Limited Practice Officers and Admission to Practice Rule 12: Taking or Not?

• Publication year: 1999
• Citation: Vol. 23 No. 02

SEATTLE UNIVERSITY LAW REVIEWVolume 23, No. 3WINTER 2000

COMMENTS

Limited Practice Officers and Admission to Practice Rule 12: Taking or Not?

Robert C. Farrell(fn*)

I. Introduction

Each year in the state of Washington thousands of real estate transactions involving billions of dollars are consummated. Almost without exception, these transactions involve an intermediary, namely an escrow holder. Following a single set of written instructions as agreed upon by the principals to the transaction-the client-depositors-the escrow holder, at different points in the transaction, takes possession of the purchaser's earnest money deposit and the seller's proceeds, and with them the opportunity to make beneficial use of such funds.

Under the Supreme Court of Washington's Admission to Practice Rule 12, escrow holders certified as limited practice officers can prepare certain routine legal documents incident to the closing of real estate transactions.(fn1) The quid pro quo for this privilege, however, is that limited practice officers are subject to Admission to Practice Rule 12.1,(fn2) a modified version of the Interest on Lawyers' Trust Accounts, or IOLTA.(fn3) Under the provisions of Admission to Practice Rule 12.1(c)(1), a limited practice officer:who receives . . . funds . . . shall maintain a pooled interest-bearing trust account for deposit of funds that are nominal in amount or expected to be held for a short period of time. The interest accruing on this account, not [sic] of reasonable check and deposit processing charges. . . shall be paid to the Legal Foundation of Washington, as established by the Supreme Court of Washington.(fn4)

Limited practice officers can no longer make beneficial use of a client-depositor's funds by pooling them into a noninterest bearing account to generate interest in the form of "earnings credits." Otherwise, these credits would find their way to an escrow holder's sister corporation, ostensibly as payment for bookkeeping services furnished by the sister corporation on behalf of the escrow holder.

Like IOLTA rules elsewhere in the country,(fn5) Washington's Admission to Practice Rule 12.1(c)(1) has spawned its share of controversy, including a suit brought by limited practice officers challenging the rule's constitutionality.(fn6) Although Legal Foundation of Washington was dismissed on a motion for summary judgment,(fn7) a recent U.S Supreme Court decision in Phillips v. Washington Legal Foundation(fn8) effectively undercut the court's rationale in Legal Foundation of Washington, prompting an appeal by the plaintiffs.(fn9)

The Supreme Court's holding in Phillips suggests that the constitutionality of Admission to Practice Rule 12.1(c)(1) is ripe for reexamination. Upon such a reexamination, the broader issue would be whether Admission to Practice Rule 12.1(c)(1) operates as an unconstitutional taking of property. Implicit within this question is the narrower question of whose property interest is taken. A variation of this question is what property interest, if any, does an escrow holder have in the beneficial use of a client-depositor's funds.

As the recipient of funds generated by the operation of Admission to Practice Rule 12.1(c)(1), the stakes for the Legal Foundation of Washington are high: in 1998, nearly forty-three percent(fn10) of the Foundation's revenue came from the application of the IOLTA rules to limited practice officers.

This Comment arrives at the conclusion that Admission to Practice Rule 12.1(c)(1) does indeed give rise to an unconstitutional taking. Implicit within this conclusion is a determination (1) that earnings on funds deposited in escrow, whether in the form of interest or earnings credits, are property; (2) that Admission to Practice Rule 12.1(c)(1) takes such property; and (3) that such taking warrants just compensation. Moreover, it is the client-depositor-not the limited practice officer-who suffers the taking.

This determination comes on the heels of another equally important conclusion: the standard disclosures used by the escrow industry as the basis for making beneficial use of a client-depositor's funds fall short of those required in a fiduciary relationship. As such, the very provision that limited practice officers sought to restore by bringing suit in Legal Foundation of Washington arguably constitutes a breach of the escrow holder's fiduciary duty to the client-depositor.

