Rethinking IOLTA.

Author:Stevenson, Drury D.
Position:Interest on Lawyers' Trust Accounts programs

TABLE OF CONTENTS I. Introduction II. Background of IOLTA III. Crowding Out A. "Crowding Out" Pro Bono B. "Crowding Out" Alternative Funding C. Proposals to Offset the Negative Impact of "Crowding Out" IV. Monopolies and Oligopolies V. Monopsony VI. Agency Costs, Principal Costs, and Proposed Reforms A. Principal Costs B. Agency Costs Inherent in Public Funding of Charities C. Proposed Reforms VII. Is There a Moral Hazard Problem? VIII. Conclusion I. INTRODUCTION

In the United States, legal services for the poor primarily come from nonprofit legal aid agencies devoted to providing free or affordable basic services. Most of their funding comes from two sources: the federal Legal Services Corporation (LSC), (1) a quasi-governmental entity whose annual budget is congressionally apportioned, and state-based IOLTA (Interest on Lawyers' Trust Accounts) programs. (2) Although LSC funds are significantly larger than the aggregate of all IOLTA funds in a given year, (3) they stringently limit the activities of recipient agencies. (4) LSC-funded agencies may not engage in lobbying; class-action lawsuits; criminal defense-related work; advocacy for abortion rights; or representation of prisoners, illegal immigrants, or assisted suicide defendants. (5) These restrictions are comprehensive enough to prompt many legal aid entities to forego LSC funds entirely and rely mostly on IOLTA money (6) supplemented by private donations, charitable fundraisers, and small allocations from the state government. (7)

The mechanics of IOLTA are relatively simple. All lawyers must deposit their clients' funds, such as those transferred between parties in a real estate transaction, in special "trust accounts" at a bank, separate from the lawyer's own money or incoming fees before the money is moved to the other party after closing, for example. (8) The banks holding these escrow accounts calculate a modest interest rate on the aggregate deposits of all of the attorneys and then contribute the yield to a state-sponsored nonprofit foundation. Usually an individual client's sum is too small and remains in the bank too briefly to generate any discernible interest. Cumulatively, however, all of these temporary deposits by lawyers total millions of dollars statewide at any given moment. The state-sponsored nonprofit foundation then distributes the funds to legal aid agencies and related needs in that state. Banks pay a low enough rate that they net some revenue by participating in the program. (9) "Without taxing the public, and at no cost to lawyers or their clients, interest from lawyer trust accounts is pooled to provide civil legal aid to the poor and support improvements to the justice system." (10)

The IOLTA funding scheme is conceptually elegant and appears to be as close to "free money" as one could imagine. It stands in contrast to most taxation programs, which impose a marginal cost or disutility on the taxpayer that is greater than the marginal value of that taxpayer's contribution to the public fisc. Much public resentment about taxation stems from the intuition that keeping one's money for oneself would result in greater good or utility than would come from dutifully paying the taxes if not for enforcement penalties. The problem is a classic tragedy of the commons: if everyone acted on this logic, everyone would feel the consequences of an unfunded government. IOLTA reverses this logic, taking sums so small that the value to the original owner, in practical terms, is zero. No tangible loss is present, and there is a sense that participation in IOLTA will benefit the state program more than it will benefit individuals. Taken together, the tiny sums, accrued a few cents at a time, form a statewide pool of millions of dollars each year. To the extent that IOLTA is a tax at all, it is a nanotax.

The American Bar Association maintains that the IOLTA programs have been a remarkable success. (11) All fifty states have implemented IOLTA programs, (12) together generating $150-250 million every year (13) for legal aid agencies across the nation. (14) In forty-three jurisdictions, participation is mandatory for all lawyers. (15) While nine remaining jurisdictions have either opt-out rules or opt-in rules, the consistent trend is toward adopting mandatory programs. (16) States may switch from opt-out to mandatory rules, but never from mandatory to opt-out rules. (17)

Despite its prevalence and popularity, IOLTA faces a severe depletion of resources after the 2008 housing and banking crisis. A second problem looms on the horizon, as several post-Kelo eminent domain reforms (18) appear to have made the IOLTA programs in their states illegal, albeit inadvertently. Ten states adopted measures banning all takings where the state transfers the property to another private entity (19)--one of the main functions of IOLTA. (20) Litigation under these new enactments has not yet begun, but it seems inevitable given the tenacity of previous legal challenges to IOLTA by conservative advocacy groups. (21)

