Interest and IOLTA

A client's advance payment sits in the trust account until the lawyer earns the fee or incurs the expense, and that wait can last months.¹ Money parked that long in a bank can earn interest, and the earlier sections never said who owns it. The interest follows the principal: it belongs to the owner of the money, so a lawyer who pockets it profits from funds held only for safekeeping.²

Cost complicates the picture. The Model Rules let a lawyer put the lawyer's own money into a trust account only to pay bank service charges on that account, and only in the amount necessary for that purpose.³ The permission reflects a practical fact: a trust account costs money to keep open, and a deposit helps its owner only when the interest it earns exceeds those costs. A large sum held for months can clear that bar. A small sum held for a few days usually cannot.⁴

Two rules result. Where the funds can earn a net return for the client, the interest goes to the client. Where they cannot, state programs pool the funds in an IOLTA account (Interest on Lawyers' Trust Accounts), and the combined interest pays for legal services and other law-related work. The lawyer keeps the interest in neither case. The first subsection shows how a lawyer decides which rule applies. The second takes up the Fifth Amendment objection that pooling invites.

How IOLTA Works

Interest earned by client money belongs to the owner of the principal. In Phillips v. Washington Legal Foundation, a case about the Texas IOLTA program, the Supreme Court held that interest income generated by funds held in IOLTA accounts is the private property of the owner of the principal, and Brown v. Legal Foundation of Washington starts from that holding.⁵ Ownership explains why a lawyer cannot keep the interest. It also explains why sending that interest elsewhere needs a justification.

IOLTA exists because of what happened to small deposits before 1980. When trust funds were so nominal, or held so briefly, that interest would not justify the cost of separate accounts, most attorneys put them in a single noninterest-bearing trust checking account holding money from all their clients. That account earned nothing for client or lawyer, and the bank got the interest-free use of the money.⁶ In 1980 Congress authorized federally insured banks to pay interest on a limited category of demand deposits called NOW accounts. Florida adopted the first IOLTA program in 1981, using NOW accounts for client funds and devoting all of the interest to charitable purposes.⁷ Every other state and the District of Columbia followed. The value that banks once kept now goes to charitable entities that provide legal services for the poor, and the aggregate in 2001 apparently exceeded $200 million.⁸ In Cone v. State Bar of Florida, the court explained the mechanics. Naming one eligible charitable recipient let the program use NOW accounts without violating a federal regulation. It also let interest from many small deposits aggregate past the bank's charges, because the bank did not need to sub-account the fund.⁹

Washington wrote the ownership principle into its rule through its supreme court. The earlier Washington rules had required attorneys to keep client trust funds in accounts separate from their own and had barred using the funds for the lawyer's own pecuniary advantage, but they said nothing about investing the money.¹⁰ The new rule recognizes accounts that bear interest for the client and a second type, a pooled interest-bearing account whose interest the bank pays directly to a nonprofit, the Legal Foundation of Washington.¹¹ The lawyer chooses between them, and the rule says how: the decision rests solely on whether the funds could be invested to provide a positive net return to the client. The lawyer weighs the interest the funds would earn during the period they are expected to be on deposit, the cost of establishing and administering the account, and the ability of financial institutions to calculate and pay interest to individual clients.¹²

The Washington court endorsed the view that those factors are facets of one question: can the client's money be invested to produce a net benefit for the client? If so, the attorney must invest it for the client, and only money that cannot earn net interest for the client goes into an IOLTA account. The court amended the rule to say that IOLTA funds are those that cannot, under any circumstances, earn net interest after transaction costs, administrative costs, and bank fees are deducted.¹³ The word net carries the test. The Supreme Court read the rule to mean that a lawyer who mistakenly puts money into an IOLTA account when it could have earned interest for the client violates the rule and is liable to the client for the lost interest, however small the amount.¹⁴ The line also moves with technology. As cost-effective subaccounting lets smaller amounts earn net interest for shorter periods, more money must be invested for clients, which is why the court called its rule self-adjusting.¹⁵

Money that belongs in the pool goes to a public purpose and not to a private pocket. States typically direct such deposits into a pooled interest-bearing trust account, the bank pays the interest to a state commission, and the state applies it to programs on the administration of justice, education about the law, student scholarships, and grants to organizations that provide legal services to the poor.¹⁶

The two deposits are the same size, so the expected holding period decides the placement. No net return could reach the first client, so that money belongs in the pooled IOLTA account. The second client's money could earn net interest, so the lawyer must invest it for that client. A lawyer who sent the second deposit to the pool would owe the client the interest it would have earned, however small the amount.¹⁷

Convenience and good causes do not decide placement. The Washington rule ties the choice to the client's net return alone, so a lawyer's wish to save bookkeeping, or to fund legal aid, cannot justify sending to the pool money that could have earned net interest for the client.¹⁸ The same reasoning keeps the lawyer from pocketing the interest on either kind of money, because the lawyer owns neither principal. Programs differ by state in origin and in name. Washington, like most states, set up its program by state supreme court order, and some jurisdictions call theirs IOTA (Interest on Trust Accounts).¹⁹ An exam answer should anchor on the net-return test and treat local details as add-ons.

Takings Challenges to IOLTA

If the interest belongs to the client, a program that routes it to a foundation for legal aid looks like the government taking private property for a public purpose. Phillips held that the interest is private property but expressly left open whether the State had taken it and what just compensation, if any, was due. Brown is the case that confronted those questions.²¹

The Fifth Amendment does not forbid taking property. It forbids taking without just compensation, and that compensation is measured by the owner's loss rather than the government's gain.²² The measure controls how to read the numbers. Every state has a program, and contributions exceeded $200 million in 2001, but an aggregate that large says nothing about what any single client lost.²³ The question for each deposit becomes whether the interest the program sent to the pool could otherwise have reached the client.

Washington's court answered that it could not. It distinguished an earlier Supreme Court decision, Webb's Fabulous Pharmacies, Inc. v. Beckwith, on the ground that the program "creates income where there had been none before, and the income thus created would never benefit the client under any set of circumstances," language it took from a Florida decision.²⁴ The court then wrote that reasoning into the rule. IOLTA funds are those that cannot, under any circumstances, earn net interest for the client after costs and fees, and money that could earn net interest must be invested for the client.²⁵ The court also described the rule as self-adjusting, able to accommodate changes in banking technology without running afoul of the state or federal constitutions.²⁶

Cone supplies the numbers. Holland & Knight held a $13.75 deposit for a client. The district court found that the sum fell below the minimum balance for a separate NOW account. It also found that even if the money could have gone into an interest-bearing account, the firm's administrative costs and the bank's service charges would have consumed the roughly six cents a month in gross interest the deposit would produce.²⁷ The client ended up in the same position with the program as without it, since in either case no interest would reach the client. A claim measured by the owner's loss has nothing to compensate there.²⁸

Here the client has lost what the foundation gained, because interest that could have reached the client went to the pool instead. The loss-based measure now has something to count. A program built like Washington's would have sent this deposit to an account paying the client, leaving no loss to measure. The design of the rule, and not the mere existence of a pool, determines whether a client can show a loss.

For professional responsibility, the portable point is the chain of reasoning. Interest belongs to the owner of the principal. Just compensation is measured by the owner's loss. The net-return test confines the pool to money that could not have earned a return for its owner.