Section 8.2: Disputed Claims, Third-Party Interests, and IOLTA

Disputed Claims, Third-Party Interests, and IOLTA (Rule 1.15)

Handling Disputed Funds and Property

On the MPRE, dispute scenarios involving client funds are extremely common. Under ABA Model Rule 1.15(e), if a lawyer is in possession of property in which two or more persons (one of whom may be the lawyer) claim interests, the lawyer must keep the property separate until the dispute is resolved. This situation typically arises in one of two contexts: a dispute between the lawyer and the client, or a dispute between the client and a third party.

The Dispute Resolution Protocol

Regardless of who is disputing the funds, the lawyer must follow a strict three-step protocol:

1. Promptly Distribute Undisputed Portions: The lawyer must immediately distribute all portions of the funds or property that are not subject to a bona fide dispute. The lawyer cannot hold the entire fund hostage simply because a small portion is contested.
2. Retain Disputed Portions in Trust: The lawyer must keep the disputed portion of the funds in the client trust account. The lawyer cannot withdraw their claimed fee from the trust account if the client objects, nor can the lawyer pay the client the disputed amount if a third party has a valid claim.
3. Resolve the Dispute: The lawyer must hold the disputed portion in trust until the dispute is resolved by agreement, arbitration, mediation, or a court order. If the dispute cannot be resolved informally, the lawyer may file an interpleader action to have a court determine the rightful owner of the funds.

Disputes Between Lawyer and Client

If a client disputes the lawyer’s fee, the lawyer must keep the disputed portion in the trust account. For example, suppose a lawyer receives a $30,000 settlement check on behalf of a client. The lawyer’s written contingency fee agreement specifies a 33% fee ($10,000). The client, however, claims that the lawyer agreed to reduce the fee to 20% ($6,000) and disputes the remaining $4,000. Under Rule 1.15(e):

• The lawyer must promptly distribute the undisputed client portion ($20,000) to the client.
• The lawyer may promptly withdraw the undisputed fee portion ($6,000) and transfer it to the operating account.
• The disputed $4,000 must remain in the client trust account until the dispute is resolved. The lawyer cannot unilaterally withdraw the $4,000, even if the lawyer is certain the fee agreement is valid.

Third-Party Claims on Client Funds

Lawyers frequently receive funds that are subject to claims by third parties, such as medical providers who treated the client after an accident, subrogated insurance carriers, or judgment creditors. Rule 1.15(d) and Comment 4 address this delicate situation.

The Lawyer's Duty to Protect Third-Party Interests

A lawyer may have a duty under applicable substantive law to protect third-party claims against wrongful interference by the client. Specifically, if a third party has a lawful interest in the funds (such as a statutory medical lien or a signed agreement where the client authorized the lawyer to pay the provider directly from the settlement), the lawyer must protect the third party.

• If the client demands that the lawyer disregard the third party's lien and hand over all the settlement money directly to the client, the lawyer must refuse.
• The lawyer must hold the disputed funds in the trust account and notify the third party of the receipt of the funds.
• If there is a dispute between the client and the third party regarding the validity or amount of the claim, the lawyer must keep the disputed portion in trust until the dispute is resolved.
• Distinction: If the third party does not have a lawful interest in the specific funds (such as a general, unsecured creditor who merely wrote a letter demanding payment but has no lien or contract right to the settlement proceeds), the lawyer’s duty is to pay the client. The lawyer cannot act as a collection agent for the client’s general creditors.

Interest on Lawyers' Trust Accounts (IOLTA)

A lawyer who holds client funds must place them in an interest-bearing account. Under standard banking practices, if a client’s funds are substantial in amount or are to be held for a long period, the lawyer should establish a separate interest-bearing trust account for that specific client. The interest earned on such an account belongs to the client.

The Purpose of IOLTA

However, in many cases, a lawyer holds small amounts of client funds (nominal funds) or holds larger amounts for a very short duration (e.g., a few days before a real estate closing). For these funds, the administrative cost of setting up a separate interest-bearing account, calculating the interest, and reporting it to the IRS would exceed the actual interest earned. Historically, banks held these small or short-term deposits in non-interest-bearing accounts, allowing banks to profit from the interest-free use of the funds.

To address this, states established Interest on Lawyers' Trust Accounts (IOLTA) programs. Under an IOLTA program:

• A lawyer pools nominal or short-term client funds into a single, shared interest-bearing trust account.
• The bank calculates the interest on the pooled account and transmits the interest directly to a state-designated nonprofit foundation (typically a legal services corporation or access to justice commission).
• The foundation uses the pooled interest to fund civil legal aid for low-income individuals, public interest law programs, and projects to improve the administration of justice.

Mandatory Nature of IOLTA

In almost all U.S. jurisdictions, participation in the state’s IOLTA program is mandatory for lawyers who handle client funds. The MPRE tests the following rules regarding IOLTA:

• No Personal Profit: Neither the lawyer nor the law firm may keep any interest earned on an IOLTA account. Doing so is a severe ethical violation.
• No Client Profit: The client does not receive the interest from an IOLTA account because, by definition, the funds placed in IOLTA are nominal or short-term and would not have earned net interest for the client after administrative costs.
• Determining IOLTA Eligibility: The lawyer must make a good-faith judgment as to whether client funds are nominal or short-term. If the funds could earn positive net interest for the client (taking into account bank fees and administrative costs), the lawyer must place them in a separate interest-bearing account for the client's benefit, rather than the IOLTA account.