What is an Attorney’s Escrow Account?
An Attorney Escrow Account, sometimes referred to as an Attorney Trust Account, is an account at a financial institution which is used exclusively to hold clients’ or third persons’ funds and the funds of the lawyer or law firm. The IOLTA portion of the account is managed within guidelines set forth by applicable state law.
Attorney trust accounts hold client funds for which the attorney or law firm has a fiduciary duty to manage in a manner similar to what would be expected of the attorney in representing that client. Funds held in an attorney trust account differ from general operating funds in the following way: ABC Law Firm received $5,000.00 for a landlord-tenant matter on January 1, 2013. We put the $5,000.00 in our operating account and used the funds to pay our rent, office supplies and salaries. On March 1, 2013 we sent the $5,000.00 to the landlord and provided the accounting for the funds received for the client . ABC Law Firm opened a checking account for the client’s money on January 1, 2013. The landlord’s lawyer placed the $5,000.00 in the account the same day. ABC Law Firm’s expense for the rent checks will be a $50.00 per hour administrative charge to maintain the books on behalf of the client.
It is not uncommon for funds received by an attorney or law firm to be escrowed without the attorney or firm being the ultimate beneficiary. Common examples of this are: An attorney holds funds for a client to purchase a house and receives them at closing. A law firm holds funds to secure payment of legal fees. Escrowed funds are also held for personal matters such as: Divorce or Family Law matter A Personal Injury or Litigation matter. An attorney trust account is a special account that is monitored by the Institute of Continuing Legal Education (ICLE) in your state. This monitoring of attorney escrow accounts enables greater oversight which translates into more professional conduct in the legal profession.
The Rules Related to Escrow Accounts
Both state and federal regulations impose specific requirements governing who may use an attorney’s trust account and when client funds may be withdrawn from those trust accounts. The State Bar Rules of Professional Conduct, particularly Rule 4-210(a)(1)-(3) (2018) specify that trust accounts are intended for client funds received in connection with legal matters, for the benefit of a third person, for deposit by a debtor, or for safekeeping on behalf of a client (e.g., through a safety deposit box in a bank). Subject to the exception below, no other funds may be deposited into client trust account. In other words, attorney escrow accounts may not be used for attorney fees, costs advanced by the attorney, or for funds received in connection with the attorney’s representation of a debtor. Rule 4-210(a)(4) also provides that an attorney is prohibited from commingling personal funds with client funds. However, an attorney may deposit "nominal amounts sufficient to open and maintain the account or pay bank charges on that account" (like a monthly service fee).
Current federal laws also mandate that client funds must be placed into a separate federally insured client trust account. 31 C.F.R. § 103.11(1)(2). Additionally, the rules of the Financial Crimes Enforcement Network (FinCEN), a division of the U.S. Treasury, require attorneys who receive more than $10,000.00 in cash to file a Report of International Transportation of Currency or Monetary Instruments (Form CMIR). 31 C.F.R. § 1030.30(a)(1).
How to Set Up an Escrow Account
The process of an attorney opening an escrow account is a little more involved than a number of other account openings. Since these accounts deal with client funds, and these funds always need to be located in the same bank (for reconciliation purposes), states have put in a number of various requirements with regards to the opening of the account.
The first step that an attorney must take in opening an escrow account is to contact their bank to determine what documentation they will require in order to complete the opening of the account. In most cases, banks will require a "criminal history" certificate from the attorney that is seeking to open the account. This is a certificate that determines whether or not the applicant has a criminal history that would make them ineligible for bar admission. A certificate such as this is generally obtained from the American Bar Association, and must be requested prior to bar admission.
Once the attorney has presented the bank with an acceptable certificate, the bank will require a FORM letter outlining the account to be opened. This letter will be signed by both the attorney and the bank. To find out a sample form letter for an account opening, attorneys are again encouraged to check with the bank that they plan on using. The bank may already have a sample letter that they want for all new accounts. In some cases however, the bank may simply provide a list of things that they want included in the form letter, and allow the attorney to draft a form letter to their specifications. In either case, if the attorney doesn’t feel comfortable drafting the letter themselves, they can work with one of our experienced attorneys, who have drafted countless sample letters for use in opening escrow accounts.
