IOLTA Rules: Got My Money on My Mind and My Mind on My Money

man in financial marketem>This article evolved from an MCLE presentation titled, “Dollars and Sense: Trust Accounting/IOLTAs for Small Firms and the New Rules” presented by Joanna Storey of Hinshaw & Culbertson, LLP and Thomas D’Amato of D’Amato Law at the Bar Association of San Francisco’s Solo/Small Firm Annual Conference on January 23, 2020.

In November 2018, the State Bar of California adopted the New California Rules of Professional Conduct. These rules brought significant changes to how lawyers practice law. Rule 1.15 “Safekeeping of Funds and Property of Clients and Other Persons” (Former Rule 4-100 “Preserving Identity of Funds and Property of a Client”) adopted the most significant changes in how attorneys handle funds and property of clients along with creating a duty to third parties. This article discusses four significant changes that impact how attorneys handle funds and property of clients and third parties.

Starting with the Change in Name of the Rule

Former rule 4-100 is titled “Preserving Identity of Funds and Property of a Client,” whereas the new Rule 1.15 adds the terms “Safekeeping” and “Other Persons” and removes “Preserving.” While the rule has changed to be more aligned with the Model Rules, the word change from “preserving” to “safekeeping” accepts that an attorney is a fiduciary entrusted with the property of clients and third parties. The concept of safekeeping is more expansive, meaning that compliance is not met by merely identifying the funds or property, placing them in a safe space (lockbox/safe or trust account), and properly disbursing such funds. Safekeeping additionally requires an attorney to keep records, maintain accounting, comply with audits, and promptly distribute any disputed funds. Further, the new title recognizes that attorneys often hold property and funds belonging not only to their clients but also to third parties. This article discusses in more detail an attorney’s duty to third parties below.

Rule 1.15 (a) All funds must be placed in trust

Former Rule 4-100(a) states:
All funds received or held for the benefit of clients by a member or law firm, including advances for costs and expenses, shall be deposited in one or more identifiable bank accounts labeled ‘Trust Account,’ ‘Client’s Funds Account’ or words of similar import…

Rule 1.15(a) states:
All funds received or held by a lawyer or law firm* for the benefit of a client, or other person* to whom the lawyer owes a contractual, statutory, or other legal duty, including advances for fees, costs and expenses, shall be deposited in one or more identifiable bank accounts labeled ‘Trust Account’ or words of similar import…

The old rule requires that “advances for costs and expenses” must go into the trust because these funds belong to the client. Nevertheless, some attorneys understood the old rule as not necessarily requiring flat fees or certain “prepayment” of legal fees to be placed in trust, provided that the attorney accounted for the fees in a client ledger. Rule 1.15 Comment 2 defines “advance for fees” as any payment intended as an advance payment for some or all of the lawyer’s services to be performed, meaning that the advance fee is the client’s funds until the attorney has earned the fees. Rule 1.15 (a) also incorporates “contractual, statutory or other legal duty,” meaning that an attorney has a duty to place funds in trust when a contract, a statute, or even a court order requires them to do so.

Rule 1.15(b) Flat fees may be placed in either IOLTA or operating accounts

Many attorneys utilize the flat fee model, and Rule 1.15(b) governs how an attorney should handle these fees. Rule 1.15 (b) has several components depending upon if the flat fee is greater or less than $1,000. Rule 1.15 (b) (1) requires an attorney to disclose in writing (i) the client has the right to require the flat fee to be placed in trust and (ii) the client is entitled to a refund for unearned fees. Rule 1.15(b)(2) requires that an attorney obtain the client’s written consent to place a flat fee in an operating account if the fee exceeds $1,000. Applying this rule, if a lawyer-client agreement is a flat fee service, then the attorney must include a clause advising the client of Rule 1.15(b)(1). When the flat fee exceeds $1,000, then the attorney must obtain client consent prior to placing the flat fee in the operating account. If the fee is less than $1,000, then the lawyer may only provide notice to the client of Rule 1.15 and the attorney’s intent to place the funds in the operating account, but the attorney is not required to obtain the client’s express consent. Because Rule 1.15(b)(1)(ii) states that the client is entitled to a refund for unearned fees, contractual language, such as “nonrefundable flat fee” or “fees earned upon receipt,” are unethical under Rule 1.15(b). See Rule 1.5(d) for a discussion of when a lawyer may use this language.

Rule 1.15(c)(2) Undisputed fees must be withdrawn

Former Rule 4-100(A)(2) and new Rule 1.15(c)(2) are essentially the same rule in that they both advise lawyers when funds may be withdrawn from trust and how to handle disputed funds. Rule 1.15(c) prohibits a lawyer from placing the lawyer’s funds in trust, as this is commingling. Many attorneys are not sure how to proceed when a client disputes fees and disbursements. When a client disputes fees or a lawyer’s contingency fee percentage, then the disputed funds must remain in trust until the dispute is settled. For example, the client has $10,000 in trust. The lawyer sends a bill for the $10,000, and the client disputes $3,500 of the earned fees. Under Rule 1.15 (c)(2), the lawyer may withdraw $6,500 but must leave $3,500 in trust until they have settled the fee dispute. By leaving the full $10,000 in trust until after the dispute is settled, the lawyer commingled earned funds with client funds.

Rule 1.15 Duties to third parties and their property

Throughout Rule 1.15, the words “other person” and “property” are incorporated into many of the subsections of the rule. Lawyers often receive funds or property belonging to third parties by way of court order, escrow, settlement disbursement checks, or third-party payor. Third-parties include former clients, third-party payors, vendors or other individuals who may have an interest in the property held by the lawyer. The inclusion of “other person” codifies a lawyer’s ethical responsibility to a third party when the lawyer receives funds or property where a third party has an interest. The inclusion of “other person” means that an attorney must handle funds and property of a third party with similar care as they would a client’s funds or property.

Under the new rule, a lawyer has a duty to handle a client’s or third person’s property properly. Property includes documents, securities, or other tangible items entrusted with an attorney for safekeeping. Like the inclusion of “other person,” the new rule recognizes that a lawyer often receives or holds property of non-clients and clients during a representation with the expectation that the lawyer will appropriately distribute the property when required; thus Rule 1.15 expands a lawyer’s ethical duty beyond funds to be placed in either the trust or operating accounts to include non-monetary property.

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