Misappropriation and Discipline

Misappropriation and Discipline

Rule 1.15 rests on one command: a lawyer keeps the property of clients and third persons separate from the lawyer's own.¹ Every duty covered so far in this chapter makes that separation checkable. Funds go into a trust account. Other property is identified, cataloged, and kept apart; a lawyer ordinarily places client securities and other valuable or negotiable documents in a bank safe deposit box maintained separately for client property.² Owners hear of receipt and are paid promptly, and a dispute freezes only the contested portion. This section takes up the failure case, in which a lawyer uses entrusted property for the lawyer's own purposes. Because the owner usually cannot inspect the account, discipline is the protection that remains when the safeguards fail.

Rule 1.15(e), the dispute rule, shows that no lawful route runs from entrusted money to the lawyer's own pocket. When a lawyer holds property in which two or more persons claim interests, and the lawyer is one of them, “the property shall be kept separate by the lawyer until the dispute is resolved,” and the lawyer must promptly distribute every portion that is not in dispute.³ A lawyer who is certain that a fee is owed therefore may not withdraw the contested amount. Certainty is not a license.

Three situations put the rule to work, and the question is the same in each: what happened to someone else's property? The lawyer may take entrusted money outright, or “borrow” it. The lawyer may take nothing and still answer for an employee's theft. Or the lawyer may discover a shortfall and compound it while trying to repair it. The lawyer's intentions answer none of these questions.

Conversion Without Intent

A lawyer who uses entrusted funds for a personal purpose breaches the separation duty at the moment of use.⁴ The profession calls the breach misappropriation, or conversion: treating another person's money as one's own. Four facts that sound like defenses leave the violation intact. The use was temporary. The lawyer meant to put the money back. The owner lost nothing. The lawyer believed a fee was owed. An exam stem will often offer several together.

The first and third excuses fail because the duty is to keep the property available to its owner. A lawyer who moves trust money into personal use, planning to return it, has still placed the owner's money where the owner cannot see it and has exposed the owner to the risk that the plan fails. The expected fee may not arrive, a closing may collapse, or the cash may not appear. A repayment that does happen is luck, and the rule does not make the owner's protection depend on luck. For the same reason, “no harm done” is no answer: the exposure during the interval was the wrong, and a later restoration shows only that the risk did not materialize.

The second excuse fails because intent to repay is a fact only the lawyer knows. Bank records show that money left the account, when it left, and where it went; they do not show what the lawyer was planning. A rule keyed to intent would turn every case into a contest over a private state of mind, and a lawyer who stole would have every reason to call the taking a loan. The taking itself is therefore the violation, and the disciplinary response follows it. When a lawyer misappropriates unearned funds from the trust account, even with the asserted intent of replenishing it by taking a “loan,” the state disciplinary authority invariably responds with one of the more severe sanctions, presumptively disbarment.⁵

The fee excuse fares no better, because the dispute rule binds the lawyer as claimant exactly as it binds anyone else: the contested property stays separate until the dispute is resolved.⁶

re Warhaftig illustrates the pattern. The lawyer repeatedly advanced fees to himself from the trust account in pending real estate matters, replaced the money when the closings occurred, and covered the withdrawals with personal funds once an audit was announced, and he was disbarred.⁷ Each restoration is the part a lawyer in his position treats as an answer, and it is the part that fails. Replacing money repairs the account but does not undo the time during which other people's money served the lawyer's own use.

Not every irregularity in a trust account is conversion. The line falls between a lawyer's own money going into the account and entrusted money being used.

The first lawyer has commingled: a trust account is reserved for client funds related to the representation and should not serve as a repository for a lawyer's own property.⁸ The second lawyer has used a client's unearned money to pay a personal debt, which is misappropriation, and the plan to repay changes neither the label nor the presumptive sanction.⁹

An exam stem on this topic usually recites good intentions, a quick repayment, and a client who never noticed, then asks whether discipline is proper. Those facts do not answer the question. Ask whether the lawyer used entrusted funds for the lawyer's own purposes. If so, the violation is complete and the presumptive sanction is disbarment.

Responsibility for Trust Accounts

Rule 1.15 speaks to the lawyer. The lawyer must keep the property of clients and third persons separate from the lawyer's own, and nothing in the rule hands that duty to anyone else.¹¹ The point matters in a firm, where a non-lawyer bookkeeper often deposits the checks, writes the disbursements, and records the balances. The lawyer in the previous subsection took entrusted money. The lawyer here takes nothing and still answers for the loss. Florida Bar v. Rousso supplies the example. Because it applies Florida's rules rather than the Model Rules, read its detailed trust-accounting standards as illustrations of the minimum controls that give Rule 1.15 its content.

