Interest on Client Money — SQE1 FLK2 Solicitors Accounts

Over a year, a firm's bank pays it £9,000 of interest on its general client account, where money for many clients is pooled. The firm applies its own written interest policy to each client's holding, works out that the fair sums due to those clients come to £6,400 in total, and pays them. Then it keeps the remaining £2,600 as its own income. Is that allowed?

Yes. Which is the first surprise in this topic, and the one everything else hangs off. This is Interest on Client Money. Interest belongs to the client, we all learn. Except that the interest the bank pays on the pooled client account belongs to the firm. Hold on to that £2,600.

Here is the route. The duty first, which is Rule 7.1 and one phrase: a fair sum. Then what the SRA does not tell you, which is almost everything. Then when interest is payable and when it is not. Then the exemption that no longer exists. And last, where the money actually comes from, which is not where you think.

Start with the rule. Rule 7.1 of the SRA Accounts Rules 2019: if you hold client money, you must account to that client for a fair sum of interest. Whether it sits in a general client account or a designated one. That is the whole of the duty, and the operative part is three words long. A fair sum.

Why? Because that money could have been earning interest in the client's own account. Holding it in yours should not cost them. It is compensation for the time their money is in your hands, and it is their entitlement, not your fee for looking after it.

Which is worth saying plainly, because firms try. Take a partner who works out that a fair sum is £180 and decides to keep it, as a modest charge for the staff time spent running the account. That is a breach. The £180 is the client's. Running a client account is the firm's overhead, recovered through its costs.

Now back to that £2,600, because the structure underneath it explains half the topic. Money in a general client account is pooled. The bank pays the interest on that account to the firm, so that interest is the firm's.

The firm's duty is a different one. Not to hand over what the bank paid, but to account to each client for a fair sum under its own policy. Discharge that duty and the surplus is yours. There is no obligation to distribute it, and no client has a claim to a share of it.

Now change one fact. A client asks you to hold £200,000 for several months. Because the sum is large you open a separate designated deposit account for her money alone. The bank pays £2,400 of interest into it. Your policy's fair sum on a comparable balance would have been £1,900. What does she get?

All of it. £2,400. Interest on a designated deposit account opened for one client's money belongs to that client, and the fair-sum policy has nothing to do with it. Pooled account: the firm's interest, and a fair sum to the client. Designated account: the client's interest, and all of it.

Which brings the single most examinable idea in this topic. Look at what the SRA does not tell you.

It does not set a rate. Rule 7.1 says fair sum, and that is all. The firm sets the rate in its own written interest policy, commonly by reference to what the money would have earned in an instant-access or designated deposit account.

It does not set a calculation method. The firm's policy sets that too, and a simple daily calculation is common. It does not set a de minimis. It does not set a minimum holding period. And it does not set a threshold of any kind.

So an accounts manager who writes to a client saying the SRA sets a de minimis of £500 has invented it. There is no £500 figure and no other. If the firm's own policy says £150, and the balance is £200, the firm owes a fair sum, even if that fair sum is a little over £1.

The SRA sets the duty. The firm's written policy sets the detail. Get that division right and most of the questions in this topic answer themselves.

A word on the mechanics. The clock starts when the money hits the client account and stops when it leaves. Where the balance moves up and down, a fair sum is worked out on what was actually held from day to day. Not on the highest figure the account ever saw. And whether interest compounds is, again, the firm's policy.

Which is why most firms let software do it. Manual calculation is possible for simple cases and error-prone for everything else. Underpay and you get a complaint. Overpay and the firm is out of pocket.

So when is a fair sum payable? Four questions, in order. Is it client money in a client account? Is it above the firm's de minimis, if it has one? Has it been held for the firm's minimum period, if it has one? And does anything displace the duty?

Three things can displace it. A statute with its own scheme. A court order or court deposit rules that provide differently. Or an alternative written agreement with the client under Rule 7.2.

And Rule 7.2 is worth a moment. A firm can agree in writing with a client not to pay interest, or to pay it differently, provided the client has enough information to give informed consent. Terms of business that explain what the client would otherwise receive, and that they are giving it up, read and signed, can be effective. A term buried in small print is a different matter.

Now a trap about which figure you measure. A firm's policy accounts for interest where the balance exceeds £9,000. It receives £10,000 in settlement of a claim and holds it for eight weeks. On the closing day it transfers £2,000 to office for billed costs and pays the client the remaining £8,000. Which figure meets the threshold?

The £10,000. You take the gross amount held, before any deduction for tax, fees or costs. Until those costs are transferred out they are part of the client money you hold. What the client eventually receives is not the measure. What you held for them is.

Then the exemption everybody remembers and nobody should. A firm holds a £48,000 deposit for a woman buying a house. Completion is delayed and it sits there for nine weeks. The firm's policy accounts for a fair sum on anything held more than 28 days. The solicitor says nothing is due, because a purchase deposit is just passing through on its way to the seller. Is that right?

No. There is no conveyancing exemption, residential or commercial. The old under-£10,000 residential exemption belonged to the earlier rules and did not survive into the 2019 Rules. A deposit in the client account is client money like any other. The policy is met, and about £330 is due.

