Client Trust Funds and Law Office Accounting

Chapter 6

Client Trust Funds and Law
Office Accounting

KEY POINTS

n A trust or escrow account is a bank account, separate from a law office’s or attorney’s business or operating checking account, where unearned client funds are deposited.

n Trust funds and office operating funds cannot be commingled.

n Trust funds cannot be used to pay for general offices expenses.

n Attorneys cannot ethically or legally take client funds out of the trust account unless they have been earned.

n IOLTA stands for Interest on Lawyers’ Trust Accounts—An IOLTA account is an interest-bearing account set up specifically to hold trust funds. The interest that accrues on an IOLTA account is given by the financial institution to a state bar foundation or other nonprofit legal organization for the good of the public.

n IOLTA accounts can usually be used only for client funds that are a nominal amount or that are expected to be held for only a short time.

n Internal control refers to procedures that an organization establishes to set up checks and balance so that no individual in the organization has exclusive control over any part of the accounting system.

CHAPTER OUTLINE/NOTES

I. Client Funds

A. Trust/Escrow Account

1. A trust or escrow account is a bank account, separate from a law office’s or attorney’s business or operating checking account, where unearned client funds are deposited. Exhibit 6–2 shows an example of a trust account checkbook and client ledgers.

B. No Commingling of Client and Law Office Funds

1. Ethical rules prohibit the commingling of client funds and law office funds in the same account.

2. The reason for the rule is that if client funds were commingled and kept in the same bank account with general law practice funds, creditors could seize these funds to repay debts of the law practice.

3. In addition, if attorneys could hide law office funds in the trust account, law office creditors would be unable to reach those funds, even though they otherwise would be able to because they were being kept in the trust account. Only client funds can be kept in the trust account.

C. Trust Account Examples

1. Unearned retainers, such as cash advances, are deposited in the trust account to apply against future fees and expenses. When the law office has earned the monies, the part of the money that has been earned can then be transferred to the law office’s operating checking account. This is usually done by issuing a trust check made payable to the law office itself.

2. The trust account is also used for distributing settlement funds, for instance. If a firm settled a case for $10,000, the opposing party would issue a $10,000 check payable to the law office and the client. The law office would deposit the $10,000 in the trust account. If the law office was entitled to $2,000 of the money, a trust check would be written to the client for $8,000, and a $2,000 check would be written to the law office itself (to deposit in its operating account).

D. Ethics and Trust Accounts

1. Ethical Rule Regarding the Commingling of Client and Law Office Funds

Rule 1.15 of the Model Rules of Professional Conduct states:

(a) A lawyer shall hold property of clients or third persons that is in a lawyer’s possession in connection with a representation separate from the lawyer’s own property. Funds shall be kept in a separate account maintained in the state where the lawyer’s office is situated, or elsewhere with the consent of the client or third person. Other property shall be identified as such and appropriately safeguarded. Complete records of such account funds and other property shall be kept by the lawyer and shall be preserved for a period of [five years] after termination of the representation.

(b) A lawyer may deposit the lawyer’s own funds in a client trust account for the sole purpose of paying bank service charges on that account, but only in an amount necessary for that purpose.

(c) A lawyer shall deposit into a client trust account legal fees and expenses that have been paid in advance, to be withdrawn by the lawyer only as fees are earned or expenses incurred.

(d) Upon receiving funds or other property in which a client or third person has an interest, a lawyer shall promptly notify the client or third person. Except as stated in this rule or otherwise permitted by law or by agreement with the client, a lawyer shall promptly deliver to the client or third person any funds or other property that the client or third person is entitled to receive and, upon request by the client or third person, shall promptly render a full accounting regarding such property.

(e) When in the course of representation a lawyer is in possession of property in which two or more persons (one of whom may be the lawyer) claim interests, the property shall be kept separate by the lawyer until the dispute is resolved. The lawyer shall promptly distribute all portions of the property as to which the interests are not in dispute.

2. Trust Account Not Used to Pay Law Office/Personal Expenses

Ethical rules prohibit attorneys from using trust funds to pay for general office expenses such as rent and payroll. Law offices are also prohibited from “borrowing” monies from the trust account. However, trust checks can be written to cover client expenses. For instance, if a client had monies in trust and the firm needed to issue a check to a court reporter to pay for a deposition transcript for the case, the office would write a check to the court reporter from the trust account. This is perfectly acceptable as long as the expense is for the client’s case.

3. One Trust Account Acceptable for All Client Funds

Law offices may have one trust account where all clients’ funds are deposited. Law offices do not have to have a separate bank account for each client, as long as there are proper records maintained showing how much each client has in the account.

4. Attorney Must Promptly Deliver Client Funds Back to the Client

Attorneys have an ethical responsibility to immediately turn over to clients any funds to which they are entitled.

Rule 1.15(d) of the Model Rules of Professional Conduct states:

5. Commingling of Client Funds Is a Common Problem

Literally hundreds of attorneys are suspended or disbarred every year for commingling client funds.

