I. Understanding
Client Fund Accounts
A. Introduction
“Safekeeping Property,” Rule 1.15 of the Massachusetts Rules of Professional Conduct (Mass. R. Prof. C.), and the Board of Bar Overseers’ (BBO) Dishonored Check Rule, establish the standards and guidelines by which attorneys are expected to manage client funds. This publication explains those standards and suggests guidelines for attorneys to follow in order to meet their obligations under Mass. Prof. C., Rule 1.15 and identify ways to avoid certain common pitfalls regarding receipt, deposit and disbursement of client trust funds.
The Massachusetts Rules of Professional Conduct including Rule 1.15, are based substantially on the American Bar Association Model Rules of Professional Conduct (Model Rules). They were adopted in 1997 by the Supreme Judicial Court Justices effective January 1, 1998, replacing the Disciplinary Rules (DRs) of the Code of Professional Responsibility (CPR).
Rule 1.15(e)1was preceded by Disciplinary Rule 9-102 (C) as amended January 1, 1990 which established a comprehensive Interest on Lawyers’ Trust Account (hereinafter referred to as IOLTA) program in Massachusetts. Through interest generated on certain client funds accounts, the IOLTA program funds legal services to the disadvantaged and projects which improve the administration of justice.
B. A Standard of Strict Accountability
Under Mass. R. Prof. C., Rule 1.15, a lawyer should hold the property of others with the care required of a professional fiduciary. This means that a lawyer handling client funds should act for the benefit of the client in the context of a relationship characterized by great confidence and trust on the part of the client and good faith and candor on the part of the lawyer.
The fiduciary nature of the relationship and the need for public confidence in the legal profession, places several burdens on a lawyer. First, in handling client funds, the lawyer must not only act properly but must also avoid even the appearance of acting improperly. Therefore, the lawyer is obligated to utilize certain protective procedures to minimize the possibility of wrongdoing. For example, securities should be kept in a safe deposit box, except when some other form of safekeeping is warranted by special circumstances. All property which is the property of clients or of third parties should be kept separate from the lawyer’s business and personal property; monies should be placed in one or more client fund accounts. Separate trust accounts may be warranted when administering money from estates or acting in similar fiduciary capacities.
Second, each lawyer is personally responsible for the proper deposit and maintenance of clients’ funds. While necessity often requires delegation of administrative duties within a law practice, the lawyer still must establish, be familiar with and ensure the proper operation of the adequate procedures for the handling of client funds. Specifically, lawyers who delegate any part of their client fund account responsibilities to their staff must provide effective guidelines for the proper handling and maintenance of these accounts and supervise staff activities.
In summary, the basic premise which underlies the rule is a lawyer who, as an incident to professional practice, holds money, any part of which belongs to another, whether a client or a third party, must keep that money in a separate account maintained in a banking institution. The funds must be deposited either in a pooled IOLTA account, which pays interest to the Massachusetts IOLTA Committee or in an interest bearing account for the client’s benefit.2 This money may not be commingled with money belonging to the law office or to the lawyer personally.
C. What are "Client Funds"?
Mass. R. Prof. C., Rules 1.15 (d) and (e)3 define client funds as funds which are held for clients or others except “advances for costs and expenses”. (For a discussion of costs and expenses click here.) The rule requires that client funds be deposited in one or more identifiable bank accounts in Massachusetts (assuming the law office is located here) in which no other funds are deposited except those necessary to pay bank service charges or to meet minimum balance requirements.
Among the monies which are to be treated as client funds are:
All advances for fees and most retainers4 received from clients, until they are actually earned by the lawyer (See section on retainers/advanced fees);
Funds which belong in part to the client and in part to the lawyer;
Funds of the client that are being held for disbursement at a later time;
Funds of third parties to be distributed at a later time;
Personal injury awards, alimony payments, real estate conveyancing monies5 and litigation settlements (See section on conveyancing accounts).
All client funds must be deposited in one of two types of interest-bearing accounts: a pooled IOLTA account, or an individual client account. A pooled IOLTA account contains all client funds which, in the judgment of the lawyer, are nominal in amount or are to be held for a short period of time. An individual client account, separately established for each client, is used for all other client funds. Interest earned on pooled IOLTA accounts is transferred by the bank to the IOLTA Committee. Interest earned on individual client accounts accrues to the benefit of the individual client and is payable as directed by the client.
In contrast to client fund accounts, a lawyer’s operating account is used to hold the lawyer’s earned fees and to pay the lawyer’s operating expenses. A lawyer must not deposit client funds to an operating account, or a personal checking or savings account. Additionally, it is recommended that a lawyer maintain separate business and personal accounts for the lawyer's own funds for clearer record- keeping.
