Handling client money happens daily in every law firm. State ethics rules require most attorneys to use trust funds to segregate client funds from firm funds. Maintaining these client trust accounts (CTAs) while meeting your state’s ethics rules can be onerous, but following the rules is better than sanctions or potential disbarment. CTA rules vary by state, but let’s look at ways you can monitor your CTA practices.

Timing payments

You sometimes may be tempted to help clients out by disbursing settlement funds before the funds have cleared, especially if your firm has a single account that holds all client funds instead of individual CTAs. Settlement checks may not clear for a variety of reasons, including a missing, insufficient or incorrect endorsement; insufficient funds; a drafting error; or a bank error. 

If you disburse settlement proceeds and the settlement check bounces, you have commingled client funds because another client’s funds have been used to cover the check that has bounced. This would be true even if the firm had covered the situation with its own money and no one appeared to be harmed because firm monies have been commingled with client funds. In a zero-tolerance jurisdiction, your license to practice can be suspended for this.

You also might risk making premature payments to the firm, particularly when you take fees paid in advance. These funds generally are a liability that you owe until you earn them, at which point you can transfer them to your operating account.

Some states allow flat or other fees paid in advance to be deposited in a firm’s operating account in certain circumstances. When in doubt, place them in the CTA until you obtain some clarification of the applicable rules. In addition, make sure credit card payments of advances are not directed to your operating account if they are not permitted.

Going negative

Many people have at some point written a check against funds they have not deposited or that have not yet cleared their consumer banking account, resulting in what is known as a negative balance. Odds are, they reason, the funds will clear before the check recipient deposits it.

CTAs generally cannot have negative balances without violating the rules. A CTA can have either a positive balance (meaning it is holding client funds) or a zero balance (because all client funds have been paid out). A negative balance signals, at best, negligence and, at worst, misappropriation.

According to the American Bar Association, when properly managed, a CTA account has no need for overdraft protection.  There should never be insufficient funds because an attorney should only withdraw funds when the fees are earned. However, overdraft protection can protect client funds in cases of misappropriation of funds. Beyond conserving resources, an overdraft protection program for IOLTAs (interest on lawyer trust accounts) can help inform disciplinary authorities before major losses occur and clients are harmed. Moreover, specific rules regarding IOLTA and client trust fund overdraft protection vary from state to state. California, for example, allows overdraft protection to compensate exactly for non-sufficient funds checks and any associated bank charges – anything beyond that is not allowed.

Maintaining records

CTA rules generally require you to hold on to bank statements and canceled checks. It is advisable to also keep deposit receipts, checkbook stubs and copies of client checks for a complete audit trail. Be sure to check your local rules for the required retention period. Do not make the mistake of relying on your bank to keep the requisite records and provide copies when needed, as this negligence alone could constitute a violation. Banks fail, merge or undergo other changes that could jeopardize the availability of years-old checks and other documentation.

Most states also expect attorneys to keep their own records explaining transactions depicted in the bank’s documents. Maintain a detailed ledger that records the transactions for each client with the:

• Date, amount and purpose of each deposit; and
• Date, amount, payee, purpose and client name for each disbursement.

Keep an account journal that tracks each transaction through each CTA. Record every deposit and disbursement to the client ledger and account journal within 24 hours so nothing falls through the cracks.

Related Read: IRS Attorneys Audit Technique Guide

Compliance is critical

Violations of your state’s rules, whether the product of intentional acts or mere negligence, can have dire consequences. Even small missteps that undermine your CTA compliance could lead to disciplinary action. Therefore, regularly review your CTA practices to ensure you are in compliance.

For more information, contact Justin Sylvan at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Law Firm Group.