Determining a trust position

March 1st, 2020
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From the inspections that the Legal Practitioners’ Fidelity Fund (LPFF) have conducted on the trust accounts of trust legal practices, the LPFF has noted that there is often a lack of clear understanding of trust deficits, and how to determine a trust deficit position. There are also trust legal practitioners who cannot distinguish between trust accounts in debit and trust deficits, and/or do not fully comprehend the impact of a trust creditor’s account that has a debit balance. This article seeks to unbundle trust positions, and in doing so, will also deal with the debit balances and their potential impact.

Needless to mention that both situations are unacceptable as can be seen from the following extracts:

  • Rule 54.14.8 of the final rules as per ss 95(1), 95(3) and 109(2) of the Legal Practice Act 28 of 2014 (the LPA) states: ‘A firm shall ensure that the total amount of money in its trust banking account, trust investment account and trust cash at any date shall not be less than the total amount of the credit balances of the trust creditors shown in its accounting records’.

This rule relates to the entire trust account of a trust legal practice, which trust account is made up of various trust creditors. To simplify this rule, it relates to all funds available in trust against the total owed to trust creditors by the trust legal practice. Funds available in trust are not limited to s 86(2) trust bank account, but also include cash on hand and money invested in terms of s 86(3) and s 86(4) of the LPA and interest thereon.

  • Rule 54.14.9 of the final rules as per ss 95(1), 95(3) and 109(2) of the LPA states: ‘A firm shall ensure that no account of any trust creditor is in debit’.

This rule relates to an individual trust creditor’s account, which account forms part of the entire trust account. This rule essentially refutes overdrawing on trust creditors’ accounts and it is meant to encourage taking of fees and making payments only from trust creditors’ accounts with available funds. Taking fees or making payments from a trust account with insufficient funds implies that another trust creditor’s funds have been used to service the obligations of another trust creditor.

We now look at the requirements in respect of keeping of trust accounting records for a trust legal practice. Section 87(1) of the LPA requires a trust legal practice to keep proper accounting records containing particulars and information in respect of –

‘(a) money received and paid on its own account;

(b) any money received, held or paid on account of any person;

(c) money invested in a trust account or other interest-bearing account referred to in section 86; and

(d) any interest on money so invested, which is paid over or credited to it.’

This article does not seek to deal with all accounting records that a trust legal practice is expected to keep but will deal with those that mainly impact on the determination of a trust deficit position, and those related to such records. We now turn to explaining pertinent trust accounting records that a trust legal practice is expected to keep.

  • Trust cashbook

A trust cashbook can be explained as a ledger that records movements in the entire trust account of a trust legal practice on a day to day basis. The salient features of a trust cashbook are –

– the period covered by the cashbook, for example, trust cashbook for the period 1 January 2020 – 31 January 2020;

– the opening balance at the beginning of the month covered by the cashbook, for example, balance brought forward – R 23 879,67;

– the transactions taking place during the month, receipts and payments as they occur; and

– the balance at the end of the month.

  • Bank reconciliation statements

These statements are used to compare the trust cashbook to the trust banking account. Ideally, these two should always reflect the same transactions and balances, but there are instances when they do not, and reconciling items, therefore, need to be determined. This can happen when there are transactions recorded in the one and not on the other: For example, cash received at the trust legal practice’s premises may be recorded in the trust cashbook, but not yet deposited in the trust banking account, leading to a difference between the two records by that outstanding amount.

Another example is when a trust legal practice writes out a cheque to pay a trust creditor or make a payment on behalf of the trust creditor, but the cheque may not yet be presented at the bank. The issued cheque will be recorded in the cashbook on the date of issuance, while the trust banking account does not have a record of the cheque until such time that the cheque is presented to and cleared by the bank; and the validity of the cheque spans over a number of months.

These outstanding amounts then become reconciling items, until they are cleared, which then brings the cashbook and trust banking account to reflect the same balances.

  • Trust creditors listing

The trust creditors listing is clearly explained in the following extracted rules, and forms part of the accounting records to be maintained for the same period as other accounting records that they relate to.

– Rule 54.15.1 states: ‘Every firm shall extract monthly, and in a clearly legible manner, a list showing all persons on whose account money is held or has been received and the amount of all such moneys standing to the credit of each such person, who shall be identified therein by name, and shall total such list and compare the said total with the total of the balance standing to the credit of the firm’s trust banking account, trust investment account and amounts held by it as trust cash, in the estates of deceased persons and other trust assets in order to ensure compliance with the accounting rules’.

– Rule 54.15.2 states: ‘The balance listed in respect of each such account shall also be noted in some permanent, prominent and clear manner in the ledger account from which the balance was extracted’.

The ledger accounts from which the balances listed in the trust creditors listings are extracted are the individual trust accounts referred to for determination of the debit balances.

Determination of a trust surplus or deficit position

A trust surplus or deficit position is determined by taking the trust creditors listing totalled balance from the cashbook balance at a specific date, for example, at month end. If the difference between the two records reflects that the cashbook balance is more than the trust creditors balance, it is a surplus trust position. However, if the difference reflects a trust creditors listing balance that exceeds the cashbook balance, it is a deficit trust position. What the latter position effectively suggests is that if the trust legal practice were to be called on to repay all its trust creditors it would be unable to do so as there would be insufficient funds to repay all trust creditors.

