Residual balances – what COFAs need to know

The holding of residual balances has been a longstanding issue for the Solicitors Regulation Authority, with various warning notices having been issued. Despite this, there continues to be a large number of qualified reports due to breaches in this area.

From our experience, although some have firmed up their processes in this area following guidance from the SRA and other advice, we continue to see a significant number of breaches in respect of residual balances.

Therefore, it is essential that firms review their systems and procedures to ensure that they are as robust as possible, given the potential implications of qualified reports, which can include reputational risk, business disruption, and PII premium increases. This is especially important given the SRA’s recent consultation paper considering a possible mandatory cut off date for dealing with residual balances.

Definition

Holding balances after the completion of a matter, or once there is no longer an ongoing underlying legal service, leads to breaches of the SRA Accounts Rules.

According to rule 2.5 of the 2019 SRA Accounts Rules, firms must ‘ensure that client money is returned promptly to the client, or the third party for whom the money is held, as soon as there is no longer any proper reason to hold those funds’.

There can be complications where clients are unresponsive and firms do not have the necessary details to return balances to clients. This creates additional administrative burden for firms, as they are still required to comply with the rules, and the SRA expects firms to take ‘reasonable steps’ to return the money. What is meant by ‘reasonable steps’ varies in accordance with the age and size of the balance, whether the firm has current client contact details, and the costs associated with tracking down the client.

Payments to charity

Firms are required to document all efforts to locate clients and return balances. However, if the balance still cannot be returned after taking proportionate reasonable steps, the balance can be donated to a charity of the firms choice, provided it is under £500 and sufficient records are kept.

For balances over £500, firms need to seek SRA approval to pay off to charity. Here the SRA will want to see the attempts made to return balances before they approve the charity donation. If the SRA give approval, they will require the funds to be donated to a charity that guarantees repayment, should the client get back in contact and the funds then need to be returned to the client.

Banking facilities

Firms are also at risk of breaching rule 3.3 here, which states that firms ‘must 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… of regulated services’.

Firms need to be especially cautious and aware of this rule, particularly where clients ask law firms to hold onto balances after the end of a matter, or requests to pay balances to third parties, as the provision of banking facilities is strictly prohibited and is a current hot topic for the SRA.

SRA consultation

In November 2024, the SRA released a consultation paper, which outlined a possible mandated timeframe of 12 weeks after the conclusion of a legal matter for firms to return excess funds, with a possible extension of a further 12 weeks in specific, difficult cases.

Even if these mandatory timeframes are not enacted, this gives good indication of what the SRA anticipate to be reasonable for dealing with all residual balances in complying with rule 2.5.

Recommendations

It is important to remember that all firms are different, in terms of size, clients, areas of practice, and software, to name a few. However, in order to ensure compliance with rules 2.5 and 3.3 in respect of residual balances, we would recommend looking at the following key areas. This list is by no means exhaustive but a useful starting point for strengthening compliance.

• COFAs should ensure they keep abreast of the latest guidance issued by the SRA on residual balances, and the banking facilities case studies.

• Ensure reports (e.g. matter balance listings) in three-way reconciliations show the ‘last movement date’ for COFAs to consider when reviewing and approving the reconciliations. Balances which appear slow moving, or those indicating residual balances should be followed up with fee earners promptly.

• Reminders for fee earners regarding both rules 2.5 and 3.3, regarding communication with clients on the prompt returning of balances directly to clients and the risks of banking facilities.

• Reminders sent to clients at least annually of balances held, detailing the ongoing legal matter.

• Implementation and regular review of file closure procedures, updating as appropriate.

• Regular review of procedures for charity donations. We would recommend firms document their written policies, considering their standard procedures for balances at different bands, for example, under £500 and the steps that the firm expects fee earners to take at each level.

Implementing the above processes can help reduce pressure on restricted resources such as staff time on the administrative burdens in relation small residual balances, as well as preventing firms from breaching the rules.

Should you have any questions, or if you would like any help in drafting your firm’s systems and procedures and specific written policies, please do not hesitate to contact us.