Answering Your Questions about Trust Accounting
The Virginia State Bar’s legal staff includes the ethics unit. The Ethics Hotline, (804) 775-0564, serves members of the bar and the public by answering questions regarding ethics and the unauthorized practice of law. Below are some of the most frequently asked questions along with summary answers regarding trust accounting. References in these answers are made to the Rules of Professional Conduct (RPCs), the Unauthorized Practice Rules (UPRs), Legal Ethics Opinions (LEOs), and Unauthorized Practice of Law Opinions (UPLs). The Rules and many of the Opinions can be found at the Virginia State Bar’s website.
1. Defining “Funds” held in “Trust” Accounts
A. What types of funds must be held in the lawyer’s trust account?
The types of funds required to be held in the lawyer’s trust account are:
1. all funds given to the lawyer by the client that are to be applied against future legal fees;
2. all funds placed with the lawyer for present or future use on the client’s behalf or at the client’s direction;
3. all funds received by the lawyer for future litigation expenses;
4. all funds received by the lawyer for the benefit of the client or his designees;
5. all funds held by the lawyer on behalf of a third party; and
6. all funds held by the lawyer as a fiduciary.
B. What types of funds may NOT be held in a lawyer’s trust account?
Funds that belong to the lawyer or law firm or to which another are/may be entitled are not escrow/trust account funds. Such funds may not be held in the lawyer’s trust account unless they have been placed there “to pay service or other charges or fees” imposed by the bank or unless “two or more persons (one of whom may be the lawyer)” dispute entitlement to the funds. In the latter case, the funds shall be held in the trust account until the dispute is resolved. Rule 1.15(a)(3)(i) and (ii).
Frequently a lawyer will receive funds that belong in part to the lawyer and in part to the client. Once a deposit has cleared the bank, the “portion belonging to the lawyer or law firm must be withdrawn.” Rule 1.15(a)(3)(ii). This includes all earned legal fees and all costs expended or accrued.
None of the following reasons overrides the clear and unequivocal ethical prohibition against commingling client’s and lawyer’s funds:
1. the need to create a buffer in the event a check deposited into escrow is returned for insufficient funds;
2. the need to hide money from creditors, the I.R.S., or a spouse;
3. the use of the escrow account as a "personal" or office savings account or as a mechanism for budgeting and managing cash flow; and
4. the desire to maintain a high enough trust account balance to qualify for the bank’s offer of interest payments or free checking.
2. “IOLTA” and “Other” Trust Accounts
TRUE or FALSE?
A. All lawyer trust accounts must be IOLTA accounts.
Answer - FALSE
Lawyers may maintain their trust accounts as IOLTA accounts. Lawyers must either “opt-in” or “opt-out” of IOLTA. If a lawyer chooses to participate in the program, he/she must obtain the necessary forms to establish the account from Legal Services Corporation of Virginia (LSCV). If a lawyer chooses not to participate in the IOLTA program, he/she must make such election on a “Request to Opt-Out” form, also provided by LSCV. See, Rules of the Supreme Court of Virginia, Part 6, §IV, Para. 20 (C) and (F). LSCV contact: 804-782-9438.
B. If a lawyer chooses to “opt-out” of IOLTA, the lawyer may deposit funds of clients in one or more interest-bearing accounts or a non-interest bearing trust account. Rules of the Supreme Court of Virginia, Part 6, §IV, Para. 20(A) and (C).
Answer - TRUE
The lawyer may deposit funds in one or more interest-bearing trust accounts provided the lawyer has established and maintains strict procedures for accounting and paying to each client the interest on such client’s funds. See Rules of Supreme Court of Virginia, Part 6, §IV, Para. 20 (A). The lawyer may also deposit funds in a non-interest bearing account “so long as the [lawyer] or law firm receives no consideration or benefit from the Financial Institution for opening a non-interest bearing trust account or from converting from an IOLTA account to a non-interest bearing trust account.” Rules of Supreme Court of Virginia, Part 6, §IV, Para. 20(C).
C. The lawyer is not required to remit to the client interest earned when funds are deposited into an “interest” bearing trust account.
Answer - FALSE
The lawyer is required to develop a program that allows for the computation of 1) interest earned and 2) the administrative costs of maintaining the account, and requires the lawyer to remit to the client, at least quarterly, the interest earned on funds held in an interest bearing trust account.
3. “Insufficient Funds” Reporting Requirements
TRUE or FALSE?
A. Unless the client expressly directs the lawyer to do otherwise, lawyer trust accounts may be maintained only in financial institutions approved by the VSB.
Answer - TRUE
Financial institutions approved by the VSB are required to submit a timely report to the VSB in the event of an overdraft of the lawyer’s trust account. See Rules of Supreme Court of Virginia, Part 6, §IV, Para. 20 and Appendix A. (See http://www.vsb.org/site/members/trust-account-depositories/ for a list of trust account depositories).
4. Commingling funds or “Salting” a Trust Account
TRUE or FALSE?
A. The lawyer can maintain a sum of money on deposit in his/her trust account for his/her own purposes.
Answer - FALSE There are only 2 exceptions:
1) the lawyer may deposit enough of his/her own funds to cover bank charges made for administration of the trust account (See Rule 1.15(a)(3) and LEO 1510); and
2) when “funds in which two or more persons (one of whom may be the lawyer) claim and interest” and those interests are disputed, those funds “shall be held in the trust account until the dispute is resolved.” Rule 1.15(a)(3)(ii). B. The lawyer can maintain a sum of money on deposit in his/her trust account to cover credit card merchant fees.
