Whether you’re a law firm owner or an individual attorney, it’s likely you’ll find yourself managing client funds at some point — including advance payments, settlement checks and expenses. As a fiduciary for your clients, you must scrupulously manage these funds — implement proper controls, keep accurate records and ensure you are being ethically and legally compliant.
In fact, improper management of client funds is a top reason why lawyers get disbarred.
Particularly as a small firm or an owner-operator of your own firm, understanding the details of client fund management is vitally important. Small firms may not have dedicated resources to address this task, especially while the lawyers themselves are busy running point on all aspects of a given case. With some state handbooks on managing trust accounts reaching 150 pages (e.g., the State of California Bar Association), client fund administration can feel daunting. And so it inevitably becomes a lower priority.
Yet given the risks, law firms of all sizes need to make client fund management a fundamental part of their operating procedures.
Basics of Client Fund Management and Administration
To get started, here are some key considerations to keep top of mind:
- All client funds must be held separate from the law firm’s operating funds and can never be co-mingled.
- Client funds can be held in either a client trust account (CTA), which is typically used for larger sums of money, or the Interest on Lawyer’s Trust Accounts (IOLTA) program, typically used for smaller amounts or short-term deposits where any potential interest earned is minimal.
- A CTA account for one or more clients can be established at a bank of the firm’s choice — but must be held in an interest-bearing “trust account” for the benefit of the law firm’s clients, or something similar.
- IOLTA accounts can only be kept at banks approved by the state bar association. Any interest earned on the deposits is not for the client or law firm but for the benefit of nonprofit legal organizations throughout the state. The financial institution where the law firm established the IOLTA account will send any interest or dividends to the bar.
Additionally, there are many accounting aspects of managing client funds that law firm owners and individual attorneys should be aware of. For example, complexity can arise when there is more than one client in a client trust account. Even though all funds are in one account, each client’s funds must remain separate from one another.
Sub-accounting is the practice of separating these individual client funds within the accounting ledger system. When done properly, the sum of each individual client ledger will equal the total amount of the trust funds within the account. Furthermore, all transactions, including credits, debits, interest earnings, and fees, must be documented via a trackable audit trail.
Protecting Client Funds From Being Lost
A new challenge has emerged for attorneys managing client funds in the wake of 2023’s unprecedented bank failures: how to protect client funds from being lost.
This topic involves a variety of banking metrics that most small firms and lawyers may not have access to. Moreover, a typical lawyer is not going to have the expertise, or the time, to properly evaluate a bank’s safety and soundness. Yet as fiduciaries for their clients’ funds, law firms may be liable should the bank they’ve chosen fail.
To prevent this, the most important thing you can do to protect client funds is to ensure that all client trust accounts are fully FDIC-insured through an individual bank or bank network.
FDIC insurance is applied to client trust accounts through what is known as “pass-through coverage.” If your accounts are titled correctly and properly managed, deposit insurance of up to $250,000 per tax ID, per institution, is available. If you are managing client funds in excess of $250,000 per client, per institution, you will need to engage additional banking partners to ensure these funds are fully protected.
To help with this process’s accounting and regulatory complexity — and mitigate associated risks — a variety of providers are available to advise small legal teams. For instance, software companies and software-as-a-service vendors can offer accounting support to ensure proper record-keeping, while other service providers can deliver solutions specifically designed for law firms. These include capabilities that automate the management of a bank network, optimize bank choice based on interest rate, and provide full FDIC insurance.
Regardless of the solution set chosen to manage client trust accounts, it is important to consider all aspects of accounting, regulatory compliance and bank safety when doing so.
Image from unsplash.com.
