IOLTA accounts will not put your firm at risk, but the improper use of them may. Let me explain why. The current credit crunch has caused 90 banks to be placed on the watch list of the FDIC. Several banks have already failed. The names of these banks are not public information. This does not mean that these banks are going to fail, it only means the FDIC is concerned about them. Even if your IOLTA account is in one of these banks and the client and the amount is less than $100,000 your firm is safe. If your firm has over the FDIC limit in an IOLTA account your firm is at risk should the depository bank fail.
Rule 4 of TAJF (THE TEXAS ACCESS TO JUSTICE FOUNDATION) requires client money to be placed in an IOLTA account, but only if the amount is nominal or for short a period of time so that the client would not realize any interest on that money. The Texas Supreme Court created the THE TEXAS ACCESS TO JUSTICE FOUNDATION to administer IOLTA accounts and as a depository for the funds collected. The funds collected are used to provide attorneys for the poor. The justification for the accounts is that prior practice had required attorneys to deposit each client’s funds in demand accounts. When the amount was small or for only a short duration, this meant a noninterest bearing accounts, because banks were not permitted to pay interest on demand deposits. This resulted in a windfall for the banks. A change in banking rules that permitted them to pay interest on demand deposits (NOW accounts) created the opportunity for the creation to IOLTA accounts.
The constitutionality of IOLTA accounts was raised in PHILLIPS v. WASHINGTON LEGAL FOUNDATION (fn1). This case established that the interest on money earned in client accounts was the property of the client. The constitutionality of these accounts was established by BROWN v. LEGAL FOUNDATION OF WASH. (fn2) This case is important to lawyers, because it establishes that if a mistake is made by placing funds which could have earned interest the loss falls on the lawyer stating:
If petitioners' money could have generated net income, the LPOs violated the court's Rules, and any net loss was the consequence of the LPOs' incorrect private decisions rather than state action. Such mistakes may give petitioners a valid claim against the LPOs, but would provide no support for a compensation claim against the State or respondents.
State Bar Rules seem to free an attorney from any liability if unqualified funds are placed in an IOLTA account.(fn 3) This is not a safe harbor. It is qualified by the words “in good faith”. Since a loss would occur if the amount deposited is over $250,000, it would be a stretch to say the deposit was a nominal amount. It is doubtful if the court can by rule change the legal liability of an attorney to his client for misplacement of the clients funds. Further, the first sentence of the rule states that it does not change the obligations for amounts that are not IOLTA qualified.
The Texas Disciplinary Rules of Professional Conduct, Rule 1.14 (a) (fn 4) set out the requirements for selecting a depository for client funds. Client funds must be separate from the lawyer's; held in an account called a “trust” of “escrow” account, maintained in account in the state of residence of the lawyer or elseware with the client’s consent; complete records must be maintained and retained for five years.It is possible to FDIC insure deposits against loss for amounts in excess of $250,000 by creating a CDAR account. These accounts allow the depository bank to spread a deposit in excess of $250,000 among several FDIC insured banks. Note Rule 1.14 requires that the account must be in the state of residence of the attorney or in a state consented to by the client. Rule 1.14 does not require that the funds be placed in a demand account. The rules of CDAR accounts require the funds be left on deposit for 30 days. If the use of the CDAR account is spelled out in the contract with the attorney, then the element of consent will not be overlooked when the account is used.
Assume that your bank does not fail, the amount is less than $250,000 and is IOLTA elgible, your firm is still at some risk. The funds are still subject to theft by illegal withdrawels from the account. The rules for reporting such theft to the bank must be strictly followed. One hapless lawyer notified his bank of the theft more than 30 days after he received his bank statement and then failed to complete the fraudulent activity affidavits properly. For those of you who believe than banks have an obligation to check signatures on your checks, think again. You are required to report any unauthorized activity 30 days from when you get your bank statement. Although the amount of money is not usually substantial, if an attorney places money in an IOLTA account that is not IOLTA qualified, the attorney is liable to the client for the loss of interest.
There are risks in handling other people’s money. I hope this little article either reduces your firm’s risk or at least makes you aware of the risks you are taking.
