IOLTAs and Client Trust Accounts

Among the myriad subjects that lawyers launching solo practices must master are the intricacies of handling client trust accounts. Once you have landed the client and received an advance fee for your future services, typical ethics rules require you to maintain those funds in a client trust account (CTA). Lawyers who chose law school to avoid accounting may cringe at the thought of client trust accounting manuals, but the requirements for client trust accounting are not difficult to master.

This article discusses some of the basic requirements for handling client funds, including the use of CTAs (including the interest on lawyers trust account, or IOLTA) and walks you through the basics of establishing and operating a CTA, as well as some general best practices and some tips for avoiding common pitfalls. Because specific procedures vary from state to state, this article provides an overview. Practitioners should be sure to review individual state procedures.

Three Common Scenarios

As a general rule, client trust accounts hold client funds or property. Whenever a lawyer holds client funds, the lawyer is acting as a fiduciary with regard to those funds. The first common scenario involving CTAs occurs at the start of the representation. Standard rules and common practice dictate that lawyers use a CTA to hold funds paid by the client up front as an advance on fees and expenses before the work is done and prior to the client’s approval of billing. Once the lawyer earns the fees and bills the client, and upon the client’s approval of the lawyer’s billing, the funds are no longer property of the client and should be removed from the lawyer’s CTA.

Another common example of a lawyer holding client funds occurs in connection with payment of a settlement. Often the settlement check is payable jointly to the lawyer and client and is intended to cover a payment to the lawyer for fees and expenses, with the balance payable to the client. Payments to third parties from the settlement proceeds may also be contemplated. Because such funds are the property of the client, the check should be deposited to the CTA. The lawyer then can present an accounting and proposed disposition of the funds to the client, spelling out the amounts of funds payable to the client, the amounts payable for fees and expenses, and any amounts payable to third parties. While the client is reviewing the lawyer’s accounting, the lawyer must wait for the settlement check to clear so that the funds are available. CTA funds cannot be advanced to a client while the settlement check clears. Once the check clears and funds are available in the CTA, and following the client’s approval of the proposed disposition of the funds, the lawyer should promptly transfer the funds out of the CTA.

A third scenario involves lawyers holding client funds as fiduciaries for their clients. One example would be a lawyer who serves as administrator of the client’s estate, holding funds for distribution to the client or other third parties. Another scenario would be a lawyer holding funds in escrow pending completion of a business or real estate transaction. Even though such roles may not include the lawyer’s representation of the client, such funds must also be held in a CTA pending distribution to the client and third parties. Typical ethics rules require the establishment of a separate CTA for such purposes.

Is an IOLTA Appropriate?

Whenever a lawyer receives client funds or funds belonging to third parties, there are several choices regarding the type of CTA that is appropriate, depending on the amount of the client funds to be held, how long the lawyer anticipates holding those funds, whether the funds relate to legal services, and perhaps to some independent fiduciary obligation of the lawyer. If the funds are significant in amount, the lawyer should open a CTA that earns interest for the client, especially if the funds will be held for a significant period of time. Conversely, when the client funds are relatively small in amount or will not be held for a time period long enough to earn interest, an IOLTA account is appropriate.

All states have IOLTA programs. IOLTA accounts are mandatory in some states and voluntary in others. Whether mandatory or voluntary, the IOLTA mechanism pools funds that could not otherwise earn interest for individual clients, and the interest on the pooled funds is payable to a state-sponsored IOLTA program. IOLTA programs in turn use the funds to finance charitable and educational endeavors, improvements to the administration of justice, and to provide indigent and low-income persons with legal services.

IOLTA programs have survived constitutional challenges asserting that requiring payment of IOLTA interest to IOLTA programs constitutes a “taking” of property in violation of the Fifth Amendment. Although conceptually there is a taking of client property, no payment of just compensation is required because the client in fact suffers no loss of funds; owing to the amount of funds and expenses associated with interest-earning deposits, the client funds deposited into IOLTA accounts could not otherwise earn interest. Brown v. Legal Found. of Washington 538, U.S. 216 (2003).

