Danger of Commingling and Conversion of Client and Third Party Funds
By Thomas P. Sukowicz
All lawyers know that it is wrong to steal from clients. These days, however, the ethics rules require that lawyers to do more than avoid stealing. In most states, they contain requirements about the kinds of accounts in which client and third party funds may be held, notices to be sent, kinds of records that must be kept, and accounting for the funds. For example, all states require that lawyers maintain separate trust accounts for client and third party funds to avoid commingling those funds with the lawyer’s own money.
ABA Model Rule 1.15, the rule upon which many states’ rules are based, requires that lawyers avoid commingling by keeping the funds of clients and third persons separate from those of the lawyer. Commingling occurs when a lawyer holds his or her own funds in the same account that is holding client or third party funds. Commingling is, itself, a violation of the ethics rules and may subject a lawyer to discipline.
Avoiding commingling may not always be easy because of confusion as to whether certain funds belong to lawyers or to their clients. For example, some fees belong to the lawyer as soon as they are paid. It would be a commingling violation in most jurisdictions to deposit these fees in a client trust account. Other fees are merely advances that the lawyer will earn as he or she bills for time spent on the client’s behalf. These funds currently belong to the client and should be deposited into the trust account under the rules as interpreted by most states.
Some states’ rules specifically allow funds reasonably sufficient to pay account charges imposed by the bank or funds belonging in part to a client and in part presently or potentially to the lawyer. The portion belonging to the lawyer should be withdrawn when due unless the right of the lawyer or law firm to receive it is disputed by the client, in which event the disputed portion shall not be withdrawn until the dispute is finally resolved.
Most rules also require that lawyers or law firms maintain specific kinds of records related to the handling of such funds and that such records are kept for a certain number of years. Every lawyer should check the ethics rules of the jurisdiction(s) in which he or she is licensed to determine what kinds of records are required to be maintained.
Even if a lawyer maintains a separate, identifiable trust account and the kinds of records required in his or her jurisdiction, there is still a risk that the lawyer will be accused of conversion of client or third party funds notwithstanding that the lawyer did not intend to convert such funds and without realizing that the funds were converted.
Interestingly, the ABA Model Rules (like the rules of many jurisdictions) does not contain a rule that explicitly prohibits lawyers from stealing (converting) client funds. The absence of an explicit rule does not mean that lawyers may misappropriate client and third party funds without being subject to discipline. In states that have rules based on the Model Rules, such as Illinois, lawyers who steal client or third party funds are charged in disciplinary proceedings with common law conversion and, usually, conduct involving dishonesty, fraud, deceit or misrepresentation in violation of Rule 8.4(a)(4) and conduct that tends to bring the legal profession into disrepute. In states such as Illinois, a lawyer can be disciplined for conduct that is as obviously wrong, even absent an explicit rule prohibiting it.
New York is an example of a state whose ethics rules specifically prohibit conversion of client funds. Its DR 9-102(A) provides that a lawyer in possession of any funds or other property belonging to another person, where such possession is incident to his or her practice of law, is a fiduciary, and must not misappropriate such funds or property or commingle such funds or property with his or her own.
Whether in a jurisdiction with an explicit rule or not, Lawyers who handle client and third party funds can run into problems in many ways. For example, a lawyer might properly deposit client funds in an appropriate trust account, but fail to maintain records showing them exactly how much money is being held in the account for each client at any given time. Without such records, such as a separate ledger for each client whose funds are being held, the lawyer relies on his or her recollection of how much went in the account for a certain client, and how much has already been disbursed. If the lawyer is wrong, as frequently happens, he or she might disburse more funds to himself or herself than are available, thus converting at least a portion of client funds to their own use.
When client trust accounts are audited by the local disciplinary authorities, one of the techniques used to determine whether the lawyer has converted client funds is to add up the aggregate amounts that a lawyer should have in the trust account on any given date for all clients. If the balance in the trust account is less than the aggregate of funds that should be in the account for all clients, then the lawyer is deemed to have “converted” some of the funds belonging to the clients. It is not necessary to identify which client’s funds were converted. It is enough that the funds in the account are less than the total amount the lawyer should have been holding for all clients.