The “conveyancing exception” to the IOLTA rule. There is one narrow exception to the requirement that client funds be deposited to either an IOLTA or individual interest-bearing client account. That exception is for conveyancing accounts, but only in certain limited circumstances. A conveyancing account is exempt from the IOLTA requirements under Mass. R. Prof. C., Rule 1.15(e) if it is an account “in a lending bank in the name of a lawyer representing the lending bank and used exclusively for depositing and disbursing funds in connection with that particular bank’s loan transactions, . . .” (emphasis added).
The rationale behind this exemption is that the interest earned will be retained by the banks making the loans. Note that the exception applies only to banks, not mortgage companies, although a mortgage company which is simply the mortgage arm of a bank would appear to qualify for the exemption.
As an example, a conveyancing account at Bank A does not have to be an IOLTA account if all the monies deposited to and disbursed from the account involve closings for Bank A. However, a closing for Bank B cannot be done from Bank A account unless the account at Bank A is an IOLTA account. Thus, if a lawyer does closings for several lending institutions from the same client account, the account must be an IOLTA account. It is only when closings are being done for the lending bank at which the account is maintained, and only for that lending bank, that the conveyancing exception applies.
Closings for mortgage companies, whether one mortgage company or multiple, must be done through an IOLTA account. As noted above, the only exception might be for closings being done for a mortgage company which is the mortgage arm of a bank. In that case, if the account is maintained at that same bank and only closings for that bank’s mortgage company are transacted through the account, an exempt conveyancing account could be established. In other words, an exempt account could be established at Bank C for closings for Bank C Mortgage Corporation only.
Even if the conveyancing exception is applicable, the rule provides that the lawyer is permitted to establish the account as an IOLTA account. Also, if the conveyancing account is not established as an IOLTA account, it should be a non-interest-bearing client account and not a NOW account or other account earning interest. Finally, the account in all circumstances must be properly denominated as an IOLTA account, conveyancing account, client trust account, or similar designation.
Note, conveyancers sometimes find themselves holding client funds for some period of time after the closing while title problems are resolved. The conveyancing exception is not applicable to this circumstance. Unless the parties direct otherwise, such funds should be moved to an individual interest-bearing client account. To the extent that the funds are retained in either an exempt conveyancing account or an IOLTA account in the expectation that the title will be quickly cleared, the lawyer must monitor the situation and transfer the funds to an individual interest-bearing escrow account when it becomes apparent that resolution of the problem will be delayed.
'Conveyancing Account’ Confusing
by Paul L. Levine, Esq. Lowell
To the Editor:
As most conveyancing attorneys know, it is mandatory as of Jan. 1 that lawyers establish interest-bearing IOLTA accounts for short-term client funds. However, there seems to be some confusion about the “conveyancing account” exemption, and what it involves.
After talking to several lawyers and hearing several versions of the rules, I decided to call the IOLTA Committee. I found that only a limited type of “conveyancing account” is exempt; the exemption does not apply to all accounts used for conveyancing.
The only accounts exempt from IOLTA are those conveyancing accounts “in a lending bank used exclusively for depositing and disbursing funds in connection with that bank’s loan transactions”.
In simple terms, an account in Bank A does not have to be an IOLTA account if all the monies put through the account involve closings with Bank A. However, a closing with Bank B cannot be put through an account with Bank A unless it is an IOLTA account.
It would seem that all conveyancers will need at least one IOLTA “conveyancing account” to handle any “miscellaneous” lenders with which they have no escrow account. But any current “conveyancing account” which is not interest bearing need not be changed so long as it is limited to closings with only that particular bank.
I hope this will help conveyancers as Jan. 1 approaches.
MLW, December, 1989
Questions about attorneys' fees generate more complaints to the Office of Bar Counsel than any other issue. The handling of "retainers" or "advanced fees" and whether they should be treated as clients funds seems to engender much confusion. The words "advanced fees" and "retainers" are used interchangeably throughout the profession.
An advanced fee or retainer is the payment of funds in advance to a lawyer for a particular service or for a particular case. Most retainers or advanced fees are payments to a lawyer to be earned as services are provided. In such cases, the funds belong to the client until they are earned through the services provided by the lawyers. C. Wolfram, Legal Ethics 505-506 (1986). Such advanced fees/retainers are always subject to refund if they are not earned.
Deposit of Retainers. Retainers or advanced fees as defined above, paid in advance for the handling of a particular case, are client funds and must be deposited to an interest-bearing account until earned by the lawyer. Mass. R. Prof. C., Rules 1.15 (d) and (e). Since the lawyer may not commingle personal funds with client funds [Mass. R. Prof. C., Rules 1.15 (a) and (d)], the lawyer must promptly withdraw the fee from the client funds account as it is earned.