Ben A. Goff, Attorney
Benjamin A. Goff, President, Professional Services Division, Access 1st Capital Bank
214 646 8733
fn 1. 524 U.S. 156 (1998) This case arose out of an action brought to determine it IOLTA accounts amounted to a “taking” under the Fifth Amendment of the Constitution. WASHINGTON LEGAL FOUND. v. TEXAS EQUAL ACCESS, 94 F.3d 996 (5th Cir. 1996). The Fifth had overturned a summary judgment in favor of TEA. The U. S. Supreme court affirmed. The Fifth Circuit remanded the case to determine if there had been a “taking” and if the petitioners were entitled to just compensation. The trial court found there was no “taking” and the petitioners were not entitled to compensation essentially because the client’s money would have earned no net interest. Again the Fifth circuit reversed finding there had been a “taking” and that the petitioners were entitled to just compensation. WA. LEGAL FOUND. v. TX. EQ. ACCESS TO JUSTICE, 270 F.3d 180 (5th Cir. 2001).
fn 2. 538 U.S. 216 (2003) Although the petitioners were not fully licensed attorneys, the same rationale would seem applicable to attorneys. This case effectively overruled Wa. Legal Foundation.
Fn. 3. STATE BAR RULES, ARTICLE XI. INTEREST EARNED ON CLIENT FUNDS HELD BY ATTORNEYS, SECTION 7. ATTORNEY LIABILITY:
Nothing in this Article affects the obligations of attorneys, law firms, or professional corporations engaged in the practice of law with respect to client funds other than client funds reasonably determined to be "nominal in amount" or reasonably anticipated to be held for a "short period of time," as those terms are defined by the rules adopted by this Court. An attorney, law firm, or professional corporation is not liable in determining which funds are nominal in amount or on deposit for a short period of time if the determination is made in good faith in accordance with the rules.
Fn. 4. STATE BAR RULES , ARTICLE X. DISCIPLINE AND SUSPENSION OF MEMBERS, SECTION 9. TEXAS DISCIPLINARY RULES OF PROFESSIONAL CONDUCT, I. CLIENT-LAWYER RELATIONSHIP, RULE 1.14 SAFEKEEPING PROPERTY
(a) A lawyer shall hold funds and other property belonging in whole or in part to clients or third persons that are in a lawyer's possession in connection with a representation separate from the lawyer's own property. Such funds shall be kept in a separate account, designated as a "trust" or "escrow" account, maintained in the state where the lawyer's office is situated, or elsewhere with the consent of the client or third person. Other client property shall be identified as such and appropriately safeguarded. Complete records of such account funds and other property shall be kept by the lawyer and shall be preserved for a period of five years after termination of the representation.
(b) Upon receiving funds or other property in which a client or third person has an interest, a lawyer shall promptly notify the client or third person. Except as stated in this rule or otherwise permitted by law or by agreement with the client, a lawyer shall promptly deliver to the client or third person any funds or other property that the client or third person is entitled to receive and, upon request by the client or third person, shall promptly render a full accounting regarding such property.
RULES GOVERNING THE OPERATION OF THE TEXAS ACCESS TO JUSTICE FOUNDATION
SECTION 5. DEPOSIT OF CERTAIN CLIENT FUNDS
(A) An attorney, law firm, or professional corporation engaged in the
practice of law, receiving in the course of the practice of law in this
state, client funds that are nominal in amount or are reasonably
anticipated to be. held for a short period of time, shall establish and
maintain a separate interest-bearing demand account at a financial
institution and shall deposit in the account all those client funds. All
the client funds may be deposited in a single unsegregated account. The
interest earned on the account shall be paid in accordance with and used
for the purposes set forth in this Article and the rules adopted by this
Court. Funds to be deposited under this article do not include those
funds evidenced by a financial institution instrument, such as a draft,
until the instrument is fully credited to the financial institution in
which the account is maintained.
(B) This Article does not prohibit an attorney, law firm, or
professional corporation engaged in the practice of law from establishing
one or more interest-bearing accounts or other investments permitted by
the Texas Code of Professional Responsibility (Article X, Section 9,
State Bar Rules sic this section has been repealed) with the interest or dividends earned on the accounts or
investments payable as directed by clients for whom funds are not
deposited in accordance with Subsection (A) of this section.
(C) An attorney, law firm, or professional corporation engaged in the
practice of law which maintains accounts provided for in this Section 5
must so advise the nonprofit corporation in writing within thirty (30)
days of the establishment of such account or accounts.
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