Sometimes the timing of the disbursement of client funds can lead to a charge of conversion. For example, the Illinois Supreme Court found that a lawyer who deposited client settlement funds in a trust account and disbursed the funds before the settlement check had cleared was guilty of conversion. In re Elias, 114 Ill.2d 321, 499 N.E.2d 1327 (1986).
The reason a lawyer may not immediately issue a check to the client is that when a settlement check is deposited into a client trust account, the funds represented by the check are not always immediately available. The funds are not available until they have been collected by the bank at which the trust account is maintained. If a lawyer issues a check to a client before the funds represented by the settlement check have been collected, the lawyer is disbursing funds belonging to someone other than the client. This becomes a serious problem if the settlement check does not clear and the funds are never collected by the lawyer's bank.
An example of this occurs when a settlement check that has been deposited into a client trust account is returned for lack of sufficient funds in the account on which the check was drawn. If the lawyer has already issued a check to the client and the client has negotiated the check, the client has received funds belonging to someone else. The "someone else" should not be the lawyer, because lawyers are not permitted to keep their own funds "commingled" with client funds in a client trust account. Therefore, the funds that the client received are likely to be funds that belong to another client.
Another common way lawyers convert funds is by taking the money of one client and paying it to another client or third person. This can occur rather innocently if the lawyer looses track of exactly how much he or she is holding for each client, and overpays one at the expense of another. While the inadvertence of the conversion and the lack of intent on the part of the lawyer are considered mitigating factors in disciplinary proceedings, they do not excuse the misappropriation that has occurred. Similarly, the fact that all clients ultimately receive all of the funds they are entitled to receive, merely mitigates the misconduct involved in using the funds of the client, even temporarily, without the client’s consent.
The ethics rules of some states provide for an exception to the prohibition against disbursing funds before the deposited check clears. For example, Illinois Rule 1.15(g), which applies to funds received in connection with the closing of real estate transactions, provides that a lawyer's disbursement of funds deposited but not collected does not violate his or her duty if, prior to the closing, the lawyer has deposited such funds in a segregated Real Estate Funds Account maintained solely for the receipt and disbursement of such funds, and is either acting as a closing agent pursuant to an insured closing letter for a title insurance company licensed in the State of Illinois and uses the REFA solely for the title insurance business, or if the lawyer has met the "good funds" requirements.
The "good funds" requirements are met if the bank in which the REFA is maintained has agreed in a writing directed to the lawyer to honor all disbursement orders drawn on the REFA for all transactions up to a specified dollar amount not less than the total amount being deposited in “good funds” such as a certified check; a government check, a cashier's check, teller's check, bank money order and other checks.
Another common way in which lawyers get into trouble over client funds is when they “borrow” funds being held in their client trust accounts, intending to repay the money once some anticipated fee is received. In one such case, a lawyer who shared office space with other lawyers was short on his share of the office expenses. He took the $1000 he needed from his client trust account, believing he could repay it from the proceeds of a case he expected to settle soon. Shortly thereafter, the State Bar audited the trust account in connection with another matter and discovered the unauthorized $1000 withdrawal. The lawyer was suspended for converting client funds. Iowa S.Ct Bd. of Prof. Ethics v. Gottschalk, 553 NW.2d 322 (1996)
In another case, when a lawyer’s personal checking account was garnished by the IRS for unpaid taxes, he began using his trust account for personal deposits and expenditures. When his check to the State Bar Disciplinary Office bounced, his trust account was audited. The audit revealed that $450 that had been withheld from a personal injury settlement to pay a medical provider was not paid, and the balance in the trust account had gone below zero. The lawyer was suspended for commingling and for conversion of the $450. Comm. on Prof. Ethics & Conduct v. O'Callaghan, 436 N.W.2d 51 (1989).
To avoid mistakes that can lead to serious consequences, such as discipline and civil action, become familiar with your jurisdiction’s rules regarding trust accounts, keep adequate records of the funds you are holding for each client and be very careful not to disburse funds to anyone other than the person entitled to those funds.