Separation of Funds and Interest
Picture a firm's bank statement with two columns living side by side: one pound note that belongs to the practice for the light bill and photocopier lease, and another that belongs entirely to a client whose house sale completes tomorrow. The moment those two pounds are allowed to mix in a single account, the client's money stops being safely identifiable — and if the firm fails, an insolvency practitioner cannot tell which pound was ever theirs to distribute to creditors. That single physical fact, more than any regulatory instinct for tidiness, is the entire reason the separation of client money exists as a rule rather than a suggestion.
The definition is deliberately wide, because the risk it guards against — money entrusted to a solicitor being lost, misapplied, or swallowed into a firm's insolvency — arises whenever a firm holds funds it does not itself own. Client money is money held or received by an authorised body for or on behalf of a client in connection with the delivery of regulated services. But the definition does not stop at money held for the named client. It extends to money held or received for a third party in connection with regulated services — the clearest examples being agents' fees or disbursements a firm is fronting on someone else's behalf. It extends further still to money held in a fiduciary or quasi-fiduciary capacity that has nothing to do with a conveyancing or litigation retainer: money held as a trustee, or as the holder of a specified office or appointment such as an attorney under a power of attorney or a Court of Protection deputy. And critically for exam purposes, it captures money that has not yet been "earned" by the firm at all — an advance payment for costs, or money for unpaid disbursements, received before a bill or other written notification of costs has been given to the client. Until that notification exists, the money is still the client's, not the firm's, however confident the firm is that it will bill for the work.
Definition to memorise: Client money = money held or received for or on behalf of a client (or a relevant third party) in connection with regulated services — including trust and appointment money, and including advance payments before a bill is rendered.
The SRA Accounts Rules require an authorised body to keep client money separate from money belonging to the authorised body itself. This is not merely good bookkeeping practice; it is the mechanism that protects clients if the firm becomes insolvent. Money sitting in a genuine client account does not form part of the firm's assets available to its creditors — a statutory trust arises over it. Mix the funds, and that protective wall dissolves: a liquidator may struggle to disentangle whose money is whose, and clients queue alongside ordinary creditors for what is left.
Three operational rules flow directly from this principle, and each is exam-testable in isolation:
- Promptness. A firm must ensure client money is paid promptly into a client account. Delay in banking client funds recreates exactly the mixing risk the rule exists to prevent.
- Availability on demand. Client money must be available on demand, unless an alternative arrangement has been agreed in writing with the client or third party for whom it is held. A firm cannot tie up client funds in a way that frustrates the client's ability to call for them, absent express written agreement.
- Naming and location. The name of a client account must include the name of the authorised body and the word "client", so that the account is unmistakably distinguished from the firm's own business account — both to the bank and to any outside observer such as an SRA inspector. The account itself must be maintained at a branch, or the head office, of a bank or building society in England and Wales, tying the protection to a regulatory regime the SRA can actually reach.
Real transactions are rarely clean. A single cheque or transfer often bundles client money with money that belongs to the firm — for instance, a completion payment that includes both the purchase price (client money) and the firm's own fee (firm money) in one lump sum. Where a firm receives such a mixed payment, it must allocate the funds promptly to the correct account: the client portion into the client account, the firm's portion into the business account. Sitting on an unallocated mixed receipt recreates the very blending problem separation is designed to prevent.
A related but distinct constraint stops firms turning the client account into something it was never meant to be: a firm must not use a client account to provide banking facilities to clients or third parties. Payments into, and withdrawals from, a client account must be in respect of the delivery of regulated services — not made simply because an underlying retainer with the client happens to exist. A solicitor is not a bank, and the client account cannot become a parking place for a client's general funds that have no connection to live legal work. This is one of the SRA's most frequently cited concerns in practice, because it is where firms drift into acting as an unauthorised deposit-taker.
Client money can only be withdrawn from a client account in accordance with the purpose for which it is held, or in the specific circumstances the SRA Accounts Rules set out. This closes off the obvious temptation to treat a healthy client account balance as a source of working capital.
The most heavily tested withdrawal scenario is the residual balance — money left over on a client matter after the matter has otherwise concluded, where the rightful owner cannot readily be identified or traced. The rules strike a proportionate balance between administrative reality and the duty to protect the client's money:
A firm may withdraw a residual client account balance without prior SRA authorisation only if the balance is £500 or less on any one client matter and it is paid to a charity of the firm's choice.
For a residual balance exceeding £500 on any one client matter, the firm must obtain the SRA's prior written authorisation before withdrawing the money.
Three safeguards attach to the charity route, and each closes a loophole a firm might otherwise be tempted to exploit:
- Proportionate tracing effort first. Before paying a residual balance to charity, the firm must make efforts proportionate to the size of the balance to trace and repay the rightful owner. A £50 balance does not demand the same investigative effort as a £480 balance.
- No deduction of tracing costs. A firm must not deduct the costs it incurred tracing the rightful owner from the balance itself before paying it to charity — the client (or their estate, or the untraceable third party) is not made to fund the firm's own compliance effort.
