breaches promptly (Rule 6.1).

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 (the 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. This article explores the key aspects of this requirement as stipulated by Rule 4.1 of the SRA Accounts Rules 2019.

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. This includes money held for a client, on behalf of a third party (e.g., stakeholder money), as a trustee, or money for fees and unpaid disbursements received before a bill is delivered (Rule 2.1).

Key Term: Business Money
Money belonging to the firm itself. This includes money received for billed fees, reimbursement for paid disbursements, and money contributed by partners or directors. It is the firm's own working capital.

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." This means that these two types of money must not be mixed or held in the same bank account, except in very limited circumstances dealt with under other rules (like handling mixed receipts temporarily).

The rationale behind this strict separation is primarily the safeguarding of client funds. Keeping client money distinct ensures that it is not inadvertently (or deliberately) used for the firm's own purposes, such as paying overheads or settling business debts. It protects client money in the event of the firm's insolvency, as funds in a clearly designated client account are ring-fenced and do not form part of the firm's assets available to creditors.

Client Accounts and Business Accounts

To facilitate the separation required by Rule 4.1, firms must operate distinct bank accounts.

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, with limited exceptions (e.g., adding firm money to open the account or replacing money withdrawn in error).

Key Term: Business Account
An account held by the firm for its own money (business money). Sometimes referred to as the 'office account'. This account is used for the firm's operational income and expenditure.

The existence of these separate accounts is the practical mechanism for complying with Rule 4.1. All client money received must generally be paid promptly into a client account (Rule 2.3), and all business money received should be paid into a business account.

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).
• Business Money: Should be paid into a business account.
• Mixed Receipts: Rule 4.2 requires prompt allocation. If a mixed payment is received (containing both client and business money), it can initially be paid into either the client or business account, but the portion belonging to the other account must be transferred out promptly.

Key Term: Mixed Payment
A payment received by a firm that includes both client money and money belonging to the authorised body (business money).

Withdrawals

• Withdrawals from a client account must only be for the specific client whose money is held and only for the purpose for which it is held, or following client instructions, or SRA authorisation (Rule 5.1).
• Importantly, a firm can only withdraw money from a client account if sufficient funds are held for that specific client (Rule 5.3). Using money held for Client A to make a payment for Client B is a serious breach, directly contravening the separation principle.
• Business expenses must always be paid from the business 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.

Breaches of the Separation Rule

Mixing client money and business money, or using client money improperly, constitutes a breach of the Rules. Rule 6.1 mandates that any breach must be corrected promptly upon discovery. If client money has been improperly used or withdrawn, it must be replaced immediately, often requiring a transfer from the business account to the client account.

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.

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? 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.
• Firms must use distinct client accounts (Rule 3) and business accounts.
• Client money must generally be paid into a client account promptly (Rule 2.3).
• Business money should be paid into a business account.
• Mixed receipts require prompt allocation to the correct accounts (Rule 4.2).
• Withdrawals from client accounts are strictly controlled (Rule 5); money cannot be used for the firm or other clients.
• Breaches of separation must be corrected immediately (Rule 6.1), often involving transfers between accounts.

Key Terms and Concepts

• Client Money
• Business Money
• Client Account
• Business Account
• Mixed Payment