Safekeeping funds and property of clients and other persons (Rule 1.15)

Special Coverage

The State Bar of California has long said that the mishandling of client trust funds constitutes moral turpitude and warrants disciplinary action. Reported disciplinary cases offer insight as to how a lawyer loses the privilege of practicing law by improperly handling money in a clients' trust account.

A proposed new rule (Rule 1.15) would make significant changes to the existing rule (Rule 4-100) governing client trust accounts. The proposed rule changes have not been without debate.

Currently, California Rule of Professional Conduct 4-100 addresses a lawyer's responsibilities in preserving the identity of a client's funds and property. Rule 4-100(A) requires lawyers to segregate a client's money and property from the lawyer's money and property. The current rule, which differs significantly from the ABA Model Rules, provides for two narrow exceptions: Funds reasonably sufficient to pay bank charges and funds belonging in part to a client and in part presently or potentially to the lawyer may be placed in the client trust account. The rule also provides that any disputed portion of the trust funds shall not be withdrawn until the dispute is resolved.

Over the years, Rule 4-100 has led to mistakes, discussions, bar opinions and case interpretations over several unanswered issues, including what should an attorney do with advance fees received and what responsibility does an attorney have over funds he or she knows are the subject of lien claims by third parties. Historically, the question of where to deposit fees paid in advance has been of great interest to lawyers in a number of practice areas, especially criminal defense lawyers, family law practitioners and estate planning lawyers. In the legislative history of Rule 4-100(A), inclusion of "advances for fees" was considered, and then intentionally excluded. So the permissive nature of Rule 4-100(A) has led most lawyers to simply deposit all such fees into their operating accounts. In fact, it is well known that lawyers in certain practice areas have not even needed to maintain a trust account due to the nature of their practices. This will change under new Rule 1.15.

In addition, as a result of Rule 4-100's silence on the issue, the issue of what to do with money received by a lawyer, burdened by the claims of lienholders like government entities, insurance companies and medical providers, has resulted in disciplinary action as recorded in formal bar opinions. Rule 4-100(B) (4) provides: "A member of the State Bar shall ... [p]romptly pay or deliver, as requested by the client, any funds, securities, or other properties in the possession of the member which the client is entitled to receive." The only exception to this rule, set forth in rule 4-100(A)(2), acknowledges the right of an attorney to hold in trust, contrary to client instructions, that portion of trust funds in which the attorney and client have conflicting interests. This rule does not, however, address conflicting interests between the client and a third party in funds held by the attorney. Rule 4-210(A)(1) touches on this issue by expressly allowing an attorney, with the consent of the client, to pay or agree to pay third parties out of funds collected or to be collected on behalf of the client.

The bar has opined that in these circumstances the attorney may not provide the funds to the client, even if demanded, and also may not simply pay disputed funds to the lienholder without the client's consent. Thus, lawyers have been advised to either hold the disputed funds in the client trust account until an agreement has been reached, or file a civil action for interpleader. (As a practice tip, this potential problem could be anticipated and should be a subject outlined and agreed to in the lawyer's original engagement letter).

To the satisfaction of some and the consternation of others, new proposed Rule 1.15 deals with both of these problem areas. And, the result has not been without controversy. In relevant part, paragraph (a) of Proposed Rule 1.15 provides as follows (emphasis added): "All funds received or held by a lawyer or law firm for the benefit of a client, or other person to whom the lawyer owes a contractual, statutory, or other legal duty, including advances for fees, costs and expenses, shall be deposited in one or more identifiable bank accounts labeled 'Trust Account'."

So, under the new proposed rule, all advances for fees, except a flat fee as discussed below, must now be deposited in the lawyers trust account. The comments to the rule define "advances for fees" as any "payment intended by the client as an advance payment for some or all of the services that the lawyer is expected to perform on the client's behalf." So, under the new rule fees paid in advance by a client for work to be performed by the lawyer in the future are required to be put into a client trust account.

