Lawyers will go to great lengths to try to avoid their obligations respecting client funds management. Some put $20,000 of their own money into an IOLTA account, so that they’re assured of never bouncing a check. (You can’t do that.) Others try to twist retainers into other forms of payment, to avoid depositing those funds into an IOLTA account. (Unfortunately for them, a retainer remains a retainer, regardless of misclassification.) Still others seek to use client trust funds as a de facto line of credit, to be borrowed from and repaid, when operating funds dip, or during a slow month. (Spoiler alert: you can’t do that, either.) The plain fact, however, is that compliance with rules is often far easier than the machinations that attorneys go through to flout them.
Of course, lawyers hate math — and by extension, finance. No one takes an accounting class in law school, which feeds the notion that most lawyers have, that ‘that’s not what I do’. This is not to say that you can’t or shouldn’t farm out your accounting processes, if you have the funds to do it — on the contrary, you can and should. Where lawyers run into trouble is when they convince themselves that farming out a process absolves them from the responsibility to manage it. Ethics rules are clear on this point: it’s the lawyer’s license; consequently, it’s the lawyer’s responsibility. So, even in a case where a lawyer or law firm is using an accountant, including to manage trust account funds and reconciliations, the oversight responsibility stays with the lawyer. Your vendors won’t be disbarred or suspended from practice, you will be; and, penalties can be that grave, depending on the nature of the infraction. Ethics boards remain dedicated (both in terms of resources spent and focus produced) to policing client funds management, in an effort to protect the public. It’s also, by the way, easier for those same ethics boards to monitor compliance respecting trust accounting regulations, which are fairly straightforward and involve stark and clear financial figures — whereas other ethics regulations are a bit squishier. You don’t want to find yourself on the wrong end of an ethics investigation related to the management of client funds; and, answers like: ‘I didn’t know how to do it’ . . . ‘No one else does this correctly, either’ . . . . and, ‘I don’t have any reconciliation reports to show you,’ will not pass muster. With your license to practice on the line, it’s imperative that you understand client funds management.
This is not, however, solely about practicing lawyers’ proclivities with respect to math and finance. The ethics rules concerning client funds management are not always writ clear. Remember, these are some other lawyers writing about financial management, who probably have a similar distaste for the subject that you do. This guide, then, will explore some of the major concepts of trust account management, in plain language. Gathering a better handle on the way your law firm manages client funds is an effective foundation for increasing your resilience against malpractice or ethics claims.
I DON’T KNOW: What is IOLTA/IOLA?
You’ve heard the term, countless times. You likely have a trust account featuring the acronym in its name. What is it? IOLTA/IOLA stands for Interest on Lawyers’ Trust Accounts/Interest on Lawyers’ Accounts. This is a pooled account that a law office maintains, in which the majority (in most cases) of its client funds that have not yet been earned (the work hasn’t been done yet) reside. The account is pooled because the individual accounts (on their own) would not generate enough interest to be judged significant. There is an IOLTA/IOLA committee/commission in each state that collects the interest from your aggregated accounts (and the interest from all the other lawyers’ aggregated accounts in your state) and parses that money out among legal-related charities it deems worthy. It kind of sounds like stealing, I know; but, the policy decisions behind the programs are that lawyers’ clients wouldn’t miss the interest anyway, and that the lawyers themselves wouldn’t want to track and disburse to clients such small amounts of money, while also paying the costs associated with maintaining so many small accounts. Better then to scrape the collected interest, and put it to good social use. The agreed-upon process, of course, makes the lawyer’s job a little easier: the law firm only takes payment or refunds from the funds the client has paid in, absent considerations of managing interest payouts.
