23.2 Interest, Breaches and Corrections

Interest on client money — rule 7

Rule 7.1 — you account to clients or third parties for a fair sum of interest on any client money held by you on their behalf. Rule 7.2 — you may by a written agreement come to a different arrangement with the client or the third party for whom the money is held, but you must provide sufficient information to enable them to give informed consent.

The 2019 Rules deliberately dropped the old, highly prescriptive Solicitors' Accounts Rules 1998 interest machinery. There is no remaining de minimis table in the Rules themselves, and no official percentage. 'Fair' is a functioning-knowledge standard: what is reasonable in the circumstances, having regard to the sum held, the length of time it is held, the interest actually available on the account in which it sits, and what the client could reasonably have earned in an instant-access account of their own. A fair sum can be small on a three-day conveyancing deposit. It is unlikely to be nil on a six-month stakeholder deposit of several hundred thousand pounds, or on estate cash held through an IHT instalment period, unless a rule 7.2 agreement properly covers that outcome.

Informed consent under 7.2 is not a buried sentence in terms of business that says 'you will not receive interest'. The client or third party needs enough information to understand what they are giving up: that client money often sits in a pooled account, that the pooled rate may exceed what they would earn alone, that the firm may retain some or all of the bank interest, and what that means in money terms on the facts. A sophisticated developer can agree that interest on a particular retentions account will be dealt with in a stated way. A first-time buyer who is never told that a £400,000 balance will sit for four months without interest has not given informed consent.

Rule 2.4 still matters. If you and the personal representatives agree in writing that a large residue will sit on a designated notice account until house sale completes, the interest earned in that designated client account is typically client money and is credited to that estate. On a general (pooled) client account, the bank usually pays interest to the firm because the account is in the firm's name. That bank interest is then the authorised body's money. The firm must still account to each client for a fair sum, which is a business expense, not a gift the firm may simply keep because the bank statement names the firm.

Property and wills facts that should trigger a rule 7 analysis:

Accounting entries for interest

SQE1 wants the books, not an economics essay. Use the same two books as in section 23.1: client ledger (client column and business/office column) and cash book (client and business/office). The Rules' name is business account; SQE materials often still say office account.

Fair sum paid from the business account onto the client's ledger (the usual general-account pattern):

Worked figures: you decide that a fair sum on a delayed purchase deposit is £180. You move £180 of the firm's money into client account and credit the buyer.

The business column of the client ledger does not move. Interest allowed to the client is not a disbursement the client owes the firm. In the firm's own profit-and-loss records (not always drawn in SQE ledgers) the £180 is an interest-payable expense.

Interest received on a designated client deposit account belonging to an estate:

The bank credits £260 to that designated client account. That £260 is client money.

No business-cash entry. You have not used the firm's money.

Fair sum paid by business-account cheque straight to the client, without passing through client account: business cash is credited; the client ledger is not used for the payment itself. SQE more often tests the first pattern, because it changes what you hold for the client.

If you fail to account for a fair sum, that is a rule 7 breach. The correction is the same pair of entries as the first table, made as soon as the omission is discovered, for the fair sum that should have been credited. Do not 'net it off' against a later bill without a bill or written notification that actually deals with that sum under rule 4.3.

Exam traps on interest: treating bank interest on a pooled client account as automatically the client's money in full; treating it as automatically the firm's money with no 7.1 duty; using a 7.2 clause that the client never saw; holding leftover completion money in order to manufacture a larger interest figure.

Duty to correct breaches promptly — rule 6.1

Rule 6.1 is short and is tested constantly: you correct any breaches of these rules promptly upon discovery. Any money improperly withheld or withdrawn from a client account must be immediately paid into the account or replaced as appropriate.

Two time words do different jobs. Promptly is the general duty for every breach (wrong posting, missing a 2.3 banking, a 4.2 mixed-payment delay, a 7.1 interest omission). Immediately is the extra requirement where client money is missing from the client account: you restore it now, from the authorised body's money if necessary. Waiting for the next five-week reconciliation, for the COFA's Monday meeting, or for the client to notice, is not immediate replacement.

The SRA warning notice Money missing from client account reminds managers that client money is sacrosanct and that rule 1.2 joint-and-several responsibility is not delegated away to the COFA. The COFA must take all reasonable steps to ensure compliance and record failures, and must report material breaches to the SRA as soon as reasonably practicable, but the managers remain responsible.

Typical FLK2 breaches, with the correction and the books:

1. Client money paid into the business account by mistake. A trainee banks a £48,000 estate life-policy cheque to the business account. Discovery is the same afternoon. Immediate correction: move £48,000 from business to client, and credit the estate ledger.

If the trainee also posted the receipt to the business column of the ledger, reverse that business-column posting as part of the same correction. The client column should show a credit of £48,000; the business column should not show a £48,000 credit that pretends the money was the firm's.

2. Withdrawal that creates a shortage (rule 5.3). You pay £12,500 SDLT from client account on a purchase when that buyer's client-column credit is only £1,800. The ledger now shows a debit balance of £10,700. Other clients' credits are not available to hide it. Immediate replacement from the business account:

The debit balance is cleared. You then investigate why the SDLT was not funded: draw down more from the client, or treat the £10,700 as a business-funded disbursement that will appear on the business side of the ledger (see section 23.3). Replacement is not optional pending that investigation.

3. Costs taken before a bill (rule 4.3). A fee-earner transfers £3,000 from client to business 'on account of costs' with no bill and no other written notification. That £3,000 was improperly withdrawn. Immediate replacement: put £3,000 back to client account (business cash CR, client cash DR, client column CR). Then deliver a proper bill or written notification. Only after that may you transfer the specific sum identified, and only if that client's remaining credit covers it.

4. Mixed payment left unallocated (rule 4.2). A completion receipt of £215,000 includes £6,000 the seller has agreed will pay your costs once billed. Banking the whole sum to client account is acceptable. Leaving the £6,000 of anticipated costs sitting unidentified, or banking the whole sum to business account and leaving the client's £209,000 there, is a 4.2 problem. Allocate promptly: after the bill, transfer the billed costs under 4.3; the rest remains client money until paid out for the purpose of the sale or returned under 2.5.

5. Interest omitted (rule 7). Discovery six weeks later that a fair sum of £90 was never credited. Prompt correction is the interest pair in the first table above, for £90. Do not wait to 'set it against' a future invoice unless the client has a bill that actually deals with that figure.

6. Residual balance ignored (rules 2.5 and 5). A £120 leftover on a completed purchase is not a rounding error you may absorb into profit. Return it. If you cannot trace the client, the prescribed charity route (section 23.1) or an SRA authority application is the correction, not a transfer to the business account.

What prompt correction is not: altering historic cash-book dates so the breach never appears; netting one client's shortage against another client's credit; waiting because 'the reporting accountant comes in March'; or obtaining the client's retrospective blessing as a substitute for replacement. Client consent does not legalise a missing client-account balance.

Once the money is restored, deal with the professional-conduct overlay: honesty with the client if they have suffered loss (Code for Solicitors 7.11 / Code for Firms 3.5), notification inside the firm to the COFA, and — if the shortage was material or part of a pattern — the COFA's duty to report to the SRA. SQE1 will usually ask for the Accounts Rules step first: replace immediately, then report as required.

Keep the official Rules open while you revise. Rule 6.1 is one sentence. The exam reward is applying it to a property completion posting or an estate receipt, with the matching DR/CR, rather than reciting the word 'promptly' as a slogan.