Rule 1.15: Not Your Father’s Client Trust Account Rule

By David C. Carr

As of November 1, 2018, California lawyers are subject to a new rule on safekeeping the property of clients and others: Rule 1.15.  The new rule differs from the prior rules in effect since 1928 in three significant areas: (1) advanced fees (2) flat fees and (3) holding funds for persons who are not clients.

Many lawyers approach client trust accounts with trepidation. There is some justification for that feeling. The duty to keep client funds segregated and intact is one of the graver responsibilities of a California lawyer. 

Applicable discipline standards generally prescribe disbarment for an intentional misappropriation of client funds, and suspension for negligent misappropriation or commingling (see Standard 2.1, 2.2, Standards for Attorney Sanctions for Professional Misconduct.) Failing to keep the detailed records required by Rule1 1.15(c) and its standards may result in actual suspension, as well.  If you are going to hold funds for clients or for non-clients, familiarity with Rule 1.15 is absolutely essential.

Advance Fees

Some lawyers have sought to avoid dealing with client trust accounts by entering into hourly fee agreements requiring an advance fee deposit, sometimes called a retainer, and then depositing those funds into a general operating account. Although the former rule on client funds, Rule 4-100, and its predecessor rules, required that “all funds held for the benefit of the client” be segregated in a client trust account, the California Supreme Court declined to extend the definition to include advanced unearned fees (Baranowski v. State Bar (1979) 24 Cal.3d 153, 164), and thereafter declined requests to revise former Rule 4-100 to explicitly require such funds to be placed in trust on at least two occasions. One of reasons the Supreme Court previously declined to require advanced fees to be placed in trust was the reliance of lawyers in certain practice areas, such as criminal defense, on such fees as an income stream.

In contrast, American Bar Association Model Rule 1.15(c), promulgated in 1983, requires unearned advance fees to be placed in trust.  The reason is to ensure those funds are promptly available for refund to the client if the lawyer’s employment ends. While this is uniformly regarded as the best practice even when not required (as in California), many lawyers, perhaps aware of Model Rule 1.15 from law school professional responsibility class and unaware of Baranowski, erroneously believed that the California rule was the same
As of November 1, 2018, California’s rule mirrors the ABA rule. California Rule 1.15(a) adopts the Model Rule requirement and now explicitly defines advance fees as client funds that must be deposited into trust:

All  funds  received  or  held  by  a  lawyer  or  law  firm  for  the  benefit  of  a  client,  or other  person  to  whom  the  lawyer  owes  a  contractual,  statutory,  or  other  legal duty, including advances for fees, costs and expenses, shall be deposited in one or more identifiable bank accounts labeled “Trust Account”  or  words  of  similar import,  maintained  in  the  State  of  California,  or,  with  written  consent  of  the client, in any other jurisdiction where there is a substantial relationship between the client or the client’s business and the other jurisdiction. (Emphasis added.)

Attorneys who formerly placed unearned advance fees into operating accounts must now put those funds into trust and withdrawn them as the fees are earned as required by Rule 1.15(c)(2), which provides:

funds belonging in part to a client or other person and in part presently or potentially  to  the  lawyer  or  the  law  firm,  in  which  case  the  portion belonging  to  the  lawyer  or  law  firm must  be  withdrawn  at  the  earliest reasonable  time  after  the  lawyer  or  law  firm’s  interest  in that  portion becomes fixed.  However, if a client or other person disputes the lawyer or law firm’s right to receive a portion of trust funds, the disputed portion shall not be withdrawn until the dispute is finally resolved. (Emphasis added.)

Flat Fees

Other lawyers looking for ways to avoid utilizing a client trust account have embraced the flat fee. Attorneys thought they could agree with the client that a flat fee was earned upon receipt, before any legal work was done, thus eliminating the need to place those funds in a client trust account. 

Rule 1.15(e) provides for flat fees, defined as “a fixed amount that constitutes complete payment for the performance of described services regardless of the amount of work ultimately involved, and which may be paid in whole or in part in advance of the lawyer providing those services.”  But new Rule 1.15(b) makes it clear that flat fees are not earnedupon receipt and must be placed in trust until earned, consistent with the requirement in Rule 1.16(e)(2) that unearned fees must be refunded when the employment terminates, unless a client knowingly waives the protection of the client trust account.

Rule 1.15(b) provides:

Notwithstanding paragraph (a), a flat fee paid in advance for legal services may be deposited in a lawyer’s or law firm’s operating account, provided:(1) the  lawyer  or  law  firm  discloses  to  the  client  in  writing  (i)  that  the  client has a right under paragraph (a) to require that the flat fee be deposited in an identified trust account until the fee is earned, and (ii) that the client is entitled to a refund of any amount of the fee that has not been earned in the event the representation is terminated or the services for which the fee has been paid are not completed; and (2) if the flat fee exceeds $1,000.00, the client’s agreement to deposit the flat fee  in  the  lawyer’s  operating  account  and  the  disclosures  required  by paragraph (b)(1) are set forth in a writing signed by the client. (Emphasis added.)

What the new rule does not do is tell us how to calculate the amount of an unearned flat fee that must be refunded to the client, although Comment 2 states that, subject to the rule on unconscionable fees (Rule 1.5), “a lawyer or  law  firm  may  enter  into  an  agreement  that  defines  when  or  how  an advance fee is earned and may be withdrawn from the client trust account.” This a lawyer and client may also agree on how the unearned portion of a flat fee will be determined if the representation terminates early.

Funds Held for Non-Clients

The third significant change is that Rule 1.15 now explicitly applies to protecting the funds of non-clients that a lawyer may hold as result of a fiduciary or contractual relationship with the non-client.  The most common examples are medical liens created by contract, statutory liens that arise by operation of law (see Kaiser  Foundation  Health  Plan,  Inc.  v.  Aguiluz(1996) 47 Cal.App.4th 302, cited in Rule 1.15, Comment 1), and agreements by a lawyer to act as an escrow holder (Johnstone v. State Bar of California (1966) 64 Cal.2d 153, 155-156, also cited in Comment 1.  The drafters of the revised Rules of Professional Conduct have explicitly incorporated many concepts referenced in case law and made them explicit, as they did here.
The strict record keeping requirements, now embodied in Rule 1.15(e) and its standards, remain unchanged in Rule 1.15.  For a comprehensive and authoritative guide to keeping those records, every lawyer and law firm with a client trust account should be familiar with the State Bar’s Client Trust Accounting Handbook

http://www.calbar.ca.gov/Attorneys/Conduct-Discipline/Client-Trust-Accounting-IOLTA/Client-Trust-Accounting-Handbook

The new requirements in Rule 1.15 regarding advance fees, flat fees and unearned fees will increase the number of lawyers at risk for violating the Rules of Professional Conduct, many out of sheer ignorance of the changes. The way to overcome a fear of client trust accounts is to understand what is required and to do the hard work of making sure those requirements are met.1. All references to rules are to the California Rules of Professional Conduct unless otherwise indicated.

David C. Carr is owner of Law Office of David C. Carr.

This article first appeared on the May 2019 issue of For the Record.