Primer on Trust Accounts — Don’t Use Money & Do Keep Records
By Sarah Diane McShea [Originally published in NYPRR April 2001]
It may seem surprising that despite nearly two decades of vigorous enforcement of the rules governing escrow accounts, the leading offenses cited in suspension and disbarment cases in New York continue to be misuse of client funds and mismanagement of attorney trust accounts. Although most lawyers are scrupulously careful about their escrow accounts and the funds entrusted to them, a surprising number of lawyers are still unfamiliar with or careless about the very basic but detailed rules governing escrow accounts. Many believe that if they don’t “steal” their clients’ funds, they are not at risk. Many lawyers in law firms believe that because someone else is responsible for managing the firm’s trust accounts, they themselves are not at risk. Others believe that only dishonest lawyers are disciplined for escrow-account violations.
Every year, dozens of otherwise honest and reasonably careful lawyers are disbarred or suspended for escrow account violations. Lawyers who want to avoid disciplinary problems must be familiar with the rules governing attorney trust accounts. This is true whether they are sole practitioners or partners or associates in large firms, whether they practice full-time or part-time, and whether they hold trust funds once a year or as a regular part of their practice.
In New York, the most important rules governing attorney trust accounts are Disciplinary Rule 9-102 of the Code of Professional Responsibility [22 NYCRR §1200.46], Judiciary Law §497 (“Attorneys Fiduciary Funds; Interest-Bearing Accounts”) and 22 NYCRR §1300 (“Dishonored Check Reporting Rules for Attorney Special, Trust and Escrow Accounts”). These rules are neither obvious nor intuitive and lawyers who are not familiar with them practice at their peril.
Trust Funds Must Be Held in Separate Account
The first cardinal rule in handling trust or escrow funds is that they must be held intact in a properly — denominated escrow or trust account. It goes without saying — or should to anyone who has studied for the bar — that a lawyer may not use, spend, convert or borrow escrow or trust funds. Yet conversion, or knowing use of escrow funds, remains the most common offense resulting in disbarment or lengthy suspension from practice. Disciplinary courts rarely excuse or tolerate the knowing use of escrow or trust funds by a lawyer, even when the lawyer’s personal circumstances are dire or tragic and even when the funds have been replaced before or immediately after a complaint is made. At most, tragic personal circumstances, restitution, and an unblemished prior record may mitigate the offense and lower the sanction imposed, resulting in suspension rather than disbarment. In most cases, a lawyer’s failure to maintain the proper balance in his or her escrow account is treated as a per se violation of the Code. Even a good-faith or mistaken use of the funds may result in a finding of serious misconduct and license impairment. [See, DR 9-102(a), 22 NYCRR §1200.46(a).]
All lawyers or law firms holding client or third-party funds must maintain either an interest-bearing attorney trust account or an IOLA account (i.e., “interest on lawyer account”). While lawyers who are not holding client or third-party funds are not required to maintain trust accounts, it is often less bother to have an established and permanent account than to open and close accounts as you need them.
The trust or escrow account must be maintained at a qualified “banking institution” in New York. (There are only limited exceptions to this New York-bank requirement). The account must be in the lawyer ‘s or law firm’s name, must be kept separate from any other fiduciary, business or personal accounts, and must be entitled “Attorney Special Account” or “Attorney Trust Account” or “Attorney Escrow Account.” [DR 9-102(b)(1), (2), 22 NYCRR §1200.46(b)(1), (2).] IOLA accounts, which are discussed below, may be entitled “IOLA Account,” together with the firm’s or lawyer’s name. [Judiciary Law §497(6).]
Commingling of Funds Prohibited
The second cardinal rule is that lawyers may not deposit their own personal or business funds in their escrow or trust accounts. The one limited exception is that a lawyer may deposit funds “reasonably sufficient” to cover the fees or charges imposed by the depository bank holding the escrow funds. [DR 9-102(b) (3), 22 NYCRR §1200.46(b) (3).] A lawyer who uses his escrow account for the deposit of his personal funds faces serious disciplinary sanctions. This is true even if the lawyer does not misuse any of the trust funds in the commingled account. Two serious concerns underlie the ban on commingling. First, commingling of personal and trust funds may destroy the escrow nature of the account and expose the clients’ funds to the risk of attachment by the lawyer’s or law firm’s creditors. Second, commingling of personal and trust funds makes it much harder to determine if the lawyer has used, or misused, any of the trust funds which were supposed to be held intact.
