Don't Buy a Yacht with Client Trust Funds and Other Practical Reminders Concerning Client Funds and Property—By Elizabeth L. Bradley

Elizabeth L. Bradley is a partner in Rosen Saba, LLP, in Beverly Hills. She is a member of the LACBA Professional Responsibility and Ethics Committee. Her litigation practice focuses on legal malpractice, employment, civil rights and general business litigation matters. The opinions expressed herein are her own.

According to the State Bar's April 2018 Draft Annual Discipline Report for Year Ending December 31, 2017,[1] the Office of the Chief Trial Counsel (OCTC) received 15,175 new complaints in 2017. Of these, OCTC took 491 cases to trial or resolved them by stipulated disposition. As a result, the California Supreme Court disbarred 129 and suspended 134 attorneys in 2017. In addition, 52 attorneys were subject to reproval, resulting in a total of 315 attorneys subject to formal discipline in 2017.[2]

The California Legislature has declared that overdrafts and misappropriations from attorney trust accounts represent a serious problem.[3] The State Bar has characterized the issuance of NSF checks by an attorney or a member of his or her office staff as an early indicator of extremely serious misconduct.[4] Learning how to handle trust funds and client property correctly is critical to any practitioner.

Business and Professions Code Section 6091.1 was enacted to require financial institutions to promptly report to the State Bar in the event any check is presented against an attorney trust account containing insufficient funds, regardless of whether the check is honored. [5] In 2017, there were 1,918 such with respect to overdrafts from attorney trust accounts.[6] That significant number does not factor in trust account violations that do not result in an overdraft. Though the vast majority .of these were closed by OCTC without action, presumably after a satisfactory explanation was provided, 53 cases were filed in the State Bar Court.[7]

One of OCTC's 2017 "Prosecution Highlights" was a case which involved extremely serious misconduct related to the misuse of client funds. The lawyer was a 10-year practitioner who agreed to hold $1.2 million, representing proceeds from the sale of a home and investments, in trust for a client. Instead, she used the money for her own personal expenses, including the purchase of a yacht. She was found culpable of misappropriation and moral turpitude, and misleading OCTC during the investigation by claiming she had returned all funds to the client. She was disbarred.[8]

Far more common than cases involving dishonesty or theft are situations arising from a lawyer's inadvertence, inattention, or negligence, resulting in violations of disciplinary rules and statutes governing client trust accounts.          

Misappropriation does not necessarily mean theft; it could include mishandling. Though such violations are far less likely to lead to disciplinary action than theft or other intentional misconduct, serious care should be taken to avoid running afoul of these critical rules. Even inadvertent acts and omissions can result in actual injury to a client. Hiring a qualified bookkeeper or accountant who is familiar with the applicable rules can help to prevent mishaps, but always remember that your duties with respect to your client's money and property are nondelegable ethical responsibilities.

Rule 4-100 of the Rules of Professional Conduct provides the basic rules governing client trust accounts and client property, while Business and Professions Code sections 6211-6213 set forth your responsibilities with respect to Interest on Lawyers' Trust Accounts (IOLTA accounts).

Rule 4-100(A) requires that "[a]ll funds received or held for the benefit of clients by a member or law firm, including advances for costs and expenses," shall be deposited into a trust account.[9] The rule is designed to ensure that you are aware at all times of exactly how much money you are holding in trust for each client. Funds you receive that are required to be held in the client trust account include money that belongs to the client, money in which you and the client have a joint interest (e.g. settlement funds that include a contingency fee), money in which the client and a third party have a joint interest, and money that you are holding as part of your representation of the client, but that does not belong to the client, such as funds at issue in an action for interpleader. It bears repeating that these types of funds must be deposited into your client trust account.[10]

Rule 4-100 also identifies the types of funds that may and may not be held in the trust account. Commingling the lawyer's or the law firm's funds with client funds held in the trust account is expressly prohibited, with two limited exceptions provided for by the rule: Funds reasonably sufficient to pay bank charges and funds belonging in part to a client and in part presently or potentially to the lawyer or the law firm, such as advance fees. These are the only two types of funds where deposit into the client trust account is discretionary.[11] Although you are not required to deposit advance fees into the trust account, best practice would be to do so and to draw out the fees on a regular basis as you earn them.

