Maintaining Trust: Rules, Snares, and Worries in Trust Account Management

Every lawyer-client relationship begins (or should begin) with an engagement agreement that sets forth how and when the lawyer will be paid. This agreement will normally control the financial relationship between client and lawyer, and almost anything (except unconscionable or unreasonable fees) can be negotiated between the parties. As a general rule, however, the client's payment for work that has been performed is to be deposited into a lawyer's general account and payment for work that will be performed is to be deposited into a client's trust account. The engagement agreement should set forth in detail the circumstances under which funds may or must be transferred from the client's trust account to the lawyer's general account. When the lawyer is entitled to make the transfer, the lawyer must make the transfer or be guilty of commingling personal and client funds, which is prohibited by the rules of professional conduct.

Ethical Snares

It all seems straightforward and clear. Yet, lawyers constantly face ethical snares on the use of and accounting for client trust accounts. These often begin with a fundamental question for the lawyer: When you first receive funds, which account should they be placed into, the trust account or the general account? In most instances, this is the rule of thumb to follow:

• If the funds are provided on retainer, then they are for a task that is not completed, and the hours are not yet earned. That means the money goes into the client trust account.
• If the funds have been earned when you receive them, then they should go into the general account.

The American Bar Association's Model Code of Professional Responsibility, Rule 1.15, specifically addresses the impermissibility of commingling the lawyer's own funds with client funds, except when necessary to pay bank service charges on the trust account. In short, money earned by a lawyer for provision of services belongs to the lawyer and must be removed from the client's trust account when earned. This must be done immediately (unless jurisdictional rules state otherwise), with the earned money being placed in the lawyer's general account.

Some jurisdictions place additional requirements on the withdrawal of funds from a trust account. In Wisconsin, as one example, the requirement is that before any funds can be withdrawn from the client trust account, the client must be given five days notice. This is the case even when the funds are earned, and even if the engagement agreement provides for immediate withdrawal. In Connecticut, a trust account is the only place where lawyers and law firms may deposit a client's or third person's funds that are less than $10,000 in amount or are expected to be held for a period of not more than 60 business days. It is thus important to verify the rules in your jurisdiction before making an immediate withdrawal of earned funds.

Account Access

Lawyers should provide in their engagement letters that the client authorizes the lawyer to debit trust account funds after a reasonable time from the date of billing ' for example, 15, 30 or 45 days, whichever is most reasonable under the circumstances. This provides a date certain for payment to the lawyer. The client, in most jurisdictions, will retain the right to dispute the charges, though clients are unlikely to do so if they understand that, by agreement, they need to be timely with any objections. The real issue, however, is that when the fee is earned, it must be withdrawn from the client's trust account to avoid commingling.

It is important to put a “protest process” into the engagement agreement. Provide that if there is no complaint or dispute in writing from the client within the number of days set forth in the engagement agreement from the date of the invoice or statement, the client will be deemed to have approved the billing. If the client protests later, you will have a prima facie reason for the transfer and the money will be in your pocket (not the trust account).

No check should be drawn from the clients' trust account until after the draft or check is honored and the deposit is confirmed to be valid. Until then, payment to one client of money in accord with a settlement that is either dishonored or rejected, despite delivery of a check or draft, is actually payment (borrowing) from the funds of another client without the second client's consent. This violates the rules of professional conduct of every state. And it does not matter that the money is repaid, even if quickly ' a technical violation is still a violation nevertheless.

Accounting Concerns

The lawyer is a fiduciary who must keep accurate accounting records of such transfers under every state's rules of professional conduct. This can give rise to ethical issues in very active personal injury or debt collection law practices, family law practices, and in large-firm real estate practices, among others. Often, the trust accounts become so large that the lawyer's record keeping becomes flawed and errors result. These may be understandable human errors, but the net result is that the funds' record keeping is not clear and accurate. This happens in many ways: Lien holders fail to cash checks written against the account; funds subject to a lawyer-client dispute remain long after the controversy is forgotten; funds are held back for a triggering event that never takes place; a departed staff member has made an incomplete or erroneous record of trust monies that the lawyer can no longer decipher.

Contingencies such as these serve as no excuse. There is an axiom in law that says, “Ignorance of the law is no excuse.” And when dealing with fiduciary matters, every state imposes a fiduciary duty to properly account for clients' funds to prevent misappropriation or negligence. Failure to provide accurate accounting records on a state bar inquiry means very bad news for the lawyer. If an accounting issue does arise, one expensive resolution is to hire an outside accountant to go through every document, check, and ledger to reconcile the account. Another suggestion is to open and operate through a new account with scrupulously “clean” records, while allowing depletion of the old account until only the few questionable items remain, with the hope and prayer that no one makes inquiry in the future.

Such alternatives miss the point. To do less than use an effective software accounting program or an outside accountant to reconcile trust and bank account records each month is to invite error, inquiry, and trouble. The stakes are high, indeed. Error is no excuse and one's professional license is at stake.

