The following is an excerpt from the MyCase eBook: “Trust Accounting Basics” by author Peggy Gruenke.
We all know mismanaging a trust account can have terrible consequences. However, while it seems to be discussed in theory, most attorneys receive little or no training on how to manage a trust account before opening one of their own. Law schools don’t address this in enough detail based on the blank look I often get when I mention trust accounting to new graduates. All of which begs the question, “Are your trust accounting practices sufficient?”
Many states have rules in place regarding how attorneys must maintain lawyers’ trust accounts. These rules vary from state to state but the common underlying theme is that as a lawyer, it is your job to act as a fiduciary of client funds. Most states have adopted Rules of Professional Conduct to help guide you in the maintenance and recordkeeping requirements related to client trust accounts. Please refer to your individual state rules. This is not intended to cover all rules related to handling and maintaining trust accounts.
The fundamental aspects of a lawyer’s duty, related to handling client funds, include:
- Identification: Deposit funds into an account specifically labeled as a trust account
- Segregation: Keep client funds on deposit separate from lawyer’s own funds
- Accounting: A lawyer must create and maintain appropriate records of funds belonging to client
In addition to these fundamental duties, some states impose additional specific duties upon a lawyer handling client funds. Below are a few of these duties your state may impose.
- Duty to pay promptly the funds to the client or otherwise owner of the funds
- Duty to notify the client upon receipt and deposit of funds
- Duty to maintain a separate ledger sheet for each client who has funds on deposit in trust account
- Duty to maintain complete, accurate records relating to the client funds which includes: amount of funds received and deposited, the amount of funds lawyer has paid or distributed out of the client’s trust account and the amount of funds still held in trust
Important Terms: Commingling and Misappropriation
There are a few terms used when discussing fiduciary duties and trust accounts that you should recognize and learn what conduct pertains to these terms. Two terms to review and understand are commingling and misappropriation.
Commingling means to intermix or put together without separation or segregation. In a legal directory, “commingling of funds” is defined as “the act of a fiduciary in mingling funds of his clients with his own funds.” As a lawyer, when you mix client funds with your own funds you will be subject to disciplinary action.
In the context of a lawyer’s trust accounting duties, commingling can occur in three different ways. The first is when a lawyer deposits money identified as a retainer or advanced payment for work the lawyer will conduct on behalf of the client in the near future into the lawyer’s personal or business account. The second is when a lawyer fails to deposit money belonging to a client, for example, settlement funds, into the lawyer’s trust account. And the third is when a lawyer deposits his funds, money already earned for legal work, into the lawyer’s trust account.
In summary, commingling occurs when client funds–funds not yet earned–are combined with the lawyer’s normal business funds. For example, you receive a retainer for a divorce case or business transaction and you deposit this money into your business operating account. This money is not yet earned and needs to be deposited into the trust account and labeled as belonging to the client.
Commingling also occurs when a lawyer uses the money in the trust account to pay for normal business expenses. The money in the trust account should never be used to pay for business related expenses. If you find your operating account running low, then evaluate your unbilled time to see if you can invoice client(s) for work completed and transfer funds from the client’s trust funds to your operating account.
When a lawyer takes or uses client funds, or funds of another, without express authorization, the lawyer misappropriates the funds. So if you “borrow” some money out of your trust account and pay it back later, you are misappropriating funds. Misappropriation also happens when a lawyer adds additional hours to a client invoice for time not spent on the case. Likewise, charging a client for an expense never incurred and receiving payment for that amount is misappropriation of client funds.
You can also misappropriate funds by simply failing to deposit client funds into a trust account. For example, if you receive an advance for fees you have yet to earn and deposit these funds into your operating account instead of a trust account, you have misappropriated client funds. “Advanced fees are client fees until the lawyer earns the fees.”
What happens when a lawyer withdraws funds from a trust account to pay the fees the lawyer has earned but the client then disputes the fees and thus the lawyer’s right to receive the fees? This is misappropriation. How do you prevent this from happening? Be sure to include in your fee agreement your billing practices and state how money held in trust will be withdrawn to cover the fees and expenses on the bill.
Questions to Ask Yourself
Finally, here are a few helpful questions to ask yourself about how you are handling client trust funds:
- Do you reconcile your Trust bank account every month?
- Do you know what three-way trust account reconciliation is and how to complete one?
- Do you provide your clients with a monthly report showing detailed information about their trust account transactions, including how their money was used to pay for fees and/or expenses and balance remaining?
- Do you accept credit cards for retainer payments? If so, where are these funds deposited and how are the credit card fees paid?
- Do you put all retainers into your Trust account?
- Do you keep a separate client ledger for each client’s money held in trust?
- Do you allow and state that the client has the right to review fees and expenses before using the money in the client trust account to pay for these items? (Put this language in your fee agreement.)
- Do you file an annual unclaimed funds report with your state which includes all outstanding checks written but not cashed? In some states, unclaimed funds held in lawyer trust accounts must be reported.
For more information on fiduciary duties and best practices for handling your trust accounting transactions, download the free MyCase eBook: “Trust Accounting Basics” by author Peggy Gruenke.
Peggy Gruenke is Chief Operating Officer at Hengehold Capital Management, as well as a law firm management specialist in operations, online marketing, technology and accounting at Small FirmSuccess.