New paragraph (b) of Rule 1.15 allows an attorney to deposit a flat fee paid in advance for legal services into an operating account provided the lawyer discloses to the client (1) the latter's right to have the flat fee deposited into trust until the fee is earned; (2) that the client is entitled to the unearned portion of the fee if the services are not completed; and (3) if the flat fee exceeds $1,000, the two disclosures above and the clients consenting signature must be in writing.

Finally, new Rule 1.15(c) adds the concept that under certain circumstances a lawyer owes duties to protect funds and property of a third person.

So now, in addition to facing possible civil liability for ignoring known lienholders, as set forth in numerous reported cases, a lawyer can face disciplinary consequences for violating new Rule 1.15.

It is important to note that an important companion rule being proposed (Rule 1.5) amends current Rule 4-200 by adding specific provisions prohibiting denominating a fee as "earned upon receipt" or "nonrefundable" except in the case of a true retainer (i.e. where a fee is paid to assure the availability of a lawyer for a particular matter or for a defined period of time). And, new Rule 1.5(d) expressly provides that a flat fee is permissible only if the lawyer provides the agreed upon services. So, except for true retainers, an advance fee is never earned unless and until a lawyer provides the services for which the lawyer was retained.

Given the gravity of the consequences for failing to comply with the rules governing client's funds and trust accounts, it would behoove all practitioners to read, understand and pay careful attention to proposed Rule 1.15 and Rule 1.5. And, remember, when in doubt, contact the State Bar or your local bar association for advice.

Rule 1.15 Safekeeping Funds and Property of Clients and Other Persons

(Proposed rule adopted by the board March 9, 2017)

(a) All funds received or held by a lawyer or law firm* for the benefit of a client, or other person* to whom the lawyer owes a contractual, statutory, or other legal duty, including advances for fees, costs and expenses, shall be deposited in one or more identifiable bank accounts labeled "Trust Account" or words of similar import , maintained in the State of California, or, with written* consent of the client, in any other jurisdiction where there is a substantial* relationship between the client or the client's business and the other jurisdiction.

(b) Notwithstanding paragraph (a), a flat fee paid in advance for legal services may be deposited in a lawyer's or law firm's operating account, provided:

(1) the lawyer or law firm* discloses to the client in writing* (i) that the client has a right under paragraph (a) to require that the flat fee be deposited in an identified trust account until the fee is earned, and (ii) that the client is entitled to a refund of any amount of the fee that has not been earned in the event the representation is terminated or the services for which the fee has been paid are not completed; and

(2) if the flat fee exceeds $1,000.00, the client's agreement to deposit the flat fee in the lawyer's operating account and the disclosures required by paragraph (b)(1) are set forth in a writing* signed by the client.

(c) Funds belonging to the lawyer or the law firm* shall not be deposited or otherwise commingled with funds held in a trust account except:

(1) funds reasonably* sufficient to pay bank charges; and

(2) funds belonging in part to a client or other person* and in part presently or potentially to the lawyer or the law firm,* in which case the portion belonging to the lawyer or law firm* must be withdrawn at the earliest reasonable* time after the lawyer or law firm's interest in that portion becomes fixed. However, if a client or other person* disputes the lawyer or law firm's right to receive a portion of trust funds, the disputed portion shall not be withdrawn until the dispute is finally resolved.

(d) A lawyer shall:

(1) promptly notify a client or other person* of the receipt of funds, securities, or other property in which the lawyer knows* or reasonably should know* the client or other person* has an interest;

(2) identify and label securities and properties of a client or other person* promptly upon receipt and place them in a safe deposit box or other place of safekeeping as soon as practicable;

(3) maintain complete records of all funds, securities, and other property of a client or other person* coming into the possession of the lawyer or law firm;*

(4) promptly account in writing* to the client or other person* for whom the lawyer holds funds or property;

(5) preserve records of all funds and property held by a lawyer or law firm* under this rule for a period of no less than five years after final appropriate distribution of such funds or property;

(6) comply with any order for an audit of such records issued pursuant to the Rules of Procedure of the State Bar; and

(7) promptly distribute, as requested by the client or other person,* any undisputed funds or property in the possession of the lawyer or law firm* that the client or other person* is entitled to receive.

