Short Guide To Trust Accounting And Three-Way Reconciliation

 Above the Law has a very short reminder of the basis related to trust accounting here.  Go read it for a quick refresher course.

Two recent decisions reiterate the ABA's approach to flat fees paid in advance

 Last May I wrote a comment on an ABA Formal Ethics Opinion on flat fees which concluded that flat fees paid in advance should be considered client funds and, therefore, should be held in a trust account until earned.  In my comment I explained why I think this is the correct view even though there is some debate about it among some jurisdictions.  You can read my comment here. 

I am writing about this topic again today because of two interesting recent opinions, one from California and one from the District of Columbia.  

In In re Alexei, ___ A.3d ___ (D.C. Ct. of Appeals 2024), 2024 WL 3611154, (available here) the court held that flat fees paid in advance are unearned until the legal services they are supposed to pay for are completed.  As such, even though the attorney may have possession of the fees, the attorney does not have ownership and, thus, the fees property of the client until the fees are actually earned.  If an attorney removes the unearned fees from their trust account, the attorney may violate Rule 1.15(a).  The court also held that the fees are actually earned only upon completion of the entirety of the solicited services unless the fee agreement specifies otherwise.

Importantly, the court rejected the notion that a flat fee paid in advance should be considered earned upon payment because if a client consent could change when a fee is actually earned, it would not be true that a lawyer can’t earn a fee for doing nothing because a client could consent to an arrangement whereby the lawyer earns a fee upfront before actually performing any work for the client.  Also, allowing a lawyers and clients to “deem earned” fees that are not earned yet goes against the intent of the rules that mandate safekeeping of property.   

Having said that however, the court recognized that attorneys could depart from the default rule by either (1) specifying in the agreement for services when and how portions of the flat fee are earned or (2) obtaining informed consent from the client to treat unearned fees as their attorney property.

Notice how this second option contradicts the policy upon which the court based its decision to reject the notion that a flat fee paid in advance should be considered to be earned upon payment.  In fact, the court essentially says that the attorney can negotiate with the client to have the client agree to do something the court has decided could result in a violation of the rules.  This makes little sense, and I explore that topic in a forthcoming article called Advanced Magic in Illinois: Amendments to the Illinois Rules of Professional Conduct and the Confusion Over How to Handle Flat Fees Paid in Advance, 56 Loy. U. Chi. L.J. ___ (2024).

The second recent case addresses the question of whether a client’s creditor may seize funds held in trust pursuant to a flat fee agreement and concludes that, logically, the answer is yes if the fee held in trust has not been earned yet.  The case is Dickson v. Mann, Super Ct. No. 37-2021-00042299-PR-TR-CTL (July 16, 2024), available here.  

The court held, correctly, that “a flat fee paid by a client to a lawyer for future legal services does not belong to the lawyer until the fee is earned through the actual provision of legal services” and since the firm presented no evidence that it had performed any legal services yet the flat fee funds still belonged to the client at the time the creditor filed the notice of seizure. Accordingly, the court ordered the firm to produce the funds for seizure by the creditor.

ABA Issues new formal opinion on advance "non refundable" fees

Way back in 2016 the Board of Professional Conduct of the Ohio Supreme Court released an advisory ethics opinion on whether a lawyer may enter into an agreement requiring a client to pay a flat fee in advance of representation and on whether a lawyer must deposit such a fee into a trust account. See Board of Professional Conduct of the Supreme Court of Ohio, Opinion 2016-1 (February 12, 2016).  Upon reading it, I thought the opinion reflected a common problem among jurisdictions that results in a confusing inherent contradiction within the applicable rule.  So, I wrote an article for Ohio Lawyer magazine (available here) in which I argued why the Board should have corrected the deficient drafting and interpretation of the rule.  

In essence, I argued a few relatively simple principles: that it would be unethical to charge or collect a fee that was not earned and that, therefore, if the fee was paid in advance, it had to be kept in trust until earned.  And, I made very specific suggestions on how to amend the rule and its comment to reflect the correct doctrine and to help lawyers better apply it.

