Client Account Operations — SQE1 FLK2 Solicitors Accounts

A firm's client account is comfortably in credit. There is a great deal of money in it, held across all the firm's clients. Today a court fee of £2,500 falls due on one client's case, and it must be paid to issue his application. His ledger shows £900. A trainee points out that the account as a whole holds far more than £2,500. Can the fee be paid from the client account? No.

Because only £900 is held for him. Pay the £2,500 and you have spent £1,600 belonging to other clients. That single idea, that the client account is not one pot but a stack of separate entitlements, runs through this whole topic. This is Client Account Operations. Keep that £900 in mind.

Here is the route. What a client account is, and how it must be named. Then the separation rule. Then which account a receipt belongs in. Then the two prohibitions that generate most of the questions. No banking facilities, and never overdrawn. Then withdrawals, and transfers to the office account. Then putting breaches right. And last, the double entry.

A client account is a bank account used solely to hold client money. Everything here comes from the SRA Accounts Rules 2019. The rule numbers are worth carrying because they organise the subject, not because anyone will ask you to recite them.

Start with the name. Rule 3.2 requires the name of a client account to include the name of the authorised body and the word client. Both. A trading name alone will not do, and the word client alone will not do either. The point is that anyone looking at a bank statement can see at once that this is not the firm's own money.

Two kinds. A general client account holds money for many clients at once, each client's entitlement shown by the client ledgers rather than by a separate bank account. A designated client account is opened for one particular client or matter, so the bank statement shows that client's money alone.

Both are client accounts, and a firm may run as many of each as its work requires. Nothing limits the number, and no SRA approval is needed. So a client selling a farm, uneasy that £700,000 of hers will sit alongside everyone else's, can be given a designated account. What she cannot be given is an exemption from any of the rules.

Now separation, which is rule 4.1. Client money must be kept separate from money belonging to the firm. And here is the trap that catches people who think accurate records are the point. A solicitor setting up on her own who runs the whole practice through one bank account, with client money and her own fee income mixed together, is in breach. However good her ledgers are.

Ledgers are not a substitute for a separate bank account. Separation means separate banking and separate records.

Which raises the question that decides where every receipt goes. Whose money is it? Money received for the firm's fees is client money if it arrives before a bill has been delivered for the same. So money on account of costs, for work not yet done, is still the client's, and rule 2.3 requires it to be paid promptly into the client account.

Once a bill has been delivered, a payment of that bill for the firm's own charges is the firm's own money, and it belongs in the office account. Two cheques in the same post, one on account of costs and one paying last month's bill, go to two different banks.

And that works in reverse. Bank a cheque paying a delivered bill into the client account by mistake, and you are holding the firm's own money there. That breaches rule 4.1 just as surely as the other way round. It must be moved out promptly.

Now the first great prohibition. Rule 3.3. You may not use a client account to provide banking facilities to clients or third parties. Payments into, and transfers or withdrawals from, a client account must be in respect of the delivery by the firm of regulated services.

Read that as a test with two halves. Is there a legal service? And does this payment relate to it? A former client whose claim is over, who asks you to park £80,000 for six months while she decides what to do with it, fails the first half. There is no legal work in respect of which the money would be held.

A current client can fail the second half. You hold £40,000 for her after a house sale, and she asks you to settle her personal credit card and send a gift to her son. Her money, her written instructions, and still no. Send the money to her own bank and let her make the payments herself.

Lending fails too. A client who cannot make his mortgage payment asks for £5,000 from the client account as a short-term loan, offering interest. Nothing is held for him, so the money would be other clients'. And advancing money against a promise of repayment is the banking facility the rule forbids. If the firm wants to lend, it lends office money.

The second great prohibition is simpler. A client account may never be overdrawn. Overdraw it and you have paid out client money you do not hold, which means you have used other clients' money and given the paying client credit.

So a completion that needs £34,000 sent today, out of a client account holding £30,000 in total, cannot be funded from the client account. It does not help that the office account holds £60,000, or that two payments are expected tomorrow morning, or that no client is likely to notice.

