It may appear to be a technical area, but the commingling of funds is a peril of legal practice that firms must learn to avoid.
Below, we explore some of the basics of commingling of funds—what legal practitioners need to understand, the types of activities that are considered commingling and their consequences, and how to avoid inadvertent commingling. Finally, we’ll discuss some technological tools that can help the modern practice avoid running aground on these hazards.
What is the commingling of funds?
Broadly speaking, commingling of funds occurs when one party mixes funds that belong to another party. This can occur when a lawyer holds their funds in the same account as their clients, for instance.
To fully grasp the concept of commingling of funds, it is best to understand the reasons behind its prohibition. This area is addressed in Rule 1.15 of the ABA Model Rules of Professional Conduct, which governs a lawyer’s duties in safekeeping property of clients or third parties.
Since the Model Rules are the basis for ethical rules for attorneys in numerous states, they serve as a good outline of lawyers’ ethical duties nationwide.
Rule 1.15 provides that, if an attorney has property of clients or third parties in their possession, they must keep that property separate from the attorney’s property.
According to the comments on this rule, this means that funds belonging to clients and third parties must be kept in trust accounts, and law firms must maintain books and records on those accounts. When holding funds on behalf of others, an attorney assumes a duty to conduct themselves with the care required of a professional fiduciary.
Generally, people refer to the failure to comply with these guidelines as commingling of funds. A law firm must keep separate the funds in a separate operating account for the firm from the trust account funds.
Examples of fund commingling
There are several ways commingling of funds can occur at law firms, even in unintentional ways.
Some situations could create the appearance that an attorney is misappropriating the client’s funds. For example, the attorney could deposit the client’s funds into a personal or business account. Alternatively, the attorney could use trust account funds to cover personal expenditures or firm expenses.
Funds can also become commingled by improperly depositing money into the client’s account. For example, an attorney could deposit personal or law firm funds into the client trust account.
As another example, if the client paid a retainer that the firm bills against, the fees must be withdrawn as they are earned. If a firm fails to withdraw its earned fees in a timely manner, the firm is again commingling firm funds with client funds.
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The consequences of commingling funds
Whether the commingling is intentional or accidental, attorneys found to have commingled funds can face a variety of consequences.
An attorney who engages in the commingling of funds, which is prohibited by the professional conduct rules of various state bars, would likely encounter state bar discipline as a consequence of this ethical breach. In less severe instances, the attorney may receive a public or private reprimand from the state bar. In more severe cases, suspension or even disbarment of the attorney could occur. Additionally, sanctions or other authorized forms of discipline are also potential outcomes.
Consider the 1996 case of an Iowa attorney who withdrew $1,000 from a client trust account to cover office expenses, figuring he could pay it back with settlement proceeds expected shortly thereafter. The state bar discovered the withdrawal in an audit on another matter, and the attorney was suspended. No matter the amounts at issue, lawyers must be extremely diligent in following the ethical guidelines here.
If the commingling amounts to conversion of the client’s funds to personal or business funds, the attorney could also face civil liability. The conversion itself may also be an ethical violation, depending on the state, which could subject the attorney to still more penalties.
Another serious consequence of commingling is the erosion of client trust and damage to your firm’s reputation.
This could result from a simple mistake regarding where to deposit funds, even when the firm corrects the error. If your firm cannot manage client funds well, clients will naturally lose faith in your ability to adequately represent their interests
Needless to say, any conversion of client or third-party funds could do permanent damage to a firm’s reputation.
Unfortunately, there is the potential for accounting mistakes to appear to be conversion, or at least to give rise to an actionable claim. A claim for conversion could also lead to a legal malpractice claim if the client looks at the legal matter more closely. It is therefore imperative that a legal practice safeguard against any chance of fund commingling.
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Best practices to guard against commingling
To ensure your firm does not engage in commingling, you will need to have your bank accounts set up in the correct way. You will also need the best trust accounting procedures in place. The following are some best practices for guarding against commingling.
Maintain separate operating and trust accounts
A law firm will necessarily require an operating account to hold funds belonging to the firm. The firm will also need a trust account for client and third-party funds.
For larger firms or more complex legal matters, separate trust accounts may be appropriate for separate clients. Trust accounts should be interest-bearing, with the interest going to the client.
In certain situations, the firm might only manage a small sum of money for the client, or the funds are held for a brief period. In such cases, the costs associated with collecting interest would surpass the interest earned, rendering the standard trust account process impractical.
These low-value or short-term client funds should be deposited into an IOLTA account. IOLTA (Interest on Lawyers’ Trust Accounts) accounts are pooled trust accounts that generate interest, and the bank forwards the interest to the state’s IOLTA program.
Prompt recording of transactions
There is no doubt that having separate operating and trust accounts can increase your firm’s administrative burden. Accordingly, It may seem tempting to put income and expenses into one account and sort out the details later. Resist this temptation.
Recording all transactions as promptly as possible will go a long way toward the prevention of commingling. Otherwise your firm raises the possibility of forgetting where incoming funds came from, or what they are for.
Beyond simply recording all transactions involving your operating and trust accounts, a legal practice must maintain comprehensive documentation for all accounts.
This documentation should include client ledgers, accounting records, and bank statements for each account. If funds from multiple clients or third parties are in a single trust account, you must track the funds belonging to each client or third party.
The good news is that online banking allows you easy access to these documents, often without having to receive paper copies in the mail. Moreover, online accounts will generally allow you to document the reason for any fund transfer or payment as you make it.
Along with regular reconciliations, document maintenance will help you remain ethically compliant. Learn more about accounting reconciliation here.
Tools and systems for fund separation
Your legal practice should search for—and implement—the best tools and systems available for separation of operating and trust accounts. Digital technology tools can serve firms well in this regard, especially with respect to:
- Electronic payment processing; and
- Trust accounting software.
Electronic payment processing
Your legal practice can easily track all transactions and ensure the correct accounts receive and send funds with the help of electronic payment processing.
Even better is working with a payment processor designed for the legal industry.
Clio Payments is an online payment solution that facilitates the processing of legal clients paying law firms.
In compliance with trust accounting rules, it is crucial that lawyers handle all trust-related transactions. For example, you must safeguard trust account funds against processing fees, chargebacks, and other third-party debiting procedures that can disrupt your accounting.
Trust accounting software
By now, most modern firms have discovered that paper accounting is too inefficient and cumbersome. Many practices have moved to Excel spreadsheets, but even these have limited capabilities.
Trust accounting software is the latest solution for seamless management of client trust accounts.
Clio Manage provides legal and trust accounting management features that help you keep trust and operating account funds segregated. The software also generates client ledger reports which display all accounts and transactions associated with any given client.
When you are also billing and collecting in Clio, reconciling accounts becomes simple because you can directly match trust transactions to the firm’s operating account.
Clio also offers an integration with Trustbooks, a legal accounting software provider. Firms can track transaction activity in Clio, then sync transaction data to Trustbooks. Then you can eliminate duplicate data entry while still maintaining compliance with ethical rules. Clio also offers integrations with more general accounting solutions such as QuickBooks Online.
Final thoughts on commingling funds
While it is important to understand the dangers of commingling funds, there is no need to give in to fear. Instead, implement best practices for proper trust account management.
In addition, deploy the best tech tools for both payment processing and trust accounting. Then you can rest assured that your firm and client funds will remain separate, leaving the hazards of commingling behind.
We published this blog post in June 2023. Last updated: .
Categorized in: Business