If you are holding funds in your trust account that belong in part to a client and in part or potentially belong to you, you must promptly withdraw your portion once your interest becomes fixed, unless there is a dispute with the client as to any portion. This requires you to be diligent in transferring your earned fees out of the trust account promptly, in order to avoid improper commingling. Consider setting up a regular schedule to transfer earned fees out of the trust account to avoid commingling due to improper delay. In the case of a fee dispute, you may not withdraw the portion disputed by the client until the fee dispute is resolved.

You are also required to promptly notify the client when the client's funds are received, and to account to the client when asked to do so. It should go without saying that, upon request, you must promptly pay or deliver funds to the client to which the client is entitled.

Rule 4-100(C) requires detailed record keeping and accountings in conformance with the State Bar standards, including a client ledger, an account journal, bank statements and cancelled checks, a reconciliation, and a journal of nonmonetary property.[12] Also required is monthly reconciliation, or balancing, of client ledgers, account journals, and bank statements. You must record every client trust account transaction twice—in the client ledger and the account journal. This is where a qualified bookkeeper is worth the expense, as long as you oversee his or her work and to stay apprised of the status of the client trust account.

The State Bar publishes a thorough Handbook on Client Trust Accounting for California Attorneys (CTA handbook), available online at no charge.[13] The CTA handbook outlines key concepts related to the interpretation and application of Rule 4-100 and relevant provisions of the Business and Professions Code, along with in-depth discussions on various topics such as opening an IOLTA account, the differences between IOLTA and non-IOLTA trust accounts, depositing money into your client trust account, and paying money out of the client trust account. Specific examples and hypotheticals are provided. New attorneys and seasoned practitioners alike would benefit from reviewing this valuable resource.

The CTA handbook explains in detail client trust account record keeping and reconciliation requirements, and provides sample forms to assist you in meeting these requirements. It also provides a comprehensive list of legal resources addressing the complex legal issues related to handling client funds and other trust money or property.

Here are a few important reminders and practical pointers to keep in mind:

  • Make sure you bank at an FDIC insured institution that is knowledgeable about IOLTA accounts;
  • Comply with all rules and laws governing IOLTA accounts;
  • Only deposit funds into the client trust account as authorized by Rule 4-100(A);

  • Remember that advances for costs and expenses related to the representation must be deposited into the client trust account;

  • Only withdraw from a client trust account client costs and expenses (e.g. court filing fees or deposition transcript costs either to be paid directly to third-party vendors or to reimburse you for costs advanced on behalf of the client), disbursement of settlement proceeds, payment of earned and undisputed legal fees to yourself, and payment of bank charges (consistent with Rule 4-100(A)(1));

  • Do not withdraw funds on behalf of a client if you are not holding funds in trust for that client, or if the amount held in trust for that client is not sufficient to cover the withdrawal;

  • Don't help one client at the expense of another, such as by loaning one client's funds held in the client trust account to another client;

  • Quickly clear up any unexplained balances in the trust account;

  • For each trust account expenditure, track the client and matter on the instrument, in your record keeping, and on receipts;

  • Keep copies of the front and back of any executed drafts such as settlement drafts;

  • Keep trust accounting records for five years after you pay out the money the records refer to;

  • Promptly pay or deliver client funds upon request;

  • Promptly comply with any request for an accounting of client funds or property held in trust;

  • Never deposit personal or office money into the client trust account;

  • Don't use trust funds to pay yourself legal fees that the client is disputing; and

  • Don't borrow trust account funds or pay for personal expenses with trust account funds.

Keep Practice tips:

  • Know your bank's funds availability policies and procedures for deposits of local and out-of-state checks to avoid overdrafts;

  • Know your bank's policies regarding the timing of crediting deposits and processing debits;

  • Make sure funds deposited into the trust account have cleared before writing checks against those funds to avoid bouncing a check or using other clients' money to cover the check;

  • If a client gives you a check that includes both money to hold in trust and money not required to be placed in trust (such as a true retainer or earned fees), either ask for separate checks, or deposit the check into the trust account and transfer the non-trust funds as soon as the check clears and the money becomes available;

  • If receiving a wire transfer of funds where part or all of the funds must be held in trust, make sure to provide the wiring information for your client trust account, not your general account