Two follow-on points. The money was hers until completion, so being destined for the seller does not stop it being client money held on her behalf. And when a policy period is met, the policy qualifies the whole holding. It does not pay interest only on the days beyond the period.

Nor is there a slice. Somebody who half-remembers the old rule and proposes to pay interest on the excess over £10,000 has made two mistakes. The exemption is gone, and even when it existed it was an exemption, not a slice off the top.

Two limits on the de minimis. First, it applies per holding. Same client, two genuinely separate and unconnected matters: £4,000 held briefly on one, and £3,000 held on the other some months later. Each is below the firm's figure. Do you add them together?

No. Genuinely separate holdings are assessed separately. But the anti-avoidance point is the mirror image. Artificially splitting one fund across matters or accounts to duck the threshold does not work, because the rules look at the substance and not the form.

Second limit, and this is the sharper one. The firm sets the de minimis, but it is not free to set whatever it likes. A policy that accounts for interest only above £150,000, so that £70,000 held for eight months earns a client nothing, does not account for a fair sum. The threshold itself is the breach.

Now the accounting, and this is where that £2,600 pays off. Where does the fair sum actually come from?

Not from the client's own money in the client account. Not from the other clients' balances in the pool. And not out of the bank interest, because that already belongs to the firm. The fair sum is paid from office money. It is a cost to the firm.

Which shapes the entries. The moment you calculate that a fair sum is due, the firm owes it. You recognise a liability then, not when you get round to paying it. A file note is not an accounting record, and leaving it on the file understates what the firm owes.

Then the payment. Money leaves the office bank account, so that account is credited. The liability falls away, so the interest payable account is debited. Get those the wrong way round and the books show the office account growing and the debt to the client rising, which is the opposite of what happened.

And if the money goes straight from office to the client's own bank account, it never touches the client account, so nothing is credited to her client ledger at all.

The rest is process, and it is short. Pay promptly once it is due. The rules do not fix a number of days. Promptly is the standard, and folding it into the monthly reconciliation is the practical answer.

Tell the client. It need not be formal. A note on a statement or a line on a bill will do, and transparency heads off disputes. Record every payment in the ledgers, and keep the calculation with the file, because if a client queries the figure you have to be able to show your working.

And one thing that is not process. No interest due does not mean no records needed. Even when the fair sum is nil, the client money is still client money, and every other rule in the Accounts Rules still applies to it.

A word on how this is tested. SQE1 will not ask you to recite a rule number. You get a scenario, five answers, and one instruction: pick the best. So learn what the rules do. The numbers are pegs to hang them on.

If you keep only three. Rule 7.1, because a fair sum is the entire duty and the SRA sets nothing else. Rule 7.2, because a written agreement with informed consent can displace it. And the pooled against designated split, because it decides both who owns the bank's interest and where the fair sum is paid from.

Four traps. One: the conveyancing exemption is dead. There is no special treatment for a deposit on a house purchase, residential or commercial, and there has not been since the 2019 Rules. If an answer option offers you £10,000 as a threshold, that is the trap.

Two: no interest due is not the same as no records needed. The de minimis exempts you from calculating and paying a fair sum. It exempts you from nothing else in the Accounts Rules.

Three: watch which way the aggregation runs. Genuinely separate matters are assessed separately, so you do not add them up to cross a threshold. But splitting one fund to fall below a threshold is avoidance, and the rules look at substance.

Four: a de minimis is the firm's to set, not the firm's to abuse. Set it high enough that substantial sums held for months produce nothing, and the policy stops producing a fair sum. The threshold itself becomes the breach.

Quick check. A firm held £200 of a woman's money for three months and paid her no interest. When she queries it, the accounts manager writes explaining that the SRA sets a de minimis of £500, so nothing is due on a balance that small. The firm's own written interest policy in fact sets a de minimis of £150. Applying its rate to £200 for three months would produce a fair sum of a little over £1.

Three candidate answers. One: yes, because the £500 de minimis applies to every firm holding client money. Two: yes, because a fair sum of a little over £1 is too small for the firm to have to pay. Three: no, because the SRA sets no de minimis and her £200 exceeds the firm's own £150 figure. Pause here if you want a moment.

The answer is three. The SRA does not set a de minimis for interest on client money. There is no £500 figure and no other. Rule 7.1 requires a fair sum, and it is the firm's own written policy that fixes any threshold.

This firm's policy sets £150. The £200 held for her exceeds it. So on the firm's own terms a fair sum is due, and it is a little over £1. Nor does the smallness of the sum help the firm. Smallness is exactly what a de minimis is for, and this firm chose £150.

Five things to take away. One: Rule 7.1 is the whole duty, and it is a fair sum of interest on client money you hold. Two: the SRA sets no rate, no method, no de minimis and no minimum period. The firm's own written policy sets all of it, and Rule 7.2 lets a written agreement with informed consent displace the duty altogether.

Three: there is no conveyancing exemption, and the old under-£10,000 rule is gone. Four: measure the threshold against the gross sum held, before costs come out. Five: on a pooled client account the bank's interest is the firm's. Which is why the fair sum is paid out of office money, and why our firm kept its £2,600. Next time, Breaches of the SRA Accounts Rules.

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.