Trust accounts come in several basic varieties.
“Escrow management” account. Sometimes called an omnibus account, this is a single escrow account, with subaccounts for each client or each matter. The sub-accounts earn interest, which the bank reports on separate 1099 interest statements issued to the named beneficiary of the sub-account, rather than to the law firm. This avoids the problem of imputing significant amounts of interest to the firm when the firm is not actually receiving the interest. The monthly statements include separate listings for each sub-account, which facilitates the firm’s required record-keeping for funds it is holding. All deposits and withdrawals are made into and from the main account, with internal transfers to and from the sub-accounts.
Care in making these internal transfers is critical. It is not uncommon for a firm to fail to transfer funds from the sub-account to the main account before issuing a check to the client or for the bank to fail to follow an instruction to transfer the funds. Since the main account is usually only a “pass-through” account, without significant funds, if a timely transfer of funds is not made from the sub-account to the main account, the result may be a bounced check report to The Lawyers Fund for Client Protection and to a disciplinary committee.
IOLA Account. This is an interest-bearing trust account in which the interest is credited to the account, but then forwarded by the bank to the State’s IOLA fund. The IOLA fund is used for public purposes (presently legal services for the indigent). Only trust funds which will be held for short periods of time or which will generate small amounts of interest should be deposited in an IOLA. The advantage of an IOLA account is that the law firm does not have to keep track of the interest on the funds held or remit that interest to the client when the client’s funds are disbursed. [See generally, Judiciary Law §497.]
Traditional Escrow Account. A third choice for trust funds is a traditional interest-bearing escrow or trust account into which all trust funds are deposited by the law firm. If a traditional escrow account is used, the firm must then keep track of and apportion the interest for each matter and client. A general escrow account requires careful record-keeping. Mistakes may not be spotted as easily as when sub accounts are used. However, with accurate record-keeping and frequent reconciliation of bank statements against the ledgers maintained for each escrow matter, a general trust account can work well. It is less complicated than an escrow management account and will still generate interest for the beneficiaries of the funds.
Individual Client Accounts. Finally, a firm may always establish individual escrow or trust accounts for specific matters or clients. Individual accounts should be interest-bearing, unless the funds will be held for only a short time or are likely to yield only a small amount of interest. If payment of interest to the recipient of the funds might present problems (a real possibility in certain situations), an individual IOLA account may be opened and the interest will be forwarded to the IOLA fund.
Interest on Escrowed Funds
As a general rule, law firms may not keep the interest earned on funds they hold in escrow or in trust accounts. If it has a prior written agreement with the client or recipient of the funds authorizing retention, the firm may retain the interest, but it should advise the client or escrow beneficiary in writing of the amount of interest credited and retained. Lawyers who retain the interest without the client’s knowledge or written consent have been publicly disciplined, even when the amounts involved are relatively modest. Lawyers may charge administrative fees for the time and work involved in handling escrow funds entrusted to them and doing the required record-keeping for those funds. However, advance written informed consent from the client or recipient of the fund is advisable if the lawyer is going to turn over less than the full amount of the principal and earned interest.
New York has very specific rules on what records a lawyer or law firm must maintain for an escrow or trust account. All lawyers, even those who are not directly responsible for their firm’s trust accounts, should be familiar with the requirements, which are strictly enforced.
All monthly bank statements, cancelled checks, deposit slips, check books and check stubs must be maintained for seven years. In addition, the firm must keep a “record” of all deposits into and withdrawals from every escrow or trust account, as well as every law firm operating account. That “record” must include the “date, source and description” of every deposit and the “date, payee and purpose” of every withdrawal. [DR 9-102(d), 22 NYCRR §1200.46(d).] Ideally, such a “record,” which is really a ledger, will be detailed enough to enable the firm to easily reconcile its monthly bank statements and balances with the amounts which should be on deposit in each account.
Lawyers and law firms are also required to keep for seven years all client retainer and fee agreements, bills rendered to clients, statements reflecting the disbursement of funds held in trust, records showing payments to lawyers, investigators or other persons “not in the lawyer’s regular employ” for services rendered, and copies of retainer and closing statements filed with the Office of Court Administration. [DR 9-102(d), 22 NYCRR §1200.46(d).]
