2 civil court rulings affect advance fees

by Ellen Peck

Until this year, whether a lawyer should place an advance fee into a client trust account or could keep it in an office account was murky at best. While for disciplinary purposes the question is still open, in the civil courts two decisions have held that an advance fee must be placed in a client trust account.

The appellate department of the superior court of Los Angeles County has held that the failure to deposit an advance fee in a client trust account constitutes a breach of fiduciary duty and professional negligence. (T & R Foods Inc. v. Rose (1996) 47 Cal.App. 4th Supp. 1, 8 [56 Cal.Rptr. 2d 41].)

In that case, in 1986, T & R Foods (T & R) paid an attorney, Fadem (the sole shareholder of a law corporation), $25,000 as an "evergreen" retainer. They agreed that as Fadem performed services for T & R, he would charge such fees against the retainer and that each month T & R would replenish the retainer to maintain $25,000 at all times. This agreement continued until 1994 when Fadem died, leaving about $24,000 in unearned fees which had been on deposit in the firm's general account. In the probate of Fadem's estate, T & R's claims for return of the unearned fees based upon breach of fiduciary duty and professional negligence, among other causes of action, were denied by the trial court and T & R Foods appealed.

The appellate department distinguished a "true" or "classic" retainer from an advance fee and a security deposit:

The appellate department concluded that T & R's retainer was not a true or classic retainer but an advance fee retainer. Since true ownership of the funds does not pass to the attorney until the legal services are performed by the lawyer, the advance fee must be placed in a client trust account until earned. (Id.)

The court also held that even though Fadem organized his practice as a law corporation, since he was personally responsible for this client's account, he was personally liable for the failure to deposit and maintain the advance fee in a client trust account. (T & R Foods, supra, at 47 Cal.App.4th Supp. 10.)

In S.E.C. v. Interlink Data Network of Los Angeles Inc. (9th Cir. 1996) 77 F.2d 1201, 1205-1207, the Ninth Circuit also held that funds paid in advance to a law firm for the performance of future legal services and from which the law firm deducted its charges for legal fees was an advance fee, not a true retainer, and should have been maintained in a client trust account. The Ninth Circuit also held that advances for fees remain the property of the client for the purpose of determining whether the deposit is subject to the freeze on client's assets.

California bankruptcy practitioners should note that In re Montgomery Drilling Co. (Bankr.E.D. Cal.1990) 121 Bankr. 32 held that advance fee payments or retainers from debtors must be kept in a client trust account.

Fixed or flat fees?

While none of these cases has yet determined the placement of a fixed or flat fee paid in advance, courts are likely to find that a fixed or flat fee paid in advance does not differ in character from an advance fee payment. Both are paid in advance for the future performance of legal services. Arguably, none of the fixed or flat fee is earned until the entire service is performed, unless the client and lawyer have agreed in advance to periodic payments or that a portion of the fixed or flat fee is earned upon the lawyer's performance of part of the services.

The California Supreme Court has historically refused to impose discipline in any reported decision for a lawyer's failure to place advance fees in a client trust account. (See Baranowski v. State Bar (1979) 24 Cal.3d 153, 154 Cal.Rptr. 752, 593 P.2d 613 [declined to determine whether rule 4-100's predecessor established a disciplinable offense for failure to deposit advance fees in a client trust account but also declined to impose discipline]; see also Baker v. State Bar (1989) 49 Cal.3d 804, op. mod. 50 Cal.3d 30 a; and Read v. State Bar (1991) 53 Cal.3d 1009, op. 1009, wherein the court modified its decisions to delete culpability for failure to place advance fees in trust.)

The legislative history of rule 4-100, Rules of Professional Conduct, presented to the California Supreme Court prior to adoption specifically stated that the rule did not include a requirement that "advances for fees be placed in the client trust account." While the State Bar subsequently forwarded rules requiring that advance fees be placed in a client trust account, such rules have not yet been adopted by the court.

Rule 3-700(A)(2) and (D)(2) requires that unearned advance fees be returned to the client upon termination of the relationship and discipline is frequently imposed for lawyers' failure to return unearned fees upon termination. Moreover, In the Matter of Fonte (Review Dept. 1994) 2 Cal.State Bar Court Rptr. 752, 758 held that there is a duty to account for expenditure of advances for fees and that if fees taken from advance fees are disputed, they must be put into the client trust account until the dispute is resolved.

In view of potential civil liability and potential disciplinary liability for failure to return unearned fees upon termination of the lawyer-client relationship, the safer practice is to place all advance fees in a client trust account and withdraw funds as they are earned.

Ellen Peck, former State Bar Court judge and former ethics counsel to the State Bar and the American Bar Association, is a solo practitioner in Malibu.