The problem with the Ohio opinion, which is not uncommon among a number jurisdictions, is that it concluded it would be fine for lawyers to “deem earned” fees that had not been earned yet in order to allow the lawyers to place the money in their general accounts rather than in their trust accounts, while, at the same time, assuring clients that if the money was not earned eventually, they would be guaranteed a refund of the unearned portion of the fee.  

In my article, I argued this resulted in making the fees both earned and unearned at the same time, and inevitably lead to commingling regardless of where the money was placed.  It also prioritized the lawyers’ interests in getting their hands on the money at the expense of clients who were placed at risk of losing their money.  Thus, I suggested specific changes to the Ohio rules to fix the contradiction and to balance the interests of lawyers and clients.

But no one listens to me, and nothing changed.

So why am I writing about this today?  Because last week the ABA’s Standing Committee on Ethics and Professional Responsibility issued a new Formal Opinion (No. 505, available here), in which it adopts the views I argued for way back then.  I guess it took a long time, but finally we have a good opinion on the subject and hopefully jurisdictions will take notice.

Opinion 505 frames the issue from a slightly different perspective, but in the end addresses the same questions.  The opinion focuses on the question of whether lawyers can label advance fees as “non refundable” but in the process talks about the same practice I discussed years ago – the practice of saying that fees are “deemed earned” when in reality they are not.  On this point, the opinion is very clear: 

“The Model Rules of Professional Conduct do not allow a lawyer to sidestep the ethical obligation to safeguard client funds with an act of legerdemain: characterizing an advance as “nonrefundable” and/or “earned upon receipt.” This approach does not withstand even superficial scrutiny. A lawyer may not charge an unreasonable fee.”  Thus, as the opinion points out, “[t]his approach departs from the safekeeping policy of the Model Rules described herein and creates unnecessary risks for the client.”

“Legerdemain,” by the way, means a skillful hiding of the truth in order to trick people.  Hiding of the truth to trick people.  That sounds bad.  You wouldn’t want to be known as a lawyer who hides the truth to trick people, would you?

Interestingly, the ABA Opinion has generated some criticism from some that say that lawyers and clients should be free to contract in any way they see fit.  Yet, this view forgets that rules of professional conduct interfere with lawyers’ “rights” all the time, for many reasons and on many topics because there are other interests at stake.  In response to that, some then argue that there is no valid interest at stake on the topic of fees paid in advance.  Yet, there is.  As the opinion argues, the interest is client protection.  The rules are there to protect clients and they do so by making sure that the lawyers abide by the rules related to safekeeping of money and the rules that mandate refunds of unearned fees.  

Some have argued that lawyers who might steal money from clients will take the money from trust accounts anyway, so mandating which account must be used to keep fees paid in advance makes no difference.  But this forgets that the idea behind mandating the use of trust accounts is not only to protect clients from the lawyer, but, more importantly, from the lawyer’s creditors.  

Finally, I’ve also heard some cite a case from Michigan called Grievance Administrator v. Cooper, 757 N.W. 2d 867 (Mich. 2008), in support of the position that it would be fine for a lawyer to charge a non-refundable flat fee paid in advance.  Unfortunately, this analysis is wrong for a basic reason: the case was wrongly decided since it did not involve a flat fee paid in advance.  It involved a security retainer, which, by definition, would be unreasonable if it were non-refundable.

One last point: the ABA Opinion refers to circumstances in which a lawyer does not have consent from a client.  An interesting question is whether a lawyer should be allowed to place an unearned fee in the lawyer’s operating account if the client gives consent.  In the District of Columbia, for example, that is allowed.  See In Re Mance 980 A. 2d 1197 (D.C. 2009).  

So, in conclusion, I think we can agree that when fees are paid in advance, they raise some ethical concerns.  One way to address these concerns is to ban lawyers from asking clients to pay in advance.  Another solution might be to stop requiring that lawyers use client trust accounts.  See, here and here, for example.   Yet, many reasons justify allowing the practice of asking for payment in advance and of requiring lawyers to keep separate trust accounts.  

