Demystifying Client Trust Accounts
California Joan tries to make client trust accounting as elementary as possible
for Watson and Holmes
By Ellen R. Peck
All rights reserved. ©2004
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Peck |
Jon Watson wailed on a telephone lifeline to his former law school classmate,
California Joan: “During law school and all my 20 years as a government
lawyer, I never dreamed I would need to know about client trust accounts. Now
that I have set up a civil practice with my partner, Shurelocke Holmes, I am
completely mystified.”
“The good news, Jon, is that you have a client trust account (CTA),”
replied Cali. “Unlike the old dog, you can learn new tricks and you are
motivated to do it right. Let’s see if we can demystify some of the most
common CTA mysteries.”
“The primary client trust account standard is rule 4-100, Rules of Professional
Conduct (CRPC), which requires that all funds received or held for the benefit
of clients, including advances for costs and expenses, must be deposited in
a CTA. Cali, what does this mean?” asked Jon.
“Not so elementary, my dear Watson!” responded Cali. “Some
types of funds must be deposited into a CTA; some funds may be deposited in
a CTA at the discretion of the lawyer, and some funds can never be deposited
in a CTA.
“Settlement checks or drafts are one example of the first category —
they are required to be deposited in a client trust account,” Cali said.
(Waysman v. State Bar (1986) 41 Cal.3d 452, 454-455, 457, 224 Cal. Rptr.
101.)
Watson added, “CRPC 4-100(A) states a second example: client’s
payments of advanced costs or expenses for litigation or other legal matters
must be deposited in a CTA.”
“Many attorneys overlook that advanced costs and expenses must be deposited
in a CTA. In Aronin v. State Bar (1990) 52 Cal.3d 276, 280, 283-284,
276 Cal.Rptr. 160, a lawyer was disciplined, in part, for depositing costs advances
into his personal savings account,” Cali cautioned.
Shirley Holmes joined in the conference call. “When the game’s
afoot and I need to pay out the costs immediately to file a legal action or
obtain an incorporation, it can be detrimental to the client to wait for the
client’s check to clear. If the funds will be paid out immediately, why
should they not be deposited into the business account?”
“A lawyer who did exactly that was disciplined. In Stevens v. State
Bar (1990) 51 Cal.3d 283, 286-287, 272 Cal. Rptr. 167, the lawyer deposited
a client’s advanced costs in his business account and then wrote a check
to the secretary of state. This practice was held to be a trust account violation,”
Cali pointed out. “If time is an issue, there are other solutions which
do not require you to violate the rule: (1) have the client write out checks
for the exact amount of the costs (e.g., a client check made out to the clerk
of the court for a filing fee for filing a legal action); (2) deposit a check
to you representing a client’s advanced costs into the CTA, advance the
client the expense and then disburse the money to your business account after
the client’s check clears; or (3) advance the expense to the client and
collect the funds from the client after the expense has been paid,” Cali
said.
“In that last example, when I get the client’s check to reimburse
me for advanced costs, that check can go into my business account?” Watson
asked for reassurance.
“Precisely, my dear Watson. Because the client’s check represents
funds that belong to you (i.e., funds to repay you for the expense you advanced),
it may never go into your CTA. The CTA is only for funds belonging to the client
or to which the client has a claim. In sending you the reimbursement, the client
has indicated an abandonment in the interest in the funds and that they belong
to you.”
Holmes interjected, “Suppose I get a check from Carl Client for $1,000;
$450 is a reimbursement to me for costs I already advanced for Carl; and the
remaining $550 is an advance for future expenses. Some of that money is clearly
mine and should not be deposited into the CTA to prevent commingling. I am clueless.”
Cali acknowledged: “The rule creates a bit of mystery here, but leaves
some clues. CRPC 4-100(A) requires that Carl’s advance for future expenses
must be deposited into the CTA. CRPC 4-100(A)(2) adds: ‘In the case of
funds belonging in part to a client and in part presently or potentially to
the member or the law firm, the portion belonging to the member or law firm
must be withdrawn at the earliest reasonable time after the member’s interest
in that portion becomes fixed.’ What do you deduce from these clues?”
“I’ve solved the mystery!” Watson exclaimed. “Because
the rule requires that a lawyer remove the portion of the funds in which the
lawyer’s interest becomes fixed, it necessarily implies that all funds
in which the client has any interest must be deposited in the CTA. Therefore,
we would deposit Carl’s check for $1,000 in the CTA because part of it,
the $550 for advanced costs, belongs to Carl. When the check clears, we should
then immediately write a CTA check to the firm for $450 because it has become
‘fixed.’”
