Most lawyers will tell you that they prefer practicing law to managing the day-to-day operations of a law firm. Although many business-related tasks may be delegated to support staff and third-party vendors, lawyers must play scrupulous attention to, as well supervise both subordinates and outsourcing providers in a responsible manner in order to ensure that duties to clients are fulfilled and that the law firm may continue to function. One of the primary responsibilities that lawyers must consider when evaluating law firm operations concerns a lawyer’s responsibility to protect client funds and property. Commingling law firm funds with client funds and conversion of client funds constitute two of the leading causes of lawyer discipline and may lead to liability issues as well. Therefore, if lawyers seek to continue to practice law, they must devote time and resources to instituting sound banking and trust accounting procedures and supervising the parties entrusted with the authority to handle client funds.
What types of bank accounts should law firms maintain?
Almost all jurisdictions require law firms to maintain three types of bank accounts: an operating account, a client trust account, and an Interest on Lawyer Trust Account (“IOLTA”) account. State supreme courts and state bar associations will designate the financial institutions in the jurisdiction eligible for law firm establishment of client trust accounts and IOLTA accounts. These selected financial institutions are obligated to alert the relevant bar disciplinary authority when a law firm’s client trust account or IOLTA account is overdrawn. Let’s review the type of funds that should be deposited in each account.
- Operating account: Client funds that the law firm has earned and monies from others that are not being held in escrow should be placed in the law firm’s operating account. Funds from clients that have not been earned must not be placed in this account.
- Client trust account: Client funds intended to pay the law firm’s fee that have not yet been earned should be deposited in a client trust account. For example, if the client pays the law firm a $5,000 retainer to work on a legal matter or on an hourly basis, and the law firm has only earned $1,000, the $4,000 balance should remain in the client trust account until earned or returned to the client.
- IOLTA trust account: Client funds or funds of third persons, which are either nominal in amount or expected to be held for a short period of time, should be placed in and IOLTA account in the vast majority of jurisdictions. The interest generated from these accounts is used to fund charitable institutions, typically legal aid entities that serve indigent clients. No jurisdiction has defined “nominal” or “short term” pertaining to IOLTA accounts with any specificity. Generally, the determination of whether a the funds of a client or third party are nominal or short term rests within the discretion of the lawyer. If the lawyer exercises sound judgment, no disciplinary action will be taken against the lawyer.
In deciding whether to deposit client funds in a trust account or IOLTA account, lawyers should consider the anticipated amount of net interest such funds are expected to generate. If the net interest is expected to be nominal, due to either the nominal amount of the principal or the limited amount of time the funds are anticipated to remain in the account, the funds should be placed in the IOLTA account, If the net interest is expected to be more than nominal, the funds should be placed in the client trust account. Any interest earned in the client trust account should go to the client, rather than the law firm.