  • If you accept payments by credit card, make sure your merchant is knowledgeable about client trust account issues;[14]

  • Proceed with caution if you choose to accept non-traditional forms of payment such as Bitcoin or other cryptocurrency, the value of which can fluctuate drastically;

  • Be wary of "instant credit" arrangements where the bank immediately credits your account for deposits while waiting for funds to clear, which could possibly constitute a loan to the attorney that is deposited into the trust account resulting in commingling;

  • Don't write trust account checks out to "cash" even if for a client expense, as it can be difficult to keep an audit trail for such transactions;

  • Don't have an ATM or debit card associated with your client trust account;

  • Consider obtaining overdraft protection as long as it does not create a commingling problem; [15]

  • Don't fall behind with monthly reconciliations required by Rule 4-100(C), including balancing of bank statements, client ledgers and the account journal;

Keep in mind that Rule 4-100 does not only apply to client trust accounts. You also must promptly identify and label a client's securities and property, place them in a safe deposit box or other safe place as soon as practicable, and maintain records. For example, if you take on a new litigation matter and the client gives you possession of the Best Actor Oscar that Marlon Brando refused in 1973 for his performance in The Godfather, which is the subject of the dispute, should you: a) take the award home to "safe-keep" it on your mantle; b) take selfies with it while dining out and post the photos on social media, identifying your location in real time; c) keep it in your office desk drawer so you can privately show it to friends and clients; or d) immediately place it in a safe deposit box in your bank? As tempting as a), b) and c) may be, of course d) is the correct answer. Remember that a violation of Rule 4-100 can in some instances also constitute a breach of an attorney's fiduciary duties owed to a client.

It is also worth the investment of time to become familiar with new Rule of Professional Conduct 1.15, recently approved by the California Supreme Court to take effect on November 1, 2018. [16] While similar to existing rule 4-100 in many respects, the proposed rule has many new provisions, such as the handling of flat fees paid in advance, and the expansion of the rule's application beyond funds held for the benefit of a client, to funds held for other persons to whom the lawyer owes a contractual, statutory, or other duty. The current rule remains in effect until Rule 1.15 goes into effect.

[1] State Bar of California Draft Annual Discipline Report for Year Ending December 31, 2017 (ADR).

[2] ADR at pp. xi-xii.

[3] Bus. & Prof. Code § 6091.1.

[4] ADR, at Appendix F-1.

[5] Bus. & Prof. Code § 6091.1, subdiv.(a).

[6] ADR, supra, at 17-18.

[7] Id., at 21.

[8] Id., at xi


[9] Rule 4-100(A) Preserving Identity of Funds and Property of a Client.

[10] Be cognizant of the fiduciary duties an attorney undertakes on behalf of a non-client third party by holding their funds in the attorney's client trust account.

[11] Rule 4-100 does not apply to a "true retainer" paid to ensure your availability to the client, because those fees are earned upon receipt.

[12] Rule 4-100, Standards.

[13] The Handbook on Client Trust Accounting for California Lawyers is a practical guide created to assist attorneys in complying with record keeping standards for client trust accounts. The handbook includes a copy of the standards and statutes relating to an attorney's trust accounting requirements, a step-by-step description of how to maintain a client trust account, an index of selected cases and opinions by topic, and sample forms.

[14] Although you may accept credit card payments, you may not sign a credit card agreement that allows the credit card processor to reach back into your client trust account and hold, freeze, or pull back client funds from the trust account in the event a dispute with the client. Make sure your credit card processor or service provider understands lawyers and lawyer trust accounts, and know your merchant's policies regarding reversing disputed charges to ensure you do not unwittingly place other clients' funds in your trust account at risk. See State Bar of California Standing Committee on Professional Responsibility and Conduct Form. Op. No. 2007-172 regarding the use of credit card payments as to fee retainers, cost retainer and earned fees. See also, Feb. 2015, California Young Lawyers Assn. publication, Understanding Attorney Trust Accounts with Robert Hawley.

[15] See State Bar Form. Op. No. 2005-169, and discussion in the CTA handbook, at p. 10.

[16] See Rule of Prof'l Conduct R.1.15, approved by the Cal. Supreme Court on May 10, 2018, to take effect Nov. 1, 2018. The current rules remain in effect until then.