The concerns can be addressed without having to go that far.  A better alternative is to eliminate the “legal fiction” of “deeming” a fee as “earned” when it is just a way to pretend that the amount of the fee belongs to the lawyer even though the work it is supposed to pay for has not been performed.  Instead of allowing this, lawyers and clients should agree on how (or when) portions of the fee are actually earned so that ownership of that portion of the money can be transferred to the attorney.  This way, the fee amount paid in advance is kept in the trust account, but the attorney can withdraw funds as they are earned before the end of the representation. 

Recent amendment to Louisiana Rule 1.15

 The Louisiana Supreme Court recently amended Louisiana Rule of Professional Conduct 1.15(d) to clarify a lawyer’s duty with respect to the interests of third parties in funds or other property in the lawyer’s possession. The rule change becomes effective on December 1, 2022.  For a summary of the changes go here.

Is it OK to deposit "lawyer money" into client trust account to prevent account from being closed for inactivity?

On October 29, 2019, the New York State Bar Association Committee on Professional Ethics issued an advisory opinion, Opinion 1176, which addresses whether a lawyer may “make a nominal deposit of the lawyer’s own funds to avoid having the lawyer’s trust or escrow account closed for inactivity or failure to maintain a minimum balance.” 

Given that most states allow lawyers to use their own money to pay for trust account fees and transactions (see Model Rule 1.15(b)), not surprisingly, the answer to the question is that it is acceptable for a lawyer to use firm money to keep the trust account alive.  You can read the opinion here.

Ethical issues related to leaving a firm

A few days ago I posted a link on "how not to practice law" about a case involving a lawyer accused of stealing files from a firm when departing from it (here).  A few days later, Ethical Grounds posted a short follow up discussing issues related to the ethics of departing from a firm.  Take a look at it here.

Texas Bar Ethics Committee Opinion on a lawyer's duty to safeguard client funds for the benefit of a third party -- UPDATED

Back in September 2018, the Texas Bar Ethics Committee issued a short ethics opinion trying to explain the proper analysis attorneys should follow to determine if they owe a duty to a third party who claims to have an interest in client money in the lawyer's trust account.

More specifically, the opinion addresses these two questions:  "when does a third party have an interest in client funds sufficient to trigger a lawyer’s duty to disburse or safeguard those funds for the third party’s benefit?" and "[d]oes termination of the attorney-client relationship affect a lawyer’s duty to safeguard or disburse client funds in which a third party claims an interest?"

You can read the opinion online here or download it in pdf here.

UPDATE (7/1/19):  Ethical Grounds has posted a comment on the opinion here.

What if a client asks lawyer to destroy the client's file or some of its contents?

Over at Ethical Grounds (the unofficial blog of Vermont's bar counsel), Michael Kennedy discusses a recent NY opinion on whether an attorney has to destroy the client's file upon request.

As Michael explains, ordinarily, upon the termination of a representation, Rule 1.16(d) requires a lawyer to surrender to the client all papers and property to which the client is entitled, which, of course, includes the client's file.  But, the lawyer is also entitled to keep a copy of the file, which, in fact, the lawyer may be required to do according to the lawyer’s malpractice.

The interesting question then becomes, what to do if a client directs a lawyer not to keep to a copy of a the file?

You can read the comment here.

ABA Opinion 483 on the duties related to data breaches

Last October, the ABA Committee on Professional Responsibility published Formal Opinion 483 to provide guidance on how lawyers should handle data breaches before, during, and after an event. In short, lawyers must take proactive steps to protect sensitive client data and they must disclose material data breaches.