“How do you know that it has become fixed?” queried Holmes.
“Elementary, my dear Holmes!” replied Watson. “We sent Carl
a billing showing that we advanced the costs. Carl evidenced his approval of
the reimbursement by sending us a payment for the advance. Those events fix
our interests.”
“Now you have it, Watson!” Cali confirmed.
“It’s a mystery why we have to have all of these writings before
we can get money that is owed to us. I do not see any requirement of all of
these writings in the rule,” muttered Holmes.
Cali conceded that CRPC 4-100 does not expressly state that a writing was required
before reimbursing the lawyer. “Again, the rule leaves important clues:
Subpart (A)(2) requires payment funds owed to the lawyer when the lawyer’s
interest is fixed. The same rule requires that when the client disputes the
lawyer’s or the law firm’s right to receive a portion of trust funds,
the portion shall not be withdrawn until the dispute is finally resolved. CRPC
4-100 (B)(3) requires that a lawyer ‘maintain complete records of all
funds . . . of a client coming into the possession of the member or law firm.’
The same rule requires a lawyer to ‘render appropriate accounts to the
client regarding funds that have come into the lawyer’s possession.’”
Holmes queried, “And what do you deduce from all of those clues?”
“The express reference to record keeping means that some writing, whether
in hard copy or electronic means, must be kept of every transaction involving
clients’ funds entrusted to the lawyer. A lawyer’s memory is not
enough. Second, before money is paid, some accounting must be given to the client.
Because the rule talks about rendering ‘appropriate accounts,’ that
infers that a writing will be delivered to a client. Third, because a lawyer
is required to retain entrusted funds in the CTA, this suggests that some accounting
would have been delivered to the client before the funds are deemed ‘fixed,’”
Cali responded.
“I have never seen a case that says exactly that,” Holmes emphasized.
“Correct, although the same result could probably be reached by patching
a number of disciplinary cases together. I am suggesting the above conduct for
risk management purposes, which also will promote good client relations,”
Cali affirmed.
“What are other examples of funds which must be deposited in the CTA?”
asked Watson.
“Other examples include (1) spousal or child support payments from a
non-client for the benefit of a client; (2) payments from an opposing spouse
in a marriage dissolution action in distribution of community assets (by settlement
or court order); (3) client funds to pay for investments, property, real estate
or taxes; or (4) funds from third parties to pay clients for rentals, leases,
real property or other investments or property,” Cali replied. (See Vapnek,
et al., Cal.Prac. Guide: Professional Responsibility §9:101 (The Rutter
Group 1997-2003.)
“I am mystified by what to do with retainers,” said Holmes. “I
understand that lawyers use the word ‘retainer’ to refer to three
different types of fees, each requiring different handling.” (T &
R Foods, Inc. v. Rose (1996) 47 Cal.App. 4th Supp. 1, 8, 56 Cal. Rptr.2d
41, 45.)
“Let’s take an advance fee retainer first (i.e., a fee that is
paid in advance for the performance of future legal services),” Cali said.
“The State Bar’s Handbook on Client Trust Accounting for California
Attorneys states that advance fees are not required to be deposited into
a CTA but they may be. (Handbook on Client Trust Accounting for California
Attorneys (Calif. State Bar 2003) at p. 14.) Because a lawyer has a duty
to return unearned advanced fees to a client after termination (CRPC 3-700(D)21),
for risk management purposes I recommend that advance fees be deposited in a
CTA or otherwise segregated until earned to ensure that you do not spend unearned
advanced fees and have it available for refund to the client.”
“If I put the advanced fee in my CTA, doesn’t that increase my
accounting burdens?” asked Holmes.
“You have a duty to account for advance fees regardless of whether the
advance fees are deposited in a CTA or a business account. (In the Matter
of Fonte (Rev. Dept. 1994) 2 State Bar Ct. Rptr. 752.) A billing, setting
forth the date the services were provided, the tasks performed, the method
of calculation of the cost of the legal services and a calculation of the amounts
remaining or owing may well comply with the accounting requirement,” Cali
responded.