Handling an Escrow Account the Right Way
The requirement that client funds be kept separate from the attorney’s funds applies not only to how the money is placed in trust, but also to its ongoing handling. Lead regulators continue to stress the importance of accurate accounting for client funds as an essential component of compliance, so much so that improper handling of client funds was the leading reported violation of trust account handling rules by the American Bar Association’s Center for Professional Responsibility in 2018-2019. Best practices for properly managing the funds in an attorney escrow account go beyond the storing of funds. They include tracking the funds with proper record keeping, and periodically reconciling those accounts to ensure they are being handled with appropriate care and transparency.
Record Keeping
State bar associations will differ about the amount of detail they require with respect to records of bookkeeping activities. However, the common standard is that attorneys be able to document a clear picture of disbursement and payment activity associated with any amount deposited into a client trust account. At a minimum, the attorney should be prepared to document the following elements of his or her accounting: Some state bar associations require attorneys to provide this documentation at the time of their license renewal. Others, including the California Bar, require checking-in on a regular basis on accounts with an eyeball review at intervals of between 12 months and 24 months.
Reconciliation
Not all escrow arrangements require reconciliation, but for many of them, particularly those associated with settlements, it is a best practice to issue a "closing statement" showing the amount placed in long-term escrow, any interest accrued, and how those funds will be disbursed over time. A closing statement will give both parties reassurance that the amount will be clearly and carefully managed. An additional measure of internal verification that those funds are being appropriately accounted for is the reconciliation of accounts at specified intervals. For example, while the State Bar of California only requires attorneys to reconcile their accounts once every two years, it strongly encourages its licensees to do so on an annual basis. Among the details that should be reviewed during a reconciliation are: In addition to the above best practices, attorneys may consider implementing other measures for ensuring their escrow accounts are appropriately managed, such as creating policies and procedures, or enlisting a third-party bookkeeper. As licensing boards continue to emphasize the importance of escrow account fidelity, lawyers should take special care to be sure theirs are properly managed and documented.
Common Compliance Issues
The most common compliance pitfalls that attorneys encounter:
Account co-mingling.
Falling behind on monthly reconciliations.
Improper attorney fees taken from an IOLTA account.
Failure to promptly remove fees deposited by error.
Missing bank statements.
Returning client funds from a trust account.
Taking a settlement deposit directly from the client.
Accounting for client funds improperly.
Improper deposits to an Interest Bearing Account .
Improper signatory authority on the account.
Recording interest that has not yet been received in attorney operating account.
No funds management plan.
Failure to comply with state bar rules.
Improper withdrawals from an IOLTA account.
Inaccurate accounting of client funds.
Misallocation of interest earned.
Withdrawing funds prior to receipt.
Not properly verifying any requests to withdraw funds.
Not filing an IRS form 1099 for interest earned by clients.
Errors Resulting from Noncompliance
The loss of client trust is perhaps the largest danger involved in the mismanagement of an attorney escrow account. Without the trust of their clients, an attorney cannot function. Each mismanagement or loss damages the reputation of the attorney and the law firm that is involved. This can also result in clients losing trust in other attorneys and law firms within the same geographic area as their attorney.
Disbarment of a lawyer can be the result of the mismanagement of an attorney escrow account. On March 31, 2017, the Director of the Office of Attorney Ethics publicly censured attorney Adam M. Proctor for violating several rules of professional conduct by improperly using his IOLTA account and non-IOLTA trust account for his own benefit and failing to maintain proper accounting records. The court found that Proctor misused his trust account at least 19 times from January 1, 2016, through February 23, 2017, for a total of $89,210.51 of his personal funds and his law firm’s funds, and failed to replace most of these funds. At the same time, he also made 54 improper IOLTA account withdrawals, totaling $109,636.64. In determining the amount that Proctor should be required to reimburse to the affected escrow account and/or IOLTA account, the court considered any money that Proctor had deposited into these accounts as reimbursement for his previous misconduct:
Proctor withdrew fees, without an agreement with his clients or countervailing documentation, from five clients’ non-IOLTA trust accounts: (A) L.M., (B) E.J., (C) K.P., (D) F.P., and (E) S.L. From January 12, 2015 to January 29, 2015, Proctor engaged in the practice of law without a law license, by representing S.L. in her personal injury case; this unpaid fee was a legitimate claim on the balance of the S.L. Trust [account]. Proctor did not withdraw all of S.L.’s funds or place these funds in his IOLTA account after he was reinstated and did not offer to take S.L.’s personal injury case on a contingency fee.
