By Alara T. Chilton
In California, a lawyer is permitted to use overdraft protection with a client trust account. Obtaining and using overdraft protection can be an attractive option because such protection avoids nonpayment from the client trust account to clients, lawyers and other parties. Overdraft protection, however, may violate the California Rules of Professional conduct or the State Bar Act if not structured properly. This article focuses on some of the ethical considerations a lawyer should consider when deciding to use overdraft protection.
What exactly is overdraft protection?
Overdraft protection, also known as overdraft coverage or service, is a bank service whereby the additional money needed to cover a payment from an account— in this case, a client trust account— is transferred from another source, including a bank account, line of credit or credit card. The bank’s transfer of additional money needed to cover the payment constitutes an overdraft. (See Cal. State Bar Form. Opn. No. 2005-169 [construing former rule 4-100(A)].)
When is overdraft protection permitted with a client trust account?
Obtaining or using overdraft protection is permitted with a client trust account as long as it does not result in commingling. (Id.) “[C]ommingling is committed when a client’s money is intermingled with that of his attorney and its separate identity lost so that it may be used for the attorney’s personal expenses or subjected to claims of his creditors.” (Clark v. State Bar (1952) 39 Cal.2d 161, 167–168.)
Commingling may occur in a variety of ways including failing to segregate client funds from funds belonging to an attorney in a client trust account. (T & R Foods, Inc. v. Rose (1996) 47 Cal.App.4th Supp. 1, 7 [addressing the former rule].) It also occurs when a lawyer uses funds held in a client trust account to pay personal business expenses. (Heavey v. State Bar (1976) 17 Cal.3d 553, 566 1238.) It may also occur when a lawyer places or leaves her personal money or her law firm’s money in a client trust account unless the money constitutes “reasonably sufficient funds” to cover bank charges. (See Matter of Respondent F (Cal. Bar Ct., Feb. 4, 1992) 2 Cal. State Bar Ct. Rptr. 17, 24 [observing that $121.83 constitutes “reasonably sufficient funds” to keep in a client trust account to cover bank charges].) Actual harm to the client is not required to establish a commingling violation. (See Hamilton v. State Bar (1979) 23 Cal.3d 868, 876 [finding ethical violation for commingling despite no client funds held in the account].)
What funds may an attorney place in a client trust account to avoid commingling?
Rule 1.15 of Professional Conduct provides a lawyer may deposit in a client trust account “funds reasonably sufficient to pay bank charges” and (2) undifferentiated funds “belonging in part to a client or other person and in part presently or potentially to the lawyer . . . .” The portion belonging to the lawyer must be withdrawn at the “earliest reasonable time after the lawyer[‘s] . . . interest in that portion becomes fixed.[i]”
What types of overdraft protection create commingling of funds?
Certain types of overdraft protection will create commingling of funds. For example, overdraft protection from a bank that immediately provides “instant credit” to the client trust fund while it waits for the check deposited to clear from another financial institution. (See Handbook on Client Trust Accounting for California Attorneys, at p.10 (2018) [describing “automatic overdraft protection” as a bank providing a loan to keep a check drawn from a client trust account from bouncing].) Since this type of overdraft protection is considered a loan by a bank, it is considered commingling of funds and must be avoided.
Additionally, if the overdraft protection provides automatic deposits of a set amount— for example, fifty dollars above the amount overdrawn— this will also create commingling resulting from the excess balance remaining in the client trust account after payment is made to cover the insufficient funds. (Ibid.)
Use of overdraft protection does not avoid ethical obligations and consequences of an underfunded client trust account.
Absent bank errors, a lawyer should never have insufficient funds in a client trust account. If a negative balance occurs, this is a violation of Rule 1.15 because a lawyer may not let her client trust account balance fall below the amount she is supposed to hold in trust.
The use of overdraft protection allows a permissible method to ensure funds are deposited into a client trust account to ensure payment of a check if the client trust account is underfunded. (See Cal. State Bar Form. Opn. No. 2005-169.) Absent this method, a lawyer is still required to take “reasonably prompt action” to make sure the insufficient funds are paid, even if doing so requires her personal funds to be deposited into the trust account. (Id.)
Moreover, Business and Professions code section 6091.1, requires financial institutions to report when a check is presented against a client trust account containing insufficient funds. Financial institutions “will report not only checks that are rejected for insufficient funds, but also checks
that are paid against insufficient funds.” (See Handbook on Client Trust Accounting for California Attorneys, at p.10 (2018).) Even where a lawyer links her business account to protect against an underfunded client trust account, a financial institution is still required to report the insufficient funds to the State Bar.
Additionally, a lawyer has a duty to determine what caused the insufficient funds or a check to be dishonored and take reasonable steps to prevent these events from reoccurring. (See Cal. State Bar Form. Opn. No. 2005-169.)
In summary, above are just a few of the ethical considerations regarding overdraft protection with client trust accounts. This bank service requires adherence to the Rules of Professional Conduct and the State Bar Act in order to protect clients and other third parties entitled to client trust funds. Careful consideration will also go a long way to protect a lawyer’s bar card.
[i] Rule 1.15 further provides, “[I]f 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.”