And now back to our £900, because there is a narrower rule behind the overdraft rule that does more work in the exam. Rule 5.3. You may withdraw client money only if sufficient funds are held for that specific client. Not for clients in general. For that one.

So the pooled credit balance is irrelevant. Only £900 is held for our man. Paying his £2,500 court fee would spend £1,600 of other clients' money, even though the account as a whole never goes into debit. The firm pays from office money and recovers it, or it waits.

Uncleared funds are the same problem in disguise. Bank a client's cheque for £15,000 on Monday, and on Tuesday he asks you to send £14,000 on. The cheque does not clear until Thursday. Pay on Tuesday and, if it bounces, you have used other clients' money. Wait, or pay from office money at the firm's own risk.

Now withdrawals generally, and rule 5.1 gives you the three gateways. Client money may be withdrawn for the purpose for which it is being held. Or on the instructions of the client, or the third party, for whom it is held. Or with the SRA's authorisation.

Notice the second gateway names the person it is held for, and that is not always your client. Take a sale where £4,000 was retained, to be held to the buyer's order until repairs are certified. Your client rings to say the repairs are done and asks for his money. You cannot pay him. It is the buyer's certification that releases it.

Rule 5.2 adds the human control. All withdrawals from a client account must be appropriately authorised and supervised. The rules do not list job titles, but they are not silent either. Take a firm where every member of staff, including the apprentices and the receptionist, can release payments, and where whoever releases a payment also does the reconciliation. That satisfies neither limb.

And an instruction from someone who is not an authorised signatory is not authority. A junior fee earner telephones the cashier to send £18,000, with nothing on the file and no partner involved. However confident he is that the money is due, that is not appropriate authorisation.

Now transfers to the office account, which is how the firm gets paid. Three conditions, and keep them apart.

First, a bill. Rule 4.3 requires a bill of costs, or other written notification of the costs incurred, to be given to the client. That comes before client money is used to pay the firm's costs. So a solicitor who has agreed a £4,000 fee with a client on the telephone, and has done the work, still cannot transfer today. Nothing has been sent in writing. Deliver the bill first.

Second, no dispute. Client money can be applied to the firm's costs only so far as the firm is entitled to it. Deliver a bill for £6,000, and the client writes saying the charges are excessive and it will pay £4,000 and no more. The disputed £2,000 stops being money you can take. It stays client money until the dispute is resolved by agreement or assessment.

Third, only what you have actually earned. And that is where unpaid disbursements catch people, which is the point we will come back to shortly.

There is a mirror image people forget. The client account must not be used to hold money the firm is entitled to either. Bill £5,000, leave it undisputed, then let it sit in the client account for seven months because nobody got round to it. That is a breach too.

When something does go wrong, rule 6.1 governs. Breaches must be corrected promptly on discovery, and money improperly withdrawn from a client account must be replaced immediately.

Immediately means from office money, now. Find the client account £350 overdrawn on the five-weekly reconciliation, because a payment went out two days before the client's funds arrived. You replace the £350 from office money today. Not next week when the client pays in. And not out of money held for the firm's other clients.

Which disposes of a myth. People say money moves from client to office and never the other way. That describes the ordinary case. It is not a rule that stops you curing a shortage. Bank a £12,000 cheque, pay £11,000 out before it clears, watch it bounce, and office money must go in to make the client account good.

Over-transfer works the same way. Move £2,900 to the office account when you were entitled to £2,000, and you have taken £900 too much. That leaves the ledger £300 in debit and sweeps away £600 due back to the client. Move £900 back the same afternoon.

And you cannot tidy a shortfall away between ledgers. Client A is £5,000 in credit, client B is £700 overdrawn after a posting error, and moving £700 from A to B is not book-keeping. A owes B nothing, so that applies A's money to B's matter. Find the error, and if there is a real shortage, replace it from office money.

Last, the accounting entries, and the way to get these right is to reason rather than memorise. Ask two questions. Has money left or entered a bank account? And does the firm now hold more or less for this client?

Money leaving the client bank is a credit in the client column of the cash book. Holding less for that client is a debit on the client column of their ledger. Those two move together on every payment out of client money.

