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Technical updates - Published 21st December 2015

Dealing With Residual Balances: What Do You Need To Know?

Advising the legal sector in the present climate of change and challenges is a mixture of compliance (assisting the COFA) and practice management. Both areas are covered in this update but first a word of warning. We have been informed by a number of firms around the country that many £100,000s have been stolen from clients’ accounts via the so-called “Friday afternoon scam”. Please make sure all your cashier teams are extremely vigilant as solicitor firms are being targeted by this and other scams, including cyber attacks.

Residual Client Balances

For many firms resolving residual client balances can be a time consuming and expensive burden on both the administration department and fee earners. These balances are often historical, arising as a result of poor systems in place, balances acquired through mergers with other firms and even pre computerisation. Although the residual balances rules were effective in 2008, we believe many firms have not dedicated sufficient resource to resolving this issue.

In addition, the SRA are, during visits, looking at systems in place to deal with residual balances and requiring firms to take greater action. One firm was fined £20,000 and given three months to address their residual balances. Not a position any firm or COFA wants to find themselves in!

However there is good news as there have been changes in the rules that may assist firms to improve matters and the underlying issue.

New rules on residual balances – limit increased from £50 to £500

With effect from 31 October 2014 the limit for donating residual balances to charity without first obtaining permission from the SRA has increased from £50 to £500. This rule will apply retrospectively, i.e. to old and new balances. Any balances above this amount will still need to be approved by the SRA.

This substantial increase to £500 is likely to reduce the occasions where you have to apply to the SRA, a process itself that was often time consuming.

Can I just pay over all balances under £500 to charity?

Whilst the amount triggering the need for an application to the SRA has increased to £500 under Rule 20.2, you must still carry out the following before making a payment:

  • Establish the identity of the owner of the money
  • Make adequate attempts to ascertain the proper destination of the money and return it to the rightful owner, unless the reasonable costs of doing so are likely to be excessive in relation to the money held
  • Pay the funds to a charity
  • Record the steps taken above and retain these records.
  • Ensure the payment to the charity is recorded in the central client cashbook

 

Returning money promptly

Going forward it is obviously most efficient to simply ensure the balances are not unnecessarily retained and it is necessary to make adequate attempts to return the money to its rightful owner. This should be done promptly, so when considering timescales it may be useful to consider individual client transactions in line with the Rule 14 guidance notes (vi) to return client funds at the substantial conclusion of the matter.

Responsibility and systems for residual balances

Whilst the finance team may take a role in returning client money, the firm’s compliance does not lie with them or the COFA alone. Everyone in the firm has an obligation to ensure regulatory compliance appropriate to their role.

The firm should have a system in place to manage residual client balances. For a smaller practice this may involve a partner reviewing the client listing on a monthly basis. For a larger firm with sophisticated practice management systems, reports can be run where there has been no movement for a set period or any time records within the previous 30 days.

Fee earners will play a key role as they are more aware of their clients and can advise the finance team when cases are concluded.

At Menzies, our legal team has provided assistance, and an external discipline to make this process and system more expeditious.

Untraceable clients

Where clients are untraceable, before paying monies over to a charity there are a number of procedures a firm should follow. Even when firms are using the new rules for amounts below £500, we would recommend that a checklist is completed documenting the work carried out attempting to return the money. Firms need to consider the commercial cost, giving consideration to “reasonable costs” of attempting to return funds in relation to the amount held. The SRA on their website provide useful guidance for firms to record what work has been done, including the amounts held, the age of the balance, available client details and work done to return the money. For your convenience, the link is http://www.sra.org.uk/guidance-sar/

Central records of donations to charity

After exhausting all attempts to return residual balances and then donating the money to a charity under Rule 20.2, the firm should keep a central record of the donations made including:

  • The name of the client
  • Amounts donated
  • Charity donated to and date of donation

 

We would recommend that the firm obtain a receipt and indemnity from the charity.

Annual confirmation of balances held to clients

Under Rule 14.4 firms are required to write periodically and not less than annually, to every client where funds are retained on client account. Our experience is that for many firms this is an area that could be improved on and would recommend that the firm and its COFA ensure procedures are in place to confirm balances held to clients.

Further information

For further information on any of the issues raised here, please email Peter Noyce at pnoyce@menzies.co.uk

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Peter Noyce - FCA

Partner

Peter Noyce is a Menzies Partner in the Woking office specialising in legal firms, corporate tax advisory services and financial solutions.