Show Me the Money (Trail): Keeping Up with the Dollars and Sense
LACBA Update, April 2010

By Lisa Miller, member, LACBA Professional Responsibility and Ethics Committee; a trustee and chair, Small Firm and General Practice Section, San Fernando Valley Bar Association; and a past chair, Solo and Small Firm Section, State Bar of California. She can be reached at (818) 802-1709 or Lisa@LMillerconsulting.com.

Attorneys sometime stumble over seemingly complex ethics rules regarding legal fees and firm finances. Here is a simplified list of seven ways to jeopardize a bar license (and how to avoid them).

1. Use Your Trust Account as the General Office Account.
See Rule of Professional Conduct 4-100(A).

Attorney Able maintains a trust account, as required by State Bar rules. The attorney deposits client-directed, or client-entrusted, funds into the account when received. But does counsel consistently manage the account in accordance with State Bar rules?

Using a client trust account as a general office account is one of the most common and serious mistakes a law firm can make. And this commingling can endanger the bar license of the responsible attorney.

In Arm v. State Bar, 50 Cal. 3d 763, 776-77 (1990), the California Supreme Court held that attorneys commingle trust account funds when they combine those funds with non-trust account funds. When this occurs, the separate identify of the client’s funds is lost because they are being used to fund the attorney’s personal expenses. As a consequence, the client’s money is subject to the claims of the attorney’s creditors. Id.

Best Practice Tip: Never use a client trust account for any purpose other than holding client-entrusted or client-directed funds. No exceptions.

2. Misappropriate Money from Your Client Trust Account.
See Rule of Professional Conduct 4-100(A).
See Business and Professions Code Sec. 6106.

Attorney Baker faithfully deposits client funds into the law firm’s client trust account. But instead of using the funds exclusively for client-related needs and expenses, Baker uses some of the funds for personal or law firm expenses. As a result, the amount held in trust for the client is greater than the balance in the trust account.

Although Baker does not believe that he has “misappropriated” anything, the imbalance in the account indicates otherwise. An attorney is entitled to take funds from the client trust account to pay the attorney’s fees, but the account must, at all times, have funds sufficient to cover the balance owed to all clients (not solely any one individual client).

According to the California Supreme Court, “willful misappropriation” occurs when the balance in the trust account falls below the amount held in trust for and due to the client(s). Chefsky v. State Bar, 36 Cal. 3d 116, 123 (1984). But note that funds in a client trust account are entirely fungible. No tracing of unique, individual client funds is contemplated, so an individual client’s dollar put into the trust account need not be the identical client dollar taken out.

Best Practice Tip: Never take funds from the client trust account for non-client-related reasons, or use one client's funds to pay expenses of another client.

3. Bounce a Check on the Client Trust Account.

Attorney Cook appropriately deposits checks from a client or settlement funds on behalf of a client into the client trust account. But Cook is distracted by the needs of the law practice and has no background in finance or accounting. As a result, Cook does not have an accurate idea of the balance in the trust account. Cook then writes a check on the account that exceeds the amount held in trust.

The bank is required to notify the State Bar in the case of an overdrawn client trust account, and the State Bar contacts the responsible attorney.

The client trust account must at all times have funds sufficient to cover the balance owed to all clients. Under Alkow v. State Bar, 38 Cal. 2d 257, 264 (1952), writing a nonsufficient funds check from a trust account is a serious breach of an attorney’s ethical obligations. This is explored in more depth in the State Bar Handbook on Client Trust Accounting at Key Concept number 2, "You Can't Spend What You Don't Have." This chapter makes clear that paying one client's expenses with another client's funds is improper.

This situation can occur when counsel receives insurance or other settlement funds in the form of a check and sends out payment checks before the deposited funds from the third party are fully credited in counsel’s trust account.

In this scenario, although the attorney tells the client not to negotiate the check for a few days, sometimes the client gets the check and fails to follow counsel’s instruction. As a result, when the client’s check is negotiated against insufficient funds in the client trust account, counsel has violated an ethical duty and is exposed to State Bar discipline.

Best Practice Tip: Have a professional manage the trust account if you do not have a background in finance or accounting. The investment is well worth the cost.

4. Use Self-Help to Resolve a Client Fee Dispute.

After attorney Dixon settles a case and deposits the settlement funds in the client trust account, the client objects to the amount that both the client and the attorney are to receive. Dixon, nonetheless, withdraws from the account the share to which she believes she is entitled.