6. Trust Account Management

Rules for good trust account management include (see Exhibit 6–4):

● Having a trust account and using it for all client monies.

● Only allowing a managing partner to sign on the account.

● Following the Interest on Lawyers’ Trust Accounts (IOLTA) rules for your state.

● Notifying the client in writing, at least on a monthly basis, regarding all deposits and withdrawals from the client’s account balance.

● Keeping unearned fees and unexpended costs in the trust account until earned or spent.

● Not commingling or putting attorney/law firm funds in the trust account.

● Reconciling the trust account monthly and maintaining a written record of the reconciliation.

● Reviewing individual client balances monthly and not delaying in giving clients their money.

● Maintaining written, detailed records justifying every deposit and every withdrawal in the trust account, including a detailed journal of all transactions and a client ledger.

● Retaining trust records even after the matter is closed, according to state rules.

Source: Adapted from Foonberg, J. (2004). How to start and build a law practice (p. 283). American Bar Association.

7. Interest on Lawyers’ Trust Accounts (IOLTA)

An IOLTA account is an interest-bearing account set up specifically to hold trust funds. The interest that accrues on an IOLTA account typically goes to a state bar foundation or other nonprofit legal organizations.

Most states provide that IOLTA accounts can only be used for client funds that are a nominal amount or that are expected to be held for only a short time. If a large amount of client funds are involved, or if an amount is to be held for a long period, the attorney should open a separate interest-bearing account for that specific client and the interest should be given to the client.

II. Budgeting

1. A budget is a projected plan of income and expenses for a set period of time, usually a year.

2. Budgets are a planning tool. They allow the firm to plan for the future, to anticipate problems, needs, and goals for the firm, and to allocate and manage resources.

3. Steps in the budget process:

- Prepare an income budget. An income budget estimates how many partners, associates, legal assistants, and others will bill for their time, what the rate or hourly charge will be, and the number of billable hours each timekeeper will be responsible for billing.

- The time-to-billing percentage adjusts downward the actual number of hours the office will bill to clients, taking into account the fact that timekeepers are not always able to bill at their budgeted levels due to sickness and unforeseen events.

- Realization is what a firm actually receives in income as opposed to the amount it bills.

- Prepare a staffing plan. A staffing plan estimates how many employees will be hired or funded by the firm, in what positions or capacities they will serve, what positions will need to be added or deleted, and how much the compensation will be.

- Estimate overhead expenses. The law office must make a budget of all expected overhead expenses such as rent, utilities, equipment, and other expenses.

- Set a profit margin. The last step is to set a target profit margin the firm would like to achieve.

4. Budgeting Tips:

- Budgets should be communicated to everyone involved.

- Budgets must be tracked year-round.

- Document budget assumptions.

- Use zero-based budgeting. A zero-based budget means last year’s budget or actual expenses are not used in figuring the coming year’s budget. Each year, the budget figures stand on their own merit and must be justified.

III. Collection

1. Collection and income are closely tied together.

2. Billing large amounts of time and not getting paid is a sure way to bankruptcy for any law office.

3. The first step in collecting a high percentage of billings is for the attorney to carefully select and weed out what clients’ cases he or she will accept in the first place.

4. Another strategy that many law offices take is to get monies up front in a case using deposits in the form of earned and unearned retainers.

5. Other strategies law offices use for collecting fees billed include sending regular monthly billings and withdrawing from cases as soon as possible and feasible, once it is determined that the client will not pay. This is sometimes difficult to do, since ethical rules put limits on when attorneys can withdraw from cases. Model Rule 1.16 provides in part:

(b) Except as stated in paragraph (c), a lawyer may withdraw from representing a client if:

(1) withdrawal can be accomplished without material adverse effect on the interests of the client;

(2) the client persists in a course of action involving the lawyer’s services that the lawyer reasonably believes is criminal or fraudulent;

(3) the client has used the lawyer’s services to perpetrate a crime or fraud;

(4) the client insists upon taking action that the lawyer considers repugnant or with which the lawyer has a fundamental disagreement;

(5) the client fails substantially to fulfill an obligation to the lawyer regarding the lawyer’s services and has been given reasonable warning that the lawyer will withdraw unless the obligation is fulfilled;

(6) the representation will result in an unreasonable financial burden on the lawyer or has been rendered unreasonably difficult by the client; or

(7) other good cause for withdrawal exists.

(c) A lawyer must comply with applicable law requiring notice to or permission of a tribunal when terminating a representation. When ordered to do so by a tribunal, a lawyer shall continue representation notwithstanding good cause for terminating the representation.

(d) Upon termination of representation, a lawyer shall take steps to the extent reasonably practicable to protect a client’s interests, such as giving reasonable notice to the client, allowing time for employment of other counsel, surrendering papers and property to which the client is entitled, and refunding any advance payment of fee or expense that has not been earned or incurred. The lawyer may retain papers relating to the client to the extent permitted by other law.

6. Another strategy to collect on billings is for the attorney to actually sue the client for the fee. This is usually a method of last resort, as no attorney wants to be put in the situation of suing his or her own client.

IV. Internal Controls