Handling Settlement Funds: A Best-Practices Checklist
“So that’s how you do that!” My article on handling retainers, “Would You Pass a Trust Account Audit?,” generated a lot of inquiries and ah-hah moments. So, I’m following up with more tips on handling trust accounting transactions, focusing on settlements.
Certain types of funds require special handling, and settlement funds fall into this category. Settlement funds are always deposited directly into your law firm’s trust account and are paid to parties of the settlement from the trust account. A settlement check is never directly deposited into your firm’s operating account. Depositing into the trust account serves as notice to the world that this money is not for you to use for regular business operations.
Here is an example illustrating a basic settlement statement.
Properly Tracking, Recording and Paying Settlement Transactions
You always want to review and follow your state’s particular ethics guidelines and procedures, but here is a general checklist, and some best practices, for handling settlements.
1. Record and deposit the settlement check. It can’t hurt to emphasize at the start of this checklist that you should never disburse funds until you have faithfully recorded and deposited the check — and made certain it has cleared. That said, here are basic procedures:
- Get signatures. If the check is made out to both the client and the law firm, you need both signatures.
- On the check, write the case number, client name and case description. (This is good risk management if you ever need to re-create your trust accounting records.)
- Scan or copy the check and save a copy in the client’s file.
- Deposit the check into the firm’s trust account.
- If it is an electronic transfer of funds, save a copy of the verification of deposit.
2. Prepare a settlement statement. The settlement statement is your audit trail and it should be reviewed and signed by both the client and the lawyer. It defines the proposed disposition of the settlement fund check and should include the following:
- Total amount of the settlement check received and the payee.
- Amount payable to the firm for fees earned per the settlement agreement.
- Amount payable to the firm for expenses paid by the firm during the course of the representation.
- Any amounts payable to third parties, with copies of the invoices to be paid.
- Amount due to the client.
- Area for the client’s and the lawyer’s signatures.
Your practice management system or accounting software should be able to produce a report that lists all expenses incurred and paid by the firm on behalf of the client during the representation. Include a copy of this report with the settlement statement. (You can download a sample statement here.)
3. Write checks and receive payments for your portion of the settlement. Once funds are available, you can write checks to all of the parties listed on the settlement statement. All funds get disbursed directly out of your trust bank account and recorded in the client’s trust account ledger. First, though, before your firm can be paid from the settlement, you need to prepare an invoice to the client for your fees and expenses, and then receive payment for it. That way, you can properly account for the revenue and expense recovery.
In your practice management system or accounting system, do this:
- Create an invoice for the firm’s portion of the settlement check showing fees earned and expenses paid during the representation.
- Write a check from your trust account, payable to your firm, to pay your invoice. On the check’s memo line, include the file or case number and client name.
- Next, “receive payment” on the above invoice in your system, making sure that you deposit the payment into your operating account and apply the money to the correct general ledger account(s).
Write other checks, completing the settlement statement:
- Write checks to third parties.
- Write a check to the client for the client’s portion of the settlement.
Next, run a client trust ledger report in your accounting system, showing all the transactions (deposits and checks written). The account balance should equal $0.00. Below is a sample of a client ledger report.
Note: When writing checks from settlement funds, be sure to go back to the settlement statement to record each check number there, then save a copy of it in the client’s file. (Ideally, your client files are electronic. Haven’t moved to paperless yet? Now is a good time to start.) This provides an additional audit trail.
4. Prepare final documentation and paperwork. Lastly, the client should be sent the following items, via certified mail or delivered in person:
- Signed copy of the settlement statement.
- Signed copy of the settlement agreement.
- Copy of the client trust ledger report.
- Copy of invoice(s) prepared and marked paid.
- Check from the firm’s trust account for the client’s portion of funds.
Now you should scan and save all of your final documentation in the client file.
With this checklist to follow, you can rest easier about being ethically compliant when handling client settlement funds. Here is a final tip to keep in mind, too.
- Don’t pay too soon! Your clients will probably try to talk you into writing their settlement check right away, before you have verified that the funds are available, or may even try to talk you into post-dating the check two or three days into the future. Don’t do it! An overdrawn trust account will get reported.
Peggy Gruenke is Chief Operating Officer at Hengehold Capital Management, as well as a law firm management specialist in operations, online marketing, technology and accounting at LegalBizSuccess. Peggy is active in the ABA GP Solo Division, a frequent ABA TECHSHOW speaker and she writes on productivity and profitability for Attorney at Work. Read more or her articles here.