A Matter of Trust: What Are (and What Are Not) Trust Funds
So, IOLTA/IOLA accounts represent one class of trust funds. These are the short-term, short (small) money payments that law firms take in advance of performing work. The reason why attorneys need to segregate these funds in separate accounts is because the lawyer has not yet earned the money, because she hasn’t yet performed the work. The thrust of trust account regulation is that lawyers have to do the work before they can be paid. Advanced payments (made before any work is done, in the first instance) are commonly referred to as retainers. The law firm can only remove money from its IOLTA/IOLA account for deposit in its business operating account when that money has been earned — but, should then transfer the funds immediately. For example, if your retainer is for $1000, and you’ve done one hour of work at $200/hour, it is then appropriate to remove those funds from your trust account, and deposit them into your operating account, leaving the retainer balance at $800, to be drawn down as work continues, until the remainder of the retainer is exhausted, or refunded. Once the initial retainer is exhausted (or drawn down to an agreed upon amount), you may ask for another retainer payment.
There are times, however, when law firms will receive significant sums of money, which they would potentially retain for longer periods of time. Those are still trust funds; they’re just not IOLTA/IOLA funds, because the sum of money or the length of time for which the money is held generates a significant-enough amount of interest to be tracked and returned to the client. (And, before you ask: no, there is no bright line monetary amount or hold time outlined in the ethics rules. You’re required to use your (reasonable) judgment.) In this case, the funds get deposited into a separate (not part of a pooled) interest-bearing account, for the benefit of the single client, with interest being paid back to the client, rather than into the IOLTA/IOLA fund.
Generally speaking, unearned fees must pass through a client trust account of some type (IOLTA/IOLA or a separate interest-bearing account) before the funds become earned and so transferred to the law firm’s operating account. But, that’s not always the case. There are some exceptions to that general rule; and, the question of which of those exceptions apply to you depends on your local rules. One exception is the so-called ‘classic’ or ‘general’ retainer, wherein the client is paying for the law’s availability over a specified period of time, during which the attorney promises not to engage another (or other) clients over the subject matter of the representation. In that case, the client is paying for an exclusive relationship with the lawyer, not for any particular legal services; and, because of that, the payment is deemed ‘earned upon receipt’ and deposited into the law firm’s operating account (usually) immediately. In practice, few solo and small firm attorneys actually utilize general retainers, because if these are not laid out clearly and appropriately, they may be classified as standard retainers subject to the trust accounting rules. This is similar to limited scope representation work, wherein lawyers must clearly spell out the starting and stopping points for the representation. Another potential exception, again depending on your jurisdiction, is the conveyancing account. This is a very narrow exception, related to real estate closings. It works like this: if the attorney utilizes an account with a bank, and that account is exclusively used to debit and credit items involving closings for that bank (or that bank’s lending arm), that account need not be an IOLTA/IOLA account, as it would usually have to be. Another very specific exception allows lawyers to add a nominal amount (usually less than $150) of their personal funds to the IOLTA/IOLA account to cover for bank fees and charges, e.g.–for check printing costs. The reason this is important is because if the attorney’s funds are not available in the account to cover for those fees, they are paid out of unearned client moneys — which would be just as bad as removing those client funds before they were earned, and placing them into the law firm’s operating account to cover other business expenses. In some jurisdictions, attorneys have the option to deposit flat fees into a trust account or into an operating account. Attorneys opting to deposit flat fees into trust often do so in case the funds (or a portion thereof) need to be refunded — there are no nonrefundable retainers — assuring that those funds remain in the trust account until earned means that the attorney is guaranteed to have the money to refund contemplated work that did not end up getting done. Alternatively, those lawyers who deposit flat fees directly to the operating account, prefer the liquidity, to have more cash on hand, and are confident that money will not need to be refunded, or that funds will otherwise be available if the need for a refund arises. (Of course, just because money is deposited into an operating account doesn’t mean that it needs to be spent immediately, either.) Your jurisdiction may have adopted a definition for flat fees, which should read if you charge flat fees, in order to gain an understanding of how those differ from standard retainers. In certain jurisdictions, advanced payments for expenses are explicitly required to be treated as trust funds.
While it does pay to know your fee, in the real world the vast majority of unearned fees paid to attorneys will be treated as IOLTA/IOLA funds. And, that is where recordkeeping requirements become paramount.