Under Crooks v. State Bar, 3 Cal. 3d 246, 358 (1970), attorneys may not unilaterally determine what their fees are and then withhold client-entrusted funds to satisfy the amount. This is so even where counsel accurately values the services rendered. Silver v. State Bar, 13 Cal. 3d 134, 142 (1974).

As a practical matter, the attorney should pay to the client what the client is due, regardless of the fee dispute. Counsel may, with the client’s authorization, withdraw the funds that are not contested by the client. Disputed fees remain in the client trust account, and the attorney should take steps to resolve the dispute as quickly as possible.

Where disputes over the distribution of settlement funds exist, attorneys should either place the disputed funds in a blocked account or interplead the funds. (See also In the Matter of Feldsott (Rev. Dept. 19927) 3 Cal. State Bar Ct. Rptr. 754.)

Best Practice Tip: Conflicts over fees generally should be resolved through third parties rather than the use of self-help.

5. Fail to Refund Unearned Fees.
See Rule of Professional Conduct 3-700(D)(2).

A client gives attorney Evans checks against future charges pursuant to a retainer agreement. Evans deposits these sums into his client trust account, as required by Rule of Professional Conduct 4-100(A).

Subsequently, the client substitutes Evans out of the matter and brings in a second attorney. Funds for work that Evans had not yet performed remain in the trust account. But Evans does not promptly return those funds to the client.

Under Rule of Professional Conduct 3-700(D)(2), counsel is not entitled to withhold funds that belong to the client.

Note that true retainers, which are paid solely to ensure an attorney’s availability, never go into the client trust account, so they are not covered by this rule. Baranowski v. State Bar, 24 Cal. 3d 153, 164, n. 4. (1979).

Best Practice Tip: Immediately refund unearned sums from the client trust account at the conclusion of the representation, absent special circumstances.

6. Fail to Withdraw Earned Funds from the Client Trust Account.
See Rule of Professional Conduct 4-100(A).

A client has given checks for advance fees—payments of a retainer or advance against fees to be earned—to attorney Foster throughout the course of the representation. Foster has faithfully performed work on the client’s matter and dutifully deposited all the client-entrusted funds into the client trust account.

However, Foster has been focused on the case and failed to withdraw funds from the trust account as they were earned.

Counsel has an affirmative duty to withdraw funds from the client trust account as they are earned. Failure to do so results in funds present in the trust account that are subject to personal and creditor claims, violating counsel’s ethical duties not to commingle funds. In the Matter of Yagman (Review Dept. 1997) 3. Cal. State Bar Ct. Rptr. 788, 803.

Best Practice Tip: Withdraw earned fees from the trust account as they are earned.

7. Charge an Unconscionable (or Illegal) Fee.
See Rule of Professional Conduct 4-200(A).

A client retains attorney Green to represent him in a dispute over the sale of a five-year-old Ford automobile that is worth $4,000. The matter is resolved in two weeks before the case is filed. Green charges the client $20,000 for his services, which took about 10 hours to perform. The client objects to the amount of the final bill.

Even assuming that the retainer agreement between the client and the attorney contains language authorizing the amount of the final bill, the attorney may not charge the client an unconscionable fee. An unconscionable fee is one that is so exorbitant and wholly disproportionate to the services performed as to “shock the conscience.” Herrscher v. State Bar, 4 Cal. 2d 399, 401-02 (1935).

In another scenario, attorney Hunter represents a minor who was hurt in a car accident. Rather than have the court determine the amount of the attorney fee after the case is settled, Hunter takes one-third of the settlement funds as her own.

This fee is illegal because it is charged in violation of a statute. Family Code Section 6602 and Probate Code Section 3601 hold that the court has the authority to determine the “reasonableness” of attorney fees in a variety of contexts, including situations related to minors. (Code of Civil Procedure Sec. 1021.1, et seq; see also In the Matter of Phillips (Review Dept. 2001) 4. Cal. State Bar Ct. Rptr. 315 (an illegal fee is one charged in violation of a statute).)

Best Practice Tip: While counsel may, to some extent, independently set fees, counsel may never charge a fee so large that it shocks the conscience or that is contrary to statutory or other legal requirements.