Law schools are failing miserably to teach up and coming lawyers the most fundamental aspects of the business of law. The absence of such training is particularly troublesome in today’s legal climate, where new law school grads far out number available entry level jobs. This economic reality can drive many newly-minted Esquires to make some very difficult life decisions, including opening up a small or solo practice.
But opening a law practice is as much about business as it is about law. It does not matter how much you know about torts and contracts if you do not know the basic ethical requirements of, for example, record-keeping, trust accounts, and the proper handling of third-party funds. A recent article published by Bloomberg entitled, Lawyers Don’t Know Enough About Business. Law Schools Are Trying To Fix That, acknowledges this problem and notes that some schools are beginning to address it by offering law students to take business courses.
Still, there are hundreds of thousands of lawyers, new and old, who do not have the slightest clue about the detailed regulations for handling client and third party money.
One “business of law” issue that creates ethics problems is the improper handling of client and third-party money. Indeed, both the USPTO and State Bars frequently discipline attorneys whose practices fail to comport with the very detailed ethics rules, codified in ABA Model Rule 1.15, governing safekeeping other people’s property.
And this is not just my opinion; when I polled the ethics experts at the Association of Professional Responsibility Lawyers (APRL) about the most common issues they see in representing new or less experienced attorneys in bar disciplinary proceedings, mishandling law firm money was number one on the list.
In recognition of “Self-Improvement Month” and with the goal of self-improvement for lawyers, here are answers to some of the most basic questions that lawyers have regarding proper and ethical handling of money. This is a must read not only for young lawyers but any seasoned veteran who is responsible for handling client money.
What are the lawyer’s ethical obligations regarding client funds?
A lawyer in possession of client funds and property is a fiduciary. As such, the lawyer is obligated to safeguard and segregate those assets from the lawyer’s personal, business or other assets.
Simply put, pursuant to ABA Model Rule 1.15(a) and USPTO Rule 37 C.F.R. § 11.115(a), the lawyer is obligated to:
Notify the client or third-party when client or third-party funds are received by the lawyer in connection with the practice of law.
Provide timely and complete accountings to the client or third-party.
Disburse promptly all funds and property to which the client or third-party is entitled.
What is a lawyer trust account?
A trust account is simply a form of a bank account established by a lawyer or law firm specifically for holding a client’s money. The trust account is for holding other people’s money, so it is imperative that the lawyer maintain trust account funds separate and apart from the lawyer’s personal funds and operating business accounts. For example, legal fees that are paid in advanced but not yet earned by the lawyer must be maintained in the trust account. It is only until after the lawyer earns the fee or incurs client expenses that the lawyer may withdraw the earned-portion of the fees and expenses from the client trust account. Often the money is transferred into a law firm’s operating account. As a rule of thumb, whether it is labeled as a retainer, advanced fee, or security deposit, any funds that the lawyer has received on behalf of a client and which have not been earned by the lawyer must be deposited in the lawyer trust account first.
Why does the lawyer need a trust account?
It is a major ethical “no no” for a lawyer to commingle (or mix together in one account) unearned client funds with earned client funds or other accounts. The trust account protects the lawyer from accidentally commingling funds that do not belong to the lawyer—such as the advanced payment or payments received but which must be paid to a third-party such as a medical provider who is owed funds from the client. The trust account also provides an important “paper trail” documenting the flow of client money and maintaining a record of all payments made from the client’s funds in trust—including dates of payment, amounts of payment, and the name of a payee. It is important to identify a specific payee for the receipt of funds from a trust account; checks drawn on a trust account should never be made out to “Cash” since it is then impossible to tell whether the payment was proper or in accordance with the lawyer’s ethical duties.
Should trust accounts be interest-bearing?
Yes. All client or third-party funds held in trust by the lawyer must be maintained in an interest-bearing, federally insured depository. If the client or third-party funds are substantial or are expected to be held for a long period of time, then the trust funds should be maintained in a separate trust account in the client’s name, with the client earning the interest on such funds.
If the lawyer receives only a nominal amount of funds, or the funds are expected to be held only for a short period of time, the lawyer can deposit the funds in a pool account which are made available for withdrawal upon demand, subject to any notice requirements imposed by the financial institution holding the money. Any interest earned in such pooled accounts is paid into the Interest on Trust Account (IOLTA) program set up by each state.