You can read the opinion here.  Here is a summary by the National Law Review:

The ABA states that data breaches pose a “major professional responsibility and liability threat” to the entire legal profession.  It defines a data breach as “a data event where material client confidential information is misappropriated, destroyed or otherwise compromised, or where a lawyer’s ability to perform the legal services for which the lawyer is hired is significantly impaired by the episode.”  When there is data breach, attorneys must first comply with state and federal legislation. Next, attorneys must disclose a breach to a current client if (a) that client’s material, confidential information is or reasonably may have been compromised (e.g., unauthorized access, use, theft, or destruction), or (b) the breach has materially disrupted the attorney’s ability to serve the client (e.g., ransomware limiting access to client information for any material amount of time). In essence, lawyers must notify clients when incidents like ransomware materially impair operations—even when there is no evidence of exfilatrated or compromised data.  Here, strong defense mechanisms include up-to-date, accessible, and easily restorable back-ups to fend off disruption of legal services

For some commentary on the opinion go here:

Faughnan on Ethics (on the relationship between the opinion and Model Rules 1.15 and 4.4)

Above the law

Lawyer Ethics Alerts Blog

ABA issues new Formal Opinion

Earlier today, the ABA Standing Committee on Ethics and Professional Responsibility issued a new Formal Opinion (Number 482) on “Ethical Obligations Related to Disasters,” which is not about what happens when a lawyer makes a huge disastrous mistake.

The Opinion is essentially a reminder to lawyers that they need to be aware of their duties when their practice is affected (or is likely to be affected in the future) by natural disasters. 

As the opinion explains in more detail, extreme weather events such as hurricanes, floods, tornadoes, and fires have the potential to destroy property or cause the long-term loss of power.  For this reason, lawyers must be prepared to deal with disasters.  Thus, lawyers have an ethical obligation to implement reasonable measures to safeguard property and funds they hold for clients or third parties, prepare for business interruptions, and keep clients informed about how to contact the lawyers (or their successor counsel).  The opinion concludes that “by proper advance preparation and taking advantage of available technology during recovery efforts, lawyers will reduce the risk of violating professional obligations after a disaster.”

You can read the full opinion here.

Virginia might soon become the next state to hold participating in Avvo Legal Services is unethical

Readers of this blog know that I have written extensively on the issues related to Avvo Legal Services.  You can go here and scroll down to see all my posts and links to some of my articles.  And, it is no secret that I have been critical of Avvo's model from the beginning, arguing that it places attorneys in a position to violate several rules of professional conduct.

For this reason, I have not been surprised to see that ethics committees in Ohio, Pennsylvania, South Carolina, New Jersey, New York and, most recently, Utah have issued opinions holding that it would be unethical to participate in Avvo Legal Services.  Florida, and North Carolina are considering the question. Of these, only North Carolina is reportedly considering holding that participating in Avvo Legal Services would be OK, but it is also considering amending the rules -- which begs the question, if is OK to participate why would you need to amend the rules to allow it?  But that is a different conversation...

Today's post is to announce the latest addition to the list of opinions holding that participating in Avvo Legal Services would violate current rules.

As reported in the Lawyer Ethics Alert Blog, just over a week ago, the Virginia State Bar voted to approve a draft ethics opinion holding that a lawyer’s participation in services such as Avvo's would violate the Virginia Rules of Professional Conduct.  Like most other opinions on the subject, it does not refer to Avvo by name but given the description of the services it addresses it is pretty clear the opinion relates to Avvo Legal Services.

Not surprisingly, the opinion reaches the same conclusions reached in the literature and other opinions, namely that participating in Avvo Legal Services violates rules related to sharing fees with non-lawyers, paying for referrals, duties to safeguard client property, and duties related to trust accounts including the duty to refund unearned portions of a fee.

Having said that, the opinion states lawyers could participate in the service if some of the conditions are changed.  Doing so, however, would change Avvo's terms and it is not clear that Avvo would want to agree to change its business model.

The opinion (which is available here) will now go before the Virginia Supreme Court for approval.

In light of so many opinions holding against Avvo's service, I have often suggested Avvo is going about its plan the wrong way.  Rather than arguing that the rules should be interpreted to say something they don't, or, worse, that they should be ignored, or continue to advance weak legal arguments, Avvo should advocate for changes in the rules.

Take a look at the position Avvo took in relation to the Virginia opinion (here) and note what they don't do.  They don't even try to address the substantive/legal arguments related to the violations of the rules.  They essentially say the opinion is bad because it does not allow Avvo to do what it wants.  The argument is essentially that what Avvo wants is good, and, thus, preventing it is bad.  Yet, the problem is that even if what Avvo wants is good, it leads to violations of the rules.  The solution can't be to ignore the rules.  The solution has to be to change the way Avvo wants to do what it wants to do so it does not violate the rules or to change the rules. 

