October 25, 2017

Client Protection Funds

Lawyers Put Their Money Where Their Mouths Are

Professionalism is one of the major themes being emphasized by ABA President Jerome J. Shestack. The protection of client interests is at the heart of professionalism and programs created for the direct protection of clients comprise one of professionalism's major components. Every member of the ABA can boast to their clients and the public that they belong to the organization most responsible for encouraging the establishment, maintenance and improvement of client protection programs. In fact, lawyers belong to the only profession that has established mechanisms to reimburse clients who have suffered financial losses due to the misconduct of its members. Every jurisdiction in the United States and Canada, except Colorado, has a lawyers' fund for client protection, (or as it is sometimes called, a client security fund) and Colorado is currently taking steps that hopefully will lead to the re-establishment of its fund.

What is a client protection fund? It is a pool of money funded and maintained by a bar association or lawyer regulatory agency, the purpose of which is to reimburse clients who have suffered financial loss due to the dishonest acts of lawyers. These funds exist because, despite the best efforts of the legal profession to establish and maintain high standards of ethics, there are, predictably, a few dishonest lawyers and they usually lack the financial wherewithal to make restitution to their victims.

The organized bar, recognizing that lawyers individually, and the bar collectively, have an obligation to keep faith with clients who have been harmed by those few lawyers who have abused their position of trust, chose to create funds to provide reimbursement to these clients. Client protection funds trace their beginnings to the early 20th Century when English Commonwealth countries first developed programs to compensate victims of lawyer theft. New Zealand emerged as a leader in the development of client protection remedies, particularly with the passage in 1908 of a provision requiring solicitors to deposit client funds into bank trust accounts. In 1939, Alberta became the first Canadian province to establish an Assurance Fund. The state of Vermont became the first United States jurisdiction to establish a client protection fund in January 1959.

The ABA Standing Committee on Client Protection and its Advisory Commission on Lawyers' Funds for Client Protection work to fulfill the Association goal to develop and strengthen client protection mechanisms, including programs to reimburse financial loss caused by lawyers' misappropriation of client funds. The Committee's recently published 1993-1995 Survey on Client Protection Funds offers information from across the United States and Canada about lawyers' funds for client protection, including new fund implementation, fund management, funding sources, reimbursement activities, claims experience and procedures, public information initiatives, loss prevention activities and records management information.

Client protection funds are financed solely by lawyer contributions. Not a single dollar comes from taxpayers or government subsidy. According to the Survey on Client Protection Funds, the funds in the United States currently have approximately 43 million dollars in reserve, i.e. monies collected from lawyer contributions and investments not designated for client reimbursement.

The ultimate goal of all lawyers' funds for client protection is to reimburse 100% of all valid claims. Unfortunately, because of funding issues, the volume of claims filed, the size of the claims and other factors, most United States jurisdictions have placed limits on the maximum allowable reimbursement per claim or per accused lawyer. According to the 1993-1995 Survey, the average maximum limit per claimant is $43,533, the average maximum limit per claim is $43,644, and the average cumulative limit per lawyer is $132, 292. Only Connecticut, Delaware, Massachusetts and Montana are without reimbursement limits.

Lawyers' funds for client protection do not address all potential wrongs committed by members of the legal profession. Typically, reimbursement is limited to losses occurring within a client-lawyer relationship or when the lawyer is serving in a fiduciary capacity. The loss must be the result of a lawyer's dishonest conduct. The funds do not reimburse for losses due to negligence or malpractice, which can be redressed through the courts. Even with the various caps and eligibility requirements, lawyers' funds for client protection paid out on average, a nationwide total of over $36 million per year for the years 1993, 1994 and 1995. Unearned legal fees, theft in the areas of estates and trusts, personal injury and real property, and improper investments and loan agreements with clients account for the vast majority of reimbursable claims.

Each jurisdiction has its own rules and guidelines governing reimbursement. Client protection funds exist as a matter of grace, not of right. Fund trustees, an increasing number of whom are nonlawyers, meet periodically to review claims and many hold evidentiary hearings. While most permit reconsideration after an initial decision has been made, only Arkansas, California, Idaho and Maryland allow for judicial review. The procedures for filing and processing claims are designed to be followed and understood by claimants without the need of retaining counsel. Some jurisdictions have enacted provisions prohibiting lawyers from taking a fee for assisting a client protection fund claimant.

Client protection funds are one of the legal profession's best kept secrets. It is perhaps predictable that the public is largely unaware of the existence of such funds. According to the Survey on Client Protection Funds, Delaware did not pay on any claims for the years 1993, 1994 and 1995. Historically, many fund trustees and administrators have been reluctant to publicize their activities for fear that there will be a Arun on the fund@ or that announcements of large pay outs will cause the public to generalize the bad acts of a few to the vast majority of lawyers who faithfully and honestly serve their clients. However, some funds, like Illinois, New York, New Jersey, Maryland, Massachusetts, Ohio and Pennsylvania make regular, even quarterly, public announcements of awards. California, the District of Columbia, Maryland, New York, Pennsylvania and Tennessee produce public service announcements to educate their citizens about the funds' existence and activities. New York and Pennsylvania have been extremely generous in sharing their announcement materials with other jurisdictions who are committed to Agetting the word out.

