Discipline
Aug. 17, 2002
Accounting Basics
Dicta Column - By Myer J. Sankary - As chairman of the executive committee of the solo and small-firm section of the State Bar, I frequently hear complaints from lawyers who feel harassed by the State Bar because of minor infractions of their client trust accounting obligations. For example, when a check drawn on his or her client trust account is returned for insufficient funds, the practitioner receives an immediate response from the State Bar.
By Myer J. Sankary
As chairman of the executive committee of the solo and small-firm section of the State Bar, I frequently hear complaints from lawyers who feel harassed by the State Bar because of minor infractions of their client trust accounting obligations. For example, when a check drawn on his or her client trust account is returned for insufficient funds, the practitioner receives an immediate response from the State Bar. The practitioner probably was unaware that his or her bank was required to notify the State Bar on the occurrence of an overdraft.
Sometime, the problem can be fixed without serious damage. However, if the State Bar investigator requests the practitioner's records maintained for client trust accounting, the problem can spiral out of control. This can happen when, through inadvertence, neglect or ignorance, the practitioner did not maintain the proper records for his or her client trust account.
To avoid investigations, unwanted publicity and possible disciplinary action, California attorneys must learn the dos and don'ts of client trust accounting. The best place to start is Rules of Professional Conduct Rule 4-100 and the related standards and regulations. Then, read the "Handbook on Client Trust Accounting for California Attorneys," published by the State Bar of California in 1997, and Ellen Peck's article on managing client's trust accounts which can be obtained online from the State Bar solo and small-firm section Web site at www.calbar.org.
Here are some basic rules for complying with client trust accounting standards:
• If you receive money or property belonging to a client, open a separate client trust account into which you deposit such funds. Then, notify your client in writing that you have deposited the funds into the account.
• Open a client trust account with a California bank that knows how to set up IOLTA accounts, which automatically transmits interest earned on clients' trust funds to the State Bar to provide services to indigents. Don't waste your time trying to educate a banker about how this must be handled. You will have nothing but problems. Use a bank familiar with the IOLTA process.
• Deposit all funds belonging to your client into the client trust account, unless the funds are to be delivered directly to the client.
• Deposit retainer fees into your client trust account if you are going to bill and charge against the retainer. Although some instances do not require retainer fees to be deposited into a client trust account, if you are going to withdraw funds from the retainer as you bill for services rendered, the better practice is to make sure the retainer is deposited into your client trust account. Your fee agreement should spell out the terms and conditions relating to any retainer fee. For example, it should specify whether money is fully earned when received or whether it is earned after performance of services.
• Select a computer software program that is easy to learn, so you can enter all required transactions once and be able to produce all the written reports required by Rule 4-100. You are permitted to keep handwritten paper ledgers, but over time, the task may become overwhelming because too many mistakes can creep in when you are trying to balance all the accounts.
A good computer program will make sure that all the related numbers are balanced and accurate. For example, an accounting program like QuickBooks can be adapted so that all of the client reports, account journals and bank reconciliations can be accomplished through a one-entry system.
• Maintain separate ledgers for each client. Although you are permitted to commingle all of your client trust funds in one bank account (separate bank accounts for each client are impractical and not required), the only way you can keep track of the funds of each separate client is to maintain separate client trust ledgers.
This ledger report should state the amount and date of all funds deposited into the account on behalf of each client, the date, amount, purpose and the name of the payee to whom funds are paid on behalf of each client. Each client ledger also must show the balance in the client trust account belonging to each client at the end of every month.
• Prepare and print each month a client trust journal for your client trust bank account which includes the name of each bank account, date, amount and client affected by each debit and credit, and the current balance in such account.
• Reconcile bank statements each month on a separate reconciliation statement which balances all debits and credits. The QuickBooks template makes reconciliation of bank statements very simple and eliminates errors that can occur by manual entries.
• Keep all bank statements, canceled checks and records of all transactions through a period ending five years from the date of the disbursement of the last of such funds.
• Keep disputed fees in client trust account until the dispute is resolved.
• Make sure that each client account eventually is reduced to a zero balance. Disburse all funds to clients promptly when due to the client or to third parties who are entitled to receive payment, such as physicians rendering services to the client in personal injury cases. Promptly disburse all funds to you or your firm when the fee has been fixed and earned.
• Don't commingle your personal funds with the client trust account. As soon as you have earned the fees, distribute such fees when they are fixed. Attorneys think that they can keep their own money in the client trust account to avoid overdrafts. This practice, however, is expressly prohibited by the rules.
Commingling personal funds with client trust funds is an extremely serious violation of client trust accounting rules. The only funds belonging to an attorney which may be deposited into the client trust is a small sum required to pay any costs related to maintaining the account, such as the cost of printing checks.
• Do not pay out funds until you have made sure that any checks or drafts received on behalf of clients have cleared the banks and there are good funds available for the client. A common mistake by well-meaning attorneys is to deliver a check on the client trust account to a needy client before the insurance check has cleared the bank, which may take several days.
This could result in a bounced check because of insufficient funds, or worse, it could result in violating the rule against converting the funds belonging to one client to pay the obligation of another.
• Do not use one client's funds to pay off an obligation to another client. As stated above, this can occur if you issue a check to a client or a creditor before the funds from a settlement have cleared the bank.
To avoid this problem, think in terms of separate client ledgers. When the funds have cleared the banks, the client's ledger is green, and you safely can write checks against the funds. Until the funds have cleared, consider the client's ledger red, and no checks can be disbursed until the ledger turns green. When in doubt, check with your bank to make sure that your client's funds are available.
• Never withdraw funds for your personal or business use which belong to your clients, even with the intention of paying it back. The rule is worth repeating: Do not withdraw funds from your clients trust account for your use unless the funds have been earned and have been determined in accordance with the agreement with your client.
If there is a dispute with a client over the fees and a challenge is made to your right to withdraw the funds, the State Bar will require that you deposit the funds in your clients trust account until the dispute is resolved.
The job of client trust accounting can be a daunting task for attorneys who are not trained in accounting and don't want to spend the time to deal with details that do not produce revenues.
The following statement from the handbook sums up the attorney's responsibility: "Whether you find it easy or difficult, the fact is that if you agree to hold money in trust, you take on a non-delegable, personal fiduciary responsibility to account for every penny as long as the funds remain in your possession. No matter whom you hire to do your books or fill out your deposit slips, you have full responsibility for his or her actions, when you receive money in trust. This responsibility can't be transferred, and it isn't excused by ignorance, inattention, incompetence or dishonesty by you, your employees or your associates. The legal and ethical obligation to account for those monies is yours ... regardless of how busy your practice is or how hopeless you are with numbers ... Failure to live up to this responsibility can result in personal monetary liability, fee disputes, loss of clients and public discipline."
Myer J. Sankary, a Sherman Oaks sole practitioner and mediator, is the chairman of the solo and small-firm section of the State Bar of California. He can be reached at myer@sankary.com.
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