Generally, it is permissible to hold funds from multiple clients in a single IOLTA client trust account, subject to certain record-keeping requirements described below. In scenarios where a lawyer is acting in a fiduciary capacity holding escrow funds or administering an estate, a separate CTA may be warranted.

Establishing an IOLTA

Although lawyers should review individual state procedures for establishing CTAs, there are several important and typical practical considerations. First, many state rules require that you establish the IOLTA account with a financial institution designated from a list of participating institutions. Typically, the account must be established in the state in which the lawyer practices, unless the client designates otherwise. Upon opening an IOLTA account, the state bar typically requires submission of an application form from the lawyer within a specified time period following the opening of the account. The proper notification forms are available from the financial institution or the state bar where the account is established. In this era of widespread financial institution failures, lawyers should pay particular heed to whether the Federal Deposit Insurance Corporation covers the financial institution selected.

Expenses associated with an IOLTA cannot be paid from client funds. Thus service charges associated with the account and other charges, such as the cost of printing checks, cannot be paid from client funds. Some financial institutions will waive these charges. Alternatively, some IOLTA programs will cover these expenses. Otherwise, the lawyer must pay separately from the lawyer’s operating account for expenses such as checks and should make periodic deposits to the IOLTA to cover the costs of monthly service fees.

Selecting the signatories for the account is another important consideration. State guidance dictates whether non-lawyers are permissible signatories on CTAs. This practice is permitted in some states. If it is permitted, lawyers should bear in mind that they are fiduciaries in handling client funds when selecting signatories and other personnel to handle client funds. Under the ethics rules of most states, lawyers are obligated to adequately train and supervise subordinate employees. Ideally, the CTA should have only one signatory: the lawyer. For other personnel involved with client trust accounting, criminal background checks are advisable. Fidelity bonds are appropriate to protect against losses.

A cautionary note regarding the acceptance of advance fees and expenses by credit card is in order. Most states permit lawyers to accept credit card payments for earned fees and expenses. Payment via credit card for advance fees and expenses is problematic where such funds must be deposited to CTAs because credit card companies typically place such funds into merchant accounts that are subject to charge backs (the imposition of debits) in the event the credit card holder disputes the charges. In such a situation, the attorney cannot fulfill the fiduciary duty to protect the client funds.

Should a CTA have overdraft protection? Conceptually, assuming that the CTA is properly managed, a lawyer will have no need for overdraft protection because there will never be insufficient funds in the CTA. In reality, rules regarding overdraft protection vary by state. For example, California permits overdraft protection that compensates precisely for a non-sufficient funds (NSF) check and related bank charges associated with the NSF check. However, overdraft protection that deposits an amount in excess of the NSF check and related expenses is impermissible. You should consult your state’s guidance on this issue.

Most client trust accounting losses involve non-lawyer malfeasance. State bar disciplinary authorities hold lawyers accountable for mismanagement of CTAs and expect lawyers to adequately train and supervise subordinate personnel involved in handling client funds. State bar disciplinary authorities sanction lawyers in situations where lawyers delegate management of the CTA to someone else who mishandles client funds. Lawyers must implement procedures to monitor the work of all personnel involved in handling client funds, including the periodic review of bank statements.

Prohibition Against Commingling

One of the most important principles in client trust accounting is the prohibition against commingling the lawyer’s own funds with the client’s funds. This means that the lawyer’s personal and business funds must be kept separate and apart from the funds of clients or third parties. Lawyers may not deposit any of their own funds into the CTA, except to pay bank service charges. For example, a lawyer cannot use a CTA as a repository for payroll funds or funds saved for taxes. Nor can the funds in a CTA be used to pay a lawyer’s personal expenses. At the same time, lawyers may not borrow client funds from the CTA.