Besides a clear misappropriation of trust funds, there are other ways in which a trust position can be concealed or incorrectly determined, and trust legal practitioners are hereby cautioned. Below are a few scenarios, however, the list is not exhaustive.

  • A trust account with a trust debit balance

Trust legal practitioners must not ignore the details in the accounting records as balances alone can easily conceal the underlying information and, therefore, mislead the trust legal practitioner. Consider the following scenario:

The trust account of XYZ Attorneys reflects three trust creditors as follows:

Trust creditors listing Trust Creditor Balance
Say (Pty) Limited R 386 435,21
Write CC R 27 321,43
Same Same (R 24 654)
Total (R 24 654)

The trust cashbook on the other hand also reflects a balance of R 389 102,64 since all the transactions that took place will reflect in the cashbook, including the payment in respect of client Same Same, which payment could have been from any of the other two trust creditors since this client clearly had no available funds.

This scenario can easily mislead a trust legal practitioner into thinking that everything is fine when just taking the balances as they will cancel out to a nil balance. However, upon scrutiny of the underlying records it becomes clear that someone else’s funds were used to service someone else’s obligations, suggesting that in fact the trust creditors listing balance is R 413 756,64 as opposed to the R 389 102,64 reflected. This is so because if the trust legal practice were to be required to repay its trust creditors, there are two trust creditors that essentially would have to be repaid: Say (Pty) Limited and Write CC and the totalled amount owed to the two trust creditors is R 413 756,64, while funds available amount to R 389 102,64, suggesting a trust deficit of R 24 654. This is an example of a concealed trust deficit.

  • Accounting records not updated

A trust surplus or deficit position can be portrayed incorrectly due to lack of updating of one or more of the trust accounting records.

– For example, a trust cashbook may not be updated with a payment made against a trust creditor’s account, while the trust creditor’s ledger and trust creditors listing are both updated with the amount. This will incorrectly suggest a surplus position in the trust account, when in fact there is none. Here is an illustration:

Trust creditors listing Trust Creditor Balance
Say (Pty) Limited R 361 781,21
Write CC R 27 321,43
Total R 389 102,64

However, the cashbook may not have recorded the R 24 654 payment that happened during the month and continue to reflect a balance of R 413 756,64. This error results in the trust position suggesting a trust surplus position, whereas there is no surplus. A trust surplus is when the available trust funds exceed the trust creditors’ balance, suggesting that there is an amount available to transfer to business.

– A trust deficit can also result from lack of updating the trust creditor ledger and thus an incorrect trust creditors listing, while the cashbooks have recorded all transactions that took place. Below on the illustration:

Trust creditors listing Trust Creditor Balance
Say (Pty) Limited R 386 435,21
Write CC R 27 321,43
Total R 413 756,64

In the meantime, the cashbook may reflect a balance of R 389 102,64 having taken into account a payment of R 24 654 from Say (Pty) Limited account. At face value, there is a trust deficit position because the trust creditors listing balance exceeds the trust funds available, meanwhile the trust creditor’s ledger and trust creditors listing are not reduced by the amount paid.

Conclusion

In conclusion, trust legal practitioners, should ensure that the updating and/review of trust accounting records is holistic to avoid concealment and/or errors reflecting on their books resulting in unwanted consequences. When trust deficit positions and trust accounts in debit, and even incorrectly determined trust surplus positions, are discovered by inspectors and/or auditors, these lead to non-compliance and qualified reports respectively issued. These in turn have a negative impact on the profile of the trust legal practice. Trust legal practitioners linked to trust legal practices with such reports are denied issuance of Fidelity Fund Certificates by the Legal Practice Council and would most likely also not qualify for letters of good standing, thus limiting their economic activities.

The LPFF is alive to the reality that not all trust legal practices write up and balance their books and appoint experts in the field to perform this function on their behalf. The LPFF urges trust legal practitioners at such trust legal practices to take interest in the trust accounting records prepared by their appointed experts, as they ultimately take full responsibility for what is presented in the trust accounting records of their trust legal practices.

As the saying goes: ‘If you think education is expensive, try ignorance’. Do not be ignorant and pay attention to all details.

Simthandile Kholelwa Myemane BCom Dip Advanced Business Management (UJ) Cert Forensic and Investigative Auditing (Unisa) Certified Control Self Assessor (Institute of Internal Auditors) Cert in Management and Investigation of Cyber and Electronic Crimes Cert in Fraud Risk Management Cert in Law for Commercial Forensic Practitioners Cert in Investigation of Financial Crimes Cert in Investigation and Detection of Money Laundering (UP) Certificate in Economic Crime Schemes (Enterprises University of Pretoria) is the Practitioner Support Manager at the Legal Practitioners’ Fidelity Fund in Centurion.

This article was first published in De Rebus in 2020 (March) DR 10.

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