Special Rules and Requirements
Under no circumstances should a lawyer write a check payable to “cash” on an escrow or trust account. [DR 9-102(e), 22 NYCRR §1200.46(e).] The original purpose of the ban on checks payable to “cash” was simply to make sure that all disbursements from a trust account could be traced and identified, thereby facilitating investigations of misuse of trust funds. The rule has been applied very strictly by the Appellate Divisions. Even lawyers who have written checks to “cash” at a client’s or bank official’s instruction, e.g., to obtain an official bank check for a real estate transaction, have been found guilty of violating this rule. No matter how good the reason or how clear the evidence of the proper application of the funds, lawyers should not write trust account checks to “cash.”
Non-lawyers may not be signatories on trust accounts. This may present problems for sole practitioners, but it too is a rule that appears to be strictly enforced by the courts.
Bounced Check Reports
Even the most careful lawyer or law firm can make an honest mistake with an escrow or trust account. Deposits are made into the wrong account, clients bounce checks, third parties stop payment on their checks and, with some regularity, New York banks make mistakes in following, or not following, the instructions of their account holders. Careful adherence to and supervision of the rules will minimize the consequences, but there are certain things that will flow inevitably from a bounced check on an attorney escrow or trust account.
Lawyers are permitted to maintain their trust accounts only at those New York banks which agree to provide bounced check reports to the Lawyers Fund for Client Protection. [DR 9-102(b), 22 NYCRR §1200.46(b).] If a trust account check is returned for insufficient funds, the bank will routinely notify the Lawyers Fund, which, in turn, will notify the disciplinary or grievance committee in the Department in which the lawyer practices. Unless the returned check is clearly the result of a bank error and the bank acknowledges the error in writing to the disciplinary committee, the lawyer will be required to produce his or her escrow records for the previous six-month period. Most investigations based upon bounced check reports are closed with no finding of wrongdoing by the lawyer or law firm and no discipline imposed. The reason is that most lawyers are in substantial compliance with the rules. The minor infractions discovered as a result of such investigations typically result in a warning or low-level private discipline. Sadly, as the investigations following bounced check reports demonstrate, too many experienced lawyers are still unfamiliar with the rules on escrow accounts and record-keeping.
Lawyers should also be aware that they may be held responsible for the acts and omissions of their partners and associates, including failures to safeguard escrow funds and maintain trust accounts in accordance with the rules. Lawyers may not delegate their responsibilities for their escrow accounts to their bookkeepers or accountants — they must know what is going on in their accounts. While there are few published decisions on vicarious disciplinary liability, it does exist and it is likely to be more vigorously enforced in the future. The courts have recently expanded the supervisory responsibilities of partners and senior lawyers. Disciplinary action against an entire law firm for firm-wide escrow account related misconduct remains a distinct threat, at least in the First Department. [DR 1-104, 22 NYCRR §1200.5; see also, 22 NYCRR §603.1(b).]
Despite rigorous enforcement, severe sanctions and almost zero tolerance, a troubling number of lawyers still do not know what the escrow account rules are or even where they can be found. As should be evident, while the rules are detailed, they are not impenetrable. Compliance can be achieved by even the most mathematically-challenged lawyer, particularly with the help of readily-available computer software specifically designed for attorney trust accounts. Now is the perfect time to make sure that your firm’s accounts and records fully comply with the rules. Later may be too late and it will certainly be more expensive and worrisome.
Sarah Diane McShea represents lawyers and law firms in legal ethics and professional discipline matters.
DISCLAIMER: This article provides general coverage of its subject area and is presented to the reader for informational purposes only with the understanding that the laws governing legal ethics and professional responsibility are always changing. The information in this article is not a substitute for legal advice and may not be suitable in a particular situation. Consult your attorney for legal advice. New York Legal Ethics Reporter provides this article with the understanding that neither New York Legal Ethics Reporter LLC, nor Frankfurt Kurnit Klein & Selz, nor Hofstra University, nor their representatives, nor any of the authors are engaged herein in rendering legal advice. New York Legal Ethics Reporter LLC, Frankfurt Kurnit Klein & Selz, Hofstra University, their representatives, and the authors shall not be liable for any damages resulting from any error, inaccuracy, or omission.
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