Accounting to Client for Fees Earned. Mass. R. Prof. C., Rule 1.15 (a) requires lawyers to maintain complete records regarding the receipt, maintenance and disposition of client funds. Retainers/advanced fees fall within this category. In addition, the lawyer must render “a full accounting” to the client or third party, upon request, for the disposition of all funds. Although there is no set time limit for rendering bills, the prudent lawyer will do so on a regular, at least monthly, basis so that the client is aware of the disposition of the retainer and is apprised of the actual cost of the representation. If the client demands an accounting, it is expected that the lawyer will do so promptly.
Non-Refundable, Flat Fees. There are no fees that are not refundable. Bar Counsel will review whether a portion of the fee should be returned regardless of whether the attorney views the fee as non-refundable or flat. The fee may not interfere with the client’s right to discharge the attorney at any time. Mass. R. Prof. C., Rule 1.16 (d). In Smith v. Binder, 20 Mass. App. Ct. 21 (1985), the attorneys were paid a retainer of $8,500 for representation in a criminal case. Plaintiff-clients sued the attorneys for an accounting and refund three weeks later, after they had discharged the attorneys. Defendant-attorneys claimed the fee was non-refundable and asked the court to take judicial notice that “it is an accepted custom and practice among attorneys of the criminal bar that retainers taken in connection with representation of criminal defendants are non-refundable.” The trial judge granted a Rule 41 motion and found that plaintiffs knew the fee was non-refundable. Appeals Court reversed, finding no evidence to support that finding. In a footnote, the Appeals Court noted authority holding that requiring a client to agree to a non-refundable fee was unethical. In its opinion, the Appeals Court observed that the right to change lawyers at any time was “[e]ssential to the lawyer client relationship” and that, if the lawyer were permitted to keep the unearned portion of the fee, the “right to change lawyers would be of little value.”
There is one narrow exception to the "retainer" discussion. There is one type of retainer, known as a “classic” retainer, in which the client binds the attorney to employment to the exclusion of adverse parties. The retainer is seen as payment for the establishment of this exclusive relationship - not for specific, pending services required. The advantage to the client is in securing the services of the lawyer of choice over a period of time, whereas the lawyer foregoes the possibility of employment by others whose interest might be adverse to the client. The payment is in return for the attorney’s agreement to be bound to the client and is therefore “earned” when paid. Blair v. Columbian Fireproofing Co., 191 Mass. 333 (1906).
D. Depositing Funds into an IOLTA Account or a Separate Interest Bearing Account
Mass. R. Prof. C., Rule 1.15 provides that client funds must be placed in interest bearing accounts, the interest must be credited to the client’s account, or deposited in an IOLTA account for the benefit of legal services to the poor and the improvement of the administration of justice. Under Mass. R. Prof. C., Rule 1.15 (e), it is the lawyer’s responsibility to exercise good faith judgment in determining initially whether funds of a client are of such nominal amount or are expected to be held by the lawyer for such a short period of time that the funds should be placed in an IOLTA account. If the lawyer determines the amounts are not nominal or short term, the lawyer must establish a separate client fund account for the benefit of the individual client. In this case, the lawyer will need to obtain the client’s social security number or employer identification number to give to the bank so that the tax on any earned interest can be assigned to the client.
Although funds such as advances for costs and expenses are not required to be deposited in client fund accounts, the lawyer has the same accounting, record keeping, and payment responsibilities for these types of funds held in a general office account as for funds held in the client fund accounts. Advances for costs and expenses may be deposited in an IOLTA account.
The obvious question is how do you know when to use the pooled account where the interest is paid to the IOLTA Committee and when to use an account where the interest is paid to the client?
The Guideline to the Rule explains how to determine which account to use. The sole question that the lawyer must answer is whether the client funds “could be utilized to provide a positive net return to the client.” In deciding whether there will be a positive net return, the lawyer must consider (1) the amount of interest the funds would earn during the period they are to be deposited, (2) the cost of establishing and administering the account including a reasonable cost for the lawyer’s services and the cost of preparing the necessary tax reports, and (3) the capability and cost of the financial institution to calculate and pay the interest to the individual client.
There is no “bright line” by which a lawyer can know where to deposit the funds. Instituting procedures to make sure that this issue is considered and resolved when dealing with client funds will help you comply with the Massachusetts Rules of Professional Conduct, and avoid potential financial liability.