Within the legal profession itself, the lack of awareness of client protection funds is widespread. Many lawyers know nothing of these funds even though they are financed by association dues, lawyer registration fees or annual assessments. Lawyers regularly miss opportunities to educate the public, the media, political critics - and those for whom lawyer bashing is a blood sport - about the legal profession's unique commitment to redressing the conduct of its few miscreants. No other profession does more to police itself or address the transgressions of those who abuse their positions of trust, not doctors, not dentists, not real estate brokers, not accountants, no one! Not a single other profession accepts financial responsibility for maintaining its collective reputation for honesty and trustworthiness in handling client money and property.

As is true with many professionalism initiatives, there are some lawyers who believe that since they are not part of the problem, they should not be forced, as a condition of licensure, to be part of the solution. As noted in the Report of the Special Committee on Clients' Security Funds, 84 Reports of A.B.A. 605, such thinking ignores the realities of the legal profession's unique role in society:

Chief Justice Vanderbilt and Reginald Heber Smith have placed its justification on an unassailable basis. We are engaged in a profession that serves the public and enjoys a monopoly in that service. We rightfully control the machinery governing admission to our privileged ranks and the discipline and disbarment of those who transgress. We lawyers cannot truly deny the existence of that control on the ground that the judiciary, the law schools and the legislature also have a voice. The public looks to the profession to keep its own house in order and when a lawyer embezzles his client's funds, the whole bar is blackened in the public eye. The rest of us, as well as the embezzler, are considered at fault because we have failed to police our own ranks and to prevent defalcation. Even if the profession could properly feel without blame, the defrauded client is a casualty whose injury arises out of the practice of our profession. Most of us approve the principle underlying the workmen's compensation laws. Why should any lawyer recoil from the Clients' Security Fund on the ground that it requires contribution from those who are not responsible for the embezzlement?'

The Standing Committee on Client Protection has also developed other innovative client protection programs. The Committee is currently encouraging jurisdictions to adopt these mechanisms:

  • Trust Account Overdraft Notification: Lawyers are required to maintain client funds in specially designated escrow or trust accounts. In 1988, the House of Delegates approved a Model Rule for Trust Account Overdraft Notification, requiring financial institutions to notify the state's lawyer disciplinary agency when an overdraft has occurred in a lawyer's trust or escrow account. This rule is designed to operate as an "early warning" that a lawyer may be engaging in conduct that might injure clients;
  • Financial Recordkeeping: In 1993 the House of Delegates adopted the Model Rule on Financial Recordkeeping. The Rule provides lawyers with practical guidance in complying with their recordkeeping duties and provides uniform and minimal standards for the maintenance of law firm financial records;
  • Random Audit of Trust Accounts: In almost all cases of overdraft, there is no intent to steal and only a technical violation of the professional conduct rules. No disciplinary action is initiated. Random audit of lawyer trust accounts functions to assist lawyers' office management skills while detecting lawyers thefts. A Model Rule for Random Audit of Trust Accounts was approved by the House of Delegates in August 1993;
  • Payee Notification: In 1991, the House of Delegates approved a Model Rule for Payee Notification that requires insurers to provide written notice to a claimant that payment was delivered to the claimant's lawyer or other representative by draft, check or otherwise;
  • Fee Arbitration: Adopted in February 1995, the Model Rules for Fee Arbitration provide a mechanism for the establishment of procedures for handling the numerous complaints received by disciplinary agencies that do not involve allegations of lawyer misconduct, but reflect legitimate client concerns regarding fee disputes; and
  • Mediation: The Committee is circulating for comment proposed Model Rules for Mediation of Client Lawyer Disputes. The Model Rules would implement Recommendation 3 of the Report of the Commission on Evaluation of Disciplinary Enforcement (McKay Commission Report) in which the Association called for jurisdictions to expand their systems of lawyer regulation by establishing mechanisms to resolve disputes between lawyers and clients and to handle nondisciplinary complaints about lawyers. The McKay Commission Report included a mediation program among its court-established dispute resolution mechanisms.

While the byproducts of client protection programs include financial reimbursement to injured clients and positive public relations, the thrust of any program is to educate lawyers and thereby make them better lawyers. As noted in the McKay Commission Report, effective client protection programs have been in existence in enough jurisdictions for a sufficient time to judge their efficacy and any problems they might cause practitioners. In jurisdictions that have used them, these measures have proven effective to deter and detect the theft of funds even before clients file complaints. Rather than being a regulatory burden on honest lawyers, these programs have provided useful guidance on proper accounting procedures and assisted lawyers in improving their office management techniques.