Beginning with a definition of an escrow, Part II of this Comment provides an overview of a transaction in escrow and an analysis of the escrow holder's relationship with and duties to his client-depositor. Part III discusses the statutory and regulatory constraints imposed on escrow holders under Washington's Escrow Agent Registration Act. Part IV explores the evolution of the limited practice officer in Washington and the advent of Admission to Practice Rule 12. Part V analyzes the takings implicated by Admission to Practice Rule 12. Finally, Part VI offers both a conclusion and suggested alternatives to current practices.

II. Common Law Duties of an Escrow Holder

A. The Escrow Transaction

An analysis of the rights and responsibilities of escrow holders- commonly referred to as escrow agents-begins with a definition of escrow. Washington's Escrow Agent Registration Act offers a convenient starting point: [A]ny transaction wherein any person or persons, for the purpose of effecting and closing the sale, purchase, exchange, transfer, encumbrance, or lease of real or personal property to another person or persons, delivers any written instrument, money, evidence of title to real or personal property, or other thing of value to a third person to be held by such third person until the happening of a specified event or the performance of a prescribed condition or conditions, when it is then to be delivered by such third person, in compliance with instructions under which he is to act, to a grantee, grantor, promisee, promisor, obligee, obligor, lessee, lessor, bailee, bailor, or any agent or employee thereof.(fn11)

Most transactions involving escrow holders entail an underlying agreement between parties for the purchase and sale of real property. In a typical transaction, a purchaser and seller designate in the purchase and sale agreement an escrow holder to "close" the transaction. The escrow transaction usually begins with the purchaser depositing earnest money with the escrow holder. Shortly thereafter, both the purchaser and seller sign a single contract with the escrow holder, referred to as a "closing agreement and escrow instructions." These escrow instructions govern the relationship amongst the escrow holder and the purchaser and seller as client-depositors.(fn12)

Often the escrow holder simply mails copies of the escrow instructions to the client-depositors, including instructions to "sign and return." Thus, not only do the client-depositors seldom negotiate the terms of the agreement, but they often never even meet the escrow holder until the time of closing. Given the stress, turmoil, and confusion that surround many real property transactions, client-depositors-with perhaps the exception of seasoned professionals-likely never read, let alone understand, the escrow instructions.

On a later designated date, referred to as "closing," the purchase and sale agreement is consummated in accordance with the escrow instructions. A closing entails two distinct transactions: (1) the seller's transfer of marketable title to the purchaser, and (2) the purchaser's delivery of sufficient funds to satisfy his obligations and close the transaction.

Delivery of a deed by the seller to the purchaser via the escrow holder as an intermediary accomplishes the requisite transfer of title. Until the conditions specified in the escrow instructions are satisfied, the seller's delivery of the deed is conditional. Once these conditions are satisfied, the escrow holder records the deed before delivering it to the purchaser. It is the delivery of the deed to the purchaser that conveys title.

Simultaneously, the purchaser and his lender deliver to the escrow holder sufficient funds to close the transaction, with the escrow holder typically depositing them into a trust account. These funds are subsequently disbursed to the seller net of any closing costs-again after all the conditions in the escrow instructions have been followed. Once all the escrow conditions and instructions are satisfied and the transaction is closed, the escrow terminates.

Absent instructions to the contrary, escrow holders not practicing as limited practice officers must deposit a client-depositor's funds into a noninterest bearing account.(fn13) In doing so, certain escrow holders engage in a complex transaction that allows them to indirectly make beneficial use of a client-depositor's funds.

The transaction goes something like this: the officers of a corporation acting as an escrow holder form a second, sister corporation that performs the accounting and reconciliation services vis-a-vis a client-depositor's funds as mandated under the Escrow-Trust Account Procedures.(fn14) The sister corporation then enters into an agreement with the depository bank holding the client-depositor's funds to perform the accounting services for these funds. The escrow holder then deposits the client-depositor's funds into a noninterest...