Disputed Funds and Property

Disputed Funds and Property

Model Rule 1.15(e) applies when two or more persons claim property the lawyer holds, and the lawyer may be one of them. It gives two commands: keep the property separate until the dispute is resolved, and promptly distribute every portion in which the interests are not in dispute.¹ The rules covered so far assume that the owner of each dollar and each document is known. Client money stays in trust for the client, and an earned fee belongs to the lawyer. Paragraph (e) governs the moment when that assumption fails and the lawyer cannot say with certainty who owns what. The delivery duty in paragraph (d) already makes room for it, since that duty applies “except as stated in this rule,” and paragraph (e) is where the rule states the exception.²

A fee dispute is the usual occasion. A lawyer who receives settlement proceeds may think the fee is one figure while the client thinks it is smaller, and the whole sum sits in the trust account under the lawyer's control. Two instincts tempt the lawyer there, and each command of the rule forbids one of them. The first is self-help: take what the lawyer believes is owed and leave the client to object afterward. The second is the freeze: hold everything until the entire disagreement is settled. Keeping the contested property in trust bars self-help. Promptly distributing every undisputed portion bars the freeze.

The four subsections below follow that structure. The first two take the commands in the order the rule states them: hold the disputed portion, then pay everything else. The last two take the settings that most often produce exam questions: the lawyer's own claim to be paid, where a lien meets the duty to safeguard the client's money, and the claim of a third person to funds held for a client. In every setting the same two questions do the work. Who claims each portion, and is any portion undisputed?

Holding Disputed Portions Separately

The first sentence of Model Rule 1.15(e) requires a lawyer who holds property in which two or more persons claim interests to keep that property separate until the dispute is resolved.³ The rule's parenthetical, which allows that one claimant may be the lawyer, gives the command most of its work. The dispute that arises most often is a disagreement between lawyer and client over how much of the money in trust the lawyer has earned: a fight over the fee to be deducted from an advance deposit, or from a payment received in resolution of the client's matter. In that setting the rule lets the lawyer keep the funds in the trust account, which preserves some security over them, and forbids the lawyer to take personal possession of the disputed amount.⁴ Separate keeps the meaning it has had throughout this chapter: apart from the lawyer's own property, which for money means the trust account and never the operating account.

The rule takes this shape because the lawyer is both a claimant and the custodian. A lawyer who disputes the client's account of what the lawyer is owed can settle the question in the lawyer's own favor simply by taking the money. The client cannot see into the trust account and would learn of the withdrawal only afterward, so the lawyer would end up judging the lawyer's own claim. Keeping the contested amount in trust removes that option. The arrangement also protects the lawyer, because the money stays on hand as security until someone resolves the claim,⁵ and it is easy to police, because the trust account records show whether the disputed amount is still there. Earned, undisputed fees are different. They should come out of trust promptly, so that the lawyer's money does not sit among entrusted funds. A fee the client contests has not yet been established as the lawyer's, so it stays where it is.

The scene isolates the fact that triggers the command: each side claims the same dollars. Under either reading the client is entitled to at least $63,000 and the lawyer to at least $30,000. Only the $7,000 between those floors is claimed by both, and the rule attaches to that portion alone. The lawyer does not freeze the whole check, and what must happen to the undisputed $93,000 is the subject of the next subsection. The rule also gives the lawyer no license to hold the entire payment hostage as leverage in resolving the dispute.⁶

Courts treat a lawyer who takes the disputed money anyway as having crossed that line. In Attorney Disciplinary Board v. Rhinehart an Iowa lawyer disbursed settlement funds from the trust account to himself even though he knew the clients disputed the amount of his fees. The Iowa Supreme Court held that he violated the rule, because in the face of that dispute he should have kept the fees separate until it was resolved.⁷ He blamed the clients' unwillingness to discuss the dispute, and the court rejected that rationalization too.⁸ A client's silence leaves the disagreement in place and hands the lawyer no resolution, and only a resolution ends the duty to keep the money apart. In In re Jones the Louisiana Supreme Court faced a different route to the same result. The lawyer placed funds in the operating account despite knowing of a fee dispute, and the court held that this “amounts to conversion of client funds,” with disbarment as the baseline sanction.⁹

The two decisions differ in where the money went. In Rhinehart the funds reached the trust account and were then paid out to the lawyer, while in Jones they went into the operating account despite the known dispute. The rule is violated at either moment, on deposit or on later disbursement, and what unites the cases is that the lawyer knew of the dispute when the money moved. Treating disputed funds as the lawyer's own is among the most severely sanctioned forms of self-help, a point the final section of this chapter develops.

