Some breathing room on an IOLTA dilemma

Managing and accounting for client funds held in trust is a personal responsibility of each lawyer, who bears all the responsibility of accounting for every penny. In an accounting sense, these funds are a liability of the law practice to the client, must be kept in an entirely separate account and cannot be commingled with any other law firm funds.

Every state imposes a fiduciary duty to properly account for clients' funds to prevent misappropriation or negligence, in order to provide for adequate safekeeping.

Recent challenges to the country's banking system raise the specter of bank failures, with implications for the safety of IOLTA 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 law practice, especially 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 from $100,000.

Even more significantly, the FDIC itself has issued a ruling that all amounts in a client's IOLTA trust account are protected, regardless of the amount. The account must be identified as an IOLTA 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 IOLTA 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 IOLTA 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 IOLTA funds obviously provides some breathing room with regard to such a dilemma. However, given that many once unthinkable financial events have happened, lawyers may not want to rely only on the FDIC pronouncement.

One way to further ensure that each client's IOLTA funds are safe is to identify in bank records the name of the client 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 on such a separate account will belong to the client. This is not an IOLTA account and doesn't come within the FDIC protective regulations, but is nonetheless safe when done properly.

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