May the lawyer ever retain interest on a client account?
No. Any interest either goes to the client or goes to the IOLTA program administrator in accordance with each state bar’s individual rules.
What about non-trust accounts? What is required?
A business or operating account is needed for every law firm or law practice into which is deposited earned fees, advanced expenses, and from which is withdrawn things such as overhead payment, employee salaries, and other operating expenses.
In addition, if the lawyer is serving as a conservator or guardian, or is representing a trust or an estate, then money received in that role must be deposited into a separate account specifically designated for such matters.
Where are fees deposited?
This depends on whether the fees have been earned yet at the time of receipt. If the fees (or a portion of them) have already been earned by the lawyer at the time of receipt, then the fee (or earned portion of the fee) must be deposited in the operating account. To the extent all or a portion of a fee has not been earned at the time of receipt, then it should be deposited in the firm’s trust account.
What if there is a dispute about distribution of money held by the lawyer?
If the client or a third-party disputes the disposition of funds held by the lawyer, then the lawyer must hold onto the funds until the dispute is resolved. Once resolved the lawyer must provide a full accounting of the distribution of proceeds.
If there is an undisputed portion of the funds held by the lawyer, then the lawyer must promptly pay to the client and/or third party the undisputed portion.
Required recordkeeping – what do you need to do?
At a high level, the lawyer must document, on a client-by-client basis, all money that the lawyer receives and all money that the lawyer disburses. A basic trust account system should include:
A trust receipt journal.
A trust disbursement journal.
A trust ledger book.
The trust ledger book should contain individual client-by-client account information for recording each financial transaction affecting each client. Most client ledger books include: (1) the date; (2) the source; (3) description of each item deposited; (4) payee; and (5) the purpose of each withdrawal.
There are many off-the-shelf computer programs designed to facilitate law firm bookkeeping.
How long should records be maintained?
Each jurisdiction has its own record-keeping requirements, although many fall within the range of 5-7 years after the termination of the matter that caused the records to be generated in the first instance.
What happens if I bounce a trust account check?
Bad things happen. The financial institution is required to report any bounced trust account checks to the Bar. The Bar, in turn, is supposed to conduct an investigation. A bounced trust account check is a huge red flag that could evidence anything from outright fraud to simple negligence.
Failing to maintain a proper accounting of a lawyer’s trust account will open up an investigation into the lawyer’s trust accounting practices to ensure that they are in compliance with the requirements of the state bar in which the funds are maintained. Deviations from the standard of care can result in substantial discipline, especially if the lawyer’s motives or intent establishes evidence of theft.
Holding money in trust is a non-delegable, personal fiduciary responsibility of the lawyer as long as that money remains in the lawyer’s possession. For these reasons, lawyers who have no experience in operating a law firm should carefully study the rules governing safekeeping of property in the jurisdiction where the trust account is to be maintained. They should also strongly consider taking some continuing legal education on client trust accounting and record-keeping requirements specific to the state in which the client funds are to be held.
Consider also studying on-line resources available in most jurisdictions. One of my favorites is the Handbook on Client Trust Accounting for California Lawyers, which is published by the State Bar of California and provides a very thorough and comprehensive discussion of the issues, complete with sample forms.
Moreover, the “ostrich defense,” also known as sticking one’e head in the sand, will not be effective in avoiding the call of disciplinary counsel. Cases of third-party theft from client trust accounts have resulted in disciplinary action against the responsible attorney for failure to supervise even where the lawyer was not complicit and had no actual knowledge of the wrongdoing. Lawyers have a duty to know. Lack of knowledge is not a defense to the underlying ethics charge, although it may be a consideration in terms of the disciplinary sanction.
The “trusted accountant” who steals from the firm trust account funds, for example, may land in prison, which is little solace for the lawyer responsible for supervising the “trusted accountant.” The ethical “buck” stops at the lawyer. Consequently, supervising lawyers in internal theft or embezzlement cases have been known to receive suspensions or even disbarments based on a third-party’s theft from the firm’s trust account based on a breach of the duty to supervise.
The takeaway is that blind trust that someone else will do the lawyer’s job for them is a fool’s game–and a high risk one at that. In the words of Ronald Reagan, “Trust but verify.” That must be the mantra of every attorney who is responsible for handling, or supervising others who handle, client or third party funds.