Requirement to pay interest on client money

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Swift & Ross LLP recently concluded a settlement on behalf of their client, Patricia, who was awarded a substantial sum after a protracted legal dispute. They held her funds in a general client account for 45 days before disbursing them. Upon disbursement, Patricia noticed that the firm did not pay her any interest. She enquired whether she was entitled to a fair sum of interest on the funds. The firm’s written policy stated that any interest below £30 would not be paid, as they consider it insignificant.


Which of the following statements best reflects the correct approach under the SRA Accounts Rules regarding interest on client money?

Introduction

The Solicitors Regulation Authority (SRA) Accounts Rules set out the obligations for solicitors handling client money, particularly the requirement to pay interest on those funds. Rule 7 stipulates that firms must ensure clients receive a fair sum of interest on any money held on their behalf, unless the amount is insignificant. Client money involves funds received for unpaid professional disbursements, anticipated disbursements not yet incurred, and settlements or compensation received for clients. Following these rules is essential for maintaining professional integrity and compliance—an area of great importance in the SQE1 FLK2 exam.

Understanding Client Money

Definition of Client Money

Client money is any money held or received by a firm on behalf of a client. This includes:

  1. Funds for unpaid professional disbursements: Such as fees for barristers or experts.
  2. Money received for anticipated disbursements: Like upcoming land registry fees or court fees not yet incurred.
  3. Settlement funds or compensation: Received on behalf of a client from third parties.

Conversely, funds meant to cover expenses already incurred by the firm—like courier charges or search fees paid on credit—are considered office money.

The Fiduciary Duty

Solicitors owe a fiduciary duty to their clients, requiring them to act in the clients' best interests when handling their funds. This duty supports the requirement to pay interest on client money, ensuring clients are not disadvantaged by the firm holding their funds.

Regulatory Framework

SRA Accounts Rules

The SRA Accounts Rules provide the framework for managing client money, with Rule 7 specifically addressing the payment of interest. Firms must:

  • Pay a fair sum of interest to clients when holding money on their behalf.
  • Have a written policy on the payment of interest, which should be made available to clients upon request.
  • Account to clients promptly for interest, unless an alternative arrangement has been agreed in writing.

Exceptions and Agreements

In certain circumstances, firms and clients may agree that interest will not be paid or will be paid at a different rate. Such agreements must be fair and reasonable, fully explained to the client, and documented.

Methods of Accounting for Interest

Solicitors have two primary methods for handling interest on client funds:

General Client Bank Account

Most firms use a general client account, where all client funds are pooled. Interest is calculated and paid to clients from the firm's own funds, treating the interest paid as a business expense. The firm must calculate a fair sum of interest for each client, considering:

  • Amount of money held: Larger sums may accrue significant interest, necessitating precise calculation.
  • Duration: The length of time the money is held affects the total interest owed.
  • Prevailing interest rates: Using rates that reflect what the client could have obtained elsewhere.
  • De minimis amounts: Thresholds below which interest is not paid, as specified in the firm's policy.

Separate Designated Client Account

Alternatively, a firm may use a separate designated client account for individual clients. This approach involves opening a separate interest-bearing account for a client's funds, and all interest earned belongs to that client. While this method offers transparency, it can be administratively demanding, especially for smaller amounts or shorter durations.

Calculating a Fair Sum of Interest

Factors to Consider

When calculating interest, firms should take into account:

  • Principal amount: The sum of money held on behalf of the client.
  • Duration: The period for which the funds are held.
  • Interest rates: Reflecting competitive market rates available to clients.
  • Type of account: Whether it is an instant access or term deposit account.
  • Administrative costs: While not deducted from the interest payable, firms consider practicality in paying interest on minimal amounts.

Example Calculation

Suppose a firm holds £150,000 for a client over 60 days, and decides to pay interest at an annual rate of 1.2%. The interest calculation would be:

Interest = (Principal × Rate × Time) / 365

Interest = (£150,000 × 1.2% × 60) / 365

Interest = (£150,000 × 0.012 × 60) / 365

Interest = (£1,800 × 60) / 365

Interest = £108,000 / 365

Interest ≈ £295.89

This amount represents the interest the firm should pay to the client for that period.

De Minimis Thresholds

Firms often set a minimum threshold below which interest is not paid—the de minimis amount. For example, if the calculated interest is less than £20, the firm might deem it negligible. The threshold must be reasonable and align with current interest rates.