What Avvo does now puts lawyers in a position to violate the rules.  Arguing that it doesn't is going nowhere fast.  So, why doesn't Avvo change course and try to present arguments for changing the rules to suggest a new approach would be better for the profession, for consumers and for society in general?  To its credit, Avvo seems to be trying this approach in North Carolina and maybe it is just waiting to see if it works there as a "test case" before trying it elsewhere.

I have argued for this change in tactics before and I am happy to report I am not alone in this view.  Brian Faughnan (of Faughnan on Ethics) has recently published "an open letter" to Avvo arguing the same point.

North Carolina is considering amending its rules to make it easier for lawyers to participate in Avvo Legal Services

Long time readers of this blog know that I have been following and writing about the debates related to Avvo Legal Services for some time now.  For an article on my position on the subject go here. 

As you may remember Avvo has attempted to argue that lawyers should not worry about participating in Avvo Legal Services because doing so does not violate rules of professional conduct, or, if it does, because the rules are unconstitutional.  Yet, all the opinions issued so far have concluded that Avvo is wrong.  And that is because under the current regulatory scheme in pretty much all states, Avvo’s arguments are weak. 

Having said that, however, note that the key to the previous statement is “under the current regulatory scheme.”  Saying that participating in Avvo Legal Services would violate the rules is not the end of the debate.  The more interesting question is whether the rules should be changed to accommodate what Avvo wants to do.

Today’s update on this story is that instead of continuing to argue that the rules don't apply or that they should be ignored, Avvo apparently has been trying to convince the North Carolina regulators to change the rules.  As a result, North Carolina may soon become the first state to change the regulatory approach in order to formally make it acceptable for lawyers to participate in services like Avvo Legal Services.  (Interestingly, as you might remember, North Carolina also amended its definition of the “practice of law” as part of an agreement with LegalZoom.)

According to documents I have reviewed, as a result of meetings between Avvo and a committee of the State Bar Association, the committee has drafted a proposal to amend several rules of professional conduct, including Rule 5.4, which bans splitting fees with non-lawyers.  The proposal would add a new paragraph to the rule to state that “a lawyer may pay a portion of a legal fee to a credit card processor, group advertising provider or online platform for identifying and hiring a lawyer if the amount paid is a reasonable charge for administrative or marketing services and there is no interference with the lawyer’s independence of professional judgment or with the client-lawyer relationship.”

Adoption of this new rule would be good news for Avvo, but would not necessarily clear the way entirely.  One point of contention within the committee was whether Avvo’s rating system operates as a recommendation to consumers which would result in a violation of rule 7.1 if lawyers were to pay Avvo for recommending them, particularly since Avvo does not disclose the basis of the rating system.  Within the committee, this created a concern over whether Avvo is providing recommendations that are not based on legitimate criteria because the rating system is not transparent since it does not provide information on the factors used to create the rating.

To address this concern, there is now a proposal to add a new paragraph to the comment of Rule 7.1 to state (in part) that “A lawyer may participate in online directories and other rating systems that allow the lawyer to “claim” the lawyer’s profile and to provide information for inclusion in the profile or to be used to rate the lawyer.  The information provided by the lawyer must be truthful and not misleading.  No money may be paid by the lawyer for a rating and, before voluntarily providing information to an online rating system, the lawyer must determine that the rating system uses objective standards that are verifiable and would be recognized by a reasonable lawyer as establishing a legitimate basis for evaluating the lawyer’s services. . . .”

If it is true that Avvo does not disclose the basis of its ratings, I am not clear how a lawyer can meet these requirements. 

Finally, as one would expect, another concern is whether allowing Avvo to retain the consumer’s payment until the lawyer finishes providing the legal services constitutes a violation of the lawyer’s duty to safeguard client’s funds in a trust account and to contribute the interest generated by that account to the state’s IOLTA program.