E. Deposits to Client Fund Accounts
1) Which Funds? All funds which qualify as client funds as defined, supra, must be deposited into a client fund account. The law firm should have a clearly expressed written policy, for all attorneys and staff, as to what funds are deposited into a client fund account.
2) When? Promptly. Deposit of client funds should be made daily.
3) Where? Under Mass. R. Prof. C., Rule 1.15 (e)(1) funds must be deposited in a bank, savings and loan association, or credit union authorized by Federal or State law to do business in Massachusetts and insured by the Federal Deposit Insurance Corporation or similar State insurance programs. The financial institution holding the account must have agreed to abide by the dishonored check rule, which became effective October 1, 1995. Client funds should not be deposited, hidden or concealed in the law office. All securities and properties of a client should be identified and labeled and promptly placed in a safe deposit box or other place of safekeeping as soon as practical. The same attentive care and precautionary procedures should be adopted for the receipt, holding and disbursement of these properties as is given to the safe maintenance of client accounts for client funds.
4) How? Sound accounting advice is never transmit money without written communication. A voucher or other documentation for receipt and instruction should be prepared by the attorney, instructing the person performing the bookkeeping function to deposit the funds into the client fund account on behalf of the client named in the voucher or receipt. Written communication avoids later arguments about what deposit instructions were and provides a needed audit trail.
5) Notify Client. Mass. R. Prof. C., Rule 1.15 (b)8 requires that clients be notified promptly of the receipt of their funds, securities, or other properties. The rule is particularly needed regarding funds received from third parties. Compliance avoids misunderstanding, mistakes and mistrust.
F. Disbursement of Client Funds
1) Timing. Before disbursement of client funds, the client’s or third party check should have cleared through the banking process. If this precaution is not taken, and the initially receipted check is returned for insufficient funds or a stop payment order is issued, the client funds of other clients will be disbursed wrongfully. Since even cashier checks and certified checks are occasionally dishonored, the best policy is to be assured that the initial receipts have cleared the banking process.
2) Amounts. Client fund disbursements from the client’s ledger must not exceed the funds received from or on behalf of that client. Otherwise, a wrongful taking of other client trust funds occurs, resulting in both civil and disciplinary liability. As a precautionary measure, both the person requesting the disbursement and the individual signing the check should have a copy of the particular client’s subsidiary ledger before requesting or authorizing the disbursement of trust funds.
3) Identify the Transaction. Again, built into the process, by either voucher request or other documentation, there should be a clear description of each disbursement, including the identity of the file to be charged and the reason for the transaction.
4) Signature. Who will sign trust checks is probably best left for each firm to decide. Generally, the person who prepares the checks should not have signatory authority. Regardless, no individual should sign a check unless presented with written documentation indicating that the disbursement is proper, principally that the original receipted funds have cleared the banking process, and that the client’s subsidiary ledger account contains adequate funds. Disbursement procedures should be clearly stated in established rules for the firm. Requiring two signatures for large check amounts is also recommended.
5) Internal Controls. Proper disbursement of client funds is greatly enhanced by a strong system of internal controls. Job functions should be structured to allow for an adequate segregation of all duties relating to the handling of client funds. For example, the reconciliation process should be performed by personnel who are not involved in the bookkeeping process, ideally by the lawyer or the firm administrator. Also, internal controls are weakened when the same person who prepares the check signs the check. Other important control procedures include: proper authorization, recording, and documentation of all client fund transactions, limited access to client fund accounts and client property, periodic independent verification of client accounting records, and sound personnel practices. Finally, no system of internal controls can function effectively without the active involvement of the attorney(s) responsible for the client funds. (Also, see recommended accounting procedures)
6) Interest of Third Parties. The trust and fiduciary obligations imposed by Mass. R. Prof. C., Rule 1.15(a) extend beyond the client to third parties who have an interest in the disposition of the funds. The rule applies to all clients’ funds accounts, including IOLTA, trust and escrow accounts. In addition, the rule pertains to any funds being held by a lawyer even if the lawyer is holding those funds in another capacity, such as a trustee or conservator for a family member or other person.
