Are Client Protection Funds Fulfilling Their Purpose?

Are Clients More Secure? Is the Integrity of the Profession Preserved?

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I’m not sure what it says about the reputation of lawyers that client protection funds exist to reimburse clients whose attorneys have committed the intriguingly named sin of defalcation. On any given day, I tend to feel more ripped off by the people who change my car’s oil or the deli guy who seems to be just making up prices for sandwiches than I do by any legal counsel operating in my periphery.

The thing with lawyers, though, is that when they’re holding for clients, they tend to be holding much more than lunch money. When the embezzling happens to be high-end, it is called defalcation. More precisely, defalcation is the inappropriate taking of money by one who happens to be in control of it but to whom the money does not belong.

Client Protection Funds Versus Lawyer Trust Accounts

Client protection funds are not the same as lawyer trust accounts (or client trust accounts), where lawyers deposit money belonging to clients. The funds in lawyer trust accounts are the client's, not the lawyer's or the law firm's money. Nevertheless, the lawyer may make withdrawals from these accounts when fees are earned and to pay client costs. If a lawyer starts dipping inappropriately into a client trust account, though, that client may eventually have to try to get reimbursed from his state's client protection fund.

The American Bar Association has published Model Rules for Lawyers' Funds for Client Protection.

How Client Protection Funds Operate   

A client protection fund may also be known as a lawyers’ fund for client protection or as a client security trust fund. A client protection fund is money, typically provided by lawyers via assessments (but also by voluntary donations and by legislative appropriation), to reimburse claimants for losses due to theft of their own money by their own lawyers.

 In other words, client protection funds are victim compensation funds. Client protection funds, generally administered by a committee of volunteer lawyers, can have annual payouts in the millions of dollars. That is reflective of a fair amount of pilfering by those who are supposed to be trustworthy with money.

Think, after all, of all the ways a lawyer can come to control vast sums of a client's money: through retainers, of course, but also when settlement checks come in, or when money for real estate transactions is held in escrow, or when a decedent's estate is being settled. A lawyer is obligated to deposit a client's money into a lawyer trust account.

Unfortunately, not all lawyers are honest. The temptation to dip into client funds for inappropriate reasons can be strong, especially if a lawyer or a firm is experiencing cash-flow problems or a slowdown in business. See, e.g., Martha Neil, Tearful runaway real estate lawyer gets 5 years in $5.9M client theft, ABA Journal (Mar. 19, 2014); Clifford Ward, Disbarred attorney sentenced for theft, Chicago Tribune (Apr. 6, 2013).

How Much Can a Duped Client Get Back?

Not every client can be reimbursed for every wrong. For specifics, ripped-off clients should check with the client protection fund in their state.

There may be ceilings on the amount of an advance that can be returned, caps on the amount of misappropriated (or, shall we say, defalcated) money that a wronged client can be reimbursed, restrictions on the status of the lawyer involved (who often must be disbarred, suspended, otherwise disciplined, or dead), and limits on the type of client that can seek redress (individuals typically, or small businesses; larger organizations are deemed to be capable of protecting themselves).

Spouses, law partners, and conspirators with the wrong-doing lawyer typically cannot submit claims for reimbursement. There generally must have been a lawyer-client relationship or the lawyer must have been acting in a fiduciary capacity with respect to the claimant.

There may be restrictions on the percentage of the net fund balance that can be paid to a single claimant.

Even approved claims might be paid proportionally (pro rata) or even deferred if a protection fund itself does not have enough money to pay all claims. There may be a requirement that all other remedies must have been exhausted, and there are limits on the time period in which such claims against protection funds may be made. These constraints both make sense and paint a scarier bigger picture: plenty of money is paid out through client protection funds each year, but the limitations on these reimbursements seem to imply that even more amounts are being stolen. It’s an interesting point to note about a system that was actually designed to foster greater confidence in the legal profession.

The first client protection fund in the United States was established in Vermont in 1959. Other client protection funds started to be created in the 1960s at about the moment that law firms themselves were transitioning from small operations with billing systems that can only be described as casual to the large firms with multiple offices that exist today. Today, every U.S. jurisdiction has a client protection fund. 

The Process for Reimbursement

Of course, wronged clients don’t just petition protection funds and get a check cut to them quickly. After the client files a form and provides supporting documentation, there’s an investigation, and, for the lawyer involved, there’s likely to be a bit of professional trouble, in the form of professional discipline, likely of the more severe kind. The out-of-money claimant will have to await the results of the investigation. To qualify for reimbursement, a claimant generally must have had an attorney-client relationship or a fiduciary relationship with a member of the bar. Payments are deemed discretionary, or a matter of grace rather than a matter of right.

A claimant might seek reconsideration of a denied claim and may have the right to judicial review of any final decision denying the claim. Even so, funds are not acting as collection agencies for clients and are not a forum for resolving fee disputes. Client protection funds do not reimburse for run-of-the-mill wrongs like malpractice and negligence. As for a lawyer’s stupidity or laziness? Well, that sometimes looks a whole lot like deliberate defalcation. As does sheer greed. Dipping into a client’s funds inappropriately is, after all, theft. If a lawyer has made off with a client’s funds out of laziness, stupidity, or criminality, the result is the same: The money is gone, and the wronged client would like to get his money back.

Clients generally are required to subrogate their claims against the wrong-doing lawyer to the client protection fund.

Why Should Honest Lawyers Care about Client Protection Funds?

It can be easy for a lawyer to pay her annual assessment to her state’s client protection fund — simply rationalized as a cost of doing business in the state — and think little more of it. Inactive lawyers and retired ones usually do not have to pay into the client protection funds, but, again, requirements vary by state.

You might give some thought to whether and what extent your firm might be liable for one of its own defalcating lawyers, should a client protection fund have to make a payment to a wronged client. If you happen to be a lawyer who has been a bit too cavalier with client funds, that your state’s own client protection fund did not have to make a payout due to your recklessness might be a mitigating factor in any disciplinary hearing. But if you happen to have been disbarred, you may have to repay your state’s client protection fund the money it reimbursed to your clients for your defalcation before you can be reinstated to the bar.

Lawyers seeking to preserve the general well-being of the legal industry might take note of how much money the client protection funds in their state are taking in, how much they’re paying out, hose those funds are generated, and who might be interested in them. In 2009, the Connecticut General Assembly tried to access the state’s client security fund and take $2 million from it to make up for a budget shortfall. The Connecticut bar fought the move, and the governor later signed a bill into law that prevents the state legislature from taking such actions.

Fostering the Profession or Perpetuating a Negative Image of Lawyers?

Even as client protection funds are geared toward protecting hapless clients, these funds, merely by their existence, seem to perpetuate a certain cynicism regarding lawyers and reinforce the notion that attorneys are so conniving that their very own customers need special protection. Of course, the fact that the extent of payouts, limited as they are, may not be reflective of the extent of lawyers’ actual misdeeds is just a bit frightening.

At the same time, that the legal industry is not, in fact, letting its own buyers beware oddly enough is sort of insulting to clients and their intelligence. The process of obtaining and understanding legal advice is not incomprehensible. And yet, clients are still duped sometimes. And their lawyers are sometimes the ones stealing from them, which is why, of course, client protection funds still exist.