Common Lawyer Trust Account Mistakes
Trust Account Mistakes That Lawyers Often Make
Mismanaging a trust account can have terrible consequences for a lawyer's career, sometimes even to the point of disbarment. Law schools do an abysmal job of training law students on how to handle Interest on Lawyer Trust Accounts (IOLTAs). Most attorneys receive little or no training on how to manage a trust account before opening one of their own.
How an IOLTA Account Works
Attorneys often receive retainer fees from clients when they mutually sign a retainer agreement that outlines the terms of the attorney's representation. That money is supposed to go into the lawyer's trust account. They're then entitled to pay that money out to themselves as they complete work for the client.
They might agree to represent Harry in a nasty divorce. Harry writes them a check for $10,000 retainer fee. The attorney deposits the money into their trust account, then spends an hour working on their new client's file. The attorney's hourly rate is $150. The attorney is then entitled to move $150 of that $10,000 from the trust account into his business account. They've earned it.
Meanwhile, $9,850 remains in the IOLTA account, and it's earning interest. That interest goes to fund a variety of legal services, typically for the poor, under the management and oversight of the IOLTA program.
Lawyers tend to make three common mistakes lawyers in managing these accounts.
"Borrowing" Money From the Account
There is no legitimate way to borrow from a trust account, but some attorneys try.
Sometimes attorneys use trust account funds before they have a right to do so. They might take trust account money before it's earned because they're having cash flow problems. They might not have completed billable work before some looming expense must be paid — payroll, office rent, or costs being advanced in a contingent fee case.
So they take more from the trust than they have a right to take at that point in time. An attorney "borrowing" these funds might have every intention of putting it back, but this kind of situation usually snowballs and ends very badly for the lawyer — as well as the client.
Sometimes either the attorney or someone with access to the trust account has reached a point of greed or desperation. Attorneys with substance abuse problems or gambling addictions can be particularly vulnerable to this type of mistake, but sometimes it happens for reasons that don't appear clear.
This trust account mistake is the one most likely to end a legal career when it's committed by a lawyer, but the lawyer is still the one on the hook for repaying the funds even if it's committed by a paralegal or a bookkeeper.
Commingling Attorney Funds With Client Money
A second major mistake often arises out of a lack of understanding about how a trust account is supposed to work.
Laura A. Calloway, a law practice management consultant at the Alabama State Bar, says:
"Many attorneys don't understand what does and does not go in the trust account. Some run everything, including earned fees, through the trust account, using it as a single general journal for their firms. Others take 'retainers' without understanding that, at least in some jurisdictions, there is no such thing as a non-refundable retainer. So they don't put a deposit against future work into trust as they should, particularly if they need it now to keep the lights on."
A lawyer might tell their client that the legal fees will be $1,000, and the court filing fee will be $200. The client writes the attorney a check for $1,200. Some attorneys will put the entire check into their business accounts because most of the money is going to the lawyer anyway.
But bar association rules require that the check must go into the trust account even if the attorney is entitled to the full attorney's fee immediately. The filing fee portion of that check has to be held in trust.
Some state bar associations prohibit attorneys from having any personal funds in a trust account while others allow attorneys to keep a small amount in the account to cover expenses related to operating the account. The recommended practice is to have all trust account fees deducted from the business account, but this doesn't always happen.
In no case is an attorney allowed to use a trust account as an operating account, a savings account, or a place to hide assets.
Sometimes lawyers fail to understand that they can't pay bills such as their office overhead expenses directly out of the trust account even when the checks are being written out of funds that have already been earned. Other times attorneys intentionally misuse the trust account as a way to hide assets.
Some attorneys use their trust accounts as rainy day funds. Rather than remove all the fees after they're earned, the attorney delays moving the money from the trust to reduce the risk of spending it. It is both a bad business practice as well as an ethics violation even though the state IOLTA fund might benefit from the extra interest earnings.
Failing to Properly Track Client Funds
The third major way that attorneys screw up their trust accounts is by failing to keep detailed records of each client's trust account transactions.
While most attorneys are good about keeping copies of their trust account checks, not all remember that they should note the client's name or file number on each check when it's issued. And while it might be easy to remember why a check was written a month ago, it might be difficult to remember a year from now.
And although it doesn't happen often, sometimes law offices and all their records get destroyed. A fire can incinerate those paper files pretty quickly as well as destroy the computer hard drive.
If a lawyer finds themselves in a position where they must reconstruct a firm's trust account records using bank statements and copies of old checks ordered from the bank, the task will be virtually impossible unless those checks indicate whose money was being used in each transaction.
Attorneys are required by their bar associations to keep records showing how much money each client has in trust at any given time. Deposits and disbursements must be clearly tracked in some way that makes it easy to determine each client's trust account balance. Otherwise, it would be quite easy to spend one client's money on another client's case.
Attorneys should make sure that their overall trust account is balanced at the end of the month, and they should also make sure that each client's account is balanced. Comparing the balances can reveal accounting errors. This simple step will sometimes catch errors that could have resulted in a bounced trust account check.
Some attorneys realize that their trust accounts are screwed up, but they don't know how to fix the problem. One solution is to contact a law practice management advisor. Many state bar associations now offer free law practice management advice to their members, and a number of private management advisors also offer their services for a fee.
Some lawyers might be afraid of discussing their trust account situation with a lawyer working for the state bar because of mandatory reporting requirements for ethics violations. But the rules of professional conduct in many states now specifically exclude law practice management consultants from reporting such problems to their ethics board.
Properly managing a trust account can be a hassle, but losing your license to practice over sloppy recordkeeping would be far worse. Lawyers who are having trouble managing their trust accounts should promptly address the problem by getting help from a qualified professional.