These two new challenges to IOLTA present an opportunity to pause and evaluate the IOLTA system. There are some theoretical weaknesses of IOLTA that until now have received no consideration in academic or public policy literature. Rethinking IOLTA would enable states to make the necessary adjustments to mitigate some of the inherent problems and to balance the programs with other sources of funding and volunteers for legal services to the poor, such as "civil Gideon" programs (22) and pro bono efforts. The purpose of this Article is not to discuss the current funding crisis or legal challenges facing IOLTA, (23) nor the property-rights issues that were the focus of the last round of IOLTA litigation in the 1990s. (24) Instead, this Article addresses the previously ignored problems inherent in the programs even when they are operating well.

The first of these concerns is the "crowding out" (25) effect that IOLTA programs seem to have on pro bono efforts and other potential funding sources for legal services, such as LSC funds and private donations. (26) The second problem inherent in IOLTA is that a few agencies in each state receive IOLTA funds, leading to the monopolization of legal services (27) and a tendency toward "viewpoint monopoly" (28) among the legal aid agencies in each state. Third, IOLTA produces a monopsony, or single-buyer, problem. (29) IOLTA has a fourth inherent problem: the special type of agency costs associated with government outsourcing or privatization. (30)

One might expect moral hazard problems to be an additional concern with civil Gideon, as they are present in other government-funded social services; that is, people with free lawyers might litigate too much (i.e., when it is unnecessary) or unduly prolong litigation. With legal aid, however, the opposite effect occurs, at least with civil Gideon programs, (31) for which we have a body of empirical studies. (32) Unlike other welfare programs, government-funded legal services reduce the symptoms of moral hazard in local legal arenas, rather than contributing to them.

The following sections discuss each of these issues in order. Part II provides background about the history of IOLTA and the policy rationales supporting it, as well as a quick overview of the litigation over the programs that culminated in the Supreme Court's decision to endorse IOLTA. The substantive discussion begins in Part III, with a detailed explanation of the "crowding" issue, as well as some proposals for reform. The problem of monopoly or oligopoly in legal services, and the extent to which IOLTA fosters the problem, is the subject of Part IV.

Part V focuses on the monopsony problem and recommends mitigating its effects by permitting more pro bono efforts and promoting more civil Gideon programs to balance the existing legal aid infrastructure. Part VI discusses agency costs inherent in IOLTA programs and possible solutions to those costs. The last substantive section, Part VII, briefly discusses moral hazard concerns and the empirical evidence showing the absence of moral hazard effects in civil Gideon programs. Part VIII summarizes the Article's main points.

Since the early years of IOLTA programs, academic literature has focused on input-side issues: the property rights of the original owners of the interest, the lawyers' compliance with the program's requirements, and the role of the banks as intermediaries. (33) This Article focuses instead on the output side, analyzing some unconsidered consequences and effects of IOLTA programs. Because next year marks the thirtieth anniversary of IOLTA in the United States, the time has come to evaluate its impact and reassess its policies.


    The concept of IOLTA originated in Australia and was already operating there and in Canada before minor changes in U.S. banking law made the programs possible in the United States. (34) Beginning in Florida in 1981, (35) IOLTA became a ubiquitous feature of the American legal system, present today in every state. (36)

    Despite its widely acknowledged successes, IOLTA programs present some chronic, albeit unavoidable, problems. For example, the wide fluctuations in available funds are a continuing source of consternation for dependent legal aid entities. (37) Budget planning is difficult when a major funding source is inherently unstable. (38) Additionally, variations in interest rates can deplete the funds available for legal aid agencies in a given year. (39) Moreover, most IOLTA deposits are from real estate transactions, so a downturn in the real estate market means fewer IOLTA deposits to generate interest. Depressed property values shrink the size of the IOLTA deposits that do come in, further depleting the funds. (40) Many IOLTA programs try to mitigate these problems by having the entity that receives and distributes the funds engage in regular charitable fundraising and apply for grants...

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