So pay a client £8,000 that is left at the end of a matter. Credit the client bank. Debit his client ledger. And nothing in the office ledgers at all, because you are simply returning his own money. A trainee who debits the bank and credits the ledger has reversed both, and has recorded the account rising and the firm holding more for him after paying him out.

Pay a third party from client money, and it is the same two entries. A £350 search fee on a purchase, paid from the £2,000 you hold for the buyer. Credit the client bank, debit his client ledger, and nothing in the office ledgers. The firm has not incurred that fee itself. It has applied the client's own money to a disbursement on his purchase, so no expense and no income of the firm arises.

That last point is worth pausing on, because it is tempting to think an office entry must be needed somewhere. It is not. Had the firm paid the £350 out of office money, the office ledgers would be involved. Paid from the client's own funds, they are not.

The transfer to office is the one with four entries, and each of the four answers one of those two questions. Bill a company £3,000, hold £8,000 of its money, and transfer the £3,000. In the cash book, credit the client bank, because £3,000 leaves it, and debit the office bank, because the same £3,000 arrives there.

Then on the company's ledger, debit the client column, because you now hold £3,000 less for it, and credit the office column, discharging the debt the bill created. The income was recorded when the bill was delivered. This transfer only collects it.

And finally the records themselves. Rule 8.1 requires accurate, contemporaneous and chronological records, including a client ledger for each client showing all receipts and payments and a running balance. Which means the entry has to explain itself.

A ledger line reading only transfer, with an amount, is not enough where three undisputed bills are outstanding. Six months later nobody can say which bill it discharged. Record the date, the amount, and the bill it paid.

A word on how SQE1 tests this. There is no case law in this topic at all. It is one set of rules, and you will not be asked to recite rule numbers either. You get a scenario about a payment, and you decide whether it may be made.

If you keep only three ideas. Sufficient funds for that specific client, because the pooled balance is a mirage. Every payment must relate to a regulated service you deliver. And a bill goes out before client money pays your costs.

Four traps. One. A healthy overall balance proves nothing. The test is always what is held for this client, and using another client's money is a breach even where the account never goes into debit.

Two. The client's instructions are not a licence. She can instruct you to do anything with her own money. You still cannot route a payment through the client account unless it relates to legal work you are doing.

Three. Separation cuts both ways. Firm money in the client account breaches the rule just as clearly as client money in the office account. So does leaving billed, undisputed costs in the client account for months.

Four. When money must go back into the client account, it comes from office money, and it goes now. Not from other clients, not by shuffling ledgers, and not at the next reconciliation.

Quick check, and this is the one I said we would come back to. A firm holds £8,000 of a client's money in the client account. It delivers a bill totalling £3,500. That is £2,000 in the firm's own professional charges, and £1,500 for a surveyor's fee which the firm has not yet paid and which falls due next week. The client does not dispute the bill.

How much may the firm properly transfer to the office account now? Three answers. One: the whole £3,500, because it has all been billed and is not disputed. Two: nothing yet, because no costs may be transferred until every disbursement has been paid. Three: only £2,000, being the firm's own charges. Pause here if you want a moment.

The answer is three. Only £2,000. On delivering the bill, the firm's own professional charges become money the firm is entitled to, and that may go across. The £1,500 for the surveyor has not been paid. It is money held to pay a third party, so it stays client money until the surveyor is actually paid. Transferring it now would take client money the firm has not earned.

Why the others fail. Option one treats the bill total as the test. The bill is what makes the charges payable; it does not turn an unpaid disbursement into your money. Option two overcorrects, holding back costs you have properly earned because something else is outstanding. Take what is yours. Leave what is not.

Five things to take away. One: our £900 is the whole topic in miniature. Withdraw only if sufficient funds are held for that specific client, whatever the account holds overall. Two: the name of the account must include the firm's name and the word client, and a firm may run as many client accounts as it needs.

Three: every movement through the account must relate to a regulated service, so no parking money, no personal payments and no lending. Four: to take your costs you need a bill delivered first, no dispute, and only what you have actually earned. Five: a shortfall is replaced from office money immediately. Next time, Interest on Client Money.

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.