Common Lawyer Trust Account Mistakes
Attorney trust account mistakes that lawyers shouldn't make
Mismanaging a trust account can have terrible consequences on a lawyer's career, even sometimes to the point of disbarment. Yet law schools do an abysmal job of training law students on how to handle an IOLTA trust account. Outside of discussing the subject at a theoretical level one day in a law school ethics class, most attorneys receive little or no training on how to manage a trust account before opening one of their own.
While there are many ways that trust accounts are mismanaged, there are three common mistakes lawyers make in managing their IOLTA accounts.
"Borrowing" Money From the Trust Account
There is no legitimate way to borrow from a trust account. Sometimes attorneys use trust account funds before they have a right to do so, while in other situations they use funds that they would never acquire the right to use. Either approach opens the door for the lawyer to get into serious trouble.
There are three ways that improper borrowing from the trust account occurs:
The Attorney Takes Trust Account Money Before It Is Earned
This often happens when an attorney is having cash flow problems. In this situation, the attorney has received a retainer that he has (hopefully) placed in the trust account, and the attorney will be entitled to pay that money out to himself or herself as the work is completed. However, the attorney won't have the work completed before some looming expense must be paid - payroll, office rent, costs being advanced in a contingent fee case, etc.
So the attorney goes ahead and takes more from trust than he or she actually has a right to take from the trust account at that point in the case.
The Attorney Borrows Money From Client Funds With the Intention of Putting It Back
When cash flow issues escalate into more severe financial problems, and the attorney has thousands of dollars in client funds sitting in a trust account, some may succumb to the temptation to borrow money from the trust account to stay afloat.
The attorney may rationalize it by thinking that if he can't pay the office bills then he can't stay in business, and if he can't stay in business, he can't take care of his clients. So he takes a little money from the trust account just to hold him over until his cash flow improves. The attorney may have every intention of replacing the funds as soon as possible, but this kind of situation usually snowballs and ends very badly for the lawyer - as well as the client.
Trust Account Theft
This situation really can't be called borrowing, and it is not referring to the scams perpetrated on law firms. In the in-house trust account theft situation, either the attorney or someone with access to the trust account has reached the point of greed or desperation that they simply decide to take money that is not theirs. Attorneys with substance abuse problems or gambling addictions can be particularly vulnerable to this mistake, but other times it happens for reasons that don't appear clear. If committed by a lawyer, this trust account mistake is the one most likely to end a legal career. But even if it is committed by a paralegal or a bookkeeper, the lawyer is still the one on the hook for repaying the funds.
Commingling Attorney Funds With Client Money
A second major mistake in attorney trust account management involves commingling attorney funds with client money. This often arises out of a lack of understanding how a trust account is supposed to work.
Laura A. Calloway, a law practice management consultant at the Alabama State Bar, said, "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 such as Alabama, 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."
Some of the common ways attorneys commingle their money with client funds include:
One Check for Two Purposes
A lawyer tells the client that the legal fees will be $1,000 and the court filing fee will be $200, so the client writes the attorney a check for $1,200. Some attorneys will put the entire check into the business account because most the money is going to the lawyer anyway. However, bar association rules require that the check goes into the trust account, even if the attorney is entitled to the full attorney's fee immediately because the filing fee portion of that check has to be held in trust.
Personal Funds Kept in Trust With Client Funds
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 (though the recommended practice is to have all trust account fees deducted from the business account). But nowhere is an attorney allowed to use a trust account as an operating account, a savings account, or a place to hide assets.
Sometimes lawyers simply 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. For example, Calloway says she has seen lawyers put personal funds into the trust account to avoid an IRS levy for back taxes. It is an obvious ethics violation.
Not Removing Earned Fees or Reimbursements From the Trust Account
Calloway says she has seen some attorneys who used their trust account as a rainy day savings account. Rather than remove all of the fees after they have been earned, the attorney delays removing the money from the trust to reduce the risk of spending it. Calloway says this is both a bad business practice as well as an ethics violation. While the state IOLTA fund may benefit from the extra interest earnings, the lawyer should be moving that money to the business operating account or some kind of savings fund.
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. There are several ways that attorneys make this mistake.
Not Putting the Client Name on Trust Account Checks
While most attorneys are good about keeping copies of their trust account checks, not all remember that they should notate the client's name or file number on each check when it is issued. While it may be easy to remember why a check was written a month ago, it may be difficult to remember why it was written a year from now.
Attorneys who think that they would never have a problem figuring out what is in their trust accounts should consider the impact of catastrophic events or natural disasters. While it doesn't happen that often, sometimes law offices and all of their records get destroyed. A fire can incinerate those paper files pretty quickly, as well as destroy the computer hard drive. A hurricane or a tornado can scatter billing records for miles. These things happen to lawyers. If a lawyer needs to 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 the transaction.
Not Keeping an Individual Ledger for Each Client
Sometimes attorneys think they can keep track of every client's account balance in their heads. At some point, they can't. And even if they can, what happens to those client accounts if something happens to the attorney?
Calloway described a situation she encountered where an attorney kept two trust accounts. He would use one trust account for one month, and switch to the other trust account the next month. His belief was that by letting each account reach a zero balance during the month it was used, he would not have to keep individual trust ledgers on the money that remained in the account. He was mistaken. Ethics rules require keeping a balance sheet on each client so that specific client funds can be identified.
To be in compliance with bar association requirements, the attorneys must keep records showing how much money every 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 for one client's money to get spent on another client's case.
Not Balancing the Individual Client Balances Against the Overall Account
Attorneys should not just make sure their overall trust account is balanced at the end of the month, nor should they only make sure that each individual client account is balanced. Compare the two together and balance them against each other. Comparing the overall balances will sometimes reveal an accounting error made on an individual account, where a check or a deposit was overlooked. This simple step will sometimes catch errors that could have resulted in a bounced trust account check.
Some attorneys realize 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 bar association members, and a number of private law practice management advisors also offer their services for a fee.
Some lawyers may be afraid of discussing their trust account situation with any attorney, especially with a lawyer working for the state bar association, because of the mandatory reporting requirements for ethics violations. However, in many states, the rules of professional conduct now specifically exclude their law practice management consultants from reporting such problems to their ethics board. Nerino J. Petro, the Practice Management Advisor for the Law Office Management Assistance program of the State Bar of Wisconsin, notes that while rules vary from state to state, some states like Wisconsin have implemented rules granting confidentiality to attorneys seeking help from the state bar's law office management assistance program (LOMAP).
Properly managing a trust account can be a hassle, but losing a law license over sloppy record-keeping would be even worse. Lawyers who are having trouble managing their trust accounts should promptly address the problem by getting help from a qualified accountant or from a law practice management consultant.