The usual exam error is to ask whether the lawyer's figure is correct. The rule asks only whether someone else claims an interest in the property. A lawyer whose reading of the fee agreement proves right still violates the rule by taking the amount while the client contests it, because the existence of the disagreement, and not its merits, keeps the property in trust. Whoever resolves the dispute decides who was right, and until then the money waits.

State versions follow the same pattern with different wording and lettering. Florida treats property claimed by two or more persons as trust property, requires the lawyer's own portion to be withdrawn within a reasonable time after it becomes due, and keeps the portion in dispute separate until the dispute is resolved.¹⁰ Another state's rule, quoted in a disciplinary opinion, appears in paragraph (c): it keeps property that the lawyer and another person both claim separate until there is an accounting and severance of their interests, and it keeps any portion later disputed separate until the dispute is resolved.¹¹ An exam answer should identify the duty by what it requires, because the paragraph letter varies from state to state.

Paying Undisputed Portions Promptly

The second sentence of Model Rule 1.15(e) completes the dispute rule. After the first sentence has kept contested property separate, this sentence adds that the lawyer “shall promptly distribute all portions of the property as to which the interests are not in dispute.”¹³ The two sentences work as a pair, and the second marks the outer limit of the first: a lawyer may hold back only the portion someone actually contests and must release everything else. The delivery duty in paragraph (d) keeps governing the uncontested portions, because its opening exception for matters the rule itself addresses covers only the portion that paragraph (e) requires the lawyer to hold.¹⁴

The reason is leverage. A lawyer holding a settlement controls the trust account, the client usually cannot see into it, and the client often needs the money. If a disagreement over one item suspended the whole payment, the client who is owed most of it would have to choose between conceding the contested item and waiting for money that nobody disputes. The lawyer would gain a bargaining position out of all proportion to the amount in controversy. The rule therefore lets the lawyer keep the contested funds in the trust account, which preserves some security for the lawyer's claim, and forbids the lawyer to hold the entire payment hostage to gain an advantage in resolving the dispute.¹⁵ The lawyer likewise may not withhold the full amount pending resolution and must distribute the portion that is not in dispute.¹⁶ Under that arrangement the effect of a disagreement stays as large as the thing disagreed about and no larger.

The command runs in the lawyer's direction as well. A fee that has been earned and is uncontested is the lawyer's own money, and leaving it in the trust account keeps the lawyer's property mixed with entrusted funds, which is the commingling the safekeeping rule forbids.¹⁷ Florida's version says so directly. The portion belonging to the lawyer or firm must be withdrawn within a reasonable time after it becomes due unless the right to receive it is disputed, in which case only the disputed portion stays separate, and the lawyer must promptly distribute every portion not in dispute.¹⁸ A dispute thus works like a filter. It holds back the dollars that two claimants both claim and passes every other dollar to its owner, whether that owner is the client, a third person, or the lawyer.

Lindgren's handling follows each step of the sort, and the single contested item controlled only one bucket. The lawyer's share and the client's share both left the trust account on time, so nobody's money was parked behind a disagreement that had nothing to do with it.

The instinct that loses points on an exam runs the other way. A lawyer who learns that the client contests some item may conclude that the prudent course is to hold everything until the disagreement is settled, on the theory that money in trust is safe. That theory answers the wrong question. The rule asks whether the money has been delivered to the person entitled to it, and safety in the account is beside the point once the portion is uncontested.

Both lawyers kept the same $5,000 in trust, and both were right to. The difference lies in the other $95,000, which one lawyer sorted and paid out and the other left frozen behind a dispute that did not touch it. The rule says only promptly, not a number of days. A lawyer needs time to confirm that the funds have cleared and to work out each person's share, but five months of silence on undisputed money cannot qualify.