- A central register. A firm paying a residual balance to charity must keep a central register recording the rightful owner's name, the amount, the recipient charity's name and number, and the date of payment — creating an auditable trail the SRA (or a later claimant) can interrogate.
Underpinning all of this is a broader records obligation: accounting records relating to client money, including records of residual balance payments, must generally be retained for at least six years. This gives a former client — or their personal representatives — a realistic window to come forward and claim money that was paid away to charity in good faith.
The second limb of this topic shifts from safekeeping the principal to sharing the benefit the principal generates while it sits in the bank. A firm must account to clients or third parties for a fair sum of interest on any client money held on their behalf. The word "fair" is doing careful work here: this is not a "hand over every penny the bank actually paid" rule. The SRA deliberately built in flexibility, because tracking and allocating exact interest earned on every individual client ledger, across pooled client accounts with fluctuating balances, would be administratively punishing and would not meaningfully improve client protection.
Fairness is assessed functionally, by reference to two variables:
- the amount of client money held, and
- the period for which it was held.
A firm can therefore adopt a written interest policy — a standing, firm-wide formula (often referencing a benchmark rate, with a de minimis threshold below which no interest is paid because the administrative cost of calculating and paying it would exceed the sum itself) — rather than calculating bespoke interest for every matter. Tellingly, the SRA Accounts Rules do not prescribe a fixed interest rate or formula; each firm must set and apply its own fair interest policy, and — this is the point examiners like to test — that policy should be applied consistently across clients rather than negotiated on an ad hoc, case-by-case basis. Treating one client more generously than another with an economically identical balance and holding period would undermine the very idea of a fair sum.
A firm remains free to depart from its standard fair-sum obligation, but only through a written agreement with the client or third party, and that agreement is only valid if the firm has given the client sufficient information to give informed consent. A client can waive their right to interest — but only through this kind of informed, written agreement, never through silence or default inaction. A client who simply says nothing has not waived anything; the burden sits with the firm to secure a positive, informed opt-out if it wants one.
| Interest scenario | Governing rule |
|---|---|
| Standard case, no special agreement | Firm must pay a fair sum, judged by amount held and period held |
| Firm wants to depart from the fair-sum default | Requires a written agreement, backed by sufficient information for informed consent |
| Client wants to waive interest entirely | Only valid via informed, written agreement — never by inaction |
| Setting the actual rate/formula | Left to the firm's own written, consistently-applied policy — the SRA prescribes no fixed rate |
Two situations illustrate that the client-account requirement, though strict, is not absolute — it targets discretionary handling of client funds, not every instance where a firm touches money on a client's behalf.
- Trustee money in genuine conflict with other duties. Money held under a trustee appointment may be exempt from the requirement to be paid into a client account if paying it in would conflict with the firm's other legal or regulatory duties as trustee — for example, where trust law or a trust instrument itself dictates a different, equally protective home for the funds.
- Legal Aid Agency payments. Money received from the Legal Aid Agency for payment of costs is a standing example of money that need not be paid into a client account, reflecting the fact that such payments already flow through a separately regulated public funding mechanism.
These are narrow carve-outs, not a general licence — the default remains that client money goes into a client account, and an exception must be independently justified.
The rules in this topic are not administrative housekeeping; they are backed by the SRA's full disciplinary toolkit. A breach of the requirement to keep client money separate, or to account properly for interest, can result in SRA disciplinary action against the firm or the individual responsible. Where the SRA identifies that client money has been misused or improperly withheld from a client account, it has the power to intervene in the firm's practice — one of the most severe regulatory tools available, effectively taking control of the firm's practice and client files to protect the public. Serious or repeated breaches can be referred onward to the Solicitors Disciplinary Tribunal, which can impose sanctions up to and including striking a solicitor off the roll.
This regulatory architecture — the SRA Accounts Rules 2019, which came into force on 25 November 2019 — replaced a far longer and more prescriptive predecessor regime with a shorter, principles-based set of rules. That history matters for understanding the exam's emphasis: the current rules trust firms to build compliant systems (a written interest policy, prompt banking procedures, a residual-balance register) rather than dictating every mechanical step, which is precisely why questions in this area so often turn on judgment calls — is this sum fair?, was this tracing effort proportionate? — rather than on rote arithmetic.
Every rule in this topic traces back to one protective idea: client money is not the firm's money, even temporarily, and the rules exist to make that separation real, verifiable, and resilient to the firm's own insolvency or misconduct. Separation into a properly named client account, promptness in banking, a ban on treating the account as a bank, tightly controlled withdrawal routes (with the £500 residual-balance threshold as the bright-line exception to SRA pre-authorisation), and a fair — not maximal — approach to interest together form a coherent system. When you see an SQE1 scenario question on this topic, the fastest way in is to ask: whose money is this, has it been kept separate, and if not, which specific rule has been broken?