G. General
Accounting Procedures
1. Client Ledger: A separate page or card for each person or entity (usually a client) for whom monies have been received in trust showing the date received and the amount and dates of subsequent disbursements, and the unexpended balance. Balances should be kept current, and the client ledgers properly organized so that an accurate accounting of all client funds can be provided to clients upon request, and the monthly reconciliations performed. (EXHIBIT A)
2. Client Fund Account Receipts Journal: A cash receipts journal, or chronological record of all cash received, listing the source of all funds, the date received, the client’s name and a description of the associated activity. All client funds must be deposited promptly and intact. A duplicated deposit slip should be prepared and kept, showing sufficient detail to identify each item deposited. (EXHIBIT B)
3. Client Fund Account Disbursement Journal: Similar to the receipts journal described above, a chronological listing of each disbursement of client’s funds should be maintained, showing the date, check number, payee, client, and the amount of the disbursement. Cancelled checks should be retained to support the amounts shown as cash disbursements. All disbursements should be by check, not cash, and when possible, signed by the attorney familiar with the case and an independent co-signer. (EXHIBIT C)
4. Monthly Control Sheet: At the end of each month, the Trust Account Control Sheet should be prepared. The steps to do so are as follows: (EXHIBIT D)
a. Total the Client Fund Account Receipts Journal to determine the total amount of cash received during the month, and enter this figure under the “received” column for the appropriate month.
b. Follow the same steps for the Disbursements Journal and record the total amount of funds disbursed during the month.
c. Lastly, take the ending balance for the prior month, add the amount received, and subtract the amount disbursed to determine the current month’s ending balance. This ending balance will be used in the monthly reconciliation process.
5. Transaction Register: An accurate transaction register (i.e. "checkbook") should be maintained for each client funds account so that a consolidated record of account activity with a running balance is kept. The check register balance is also used in the monthly reconciliation process. (EXHIBIT E)
Note: In some circumstances, it may be acceptable to use just a check register to record the information found in the Receipts and Disbursements Journals. However, it may be difficult to record all the necessary information in all but the most sophisticated check registers. Also, the journals make it easier to total receipts and disbursements separately for the Control Sheet.
6. Bank Reconciliation: When the month end bank statements are received, a written reconciliation should be performed for the amounts shown in the bank statements, the Monthly Control Sheet, the total of the Client Ledgers, and finally the attorney's check register or transaction register. To arrive at the reconciled bank statement balance, a list of deposits in transit not shown on the bank statements, as well as any checks not yet cleared need to be included, as shown in the exhibit. All reconciliations should be saved with the bank statements, and if possible, performed by an independent person not involved in the client funds bookkeeping function. (EXHIBIT F)
7. Accounting to Clients: Periodically the lawyer should advise each client of the status of the client account. Adequate description should be provided indicating what receipts and disbursements have occurred and any unexpended balance. If the client should object to any proposed disbursement, for example for earned fees, then, pursuant to Mass. R. Prof. C., Rule 1.15(d)(2), those funds must remain in the client account pending the resolution of the dispute.
H. Dishonored
Check Notification Rule 9
Effective October 1, 1995, all financial institutions which want to qualify to handle attorney client fund accounts must agree to report all client fund account checks which are dishonored because of insufficient funds to the Board of Bar Overseers. A copy of the Dishonored Check Rule is included in the materials. In addition all lawyers who are notified of a dishonored check are required to provide the BBO with a written explanation of the reasons for the dishonored check.
The Board of Bar Overseers maintains a central registry of all banking institutions whose agreements to abide by the dishonored check rule have been approved. It is important to note that it is the attorney’s responsibility to ensure that the banking institutions he or she uses are those that have agreed to the rule. The bank in which the client fund account is maintained must provide dishonored check reports to the BBO. Such a notification must be generated whenever a check that would otherwise be properly payable is dishonored because of insufficient funds.
Once the BBO receives a dishonored check notice from a bank, a report is made and a file opened on the attorney. Bar Counsel then sends a letter to each attorney, requesting an explanation as to why the check was dishonored. If the check was dishonored because of a bank error, then the file may be expunged. If the BBO is satisfied with the attorney’s response as to why the check was dishonored, the file is closed and considered a grievance. If the BBO is not satisfied with an attorney’s explanation of why a check was dishonored, further investigation will be conducted into the attorney’s accounting methods and business practices.10
The experience with this rule indicates that there are several causes of dishonored checks that can be eliminated. The following steps will help you avoid this problem:
(1) Make sure that you have deposited the client funds and they have cleared the banking process before you disburse funds.
(2) Keep accurate deposit records in case there is ever a question of depositing to the correct account. Banks occasionally credit the wrong accounts of law firms, or otherwise inaccurately record transactions.
(3) Determine the amount and timing of service fees, especially the cost of check printing. It is permissible to maintain a minimal amount of attorney funds in the account to cover service charges, check charges and minimum balances. Treat these funds as a separate “client” and keep track of them on their own ledger. Deduct these charges from the account balance.
(4) Reconcile your account regularly so that mistakes do not multiply into a dishonored check.
(5) Find out how your bank handles the closing of accounts, and insure that all outstanding checks have cleared before closing a client fund account.