In Rousso, the two respondent lawyers said that the firm's non-lawyer bookkeeper, Fernando Horigian, had embezzled $4.38 million. The referee found no clear and convincing evidence that either lawyer misappropriated the money or received any direct benefit from its disappearance.¹² The Florida Supreme Court disciplined them anyway. It held that ultimate responsibility for trust account funds rests with the attorneys, that a lawyer's responsibility for safekeeping those funds cannot be delegated to a non-lawyer employee of the firm, and that misappropriation by office staff does not relieve the lawyer from the minimum standards for a trust account.¹³

The violation lay in the controls the lawyers left out. Florida's Rules 5-1.2(b) and (c) set minimum trust accounting records and procedures, and the court found clear and convincing evidence that the lawyers failed to do four things:¹⁴

1. They did not examine endorsed checks to ensure against possible forgery.
2. They did not prepare and keep memoranda supporting disbursements of trust funds to their own interests or business concerns, and those disbursements occurred when the account could not cover client liabilities.
3. They did not keep a separate file or ledger for each client or matter showing individual receipts, disbursements, transfers, and any unexpended balance.
4. They did not cause a monthly reconciliation to be made, comparing the account against the total of the trust ledger cards or pages and describing any differences and the reasons for them.

Each control produces a record that someone other than the bookkeeper can read, and together they work as a system. Reviewing endorsements tests the checks that went out against the people who were supposed to receive them. A disbursement memorandum forces someone to say why entrusted money moved toward the firm's own side. A client ledger ties every dollar to a named owner, which a single bank balance cannot do. The monthly reconciliation then compares the bank's total with the ledgers' total, so a shortfall appears as a gap in the month it opens and does not stay buried in a running balance.

The referee found that if the lawyers had adhered to the minimum standards, they would have been safeguarded against embezzlement, and that the pattern of theft could have been exposed before the damage extended beyond the second month.¹⁵ The lawyer's exposure is measured against what the controls would have revealed, and the price of skipping them is every month the theft continues unseen.

The rule against delegation follows from who relies on whom. The owner of money in a trust account cannot see the account and has usually never heard of the bookkeeper. That owner relies on the lawyer, who is the licensed fiduciary. The Florida Supreme Court has said that lawyers have a “unique fiduciary duty,” individually and as a profession: “Never is an individual's trust in attorneys more evident, or more at risk, than when he places funds or property into the hands of his attorney.” In Rousso the court said the lawyers abandoned their professional duty to safeguard their clients' funds.¹⁶ If hiring a bookkeeper carried the responsibility along with the work, the person with authority over the account would have no reason to watch it, and the owners, who cannot watch it, would absorb the loss. Leaving responsibility with the lawyer gives the person who controls the system a stake in testing it.

Set that firm beside the firm in Rousso, which kept no ledgers, no reconciliations, and no review of endorsements. Both face a dishonest employee. What differs is whether the lawyers kept the controls, and so whether the theft surfaced in the second month or after the damage had grown. The firm in Rousso cannot treat the bookkeeper's crime as the end of the inquiry, while the first firm has done what the standards ask.

The referee recommended suspensions of twelve months for Rousso and fifteen months for Roth. The Florida Supreme Court disapproved them and imposed disbarment, after weighing the egregious misconduct in the whole record, including the conduct after the shortage surfaced that the next subsection examines.¹⁷ It stopped short of permanent disbarment: the Bar's cases involved attorneys who themselves misappropriated funds, most of those cases ended in ordinary disbarment, and the referee counted the lawyers' efforts to cover client liabilities as a mitigator.¹⁸

An exam stem that features a dishonest bookkeeper, paralegal, or office manager invites the answer that the lawyer is a victim and owes nothing. That answer skips the real question, which is whether the lawyer kept the minimum controls and monitored the account. A lawyer who delegated the account and checked nothing answers for the theft even though the lawyer took no money and gained nothing from it.

Covering Shortfalls Improperly

Rule 1.15's separation command does not lapse when a lawyer learns that the account is short.²⁰ A lawyer who discovers a shortfall must repair the loss through steps that are each governed by duties owed to the same owners, and Rousso shows how quickly the repair can multiply violations.²¹ The embezzlement left the firm's trust account $4.38 million short.²² This subsection follows what the lawyers did once they knew. The court found that their response generated violations of its own and disbarred both of them.

The lawyers drew on whatever money they could reach: personal funds, funds borrowed from family, money borrowed from a client, credit lines, and proceeds related to a claim against the firm's malpractice insurer.²³ By April 2008 they had deposited $245,600 of personal funds, in June 2008 each deposited a $100,000 check, and in July 2008 Roth used a $231,223.68 personal loan from client Yordi to shore up the account.²⁴ The referee found that the lawyers extended themselves to financial ruin to make right the bookkeeper's wrong, and counted that effort as mitigation.²⁵ The court nonetheless found that the repair broke four separate sets of rules.

