Who Do You Trust…with Client Trust Funds?
LACBA Update, October 2008

By Joan Mack, member, LACBA Professional Responsibility and Ethics Committee, and Tina Wong, both of Caldwell Leslie & Proctor, PC, www.caldwell-leslie.com. The opinions expressed are their own.

In the wake of IndyMac Bank’s collapse—reportedly the second largest bank failure in U.S. history—attorneys are facing unsettling questions: What happens if a failed bank holds your client’s trust money? Even worse, what happens if a client has more than the FDIC-insured amount of $100,000 in the bank? 

Because attorneys have a nondelegable, personal fiduciary responsibility to account for monies held in trust for a client, bank failures raise the specter of legal malpractice suits, fee disputes, disciplinary actions, and even personal monetary liability. The problem is not a new one. For years, the State Bar of California has advised attorneys to keep client trust accounts in financially stable banks: “This isn’t a rule; it’s common sense. As your clients’ fiduciary, if the bank you’ve put their money in goes under, you’re in for some trouble.” California State Bar, Handbook on Client Trust Accounting for California Attorneys 9 (2006). With the stunning collapses of IndyMac, Lehman Brothers, and AIG, and rumors of more bank failures to come, however, common sense might not be enough. 

Here are a few things to keep in mind:

  • Client trust accounts must be maintained in FDIC-insured banks. The FDIC insures only $100,000 per client. This limit includes all the client’s deposits at the bank, so if an attorney holds $80,000 for a client in a trust account and the client holds $40,000 in a savings account at the same bank, then only $100,000 of the $120,000 is covered by FDIC insurance.
  • FDIC insures $100,000 per client per bank. If you are holding more than $100,000 for a client, the funds should be spread among multiple banks. An attorney holding $500,000 for a client, for example, should deposit those funds in five different FDIC-insured banks. A rule of reason applies, of course. If the funds will be held for a short time or if the total amount will exceed $100,000 for only a few days, then it may be impractical to spread deposits across multiple banks.
  • Client funds that “are nominal in amount” or held “for a short period of time” must be deposited in common client trust accounts known as Interest on Lawyers Trust Accounts or “IOLTA accounts.” Bus. & Prof. Code §6211(a). Interest and dividend earned on IOLTA accounts are paid to the State Bar for the Legal Services Trust Fund Program. IOLTA accounts are fiduciary accounts for FDIC insurance purposes, so each client is insured up to $100,000. For this to be true, however, the FDIC must be able to ascertain the amount belonging to each client from bank records “or from records maintained, in good faith and in the regular course of business” by the depositing attorney or by a third-party that has undertaken to maintain such records for the attorney. 12 C.F.R. §330.5(b)(2).
  • As with client trust accounts, monies held in IOLTA accounts are aggregated with the client’s other deposits in the same bank. For example, if a client has $80,000 in a client trust account, $10,000 in an IOLTA account, and $30,000 in a savings account in the same bank, then FDIC insurance will cover only $100,000 of the $120,000.
  • Under Rule 4-100(C) of the California Rules of Professional Conduct, attorneys must retain client trust bank account statements and cancelled checks for five years. Do not assume that you can always retrieve records from your bank. If the bank collapses, records may be difficult or impossible to obtain. 

Even with the protection offered by FDIC insurance, substantial headaches could arise if a bank goes under. The FDIC is obligated to pay insured depositors “as soon as possible” after a bank collapses (12 U.S.C. §1821(f)(1)), but there is no upper limit to how long the process can take. According to the FDIC, the agency historically has paid insurance “within a few days after a bank closing,” but the process often takes longer with IOLTA accounts because the agency must review records to establish each client’s interest in the account. By the time the FDIC pays a client, the client may have lost a substantial business opportunity. 

The best way to avoid these headaches, of course, is to do everything possible to ensure that client money is kept in financially stable banks. Attorneys should periodically research the financial soundness of banks holding their clients’ money. A good resource is Veribanc, a bank rating company that rates the safety and soundness of every financial institution in the country. Anyone can order individual bank reports or summaries of every bank in a particular state through the Veribanc Web site at www.veribanc.com.

Proper research also helps insulate attorneys against claims that they acted negligently in placing their clients’ money in financially unsafe banks. An attorney’s ability to foresee a bank’s demise was the crux of the only case to address this issue to date: Bazinet v. Kluge, 14 A.D.3d 324 (2005). The New York Appellate Division in Bazinet held that an attorney was not liable for legal malpractice when, while acting as an escrow agent in a real estate transaction, he placed $2.73 million of escrowed funds in a bank that went under. The court dismissed the suit because there was no legal requirement that the escrow funds be placed in an account fully insured by the FDIC, and the complaint contained no allegations that the lawyer knew of the bank’s financial instability. Id. at 325. 

That’s a shakier proposition these days, with rumors of cascading bank failures rumbling through Wall Street. The fact that further bank failures are all but certain makes it imperative that attorneys properly research their bank’s financial soundness and take precautions to ensure that all their clients’ funds are covered by FDIC insurance.