The rule against commingling also requires that timely disbursements are made from the lawyer’s CTA. A lawyer should withdraw fees earned by the lawyer from the CTA at the earliest reasonable time once the fees become fixed, so that none of the funds the lawyer is entitled to are kept in the CTA. Also, the lawyer should promptly pay to the client any settlement proceeds that the client is entitled to receive. Finally, funds associated with costs and expenses paid for the client’s benefit should be withdrawn from the CTA in a timely manner.

Record Keeping

Record-keeping requirements for IOLTA accounts vary by state. The objective of such requirements is to be sure that accurate information is maintained for the benefit of the client and others, including third parties and the state bar. At a general level, record keeping for an IOLTA account should track all deposits and disbursements through the account, and each such transaction should be associated with a particular client. Typically, the lawyer should keep a written ledger detailing every monetary transaction for each particular client. In addition, the lawyer should maintain an account journal for each account, tracking each transaction through the account. The lawyer should perform a monthly reconciliation for the IOLTA account.

Lawyers should also keep copies of all deposit slips, bank statements, checkbook stubs, cancelled checks, and client checks to create an audit trail relating to all transactions. The lawyer should not draw checks on the account that are payable to “cash.” Checks drawn on a CTA should be payable to clients or their creditors. State bars may require that the lawyer retain such records for a specified period of time, for example, five years or longer in the event of an investigation by the state bar that involves the lawyer’s trust account.

If such record-keeping procedures are followed properly, there should not be any NSF checks. However, in reality, there are a large number of NSF checks on CTAs annually. State bar guidance for handling NSF checks may vary, but typically, a lawyer should deposit funds into the CTA to clear the NSF check and investigate to determine what occurred. The situation may also warrant an explanation to the client. The lawyer should also take steps to prevent the recurrence of NSF checks.

Misuse of Client Trust Account

Several common misuses of CTA funds are referenced above. For example, a lawyer cannot use the CTA funds to pay the lawyer’s own personal or business expenses of any nature, including taxes and payroll. Instead, funds such as earned fees should be paid from the CTA to the lawyer, and a separate account should be used to pay the lawyer’s personal or business operating expenses.

In addition, a lawyer should not advance funds to a client in connection with the payment for a settlement before the settlement check clears. Any such advance could only be paid with funds from another client that might happen to be in the CTA. Such payment would constitute a breach of the lawyer’s fiduciary duty to maintain funds of the other client on deposit in the CTA.

Funds deposited into a lawyer’s CTA may be legally protected against levies by a client’s creditors. However, the deposit of either the client’s funds or the lawyer’s funds into a CTA in order to defraud third parties by barring access to those funds constitutes a misuse of a CTA and a violation of the law governing fraudulent transfers. Thus, a lawyer should not use a CTA to bar access to funds by a client’s creditors, including business creditors of the client, the Internal Revenue Service, or the client’s spouse.

Fee Disputes

Should a dispute over fees arise, it is important that the lawyer handle the funds in the CTA properly. First, any undisputed portion of the funds payable to the client should be disbursed from the CTA. Next, any undisputed portion of fees and expenses payable to a lawyer and third parties should be paid out of the CTA. If a third party’s entitlement to funds is impacted by the dispute, the lawyer should notify the third party of the dispute. Where the dispute cannot be resolved in a timely manner, state law may permit the lawyer to interplead the funds.

Conclusion

I will close with a cautionary tale of a lawyer who hired an employee with a past criminal record to run her office and provided this office manager with a rubber stamp to sign checks. The lawyer’s inattentiveness to her CTA resulted in losses estimated at $1.7 million—the exact amount could not be proven as her office manager told her the bank statements were “stolen.”

Prudent attention to client trust accounting established as a standard operating procedure, combined with constant monitoring to assess compliance, can both avoid risk of harm to clients and protect you and your practice.