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 web site: http://www.vsb.org.
1. Defining “Funds” held in “Trust” / “Escrow” Accounts
A. What types of funds must be held in the lawyer’s trust/escrow account?
The types of funds required to be held in the lawyer’s/escrow 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; and
4. all funds received by the lawyer for the benefit of the client or his designees.
Note that the term “lawyer escrow account” means an account maintained in a financial institution for the deposit of funds received or held by an attorney or law firm on behalf of a client. Rule 1.15(f)(1)(vi).
B. What types of funds may NOT be held in a lawyer’s trust/escrow account?
Funds that belong to the lawyer or law firm are not escrow funds. Such funds may not be held in the escrow account unless they have been placed there “to pay bank charges…” or the lawyer’s entitlement to them “is disputed by the client….” Rule 1.1.5(a)(2).
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 Once a deposit has cleared the bank, the “portion belonging to the lawyer or law firm must be withdrawn.”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)(2). 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 escrow account balance to qualify for the bank’s offer of interest payments or free checking.
2. “IOLTA” and “Other” Escrow Accounts
TRUE or FALSE?
A. All lawyer escrow accounts must be IOLTA accounts.
Answer - FALSE
Lawyers can “opt-out” of IOLTA – if you choose not to participate in the program, pursuant to Rules of Supreme Court of Virginia, Part 6, §IV, Para. 20 (F), you will need to contact the Legal Services Corporation of Virginia at 804-782-9438 and request a notice of election form to “opt-out”.
B. If a lawyer chooses to “opt-out” of IOLTA, the lawyer may deposit funds of clients in one or more interest-bearing accounts?
Answer - TRUE
The lawyer may deposit funds in one or more interest-bearing escrow 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)).
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.
Exceptions exist when the lawyer holds funds or property as a fiduciary. The rules require that in the event that client funds exceed $5,000 and will be held in trust for a period that exceeds 30 days, those funds must be held in a separate fiduciary account and not commingled with the assets in the attorney’s common escrow account. (See Rule 1.15(d)(1)(i) and (ii)).
3. “Insufficient Funds” Reporting Requirements
TRUE or FALSE?
A. Unless the client expressly directs the lawyer to do otherwise, lawyer escrow 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 http://www.vsb.org/site/members/trust-account-depositories/ for a list of trust account depositories).
4. Commingling funds or “Salting” an Escrow Account
TRUE or FALSE?
A. The lawyer can maintain a sum of money on deposit in his/her escrow 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 escrow account (See LEO 1510); and
2) when an item received by the lawyer includes amounts belonging to the client and amounts to which the lawyer is entitled (such as fees or reimbursement for previously advanced expenses), such an item must be deposited in the trust account. (See Rule 1.15(a)(2)).
B. The lawyer can maintain a sum of money on deposit in his/her escrow 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(e)(1)(i)).
This record, required by Rule 1.15(e)(1)(i), need be nothing more than regular entries in the escrow 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.).
A “duplicate deposit slip” or “other” record shows the identity of each item (i.e., the date and amount of funds deposited) the client on whose behalf the funds were received, and the identity of the source of the funds. (Rule 1.15(f)(2)).
2) Cash disbursements journal – recording all cash paid out. (Rule 1.15(e)(1)(i)).
Required by Rule 1.15(e)(1)(ii), 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 escrow 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(e)(1)(iii)).
Rule 1.15(e)(1)(iii) requires the lawyer to maintain “a separate account [“record”] for each client (ii) and for every other person or entity from whom money has been received in escrow . . .. 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” must also identify the date (vi) and amount of each deposit (x) for that particular client and the date (vi) and amount of each disbursement (ix) and the identity of the recipient (vii). The rule requires that “all fees paid from escrow” be “clearly identified.”
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 (i.e., quarterly) reconciliation of cash balances to the subsidiary/(client) ledger. (Rule 1.15(f)(4));
2) a monthly reconciliation of the escrow account check book. (Rule 1.15(f)(5)(i)); and
3) a periodic (i.e., quarterly) reconciliation of the cash balances to the subsidiary ledger trial balance. (Rule 1.15(f)(5)(ii)).
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. (Rule 1.15(e)(2)).
For the purposes of Rule 1.15, the term “fiduciary” includes only personal representative, trustee, receiver, guardian, committee, custodian and attorney-in-fact.
D. For how long must books and records be maintained?
5 years (Rule 1.15(e)(1)).
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. (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 their escrow account?
The lawyer needs client authorization, preferably in writing. Client authorization can be obtained in a retainer agreement for litigation costs etc., or separate written instruction from the client.
G. When can a lawyer ethically distribute 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.
Updated: Dec 08, 2009