Holmes continued, “‘True’ or ‘classic’ retainer
fees (client money paid to secure an attorney’s availability over a given
period of time, but not for performance of legal services) are earned when received,
are non-refundable and should never be placed in a CTA.” (Rule 3-700(D)(2),
Rules of Professional Conduct; Baranowski v. State Bar (1979) 24 Cal.3d
153, 164, fn. 4; In the Matter of Fonte (Review Dept. 1994) 2 Cal.State
Bar Ct. Rptr. 752, 757.)
“Right you are, Holmes,” said Cali. “The last category of
retainer fees — security deposits (money to be held by a lawyer to secure
payment of fees for future services that the lawyer is expected to render) —remains
the property of the client until the lawyer applies it to charges for services
actually rendered; any unearned fees are returned to the client and therefore
must be deposited in a CTA.” (T & R Foods, supra, at 47 Cal.App.4th
Supp.1, 7.)
“From what you have said, no funds belonging to Holmes or myself should
be deposited in a CTA because that would be a prohibited commingling?”
Watson asked.
“You’ve got it, Watson!” Cali encouraged. “But there
are exceptions when you can have your own funds in the trust account.”
Holmes and Watson felt the mystery deepening.
“The first exception we’ve already discussed. Entrusted funds on
deposit in the CTA, in which the lawyer claims an interest but are disputed
by the client, must remain on deposit pursuant to CRPC 4-100(A)(2),” Cali
said. “Second, CRPC 4-100(A)(2) permits lawyers’ personal funds
sufficient to pay bank administrative charges to be deposited in the client
trust account.”
Holmes jumped in again: “I understand that a lawyer’s buffer or
reserve fund deposited in a CTA to prohibit overdrafts is prohibited commingling.
How much money can I deposit to cover bank administrative charges without being
accused of having a prohibited buffer fund?”
“That is a mystery, Holmes,” Cali acknowledged. “There is
no statute, rule or guideline establishing the minimum or maximum amount which
may be deposited as a bank administrative charge. More than a decade ago, the
State Bar Court review department ruled that the amount of $121.57 is reasonable
as a banking administrative charge, absent guidelines established by the Supreme
Court or the State Bar. (In re Respondent F (Rev. Dept. 1992) 2 Cal.State
Bar Ct. Rptr. 17.) That amount, which was based upon the specific facts of the
case and pre-dated the many different kinds of service charges that a lawyer
may now face, is far too low.
“A lawyer should examine the type of practice and deposit a reasonable
amount to cover potential bank administrative costs, including but not limited
to: monthly service charges (for non-IOLTA CTAs), additional service charges
for online banking, printing charges for checks and deposit slips, service charges
from the clients’ credit card companies for advanced fees or costs paid
by the client with a credit card; fees for processing client or your (oops!)
insufficiently funded or dishonored checks, stop payment charges, wire transfer
fees, electronic transfer fees, endorsement stamp costs and ATM service charges,
if any.
“Some lawyers deposit this amount on an annual basis, while others deposit
it quarterly. There are no cases or ethics opinions suggesting that either practice
is unethical. It is more important to be able to demonstrate that the amount
that you deposit was calculated based upon your estimated potential bank administrative
charges rather than a fixed amount (which is more likely to be perceived to
be a ‘buffer’).”
Cali finished with the third exception: “The California Supreme Court
has held that repayment of client trust monies wrongfully taken, through the
deposit of the lawyer’s own personal funds, is considered early restitution
and therefore is not commingling for which discipline will be imposed.”
(Guzzetta v. State Bar (1987) 43 Cal.3d 962.)
Watson added, “That underscores the importance of reconciling my CTA
every month, without fail. I can determine if there are any trust account irregularities
for that month and remedy them, if need be, by a deposit of my own money to
make restitution.”
“That’s keeping on the right path, Watson,” Holmes approved.
“Let’s save any other CTA mysteries for our next conversation with
California Joan.”
Ellen Peck, a sole practitioner in Escondido, is a former judge of
the State Bar Court, a past chair of the State Bar’s Committee on Professional
Responsibility and Conduct, a member of the Commission to Revise the Rules
of Professional Conduct, a visiting professor of Professional Responsibility
at Concord University School of Law and co-author of The Rutter Group’s
California Practice Guide — Professional Responsibility.
Certification
- This self-study activity has been approved for Minimum Continuing Legal
Education credit by the State Bar of California in the amount of one hour
of legal ethics.
- The State Bar of California certifies that this activity conforms to the
standards for approved education activities prescribed by the rules and regulations
of the State Bar of California governing minimum continuing legal education.