The size of each bucket depends on what is actually contested, so the same fund sorts differently on different facts. Suppose the client in Lindgren's case had accepted the $5,000 in costs and contested the entire $30,000 fee. The disputed bucket would then be the $30,000 fee, the lawyer's undisputed bucket would hold only the $5,000 in reimbursed costs, and the client's $65,000 would still go out at once. The lawyer's own view of the merits changes none of this. A lawyer who is confident that a contested amount belongs to the lawyer still leaves it in trust, and a lawyer who is annoyed by the contest still pays everything else. A complete exam answer states both consequences: the contested amount stays in the trust account, and every other amount moves out promptly, including the lawyer's own.

Liens and Setoff Limits

Rule 1.15(e) tells a lawyer how to handle property that two or more persons claim, and the lawyer may be one of them: the contested property stays separate until the dispute is resolved, and every undisputed portion is promptly distributed.²⁰ What the rule does not say is when the lawyer's own claim to be paid is a legitimate one, because that question belongs to law outside the rule. The delivery duty yields to what the law permits, and Florida's version says expressly that it does not preclude holding money or property on which the lawyer has a valid lien for services, or paying agreed fees out of the proceeds of a transaction or collection.²¹ A lien is a legal right to hold property or a recovery as security until a debt is paid, and state law decides when a lien exists and what it reaches.

Whatever form a state's lien takes, the lawyer may assert it against client funds only when the lawyer has a legitimate claim to payment of fees or expenses for legal services.²² The condition follows from what a lien is. It secures a debt, so a lawyer with no genuine debt gives it nothing to secure. Even a lawyer with a genuine debt holds a lien that operates inside Rule 1.15(e): the lawyer may not withhold the entire fund pending resolution of the dispute and must distribute the portion that is not in dispute.²³ The lien gives the lawyer a reason to leave the contested amount in trust. It gives no permission to take it.

Three limits keep the lien in that role. They address different facts, namely the purpose of the fund, the timing of the fees, and the kind of property, yet each answers the same worry: that a right to be paid might grow into a right to seize whatever the lawyer happens to hold.

The first limit protects money the client supplied for a designated purpose, such as paying a settlement or judgment or completing a transaction. Such funds are not subject to a lien.²⁴ The client handed the money over to accomplish a particular act, and a lawyer who diverts it to a fee bill defeats that act. The lawyer owes the client a duty to take no action that would prejudice or impede the client's lawful objectives, and a settlement left short because the lawyer deducted a fee from the settlement money is a plain instance of that prejudice.²⁵ Florida's rule reaches the same result through the idea of setoff, which means deducting what the client owes the lawyer from money the lawyer holds for the client. Money entrusted for a specific purpose, including advances for fees, costs, and expenses, must be applied only to that purpose. Money of clients in the lawyer's hands is not subject to counterclaim or setoff for attorney's fees, and a refusal to account for and deliver such property on demand is deemed a conversion.²⁶

A claim of the same kind, asserted against a recovery the lawyer's own work produced, supports a lien, as the Kessler scene shows. What differs between the two scenes is the purpose for which the client supplied the money.

The second limit fixes how much a lien can secure. When another creditor obtains a security interest in the same funds or tries to garnish them, the lawyer's lien secures only fees and expenses already incurred, and it cannot justify holding the funds against fees the lawyer expects to earn later.²⁷ The amount the lien secures becomes fixed at the moment a question of priority arises between the lawyer and the other claimant.²⁸ The rule has to work this way because a lien is security for a debt that exists, while anticipated fees are a forecast of work not yet done. If the forecast counted, a lawyer could rank ahead of other creditors simply by predicting a long case, and a competing claimant could never know how large the prior claim was. Fixing the amount when the conflict arises gives every claimant a definite number to measure.

The third limit concerns property other than money. A lien may reach the client's file as well as funds, but the lawyer may not withhold the file against an unpaid fee bill if doing so would prejudice the client in an ongoing matter, as when the client has retained new counsel to handle a pending lawsuit.²⁹ The file holds the pleadings, discovery, and research on which the pending case depends. A lawyer who holds it back puts pressure on the client in the very proceeding the client must win, and that pressure has little to do with collecting the debt. An unpaid bill does not entitle the lawyer to keep a file that a pending case needs.

