Mismanaging a trust account can have terrible consequences on a lawyer's career, even sometimes to the point of disbarment. Yet law schools do an abysmal job of training law students on how to handle an IOLTA trust account. Outside of discussing the subject at a theoretical level one day in a law school ethics class, most attorneys receive little or no training on how to manage a trust account before opening one of their own.
While there are many ways that trust accounts are mismanaged, there are three common mistakes lawyers make in managing their IOLTA accounts.
1. "Borrowing" money from the trust account.
There is no legitimate way to borrow from a trust account. Sometimes attorneys use trust account funds before they have a right to do so, while in other situations they use funds that they would never acquire the right to use. Either approach opens the door for the lawyer to get into serious trouble.
There are three ways that improper borrowing from the trust account occurs:
(a) The attorney takes trust account money before it is earned. This often happens when an attorney is having cash flow problems. In this situation, the attorney has received a retainer that he has (hopefully) placed in the trust account, and the attorney will be entitled to pay that money out to himself or herself as the work is completed. However, the attorney won't have the work completed before some looming expense must be paid - payroll, office rent, costs being advanced in a contingent fee case, etc. So the attorney goes ahead and takes more from trust than he or she actually has a right to take from the trust account at that point in the case.
(b) The attorney borrows money from client funds with the intention of putting it back. When cash flow issues escalate into more severe financial problems, and the attorney has thousands of dollars in client funds sitting in a trust account, some may succumb to the temptation to borrow money from the trust account to stay afloat. The attorney may rationalize it by thinking that if he can't pay the office bills then he can't stay in business, and if he can't stay in business he can't take care of his clients. So he takes a little money from the trust account just to hold him over until his cash flow improves. The attorney may have every intention of replacing the funds as soon as possible, but this kind of situation usually snowballs and ends very badly for the lawyer - as well as the client.
(c) Trust account theft. This situation really can't called borrowing, and it is not referring to the scams perpetrated on law firms. In the in-house trust account theft situation, either the attorney or someone with access to the trust account has reached the point of greed or desperation that they simply decide to take money that is not theirs. Attorneys with substance abuse problems or gambling addictions can be particularly vulnerable to this mistake, but other times it happens for reasons that don't appear clear. If committed by a lawyer, this trust account mistake is the one most likely to end a legal career. But even if it is committed by a paralegal or a bookkeeper, the lawyer is still the one on the hook for repaying the funds.
2. Commingling attorney funds with client money.
A second major mistake in attorney trust account management involves commingling attorney funds with client money. This often arises out of a lack of understanding how a trust account is supposed to work.
Laura A. Calloway, law practice management consultant at the Alabama State Bar, said, "Many attorneys don't understand what does and doesn't go in the trust account. Some run everything, including earned fees, through the trust account, using it as a single general journal for their firms. Others take 'retainers' without understanding that, at least in some jurisdictions such as Alabama, there is no such thing as a non-refundable retainer. So they don't put a deposit against future work into trust as they should, particularly if they need it now to keep the lights on."
Some of the common ways attorneys commingle their money with client funds include:
(a) One check for two purposes. A lawyer tells the client that the legal fees will be $1,000 and the court filing fee will be $200, so the client writes the attorney a check for $1,200. Some attorneys will put the entire check into the business account because most the money is going to the lawyer anyway. However, bar association rules require that the check go into the trust account, even if the attorney is entitled to the full attorney's fee immediately, because the filing fee portion of that check has to be held in trust.
(b) Personal funds kept in trust with client funds. Some state bar associations prohibit attorneys from having any personal funds in a trust account, while others allow attorneys to keep a small amount in the account to cover expenses related to operating the account (though the recommended practice is to have all trust account fees deducted from the business account). But nowhere is an attorney allowed to use a trust account as an operating account, a savings account, or a place to hide assets.
Sometimes lawyers simply fail to understand that they can't pay bills such as their office overhead expenses directly out of the trust account, even when the checks are being written out of funds that have already been earned. Other times attorneys intentionally misuse the trust account as a way to hide assets. For example, Calloway says she has seen lawyers put personal funds into the trust account to avoid an IRS levy for back taxes. This is an obvious ethics violation.