Whom Do You Trust? Beware of Gray Areas Regarding Trust Accounts

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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 and approved. As a general rule, however, most engagement agreements stipulate that 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 generally 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, they are for a task that is not completed and therefore, 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, they should go into the general account.

The American Bar Association's Model Code of Professional Responsibility, Disciplinary Rule DR 9-102, specifically addresses the issue of trust accounts and commingling of funds. The clear conclusion to be drawn from the ABA requirement is that 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 may 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 In Wisconsin, as one example, the requirement is that before any funds can be withdrawn from the client trust account, the client must be given five days notice.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 or withdrawal on a date certain. It is thus important to verify the rules in your jurisdiction before making a withdrawal of earned funds.

Flat fees versus hourly billing

If you charge a flat fee and agree that it is earned on receipt, trust account withdrawal probably cannot be questioned. It may be better to deposit the flat fee into a client's trust account and withdraw when reaching specific events: a date certain, the filing of a complaint, the signing of a settlement or merger agreement.

Even retainer fees can be deposited into a general account if the agreement says that the retainer is not for future work but for the lawyer specifically being engaged (and thus taken off the market). In other words, there is a valid charge for not being available to others. Some opinions on the subject suggest that the retainer for this purpose must be "reasonable," again as negotiated and detailed in the engagement agreement. If you receive a retainer for future work, it would seem best to put this into your client's trust account. Again, however, it might be best that the engagement agreement provide for this upon realizing a certain date or event.

When discussing flat or fixed fees, a case can be made that hours involved are irrelevant. If you compute the flat fee based on the number of hours you anticipate and discuss that with the client (suggesting that the fee will increase if actual hours exceed the estimate), that looks like hourly billing. Traditionally, hourly billing fees require deposit of retainers into the trust account first, and then withdrawal and deposit into the general account once the fee has been earned. The real issue remains that when the fee is earned, it's yours and MUST be withdrawn from the client's trust account. Otherwise, it's commingling – which violates the Code.

A small violation?

How ironclad is the commingling prohibition? One legal commentator suggested that he escaped an ethical problem becausehe had a few extra dollars inhis clients' trust account. Those few ($100) dollarsassured himthathis bank wouldn'tinvade clients' funds if they charged an expense item against the account. However, many states would consider even only $100 of personal funds in a clients' trust account as commingling. To be safe, a lawyer should negotiate with her/his bank to take any charge or expense from the general account, not the trust account.

Despite urgent client needs and requests, 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!

Trust account disputes

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. It is important to put a "protest process" into the engagement agreement. Provide that if you don't receive a complaint or dispute in writing from the client within that number of days set forth in your 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), except as otherwise provided in your jurisdiction's rules of professional conduct.

"Forgotten" trust funds

Yet another ethical issue often arises in very active personal injury or debt collection law practices, or in large firm real estate practices: Trust accounts become so large that the lawyer's record keeping does not keep the funds straight. 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.

Such contingencies serve as no excuse. Every state imposes a fiduciary duty to properly account for clients' funds to prevent misappropriation (theft) or negligence and failure to provide accurate accounting records on a State Bar inquiry means very bad news for the lawyer!

Banks are required to notify the Bar of any defalcations and a bounced check from a trust account brings the Bar into the lawyer's office almost instantly.

What should you do if you cannot properly account for trust funds? One expensive resolution is to hire an outside accountant to go through every document, check and ledger and 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. At least then, so the theory goes, you will have only a small problem. Such alternatives miss the point. The lawyer is a fiduciary who must keep accurate accounting records under every state's rules of professional conduct. This requires having an outside accountant reconcile trust and bank account records each month. To do less is to invite inquiry and trouble!