Answer - TRUE, BUT NOT ADVISABLE
The lawyer may pass along merchant fees associated with credit card use to the client with disclosure and consent. These fees may be deducted from the lawyer’s escrow account; however, when possible, a lawyer should contract with the financial institution that all debits of fees and costs associated with credit card use, including “chargebacks,” be made from the lawyer’s operating account. (See LEO 1848).
5. Managing your Escrow Account
A. The following 3 types of records must be kept on a trust account:
1) Cash receipts journal – recording all cash received. (Rule 1.15(c)(1).)
This record, need be nothing more than regular entries in the trust account check book which identify the date (i) and amount of funds deposited (ii) and the client (iii) on whose behalf the funds were received. A lawyer may maintain a separate “journal,” “ledger,” or any other type of record in addition to or in lieu of check book stub entries. As long as the record being maintained produces a running balance (necessary for other Rule 1.15 accounting requirements) and provides the details concerning the dollar amount, client identity, and date of deposit, that record satisfies Rule 1.15. Bear in mind, however, that for routine record keeping purposes as well as for compliance with Rule 1.15, the lawyer should maintain additional records that articulate “the purpose” underlying the receipt of funds into escrow (i.e., invoices, transmittal letters with explanation, etc.).
2) Cash disbursements journal – recording all cash paid out. (Rule 1.15(c)(1).
This document is maintained by the same methods described above for the “cash receipts journal.” In fact, checkbook stubs would suffice. Regardless of the system used, every disbursement from the trust account must be recorded and must always clearly detail the date (i) and amount of funds (ii) disbursed or paid out and the identity of the client (iii) on whose behalf the funds were disbursed. Although not required by the rules, it is good practice to have this record or journal also identify the recipient of the specific funds and the purpose (iv) for which the disbursement was made.
As with the cash receipts journal, for routine record keeping purposes and to satisfy the requirements of Rule 1.15, the lawyer needs to maintain sufficient supplemental documentation which will corroborate “the purpose” giving rise to each disbursement of client funds being held in escrow.
3) Subsidiary ledger which includes recordation of transactions for each client. (Rule 1.15(c)(2).
Rule 1.15(c)(2) requires the lawyer to maintain “a separate entry for each client, other person, or entity from whom money has been received in trust.” To comply with other Rule 1.15 requirements and sound accounting procedures and to help avoid math errors that might be made along the way, this “subsidiary ledger” should also identify the client or matter, the date of the transaction, the payor or payee and the “means or methods by which trust account funds were received, disbursed or transferred and any unexpended balance.”
The concept of receipts and disbursements journals and client subsidiary ledgers is simple. The sum total of all subsidiary ledgers at any given time should equal the amount in the escrow account.
B. Rule 1.15 requires the lawyer to maintain the following reports:
1) a periodic (at least quarterly) reconciliation “that reflects the trust account balance for each client, person or entity.” Rule 1.15(d)(3)(i);
2) a monthly reconciliation of the cash receipts journal, cash disbursements journal, the trust account checkbook balance and the trust account bank statement balance (Rule 1.15(d)(3)(ii); and
3) a periodic ( at least quarterly) reconciliation of the cash balances to the subsidiary ledger balance. (Rule 1.15 (d)(3)(iii)).
C. What are the record keeping requirements for lawyers serving as fiduciaries?
Lawyers serving as fiduciaries must keep annual summaries of all receipts and disbursements “comparable to…an accounting…required of a court-supervised fiduciary.” (Rule 1.15(c)(3)).
D. For how long must books and records be maintained?
At least 5 calendar years after termination of representation or fiduciary responsibility. (Rule 1.15(c)(4)).
E. What happens when the law firm has monies in trust that belong to clients, and the firm is unable to locate the client?
The firm can use a reasonable amount of the client’s monies to try to locate the client. Otherwise, the lawyer is required to turn over to the Commonwealth unclaimed funds after 5 years of not being able to locate the client. (Virginia Code Section 55-210.1). (See also “Answering Your Questions about Legal Ethics - 1. The Missing Client & Abandoned Client Funds,” located at http://www.vsb.org/profguides/FAQ_leos/LegalEthicsFAQs.html.)
F. What should a lawyer do prior to disbursing funds from his/her trust account?
The lawyer must have client consent or consent of any third part with a valid lien, preferably in writing. Client authorization can be obtained in a retainer agreement for litigation costs etc., or separate written instruction from the client. See Rule 1.15(b)(5) and Comment [2a].
G. When can a lawyer ethically disburse monies from their escrow account?
The lawyer cannot disburse the funds until they are deposited, credited, “cleared,” and are available for disbursement.
3 If a combined transfer is being made from client's funds held in escrow into the lawyer or firm operating account which transfer is intended to both cover legal fees and reimburse for previous disbursements, the best procedure would be to clearly identify on the client's subsidiary ledger the dollar amounts being transferee for each, i.e., “Transfer to firm: Fees - $xxx.xx; Costs - $yy.yy.