Disputed Funds in the Possession of a Lawyer
| Publication year | 2015 |
| Pages | 47 |
Articles Professional Conduct and Legal Ethics
Disputed Funds in the Possession of a Lawyer
By Alec Rothrock, Judge.
Professional Conduct and Legal Ethics articles are sponsored by the CBA Ethics Committee. Articles published here do not necessarily reflect the legal interpretation of the Committee.
Coordinating Editor
Stephen G Masciocchi, Denver, of Holland & Hart LLP—(303) 295-8000, smasciocchi@hollandhart. com
Nothing brings out the worst in people like a fight over money. No one trusts the person holding the funds. If the person holding the money is a lawyer, the Colorado Rules of Professional Conduct superimpose a layer of disciplinary exposure over the lawyer's civil liability exposure. This article begins by discussing the lawyer's basic ethical obligations when holding disputed funds. Then it addresses the lawyer's duties when the dispute is between the client and a third party, the client and the lawyer, or the lawyer and a third-party creditor of the client, including another lawyer.
Holding fought-over money, such as settlement funds, can be very unsettling. Whatever the lawyer does with it is sure to incense someone. Ominous demands can come from many directions—the client, the client's creditors, the client's lawyer, or another lawyer. The longer the lawyer holds on to the money trying to figure out what to do, the more the tension builds. A state of siege sets in.
This article attempts to clarify the lawyer's ethical obligations in these circumstances. It begins by describing the lawyer's basic ethical obligations. It then suggests rules according to the participants in the dispute, whether client-third party, client-lawyer, lawyer-third party, or lawyer-lawyer.
A Lawyer's Basic Duties Under Rule 1.15A
A lawyer is required to hold funds belonging to clients or third parties in a trust account, separate from the lawyer's funds.[1] When a lawyer receives funds that a client or third party is "entitled to receive, " the lawyer must deliver the funds "promptly" to that person and, if requested, provide an accounting of the funds.[2] When the lawyer holds funds that are the subject of a "dispute" between or among two or more persons (one of whom may be the lawyer), the lawyer must keep the disputed portion segregated, which means maintaining the funds in a trust account or depositing them in a court registry as part of an interpleader action.[3] If any of the funds are undisputed, the lawyer must promptly distribute that portion.[4]
These rules, found in Colo. RPC 1.15A, must be read together.[5] They require a lawyer in these circumstances to determine when a client or third party is "entitled to receive" certain funds, and whether a "dispute" over those funds means that the client or third party is not entitled to receive them—at least not yet. As explained in CBA Ethics Committee Formal Opinion 94 (Opinion 94), [6] in some instances, the lawyer is required to disburse the funds to the client notwithstanding the claim of a third party. In other circumstances, the lawyer must refuse a client's demand for the funds and pay them to a third party or hold them in a trust account while the lawyer's own claim to them can be resolved.
Lawyers holding funds claimed by different people have significant ethical obligations. Lawyers have been disciplined for disbursing disputed funds to themselves[7] or to a client[8] before the dispute was resolved, and for failing to disburse funds that were not in dispute.[9] Although a lawyer holding funds in which a third party claims an interest does not owe a fiduciary duty to that party, [10] the lawyer may be civilly liable to that party for disbursement in contravention of the third party's interest.[11] The lawyer's obligations with respect to funds in the lawyer's possession vary according to the identity of the parties to the dispute.
Disputes Between Clients and Third Parties
Comment [4] to Colo. RPC 1.15A anticipates disputes between a client and a third party over funds held by the lawyer in a trust account:
Third parties, such as a client's creditors, may have just claims against funds or other property in a lawyer's custody. A lawyer may have a duty under applicable law to protect such third-party claims against wrongful interference by the client, and accordingly may refuse to surrender the property to the client.[12]
Several ethics opinions from other jurisdictions interpret the "just claim" language in similar or identical comments to determine whether a third party is entitled to receive the funds within the meaning of rules similar or identical to Colo. RPC 1.15A(b).[13] Without invoking the just claim comment language, Opinion 94 offers guidance to lawyers on which third-party claims they must pay from the entrusted funds and which they may not pay, and, in that instance, what to do with them.[14]
The opinion starts with the basic requirement in Colo. RPC 1.15A(b) that a lawyer is required to deliver promptly to a client or third party, as the case may be, funds in the lawyer's possession in which the client or third party has an interest and to which it is entitled.[15] An "interest" is a "right, claim or legal share in property, such as the right a third party has to property by virtue of a statutory lien, contract or court order."[16] In footnotes, the opinion gives examples of statutory liens and defines a "contract" for purposes of the opinion as an
oral or written agreement between the client and a third party, granting the third party a right to receive funds which are expected to come under the control of the lawyer on behalf of the client as a result of that agreement, including by way of example: an assignment by the client, an agreement between a health care provider and the client for health care services, agreements between the client and an employer, a landlord, or an insurer.[17]
Opinion 94 goes on to state that in holding such funds, the lawyer's ethical duty, as a general matter, is to the client and not to the third party.[18]
As relevant here, the broad conclusions of Opinion 94 are that if the third party does not hold an interest in the funds as a result of a statutory lien, contract, or court order, the lawyer must promptly distribute the funds to the client.[19] If the third party holds an "undisputed interest" as a result of a statutory lien, contract, or court order, the funds should be distributed to the third party in accordance with the statutory lien, contract, or court order.[20] If there is a dispute about the validity of the third party's claim, the lawyer should promptly distribute the undisputed portions and interplead the remainder, unless the client and third party agree to let the lawyer hold the funds until they resolve their dispute.[21] The common denominator among Opinion 94 and ethics committee opinions from other states is that a lawyer is not required to keep the funds from the client unless the third party claim relates specifically to the funds in the lawyer's possession, unlike a general unsecured claim.[22]
One underlying assumption of Opinion 94 is that the lawyer is fully aware of the third party's claim or interest. In fact, the opinion states that when the basis for the third party's interest in the funds is a statutory lien, the lien must have been "brought to the lawyer's attention."[23] Other state ethics committees have concluded that only a lawyer's actual knowledge of the third party's interest triggers the lawyer's ethical obligations.[24]
Although Colo. RPC 1.15A(c) does not expressly condition the lawyer's obligation to segregate disputed funds on the lawyer's knowledge of the claimed interest in the funds, it seems unlikely that a lawyer would be subject to discipline for disbursing funds to a client without actual knowledge of t he third party's interest. Holding lawyers to a constructive knowledge standard seems harsh and unrealistic in light of the many contracts and statutes that might give a third party an interest in the funds. This does not mean, however, that the state of a lawyer's knowledge is determined by the lawyer's own word. Under the Rules of Professional Conduct, a lawyer's knowledge can be inferred from the circumstances.[25]
Another issue addressed in Opinion 94 is whether a lawyer must refuse to disburse funds to a client if a third party lacks a contractual or statutory interest in the funds but represents that he or she is prepared to seek a court order preventing the disbursement. According to Opinion 94, the lawyer may disburse the funds to the client without waiting for the third party to obtain a court order. This means, presumably, that if the lawyer believes that a court order preventing the lawyer from disbursing the funds is about to be issued, the lawyer may disburse the funds quickly, as long as he or she beats the court order. Timing is everything.
In one area, Opinion 94 is confusing. Section 3 states...
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