Compliance and Best Practices

Written Interest Policy

A firm must have a clear written policy on how it deals with interest on client money. This policy should:

  • Explain how interest is calculated.
  • State any thresholds or de minimis amounts.
  • Outline circumstances where interest may not be paid.
  • Be communicated to clients, preferably at the start of the engagement.

Prompt Payment

Interest owed to clients should be paid promptly. The SRA expects firms to account to clients for interest as soon as practicable after it becomes due, ensuring clients are not unfairly disadvantaged.

Record Keeping

Firms must maintain accurate records of:

  • Amounts held for each client.
  • Duration of funds held.
  • Interest calculations and rates applied.
  • Agreements with clients regarding interest.
  • Payments made to clients, including dates and amounts.

Handling Complex Scenarios

Mixed Funds

When a firm receives a payment that includes both client money and office money—such as a single cheque covering unpaid disbursements and the firm's fees—the funds must be handled appropriately:

  • Before invoicing, the entire amount is considered client money and must be kept in the client account.
  • After invoicing, the firm can transfer the fee portion to the office account.

Residual Balances

Occasionally, small amounts may remain in the client account after a matter concludes. Firms must:

  • Make reasonable efforts to return residual balances to clients.
  • Document attempts to contact clients.
  • Follow SRA guidelines for unclaimed balances, which may include donating to charity if certain conditions are met.

Negative Interest Rates

In scenarios where banks impose negative interest rates on deposits, firms need to address the implications for client money:

  • The firm's interest policy should specify whether clients will bear the cost of negative interest.
  • Transparency is essential—clients must be informed of any charges that may affect their funds.

Ethical Considerations

Transparency with Clients

Open communication with clients about the handling of their money fosters trust. Firms should:

  • Explain how interest is calculated and any applicable thresholds.
  • Provide the interest policy upon request or at the outset.
  • Inform clients of any factors that may affect the interest payable.

Avoiding Conflicts of Interest

Firms must not use client money for their own benefit. Retaining interest owed to clients would breach their fiduciary duty and could lead to:

  • Regulatory action by the SRA.
  • Disciplinary proceedings affecting the firm's ability to practice.

Compliance with Regulations

Following the SRA Accounts Rules upholds legal obligations and the profession's reputation. Non-compliance can result in:

  • Financial penalties.
  • Suspension or revocation of practicing certificates.
  • Damage to professional reputation.

Application for the SQE1 FLK2 Exam

Understanding the requirement to pay interest on client money is important for the SQE1 FLK2 exam. Candidates should be able to:

  • Identify client money and distinguish it from office money.
  • Explain obligations under the SRA Accounts Rules, particularly Rule 7.
  • Perform interest calculations accurately in various scenarios.
  • Apply rules to complex situations like mixed funds and residual balances.
  • Recognize ethical implications in handling client funds.

Conclusion

Calculating and paying interest on client money involves a detailed interplay of regulatory compliance, mathematical precision, and ethical responsibility. The complexity of the SRA Accounts Rules mandates a thorough understanding of:

  1. Precise definitions of client money versus office money, ensuring correct handling of funds.
  2. Accounting methods for interest, whether through a general client account or separate designated accounts.
  3. Principles of interest calculation, factoring in amounts, durations, and appropriate interest rates.
  4. Compliance requirements, including maintaining a written interest policy, prompt payment, and diligent record-keeping.
  5. Managing complex scenarios, such as dealing with mixed funds, residual balances, and the impact of negative interest rates.

Understanding these concepts is essential for demonstrating competency in the SQE1 FLK2 exam and for upholding the standards expected of the legal profession. Competence in these requirements ensures that solicitors act in their clients' best interests, maintain trust, and follow the ethical and regulatory frameworks that govern their practice.

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Pleased to share that I have successfully passed the SQE1 exam on 1st attempt. With SQE2 exempted, I’m now one step closer to getting enrolled as a Solicitor of England and Wales! Would like to thank my seniors, colleagues, mentors and friends for all the support during this grueling journey. This is one of the most difficult bar exams in the world to undertake, especially alongside a full time job! So happy to help out any aspirant who may be reading this message! I had prepared from the University of Law SQE Manuals and the AI powered MCQ bank from PastPaperHero.

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Senior Associate at Trilegal