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Trust accounting is arguably one of the most fraught and complex concerns of every law firm.
The challenge of safeguarding and protecting client funds, while also sheltering your attorneys and your firm from the extremely serious consequences of improperly managed trust (and any hint of impropriety) is not easy. Client funds do not belong to you or your firms…You must segregate them from firm funds.
Navigating the how-tos of trust accounting requires a few important decisions:
5 Questions to Ask About Your Firm’s Trust Accounting
1. What does my state require?
Every state applies different regulations to the governance of trust accounts. The list of rules can tally up to a hundred pages. It can take years to extricate a lawyer or your firm from sanctions incurred even from accidental misuse (often discovered by random audit) and attorneys can lose their licenses.
So knowing and aligning your trust accounting practices with those rules is paramount.
2. How do I prevent accidental mismanagement of trust accounting?
A lawyer trust account is basically a business checking account set up to keep funds from commingling. Seems simple enough, right? It is not.
Recommended tactics for avoiding accidental misuse of client funds include:
Keep the firm’s operational bank account and the trust account at different banks. (This might not be an option, because trust accounts don’t earn banks any money, so some banks don’t offer them as a stand-alone account.) The challenge here is that you must have a trust in each state you operate in, and it must adhere to that state’s regulations.
Set up trust accounts at APPROVED financial institutions. Believe it or not, not all banks know all the rules about trust accounts, and you can be held liable for their mishandling of any aspect of the account(s).
Use different colored checks, with TRUST ACCOUNT written boldly on those designated for trusts.
Maintain separate accounts for each client. Though not a requirement, some firms find separate accounts can help keep things cleaner.
Err on the side of caution. One of the challenges of trust accounting revolves around which incoming fees actually belong to the firm. Some actually do. But it is extremely important to know in advance how your state views retainers, fees in advance, flat fees and non-refundable fees. When in doubt, go with the trust, especially for any unearned fees. (Source)
Pay close attention to ‘available’ and ‘cleared’ funds. No funds may be disbursed until the bank has fully collected the funds. To disburse before that is to allocate trust funds that don’t belong to the client, which is illegal. (Source)
Use the trust account as little as possible. “Avoiding trust accounts means less bar oversight, less accidents jeopardizing one’s license, and fewer fund transfers between accounts,” says lawyer Willie Peacock. (Source). See #3 below for more on this.
3. How do I handle IOLTA?
IOLTA (Interest On Lawyer Trust Accounts) is a non-profit program that funds the provision of civil legal services for the indigent and sponsors other programs that further the administration of justice.(Source) The bank doesn’t earn interest on these trust accounts; instead, funds that remain under specific financial thresholds allocate the interest earned to IOLTA. Earned interest over those thresholds goes to the client.
Some states require that all client funds be held in an IOLTA. Even then, some firms seek to circumvent IOLTAs by structuring their fees and payment plans to fall below this threshold where possible. (Source)
4. What is the best way to manage trust accounting?
Without a doubt, the answer is technology! Considering the complexities (and consequences of mistakes) in trust accounting, it’s almost inconceivable to imagine managing without the help of software designed for this very need.
Legal Practice Management (LMS), case management software, and legal-based accounting solutions address the challenges of trust accounting. LexusNexus recommends at least the following capabilities of your analytics solution (Source):
Three-point trust account reconciliation: Does the balance in the trust account align with your trust balance sheet for all times and dates? And can you break down this balance for each client?
Client Trust Ledgers – You must be able to track all transactions related to your client from the initial deposit to trust through the last disbursement from trust. Your software should be able to do this filtered by client, matter, date range and transaction type.
Easy movement of trust funds – You should be able to easily move trust funds to your operating account in payment of an outstanding invoice and/or to reimburse your firm for disbursement work in progress (WIP). In some jurisdictions, it is permissible to transfer funds from trust to operating accounts immediately before billing so that the transaction can be reflected on your client/ matter invoice.
Easy production of trust reports – Nothing would be worse than to have to scramble to provide simple, basic trust account reports when you have a state bar trust account auditor standing in front of you demanding them. (See #5 below) But more importantly, it is important to always know your trust balances on a matter by matter basis and ensure that the total balance (matter by matter) equals the balance in your IOLTA or trust bank account for the same date range.