To address this concern, Avvo has suggested an amendment to the comment of the rule on safeguarding property, but it is not clear that the committee of the State Bar has adopted it.  Avvo’s proposal is to add a new paragraph to the comment to read: “Client or third person funds sometimes pass through, or are originated by, intermediaries before reaching the lawyer’s account.  Such intermediaries have traditionally included banks, credit card processors, or litigation funding entities, and have been chosen unilaterally by the client.  However, newer intermediaries include attorney marketing programs, chosen by the attorney, that collect payments directly from clients and pass them through to the attorney.  Attorneys have an affirmative obligation to ensure that such intermediaries 1) adequately protect client funds and 2) do not retain client funds for a period [of time] that materially impacts i) the client’s opportunity to earn interest on the funds, or ii) the availability of interest earnings for [state legal services organization that receives IOLTA interest, if applicable].  Absent other indicia of fraud (such as the use of non-industry standard methods for collecting credit card information), an attorney’s diligence obligation will be deemed met with respect to intermediaries that collect client funds using credit or debit cards and remit such funds to attorney accounts within [ ] days.”

As of now, I don’t know if the State Bar proposal will include this suggested language.  It is not included in the copy I have, but there may be more documents I have not seen yet.  Clearly, Avvo's goal is to exempt lawyers from having to deposit client money in a trust account, at least for some, as of yet not determined, period of time.  For those who have argued the rules about trust accounts should be abandoned or relaxed, this would not be a problem.  But for those who think they need to be followed strictly in order to protect clients, this proposal might be a problem.  The North Carolina rules regarding trust accounts can be found here.

The documents I have seen about these proposals are all from within the last three months, but I do not know what is the current status of the proposals.  It remains to be seen if they will be adopted by the State Bar Ethics Committee.

Stay tuned.

ABA Committee on Ethics and Professional Responsibility issues new opinion on safeguarding fees to be split with lawyers outside the firm

The ABA Standing Committee on Ethics and Professional Responsibility has issued a new Formal Opinion (No.475) to explain the duties of a lawyer who receives earned fees that must be shared with a lawyer from another law firm.  According to the opinion, the lawyer who receives the money must take steps to appropriately safeguard the funds by placing them in an account separate from his or her own property.  The attorney must then promptly notify the other lawyer, promptly forward the agreed portion to the other lawyer, and provide an accounting if the other lawyer requests it.  The opinion is available here for a limited time.

Not all jurisdictions agree with the approach but it makes sense to me.  The alternative is to have the lawyer transfer the money to the lawyer's general account and then pay the outside lawyer with funds from there.  Either way, the money will be commingling with either clients' money or lawyer's funds for a period of time.

IPethics & INsights has a nice comment on the opinion and its applicability to IP practice here. The Lawyer Ethics Alert Blog also has a comment on the opinion here.

My article on Avvo is now available

During the spring and summer I wrote an article on ethical issues related to joining Avvo Legal Services.  I started writing the article soon after Avvo announced the new service, and finished it before the recent ethics opinions from Ohio, South Carolina, and Pennsylvania.  Georgetown agreed to publish the original article, but because it took them a long time to get around to it I had the chance to update the draft a little bit based on the recent opinions.  Now the article is finally available.  You can go to the Georgetown website and read it or download it here. 

ABA issues new ethics opinion on what to do when lawyers received a subpoena for client's documents

 The ABA Standing Committee on Ethics and Professional Responsibility recently issued a new opinion which provides some guidance to lawyers receiving subpoenas for client documents or information. You can download Formal Opinion 473 here but do so soon because once the opinion goes into the "archive" it will be available for free only to members of the Center for Professional Responsibility.

For comments on the opinion go here and here.

NY opinion on what to do when client files are accidentally destroyed by fire or natural disaster

When a hurricane, fire, or other disaster destroys client files, attorneys face the difficult question of how to communicate the loss to clients. Until recently, most ethics guidance on this topic focused on what lawyers can do ahead of time to reduce the risk of loss. Now, a new ethics opinion by the New York City Bar Association's Committee on Professional Ethics offers guidance on what lawyers should do after client files are inadvertently destroyed. Here's a helpful summary.