The first violation was commingling. A trust account is reserved for client funds related to the representation and should not serve as a repository for a lawyer's own property, and the funds used here were personal to the lawyers.²⁶ The court counted the repeated deposits of personal funds and the use of the Yordi loan to bolster the account as commingling, and it disapproved the referee's recommendation that the lawyers be found not guilty of violating the rule against it.²⁷ A repaired balance and a properly separated account are different things. The deposits fixed the total while placing the lawyers' own money, and money borrowed from others, in an account meant to hold only what belongs to clients and third persons. A wish to make the owners whole explains why the money went in and leaves untouched the question of where it went.

The second violation was a conflict of interest with current clients. The lawyers accepted funds from clients when they knew the account was underfunded, and the court called that a conflict of interest.²⁸ They did not tell those clients about the firm's financial problems, yet they kept representing them, and they used this “fresh money” from some clients to satisfy past-due liabilities to others.²⁹ The arithmetic of an underfunded account explains the conflict. When the account holds less than the lawyers owe, each payment to one owner leaves less for another, and whoever sets the order of payment decides which owners absorb the loss. The referee put the standard plainly: no client should ever have cause to question the order of disbursements from an underfunded trust account.³⁰ Informed consent could have addressed the conflict, but the lawyers chose to cover the losses quietly, so the majority of clients were never advised of the situation and never gave consent.³¹ A client who does not know the account is short cannot decide whether to accept a delay, a promissory note in place of cash, or a lawyer who has chosen to pay someone else first. The newer client's deposit also became a source of repayment to earlier clients without that client's knowledge, so the client with the least information carried the risk.

The third violation was the Yordi loan. Roth solicited a personal loan from client Yordi, which the court called a conflict of interest, and the lawyers used the money to bolster the trust account.³² A lawyer may take a financial interest from a client only if three conditions are met: the transaction and its terms are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner the client can reasonably understand; the client is advised in writing of the desirability of seeking, and is given a reasonable opportunity to seek, independent legal advice; and the client gives informed consent, in a signed writing, to the essential terms and the lawyer's role.³³ Both lawyers benefited from the loan, yet neither told Yordi in writing that outside funds were needed to cover embezzling from the trust account, that the size of the imbalance was unknown, that the firm might not survive and so might be unable to repay, that he should engage an independent lawyer, or that the loan could not close without his informed consent.³⁴ Each omitted item was a fact Yordi needed to judge the risk of lending to his own lawyers. The referee found that Roth did not know the extent of the loss when he asked and thought the firm could repay, and the court still called the Yordi funds a serious breach of conduct.³⁵ It did not leave the matter as a private debt. It approved the requirement that the lawyers show they fulfilled their settlement agreement with Yordi before readmission to the Bar, because applicants must show that they conduct financial dealings in a responsible, honest, and trustworthy manner, and financial irresponsibility is disqualifying.³⁶

The fourth violation, dishonesty, tied the others together. The referee found that the lawyers breached an affirmative duty to disclose the true conditions and to advise their clients to seek informed consent, and the court approved the finding of guilt under rule 4-8.4(c).³⁷ Their silence gave clients the false impression that financial matters were stable. The referee found the conduct dishonest, fraudulent, deceitful, and a type of misrepresentation when the lawyers continued representing clients and continued taking clients' money into a trust account they knew was seriously underfunded.³⁸ None of this required a false statement. A client who relies on a lawyer to say if something has gone wrong with the client's money reads silence as a sign that nothing has, and the duty to disclose makes that silence a deception. The court also faulted the lawyers for taking an excessive length of time to deal seriously with the shortage.³⁹

The sanction shows what good intentions are worth after the fact. The referee counted the lawyers' efforts to cover client liabilities as mitigation and found no clear and convincing evidence that either lawyer misappropriated the missing money.⁴⁰ Neither finding saved the lawyers from disbarment, which the court held appropriate after considering case law and the egregious misconduct in the case.⁴¹ The court imposed ordinary rather than permanent disbarment, noting that the Bar's cases involved attorneys who misappropriated funds.⁴² Mitigation moved the sanction away from the harshest end of the scale, and the violations stayed on the record as violations.

An exam stem on this topic usually shows a lawyer who finds missing trust money and quietly puts it right, with generous motives and a happy ending in which every client is eventually paid. Sort the lawyer's conduct by what each step did. Depositing personal or borrowed money commingles it with entrusted property. Accepting new money into an account known to be underfunded, or using it to pay older liabilities without telling anyone, creates a conflict with current clients and is dishonest. Borrowing from a client without written disclosure, written advice to seek independent counsel, and signed informed consent breaches the conditions for dealing with a client. The lawyer's motive and the eventual repayment bear on the severity of the sanction and cure none of these violations.