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Demystifying Client Trust AccountsIMPORTANT NOTICE: This article is provided solely for research and archival purposes. MCLE self-study credit is no longer available. Even if you follow the instructions and submit payment you will not be granted MCLE self-study credit. Please note that low-cost MCLE is provided by the California Lawyers Association, pursuant to Business and Professions Code section 6056. California Joan tries to make client trust accounting as elementary as possible for Watson and Holmes By Ellen R. 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
Self-assessment testAnswer 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.
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