(e) The Board of Trustees of the State Bar shall have the authority to formulate and adopt standards as to what "records" shall be maintained by lawyers and law firms* in accordance with subparagraph (d)(3). The standards formulated and adopted by the Board, as from time to time amended, shall be effective and binding on all lawyers.

Standards:

Pursuant to this rule, the Board of Trustees of the State Bar adopted the following standards, effective __________, as to what "records" shall be maintained by lawyers and law firms* in accordance with subparagraph (d)(3).

(1) A lawyer shall, from the date of receipt of funds of the client or other person* through the period ending five years from the date of appropriate disbursement of such funds, maintain:

(a) a written* ledger for each client or other person* on whose behalf funds are held that sets forth:

(i) the name of such client or other person,

(ii) the date, amount and source of all funds received on behalf of such client or other person,

(iii) the date, amount, payee and purpose of each disbursement made on behalf of such client or other person,* and

(iv) the current balance for such client or other person;

(b) a written* journal for each bank account that sets forth:

(i) the name of such account,

(ii) the date, amount and client affected by each debit and credit, and

(iii) the current balance in such account;

(c) all bank statements and canceled checks for each bank account; and

(d) each monthly reconciliation (balancing) of (a), (b), and (c).

(2) A lawyer shall, from the date of receipt of all securities and other properties held for the benefit of client or other person* through the period ending five years from the date of appropriate disbursement of such securities and other properties, maintain a written* journal that specifies:

(a) each item of security and property held;

(b) the person* on whose behalf the security or property is held;

(c) the date of receipt of the security or property;

(d) the date of distribution of the security or property; and

(e) person* to whom the security or property was distributed.

Comment

[1] Whether a lawyer owes a contractual, statutory or other legal duty under paragraph (a) to hold funds on behalf of a person* other than a client in situations where client funds are subject to a third-party lien will depend on the relationship between the lawyer and the third-party, whether the lawyer has assumed a contractual obligation to the third person* and whether the lawyer has an independent obligation to honor the lien under a statute or other law. In certain circumstances, a lawyer may be civilly liable when the lawyer has notice of a lien and disburses funds in contravention of the lien. See Kaiser Foundation Health Plan, Inc. v. Aguiluz (1996) 47 Cal.App.4th 302 [54 Cal.Rptr.2d 665]. However, civil liability by itself does not establish a violation of this rule. Compare Johnstone v. State Bar of California (1966) 64 Cal.2d 153, 155-156 [49 Cal.Rptr. 97] ("'When an attorney assumes a fiduciary relationship and violates his duty in a manner that would justify disciplinary action if the relationship had been that of attorney and client, he may properly be disciplined for his misconduct.'") and Crooks v. State Bar (1970) 3 Cal.3d 346, 358 [90 Cal.Rptr. 600] (lawyer who agrees to act as escrow or stakeholder for a client and a third-party owes a duty to the nonclient with regard to held funds).

[2] As used in this rule, "advances for fees" means a payment intended by the client as an advance payment for some or all of the services that the lawyer is expected to perform on the client's behalf. With respect to the difference between a true retainer and a flat fee, which is one type of advance fee, see rule 1.5(d) and (e). Subject to rule 1.5, a lawyer or law firm* may enter into an agreement that defines when or how an advance fee is earned and may be withdrawn from the client trust account.

[3] Absent written* disclosure and the client's agreement in a writing* signed by the client as provided in paragraph (b), a lawyer must deposit a flat fee paid in advance of legal services in the lawyer's trust account. Paragraph (b) does not apply to advance payment for costs and expenses. Paragraph (b) does not alter the lawyer's obligations under paragraph (d) or the lawyer's burden to establish that the fee has been earned.