How to Avoid Compliance Problems
Making sure proper accounting and bookkeeping procedures are in place and followed is the best way to protect your clients and your law firm.
In order to keep compliant with relevant rules and regulations governing attorneys’ trust accounts, your firm should implement and adhere to the following tips:
Implement a financial safeguard plan
Designate at least one person in your office to manage client trust funds. It’s also recommended that you maintain an up-to-date list of every banker, bookkeeper and accountant in your firm with access to your firm’s IOLTA and demand accounts.
Client trust funds may be deposited in one or more interest-bearing accounts, both institutional and non-institutional. However, attorneys must monitor and periodically review the account interest accruals to determine whether the amount of accrued interest is greater than the cost of establishing an outside non-IOLTA account for the client’s property.
Pay interest earned on client funds held in non-IOLTA accounts in accordance with the law and your state bar association guidelines. You must promptly remit accrued interest to clients when timely payment is requested. If you cannot determine which clients’ funds earned the interest, you may divide the interest and allocate it proportionately among all clients whose funds are deposited in the account.
Compensate staff fairly and in accordance with IRS requirements
Since IOLTA management requires detailed record-keeping, your firm may see the need to compensate staff for their efforts. Be sure to investigate tax records to ascertain what employer expenses must be included as taxable wages if you pay your law firm’s employees or independent contractors to perform IOLTA compliance functions.
For instance, if you reimburse employees for their mileage and other travel, be cautious about how you handle the payments. As explained in IRS Publication 535, Business Expenses, if travel meets the definition of deductible transportation, no portion of travel is taxable. But if travel is personal in nature and is not primarily for business reasons, the entire reimbursement, including the cost of meals and lodging, are expected to be reported as taxable wages.
Staff lawyers on an overtime or commission basis must be cognizant of the potential applicability of federal and state overtime requirements. Although outside consultants are not likely to be considered employees, they may be treated as employees under IRS guidelines.
Establish strict procedures for dealing with bounced checks
Decide right away how bounced check situations will be handled. We suggest you devise a written policy and make sure all partners and staff are made aware of its terms.
Be patient
Concern for compliance may cause you to want to take action immediately. Wait a few minutes and re-read your last IOLTA reconciliation. If necessary, verify that your actual calculations are correct.
Attend ABA annual meetings and watch CLE webinars
Attend American Bar Association (ABA) meetings to network with lawyers who also have IOLTA accounts. Start watching webinars and tutorials specifically about IOLTA. You may find those created by the ABA particularly helpful as they are expertly presented and cover a wide variety of topics related to compliance.
Don’t forget continuing education
Many states require attorneys to comply with mandatory continuing legal education (MCLE) credits. Take advantage of classes that focus on IOLTA and how to remain compliant with state and ABA rules.
To learn more about the importance of keeping good records for your firm’s trust and IOLTA accounts, please visit this Nolo.com webpage for further information.
Conclusively, a well-organized law firm will have a plan for making sure proper accounting and bookkeeping procedures are in place and followed. Think about every conceivable way the firm can be financially harmed, then put safeguards in place to prevent these things from occurring.
When to Hire a Professional
When navigating the complex and constantly evolving landscape of attorney escrow account rules and regulations, legal practitioners may find themselves in need of outside help. Hiring a professional to manage a firm’s escrow accounts might be the best route for some attorneys. For instance, employing the services of an accountant who understands client trust accounting can help attorneys keep track of IOLTA accounts, monitor CLE trust accounts, and steer them through any disciplinary counsel investigations. Furthermore, seeking the help of a compliance consultant can be invaluable for those newly registered in states with rigorous record-keeping, reconciliation, and monitoring requirements.
Lawyers seeking to gain a confidant in their endeavor to securely manage their attorney fiduciary funds may also want to look for a compliance-focused technology solution . Cloud-based products like TrustBooks facilitate bookkeeping and compliance monitoring and warning systems to minimize the risk of falling out of compliance by automating "routine" tasks and utilizing high-end security to get the right permissions to the right people. Software like this can save lawyers time and money, while offering the peace of mind that comes with knowing they are in good hands with a solution that keeps them safe and secure.
Ultimately though, the responsibility for finding the solution that works best, or presenting their current solution to the state bar, rests solely with the attorney. The bottom line is that attorneys need to be able to explain their system to a third party if necessary. The resulting conversations are not just looking at alternative offerings, but finding a solution that works best for the practice, clients, and budget.