Karen Edwards, Head of Professional Development at The ILFM
By Karen Edwards, Head of Professional Development at Legal Futures Associate The ILFM
Residual client account balances present a significant compliance challenge for law firms. These sums, often overlooked in daily operations, carry substantial regulatory implications under the Solicitors Regulation Authority (SRA) framework.
This article explores the current SRA rules and guidance, as well as practical approaches for efficiently and proactively managing these balances.
The recent SRA consultation on how client money is handled may, of course, have an impact on this area in the future, but for now we await the results of that consultation.
Understanding Residual Balances
A residual balance is any amount remaining in a client account after the completion of a matter, and which a firm is unable to return to the client or third party legally entitled to it. These balances arise from a range of reasons including, but not limited to, uncashed client refund cheques, balances acquired following an acquisition, clients changing contact details without a firm knowing, and refunds or payments received by a firm after the conclusion of a matter.
Current SRA Rules and Guidelines
The SRA Accounts Rules and published guidance define the regulatory framework for handling residual balances. The current guidance stipulates:
- De Minimis Threshold: Balances below £500 may be paid to charity without the SRA’s approval, if certain requirements are met.
- Documented Attempts: Firms must demonstrate reasonable efforts to locate and return funds to the rightful owner, including multiple contact attempts through different communication channels, taking into account the age and amount of the balance, whether firms have up-to-date contact details, and the costs associated with tracing.
- Record-Keeping: A central register of all residual balances must be maintained, detailing the owner, amount, name of the recipient charity, date of payment and steps taken to return funds as well as records of all receipts from the charity and confirmation of any indemnity provided.
- SRA Authorisation: For balances exceeding £500, firms must apply for SRA authorisation before paying the balance to charity, providing information such as the amount being held (included accrued interest), the age of the balance, attempts made to contact the rightful owner (the SRA will require you to provide evidence of the steps already taken to trace the rightful owner), and the likelihood of success of tracing.
- Out-of-pocket expenses – firms are not permitted to deduct from any balance under £500, any costs incurred in attempting to trace or communicate with the rightful owner. The SRA can take into account any reasonable out-of-pocket expenses when granting authoring for balances over £500.
Practical Approaches for Compliance
It is good practice to have prevention strategies in place, as they significantly reduce the administrative burden, compliance risks, and potential reputational damage associated with breaching these rules.
The ILFM recommends timely completion of file closure processes to ensure that client ledgers are reviewed upon completion of the work, and any residual balances are therefore investigated as part of that process.
Regular matter balance reviews is another control mechanism that could be put in place. Many practice management systems will now provide matter balance and exception reports to identify amounts held on each client ledger that have not moved for a certain period, with an obligation to review and take appropriate action on any balances no longer required.
It may also be helpful to explain to clients at the outset what your firm’s processes are. Wherever possible, the client’s own bank account details should be obtained at the outset of the matter so that any balances can be repaid directly to that account. This will avoid the problem of repaying balances by way of cheque where there is a possibility that those cheques may not be presented. It is widely recommended now to avoid sending cheques altogether for this reason. Firms may also wish to communicate to clients in writing how any remaining balances will be handled, if clients or third parties cannot be traced after the closure of a matter. However, you must always bear in mind such arrangements, the obligation to treat clients fairly.
Policies and Procedures
Even with the best prevention measures, residual balances will inevitably occur. Having clear policies and processes in place to detail your firm’s procedures for the prevention and management of residual balances is key to ensure consistency and control. This also provides a clear audit trail should questions arise during SRA inspections, for example, or from your reporting accountant when it comes to preparing the accountant’s report.
As a matter of good practice, the Law Society recommends reviewing outstanding client balances at least every 6 months. Some firms will review them more frequently, for example, every quarter.
Comprehensive documentation records must be maintained throughout and kept for a minimum of six years. All communication and tracing attempts should be meticulously recorded, including copies of correspondence, delivery receipts and attendance notes.
These policies and procedures, along with regular training, will clarify the firm’s expectations for the management of residual balances and will make sure that those expectations are met.
Best Practice Implementation
The following best practices bridge the gap between theory and practical application, ensuring that good residual balance management becomes embedded in the firm’s day-to-day practices, rather than as an afterthought, or tick-box compliance exercise.
Firms could consider several additional practices to enhance their approach. Assigning a specific employee (or team where resources allow) to oversee residual balance management will help to ensure consistent application of policies across the firm.
Conducting an annual review of all residual balance procedures, enables firms to identify process improvements and ensure regulatory compliance on a consistent basis. This should be underpinned by the development of clear written policies for handling residual balances that align with SRA requirements as well as tailored to the size, structure and nature of each firm. Through these measures, firms can establish a robust framework that effectively manages residual balances as part of standard operational procedures, rather than as exceptional events.
Residual balances are an inevitable aspect of client money management and, while they may seem minor compared to more complex accounting tasks, they should not be overlooked or addressed as an afterthought. The way these balances are managed reflects the firm’s overall commitment to compliance and protecting client money, which, though sometimes perceived as burdensome, remains a priority. If these rules are breached and continue to be breached, it can attract a significant fine, cause reputational damage to the firm and any individuals involved, and a potential referral to the Solicitors Disciplinary Tribunal (SDT).