Banking Safety

Recent challenges to the country's banking system raise the specter of bank failures, with implications for the safety of trust accounts. The problem arises when any single account, in one person's name, exceeds the Federal Deposit Insurance Corporation guaranteed limit. In an active family law, real estate, personal injury, or debt collection practice, it's conceivable to grow beyond this cap.

The good news is that this possibility is less likely, now that Congress (as part of its financial system rescue tactics) has raised the FDIC limit for the first time in 28 years, to $250,000 rather than $100,000. Even more significantly, the FDIC itself has issued a ruling that all amounts in a client's trust account are protected, regardless of the amount. The account must be identified as a trust account and lawyers must maintain their clients' trust accounts in accordance with generally accepted accounting principles and the trust rules of the jurisdiction for such accounts, including identification of the amounts held for each client.

This deals with an eventuality that some commentators raised by holding that a lawyer would be exposed to personal liability if the bank with trust accounts failed. The argument went like this. The lawyer selects the bank for deposit of funds, which could come from advanced fee payments, settlement amounts, or trial victories. If the amounts for the benefit of a client exceeded the FDIC insurance limit, then the lawyer was allowing those excess funds to be at risk. If not protected and lost because the bank fails, the lawyer as the principal in selecting the bank ' according to this school of thought ' would be strictly and personally liable to the client for the loss in view of the ethical responsibility to keep trust funds safe.

This viewpoint would have required lawyers to inspect the financial solvency of their banks and vouch for their stability. The FDIC's blanket protection on all client trust funds obviously provides some breathing room with regard to such a dilemma. However, given that many once-unthinkable financial events have happened, lawyers may want to further ensure that each client's trust funds are safe. Identify the name of the client in bank records and the amount of dollars held for that client, in effect creating sub-accounts. Another, more direct approach is to maintain a separate trust account for each client whose funds are likely to be held for an extended period of time. The interest earned on such separate accounts will belong to the client.

Because this increases trust fund accounting expenses, one might consider providing in the engagement agreement for an administrative charge to cover the cost of trust account administration. The extra peace of mind that it provides for client and lawyer could be well worth it.

Edward Poll, a member of this newsletter's Board of Editors, helps attorneys and law firms increase profitability by consulting on issues of internal operations, business development, and financial matters. He has 25 years' experience as a practicing attorney and has served as CEO and COO for several manufacturing businesses. He founded LawBiz' Management Company and is now focused on coaching and training law firms. His newest book is Law Firm Fees & Compensation: Value & Growth Dynamics (LawBiz'Management, Co., 2008). He is also a columnist for the Association of Legal Administrators and contributes the 'LawBiz' Coach's Corner' to Lawyers Weekly.

Every lawyer-client relationship begins (or should begin) with an engagement agreement that sets forth how and when the lawyer will be paid. This agreement will normally control the financial relationship between client and lawyer, and almost anything (except unconscionable or unreasonable fees) can be negotiated between the parties. As a general rule, however, the client's payment for work that has been performed is to be deposited into a lawyer's general account and payment for work that will be performed is to be deposited into a client's trust account. The engagement agreement should set forth in detail the circumstances under which funds may or must be transferred from the client's trust account to the lawyer's general account. When the lawyer is entitled to make the transfer, the lawyer must make the transfer or be guilty of commingling personal and client funds, which is prohibited by the rules of professional conduct.

Ethical Snares

It all seems straightforward and clear. Yet, lawyers constantly face ethical snares on the use of and accounting for client trust accounts. These often begin with a fundamental question for the lawyer: When you first receive funds, which account should they be placed into, the trust account or the general account? In most instances, this is the rule of thumb to follow:

• If the funds are provided on retainer, then they are for a task that is not completed, and the hours are not yet earned. That means the money goes into the client trust account.
• If the funds have been earned when you receive them, then they should go into the general account.

The American Bar Association's Model Code of Professional Responsibility, Rule 1.15, specifically addresses the impermissibility of commingling the lawyer's own funds with client funds, except when necessary to pay bank service charges on the trust account. In short, money earned by a lawyer for provision of services belongs to the lawyer and must be removed from the client's trust account when earned. This must be done immediately (unless jurisdictional rules state otherwise), with the earned money being placed in the lawyer's general account.

Some jurisdictions place additional requirements on the withdrawal of funds from a trust account. In Wisconsin, as one example, the requirement is that before any funds can be withdrawn from the client trust account, the client must be given five days notice. This is the case even when the funds are earned, and even if the engagement agreement provides for immediate withdrawal. In Connecticut, a trust account is the only place where lawyers and law firms may deposit a client's or third person's funds that are less than $10,000 in amount or are expected to be held for a period of not more than 60 business days. It is thus important to verify the rules in your jurisdiction before making an immediate withdrawal of earned funds.

Account Access

Lawyers should provide in their engagement letters that the client authorizes the lawyer to debit trust account funds after a reasonable time from the date of billing ' for example, 15, 30 or 45 days, whichever is most reasonable under the circumstances. This provides a date certain for payment to the lawyer. The client, in most jurisdictions, will retain the right to dispute the charges, though clients are unlikely to do so if they understand that, by agreement, they need to be timely with any objections. The real issue, however, is that when the fee is earned, it must be withdrawn from the client's trust account to avoid commingling.