Self-assessment test
Answer the following true-false statements after reading the MCLE article on
Rule of Professional Conduct 2-100. Use the answer
form provided to send the test, along with a $20 processing fee, to the
State Bar. If you do not receive your certificate within four weeks, call 415-538-2504.
- All funds received or held for the benefit of clients may be deposited
into a client trust account or a business account.
- Client advances for costs and expenses must be deposited in a CTA.
- Where the client has an immediate need for the proceeds of a settlement
check or draft, the lawyer, with the client’s permission, may cash the
check or draft at the bank and immediately give the client her portion of
the recovery.
- Client advanced costs and expenses need not be deposited into a CTA if
part of the client expense is required to be immediately paid out for the
benefit of the client.
- A client may write a check payable to a governmental entity or vendor for
a litigation cost or expense instead of advancing that cost to the lawyer.
- Jon Watson advanced filing fees of $250 to Vicky Victim. After billing
her for the advanced filing fee, Vicky sent Watson a check in the amount of
$250. Watson may not deposit Vicky’s check into his CTA.
- Jon Watson advanced filing fees of $250 to Vicky Victim. When Vicky got
Watson’s billing, she misread it and sent Watson a check for $350. Watson
must deposit Vicky’s check into his business account.
- Holmes received an advanced fee from IdeaCorp in the amount of $10,000
that he deposited into his CTA. Pursuant to their hourly retainer agreement,
he conducted an investigation regarding theft of trade secrets from IdeaCorp
and drafted a complaint against Moriarty, the defendant who allegedly perpetrated
the theft. Holmes sent a bill for $5,000 and the draft complaint to IdeaCorp.
IdeaCorp changed its mind and decided not to go after Moriarty. IdeaCorp requested
that Holmes refund $5,000. Assuming he did not perform any further legal services,
Holmes’ refusal to refund $5,000 may subject him to discipline.
- Assume the same facts as in question 8 and add: IdeaCorp sent Holmes a
letter indicating its dissatisfaction with the competence of his services
and demanded that he reduce his billing to $2,500. Holmes will be disciplined
if he retains the entire $5,000 in a CTA until the dispute is resolved.
- A lawyer must maintain complete records of all funds of a client coming
into the possession of the member or law firm.
- Watson is required to render an appropriate account to Vicky Victim concerning
how he spent costs advanced by Vicky.
- Holmes is not required to account to IdeaCorp concerning the advanced fees.
- Irene Adler retained Holmes to obtain a dissolution of marriage from her
second husband, the Prince of Bavaria, a resident of Malibu. Irene paid Holmes
an advance fee of $100,000 that Holmes deposited into his business account.
Holmes may be disciplined for the failure to place the $100,000 in his CTA.
- Watson represented Inspector LeStrade in leasing his London flat while
LeStrade toured the world on the Queen Mary 2. Watson appropriately deposited
all monthly payments from the tenant in a CTA until LeStrade returned.
- Henry Baskerville retained Holmes to defend him in a dog bite case. At
Holmes’ request, Baskerville gave Holmes a check for $2,000 as a security
deposit. Holmes may deposit the $2,000 into his business account.
- Jabez Wilson sent Watson a retainer in the amount of $2,000. He wanted
Watson to stand by and be available to sue the Red-Headed League and others
for fraud for a period of six months. He and Watson agreed that if Wilson
did file suit, Watson would be entitled to one-third of any recovery for his
handling of the case. Watson may deposit the $2,000 in his business account.
- A lawyer may never deposit his or her personal funds in a CTA.
- California trust account rules permit Holmes to deposit a minimum of $1,000
in his CTA to pay bank administrative charges for that account.
- After completing his monthly reconciliation of the CTA, Watson discovers
that his book keeper deducted $300 from client Effie Munro’s funds on
deposit due to a mathematical error. Watson immediately deposited $300 of
his own money into the account to make restitution to Effie. Watson’s
deposit was not commingling.
- Hall Pyecraft, a former stockbroker and former Holmes client, complained
to the State Bar that Holmes had withheld money from his settlement because
Holmes retained monies to pay liens that Pyecraft had disputed. The State
Bar concluded that Holmes had properly retained the disputed lien funds but
charged him with commingling because it found $121 belonging to Holmes in
the CTA. Holmes will be vindicated on the grounds that $121, maintained to
pay banking administrative charges, is an exception to the commingling prohibition.
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