Client Money — SQE1 FLK2 Solicitors Accounts

A cashier pays a £7,000 cheque into the firm's office account. It should have gone into the client account, because it is a client's money for a property purchase. The mistake comes to light two days later, and by then the office account holds £2,500, because the month's wages have gone out of it. So what does the firm owe? Not £2,500. Not the shortfall. It owes £7,000 into the client account, today, and £4,500 of that has to come out of the firm's own pocket.

That is the whole subject in one mistake. Client money is never the firm's, the rules are strict, and when you get it wrong the firm pays. This is Client Money. What counts as it, where it has to go, when you may take some of it, and what to do when somebody banks it in the wrong place. Keep that cashier in mind.

Here is the route. What client money is, and the limb of the definition that catches people out. Then what office money is, and the one case where a payment from a client is not client money at all. Then the movement rules. In promptly, out only for the right reasons, and never mixed. Then taking your own costs. And last, the bookkeeping, and what happens when it goes wrong.

Start with the definition, because everything else follows from it. Under rule 2.1 of the SRA Accounts Rules 2019, client money is money you hold or receive relating to the regulated services you deliver. Money held on behalf of a third party. Money you hold as trustee, or as the holder of an office such as executor. And money received for your own fees and unpaid disbursements, before you have delivered a bill.

So the category is much wider than money belonging to the person who instructed you. A stakeholder deposit on a house purchase is client money, because it belongs to whoever ends up entitled to it. Estate funds you hold as executor are client money. So are trust funds you hold as trustee, though there is no solicitor and client relationship in the ordinary sense. Money another firm sends you for its client is client money in your hands.

That last limb of the definition is the one that catches people. Money received for your own fees is client money until a bill or other written notification of costs has been delivered. Not until you have earned it. Not until the work looks finished. Until you have billed it. A client who sends you money on account of costs has not paid you. She has given you something to hold.

Which brings the mirror image. Office money is money that belongs to the firm. Fees you have billed. Partners' capital. The firm's own profits. Try one. On Tuesday the firm pays a £600 court issue fee out of the office account. The client has sent no money, and the claim has to be issued that afternoon. On Friday the client sends a cheque for £600 to cover it. Client account, or office account?

Office account. Money on account of a disbursement not yet paid is client money. But this disbursement has already been paid, out of the firm's own money, so the client is simply repaying a debt to the firm. The classification is fixed by the facts, not by the firm's preference and not by what the covering letter says. Pay the fee first from office money, and the reimbursement comes back to office money.

And when you genuinely cannot tell, there is a default. Treat it as client money. Putting office money into a client account is inconvenient and rarely a breach. Putting client money into the office account is a breach. The asymmetry is deliberate, and it should decide every borderline case for you.

Now what you do with it. Rule 2.3 requires client money to be paid promptly into a client account. There is no fixed period in the Rules, and promptness is judged on the facts of the firm. If a firm banks by hand every working day and the branch is open, the next banking day is the answer.

So a cheque that arrives on Friday afternoon should be banked on Monday. A solicitor who is in court on Monday and leaves it in the file until Tuesday, because that suits him better, has delayed. Recording the receipt in the cash book on Friday does not help. The money is still sitting in a file, unprotected, and the delay is one he would struggle to justify.

Rule 4.1 requires client money to be kept separate from money belonging to the firm. Which brings back our misbanked cheque. The £7,000 was client money. It went into the office account by mistake. Two days later the office account is down to £2,500 because the wages have gone out. Notice what the firm owes. Not £2,500. Not the difference. Seven thousand pounds into the client account, at once.

What about a cheque that is partly one and partly the other? Rule 4.2 covers it. A single cheque for £6,400, of which £6,000 is the client's own money coming back to her and £400 settles a bill delivered last week. Two routes. Pay the whole cheque into the client account and promptly transfer the £400 out. Or split it and allocate promptly. What you may never do is run the client's £6,000 through the office account.

Money coming out. Rule 5.1 lets you withdraw client money only for the purpose for which it is held, or following the client's instructions, or on the SRA's prior written authorisation. There is no general power to move client money about because it is convenient.

And rule 5.3 adds the arithmetic. You may only withdraw if sufficient funds are held for that specific client. Try it. The ledger shows a credit balance of £4,200 for a woman selling her business. The client account overall holds far more than £6,000 across all clients. She asks you to send £6,000 today, and promises £3,000 tomorrow once her buyer's funds clear. Can you send it?

No. Only £4,200 is held for her. Paying £6,000 would spend £1,800 belonging to other clients, and a healthy total balance is no answer, because the total is other people's money too. The promised £3,000 counts when it is received and cleared, not when it is promised. Then the £7,200 would be enough. Not before.

Taking money for your own costs has its own rule. Rule 4.3. You must give the client a bill, or other written notification of the costs incurred, before you transfer anything. The payment must be for the specific sum identified in that bill. And the money you hold for that client must cover it. Three conditions, and the order matters. Bill first, transfer second.

Work one through. The firm has finished a conveyancing matter and holds £5,000 for the client. Last week it delivered a bill for £2,500, which he has not questioned. The fee earner wants to move the whole £5,000 across and send back anything not ultimately earned. He may move £2,500. The other £2,500 is still the client's money, and with no reason left to hold it, rule 2.5 requires it to go back to him promptly.

Withholding client money needs authority, and there are only a few sources. Costs the client has agreed and does not dispute. A valid lien. A statutory requirement, or a court order about how money is to be held or paid. Or the client's written authority to deduct a specific sum. What is not enough is the firm's own view that it is owed the money.