The limit turns on prejudice in an ongoing matter, so look in the stem for a pending case or a new lawyer waiting for the file.

The three limits and the dispute rule combine into one sequence that can be run on any fact pattern in which a lawyer is owed money and holds something belonging to the client.

An exam stem usually makes the lawyer's fee claim sound entirely legitimate, and that settles little, because each limit asks about something other than the soundness of the bill: what the money was given for, how much of the bill is already incurred, and whether the file is needed in a pending case. A lawyer who skips these questions and pays himself is in the position of the Iowa lawyer in Rhinehart, who paid disputed fees to himself and blamed the clients' unwillingness to discuss them, a defense the court rejected when it held that the rule required him to keep the fees separate.³⁰

Third-Party Claims

Model Rule 1.15(e) is written broadly enough to reach disputes in which the lawyer claims nothing. It applies whenever a lawyer possesses property in which two or more persons claim interests, and it says only that the lawyer may be one of them.³² The preceding subsections followed the version in which the lawyer's own fee competes with the client's share. A third person can also assert a right to money the lawyer holds for a client, as when a medical provider, an insurer, or a lender points to a settlement and asks to be paid from it. The lawyer then has to weigh two things together: the directions the client has given and the legal force of the claim the outsider makes.³³

The easy case is the one in which the client's wishes and the outsider's claim point the same way. Suppose a personal injury client agrees in advance that a stated amount or share of an expected settlement or judgment will go to a hospital, a medical provider, or an insurer that covered the treatment. The lawyer ordinarily distributes the funds between the client and that third person in accordance with the understanding.³⁴ Two reasons support following it. The money belongs to the client, so the client's agreement is the ordinary source of authority for sending part of it elsewhere. And once the client has agreed, nobody contests the share: the client and the provider want the same dollars to go to the same place, so the competing claims that trigger the dispute rule are absent. The delivery duty in paragraph (d) then runs to the provider as a third person entitled to receive the agreed share, and the lawyer pays it promptly.³⁵

An exam stem that has a third person demanding part of the settlement is testing whether that agreement exists. If the client never consented to a distribution that includes the other person, or expressly withdraws an earlier instruction and orders the whole sum paid to the client, the agreement no longer settles the matter. The lawyer must then evaluate the competing claims under the substantive law of property rights and security interests, a body of law outside the scope of this chapter. That law decides whether the outsider holds a real interest in specific funds or only a grievance against the client.³⁶ The lawyer tests the claim without becoming an impartial arbiter between the parties. The lawyer remains responsible and answerable to the client unless the third person confirms a properly presented and secured claim of interest in specific property or funds.³⁷

The standard is shaped to prevent two mistakes that run in opposite directions. A lawyer who paid whatever any outsider demanded would turn the trust account into a collection tool against the client, even though a bare demand gives the outsider no right to specific funds and the client's instructions ordinarily govern the client's money. A lawyer who paid the client every time the client said so would turn the account into a shield against valid claims, even though Rule 1.15(a) protects property of third persons as well as property of clients.³⁸ The lawyer cannot escape the problem by picking the more sympathetic side, because picking is an act of decision, and the lawyer has no authority to decide a dispute between a client and a stranger. What the lawyer can do is ask whether the third person holds a claim secured in specific funds, and the answer determines which of the two mistakes to avoid.

The client's order and the dollar figures are the same in both scenes, so the fact that moved the answer is the legal footing of the outsider's claim. The sequence below runs the analysis in the order a lawyer would need to apply it.

The instinct that loses points is to treat the lawyer as a neutral stakeholder who freezes the whole fund or splits the difference the moment an outsider speaks. The lawyer is the client's fiduciary, so a bare demand does not override the client's instructions, and the lawyer's own view of who deserves the money is no basis for distribution. The opposite error, treating the client's order as final when a secured claim exists, fails for the reason the second scene shows: Rule 1.15(a) protects property of third persons, and paragraph (e) keeps the contested portion in trust.