This is by no means a new issue as anyone who works in or with law firms will be acutely aware. To give a very brief history lesson – before 2008 there was no specific Accounts Rule addressing balances remaining at the end of a client matter. This is perhaps, in part, the reason why some of the cases that have been reported recently refer to funds being held for over 20 years! When the 2008 amendment was introduced, many firms were starting on the back foot, as it were. That said, many firms have dealt with those older balances and taken measures to avoid new problems building up in this area but, then again, many have not.

The current Rule 2.5 (taking its cue from the 2011 version) requires ‘prompt’ repayment once there is no longer any proper reason to retain those funds. If monies have not been repaid promptly, and it now proves impractical or impossible to return them, Rule 5.1 (c) applies – requiring funds to be paid over to charity, either via the ‘self-certification’ route (matter balances below £500) or via SRA approval (balances exceeding £500).

Cases over the past two or three years (Solicitors Disciplinary Tribunal and SRA’s Regulatory Outcomes) make it is abundantly clear that not attending to these balances is leading to some hefty fines and penalties. It is also one of the most common reasons why a Reporting Accountant will take the decision to qualify a law firm’s annual report (AR1), especially where previous warnings to improve the position have not led to change.

Taking a small selection of recent cases as examples illustrates the seriousness of these breaches. While there are typically other significant regulatory failures, the residual balance problems are a key element of the final disciplinary outcomes. They should make sobering reading if this is a less well attended to aspect in your/your client’s firm.

• January 2022 – this involved the ‘temporary misuse’ of £46,000 of client balances that had already either been approved by the SRA for payment to charity or identified by the firm as otherwise residual. This was used on three separate occasions to meet the firm’s VAT and payroll obligations. These breaches led to £45,000 of fines and penalties as well as practicing restrictions being imposed.
• June 2023 – £121,000 of balances were held on matters with no movement for at least 12 months. Some of them dated as far back as 1984! The firm had no proper systems or controls in place to deal with these. Additionally, no Accountant’s Reports since 2014! Suspensions of 18 and 6 months were handed to the partners.
• September 2023 – from 2008 to 2021 the firm allowed £105,000 to be built up in the client account by failing to address inactive or completed matters. There were no procedures in place to deal with these residual balances, and its systems did not identify receipts in the client account. They self-reported this, and other breaches, expressed remorse and put in place an action plan to improve timeliness about dealing with remaining client money. Regular updates were to be made to the regulator and more training was to be provided to staff. While there was no lasting significant harm to clients, the ‘disregard’ of obligations for such a long period was harmful. Annual letters to clients, the SRA noted, would have raised a red flag. The firm was fined £14,116 and agreed to pay £600 costs.
• February 2024 – £600,000 was held across 393 balances where there had been no movement for over 12 months. Balances ranged from £0.01 to £79,000 and some were 29 years old. Two years of Qualified Accountant’s Reports eventually led to an SRA investigation. The firm’s focus on current matters had resulted in historic cases being left where the client could not be located. Policies and procedures have since been implemented to prevent future breaches and tackle outstanding matters. The relatively small fine, £5,899, would no doubt have been dwarfed by the management and other time spent dealing with the Reporting Accountants, the SRA and now these balances!

It is notable that, alongside the huge question of whether law firms should continue to hold client money at all, Rules 2.5 and 5.1 (c) are being ‘tested’. Due to the cases cited above, qualified reports, the level of such balances on interventions etc., the consultation considers whether more ‘robust’ rules are needed. In particular, whether a specific time frame should/can be brought into the Rules to replace ‘promptly’ under Rule 2.5 and to determine how quickly thereafter Rule 5.1 (c) requirements should apply.

This will no doubt receive a mixed response, but it highlights the concern felt where firms are holding funds that really belong with someone else.

It is always important to highlight that if a firm continues to hold funds when it no longer has proper reason to do so (such as the matter being complete), it is likely the firm will ultimately also be in breach of Rule 3.3 – the provision of banking facilities.

Any firm that hasn’t taken this seriously until now will have to ‘up their game’. Reporting Accountants too will need to take this very seriously in their testing and reporting.

Like all compliance, clear policies and procedures are the key. These should cover time frames for closing files and repaying funds, training for staff on this and other Accounts Rules issues, setting expectations for staff, and then properly monitoring and policing non-moving client balances, recording evidence of actions taken. Prevention is always better than cure.

The SRA has itself been collecting data from firms recently regarding levels of balances with no movement for twelve months. The issue is not going away.

• Watch the 30 minute webinar on residual balances