And the authority is matter-specific. A firm acting for a company on two unrelated matters holds £8,000 from a completed sale, and is owed £3,000 on the litigation. It would like to keep £3,000 back. It may not, without the company's authority. Money held for a client on one matter cannot be applied to the firm's costs on a different matter. Return the sale money, and pursue the bill by proper means.

Giving money back. Rule 2.5 requires client money to be returned promptly, as soon as there is no longer any proper reason to hold it. It goes back to the client, or to the third party for whom it is held. And it must go to the person actually entitled. Estate funds go to the beneficiaries. A stakeholder deposit goes to whoever the contract says. Paying the wrong person is a breach.

Old balances have their own route. Where a client cannot be traced, the firm may withdraw the money and pay it to charity. For a balance of £500 or less it can do that without prior authorisation, provided the conditions are met. Those include reasonable steps to trace, and an undertaking to refund if the client reappears. Above £500, the firm needs the SRA's prior authorisation. A £900 balance has to be asked about.

Now the bookkeeping, and it is simpler than it looks. Every movement of client money is recorded twice. Once in the cash book, which is the chronological record of the bank account. Once in that client's ledger, which shows how much of the money in the account is theirs. Money in, two entries. Money out, two entries. If you only write it in one place, nothing will reconcile.

Receipts feel backwards until you see why. Money into the client account is a debit in the cash book, and a credit on the client's ledger. Your instinct says the opposite, because on your own bank statement a payment in shows as a credit. But that statement is written from the bank's point of view. A deposit is money the bank owes you. In your own books the client bank is an asset, so money arriving is a debit.

Payments reverse it. Money out of the client account is a credit in the cash book and a debit on the client's ledger, which reduces the balance you are holding. So paying £200 to the Land Registry for a search out of the client's money is a client bank credit and a £200 debit on his ledger. Two entries, and they always move together.

A transfer for costs is the one that takes four entries, because two accounts are involved. Client side: credit the client bank, because money is leaving, and debit the client ledger, because you are holding less for him. Office side: debit the office bank, because money is arriving, and credit his office ledger, recording the fees you have earned. Four entries, one transaction, everything still in balance.

Last, what happens when it goes wrong. Rule 6.1 requires breaches to be corrected promptly and shortfalls to be replaced. Which is why our misbanked £7,000 costs the firm £4,500 of its own money. And why a firm that sends £45,000 to a fraudster on an unverified email still owes its client £45,000. Paying away client money to the wrong person does not discharge the duty. It creates a shortfall the firm must make good.

A word on how SQE1 tests this. You will not be asked to recite rule numbers. You get a scenario, five answers, and one instruction. Pick the best. What actually earns marks here is classifying the money correctly, then applying the movement rule that follows. Get the classification wrong and every later step is wrong with it.

If you keep only three things, keep these. Rule 2.1, and in particular that money for your own fees is client money until you have billed it. Rule 4.3, bill first, transfer second, and only the sum in the bill. And rule 6.1, which is the one that costs money: correct it at once, and make up any shortfall from the firm's own funds.

Four traps. One. When you cannot tell, bank it as client money. The two errors are not symmetrical. Office money sitting in a client account is untidy and rarely a breach. Client money in the office account is a breach from the moment it is banked.

Two. A delivered bill is a precondition of a transfer, not proof that the money is yours. It unlocks the door. If the client disputes the sum, delivering the bill changes nothing about your entitlement. It only means you are not barred by the timing point.

Three. No raiding across matters. Money you hold for a client on one file cannot be used for your costs on another, however clearly that client owes you. Without their authority, the money goes back and you chase the bill like any other creditor.

Four. Paying the wrong person does not discharge you. Send a client's money to a fraudster on an email you did not verify, and the client is still entitled to every penny. The firm replaces it from its own funds first, and argues about recovery afterwards.

Quick check. A client sends a firm £10,000 at the start of a dispute. Her covering letter says £2,000 is to cover the court fee and other disbursements, and the remaining £8,000 is on account of the firm's own fees. The firm has done no work, paid no disbursement, and delivered no bill or other written notification of its costs. The fee earner says the £8,000 is plainly meant for the firm.

May the firm bank the £8,000 in its office account? Three candidate answers. One. Yes, because the client has said in writing what the £8,000 is for. Two. No, because money on account of costs is client money until a bill is delivered. Three. Yes, because only money for unpaid disbursements is client money here. Pause here if you want a moment.

The answer is two. Rule 2.1 is where it lives. Money received in respect of the firm's fees and unpaid disbursements is client money, if it arrives before a bill or other written notification of those costs is delivered. Nothing has been billed and no disbursement has been paid. So the whole £10,000 is client money, and the whole £10,000 goes into the client account under rule 2.3.

Why the others fail. Option one makes the client's description decisive. It is not. What matters is that the firm has not billed. Option three halves the definition. Money on account of the firm's own fees is client money too. The £8,000 moves across only once a bill has been given.

Five things to take away. One. Client money is money held for anyone else, and it includes money for your own fees until you have billed them. Two. In promptly under rule 2.3, back promptly under rule 2.5, and never mixed with the firm's money under rule 4.1.

Three. Out only for the purpose it is held for, or on the client's instructions, and only if you hold enough for that particular client. A large total balance is other people's money. Four. For your own costs, a bill first, then the transfer, and only the sum in the bill.

Five. When it goes wrong, correct it at once and replace the shortfall from the firm's own money. Which is where our cashier came in. A £7,000 cheque in the wrong account, £2,500 left in it, and £4,500 of the partners' money going in to put the client back. Next time, Client Account Operations.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.