It is important to put a “protest process” into the engagement agreement. Provide that if there is no complaint or dispute in writing from the client within the number of days set forth in the engagement agreement from the date of the invoice or statement, the client will be deemed to have approved the billing. If the client protests later, you will have a prima facie reason for the transfer and the money will be in your pocket (not the trust account).

No check should be drawn from the clients' trust account until after the draft or check is honored and the deposit is confirmed to be valid. Until then, payment to one client of money in accord with a settlement that is either dishonored or rejected, despite delivery of a check or draft, is actually payment (borrowing) from the funds of another client without the second client's consent. This violates the rules of professional conduct of every state. And it does not matter that the money is repaid, even if quickly ' a technical violation is still a violation nevertheless.

Accounting Concerns

The lawyer is a fiduciary who must keep accurate accounting records of such transfers under every state's rules of professional conduct. This can give rise to ethical issues in very active personal injury or debt collection law practices, family law practices, and in large-firm real estate practices, among others. Often, the trust accounts become so large that the lawyer's record keeping becomes flawed and errors result. These may be understandable human errors, but the net result is that the funds' record keeping is not clear and accurate. This happens in many ways: Lien holders fail to cash checks written against the account; funds subject to a lawyer-client dispute remain long after the controversy is forgotten; funds are held back for a triggering event that never takes place; a departed staff member has made an incomplete or erroneous record of trust monies that the lawyer can no longer decipher.

Contingencies such as these serve as no excuse. There is an axiom in law that says, “Ignorance of the law is no excuse.” And when dealing with fiduciary matters, every state imposes a fiduciary duty to properly account for clients' funds to prevent misappropriation or negligence. Failure to provide accurate accounting records on a state bar inquiry means very bad news for the lawyer. If an accounting issue does arise, one expensive resolution is to hire an outside accountant to go through every document, check, and ledger to reconcile the account. Another suggestion is to open and operate through a new account with scrupulously “clean” records, while allowing depletion of the old account until only the few questionable items remain, with the hope and prayer that no one makes inquiry in the future.

Such alternatives miss the point. To do less than use an effective software accounting program or an outside accountant to reconcile trust and bank account records each month is to invite error, inquiry, and trouble. The stakes are high, indeed. Error is no excuse and one's professional license is at stake.

Banking Safety

Recent challenges to the country's banking system raise the specter of bank failures, with implications for the safety of trust accounts. The problem arises when any single account, in one person's name, exceeds the Federal Deposit Insurance Corporation guaranteed limit. In an active family law, real estate, personal injury, or debt collection practice, it's conceivable to grow beyond this cap.

The good news is that this possibility is less likely, now that Congress (as part of its financial system rescue tactics) has raised the FDIC limit for the first time in 28 years, to $250,000 rather than $100,000. Even more significantly, the FDIC itself has issued a ruling that all amounts in a client's trust account are protected, regardless of the amount. The account must be identified as a trust account and lawyers must maintain their clients' trust accounts in accordance with generally accepted accounting principles and the trust rules of the jurisdiction for such accounts, including identification of the amounts held for each client.

This deals with an eventuality that some commentators raised by holding that a lawyer would be exposed to personal liability if the bank with trust accounts failed. The argument went like this. The lawyer selects the bank for deposit of funds, which could come from advanced fee payments, settlement amounts, or trial victories. If the amounts for the benefit of a client exceeded the FDIC insurance limit, then the lawyer was allowing those excess funds to be at risk. If not protected and lost because the bank fails, the lawyer as the principal in selecting the bank ' according to this school of thought ' would be strictly and personally liable to the client for the loss in view of the ethical responsibility to keep trust funds safe.

This viewpoint would have required lawyers to inspect the financial solvency of their banks and vouch for their stability. The FDIC's blanket protection on all client trust funds obviously provides some breathing room with regard to such a dilemma. However, given that many once-unthinkable financial events have happened, lawyers may want to further ensure that each client's trust funds are safe. Identify the name of the client in bank records and the amount of dollars held for that client, in effect creating sub-accounts. Another, more direct approach is to maintain a separate trust account for each client whose funds are likely to be held for an extended period of time. The interest earned on such separate accounts will belong to the client.

Because this increases trust fund accounting expenses, one might consider providing in the engagement agreement for an administrative charge to cover the cost of trust account administration. The extra peace of mind that it provides for client and lawyer could be well worth it.

Edward Poll, a member of this newsletter's Board of Editors, helps attorneys and law firms increase profitability by consulting on issues of internal operations, business development, and financial matters. He has 25 years' experience as a practicing attorney and has served as CEO and COO for several manufacturing businesses. He founded LawBiz' Management Company and is now focused on coaching and training law firms. His newest book is Law Firm Fees & Compensation: Value & Growth Dynamics (LawBiz'Management, Co., 2008). He is also a columnist for the Association of Legal Administrators and contributes the 'LawBiz' Coach's Corner' to Lawyers Weekly.