Third-Person Claims

Rule 1.15(e) does not confine the rival claimants to the lawyer and the client. It applies whenever a lawyer, in the course of representation, holds property in which two or more persons claim interests.¹ The preceding sections treated the lawyer as one of the claimants. This section turns to a rival from outside the representation: a hospital, a lender, a former business partner, or a creditor who has learned that a recovery or a sale has put the client's money in the lawyer's trust account. The rule's two commands carry over unchanged. The lawyer keeps the contested part separate until the dispute is resolved, and promptly distributes every portion not in dispute.² What changes is the first question. Before applying either command, the lawyer must decide whether the outsider has a claim at all.

The trigger in paragraph (e) is a claim of an interest in the property, and that word sorts outsiders into two groups. Some hold a legally cognizable stake in the particular funds, such as a security interest or lien attached to them. Others hold only a demand to be paid, which may rest on a real and even undisputed debt but gives no right to this money in particular. The second group is pursuing the client, not the funds. Only the first group gives the lawyer a reason to hold money the client is asking for.

Two dangers press from opposite sides of that line. A lawyer who pays out funds over a genuine third-party interest assists the client in taking another person's money, and loyalty to the client does not reach that far. A lawyer who treats every creditor's letter as a freeze order lets anyone able to write a letter tie up a recovery, and becomes a collection agent for the client's creditors, a role the lawyer has no authority to play. An exam stem in which a third person presses a lawyer for part of a client's funds asks which side of the line the demand falls on. The four subsections below follow the lawyer's reasoning in order: how to test the outsider's claim, what makes a claim binding, what a bare creditor lacks, and when no real dispute exists.

Testing the Third Party's Claim

Rule 1.15(e) covers a rival who is neither the lawyer nor the client, but it protects an outsider only if the outsider's claim is one the rule recognizes.³ When the rival is a hospital, or an insurer that covered the client's treatment, the lawyer answers that threshold question from two inputs: what the client has directed, and how much legal force the third person's claim carries.⁴ The inputs come in a fixed order. Taking them in that order guards against two opposite mistakes: treating every outsider's demand as a freeze order, and treating the client's say-so as final whatever the outsider holds.

The client's consent comes first because the client and the third person often want the same thing. When a client in a personal injury action agrees in advance that a particular amount or share of an expected settlement or judgment goes to another, such as a hospital 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.⁵ No dispute exists in that situation. The client approved the third person's share, and paying as agreed carries out the client's own instruction without passing judgment on anyone's rights.

Consent may be missing or withdrawn. The client may never have agreed to a distribution that includes the third person, or may expressly countermand a prior instruction and order the lawyer to send the full sum to the client. Either way the harmony is gone, and the lawyer must evaluate any competing claim in light of the substantive law of property rights and security interests.⁶ When the third person says the client's debt should be paid from these specific funds, the law of secured transactions supplies the test for whether a genuine dispute exists over a specific interest in them.⁷ The lawyer needs a standard that does not turn on which party seems more deserving, and property and security-interest law provides one. It shows whether the outsider holds a real interest in these particular funds, such as a perfected lien, or only a grievance against the client, and that answer decides whether paragraph (e) has anything to freeze.

The evaluation serves a limited purpose. When another person claims funds held in trust, the lawyer does not become 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.⁸ The default therefore runs toward the client, and the third person must earn an exception by showing a secured interest in the funds themselves. Two reasons support that allocation. The client retained the lawyer, so deferring to the client where the law recognizes no competing property right keeps the lawyer from substituting personal judgment for the client's. And a quarrel between a client and a creditor over a contract belongs to those two, so a lawyer who pays the creditor from the client's money on the strength of a demand letter has taken sides in it. The freeze reaches an outsider's claim only after that claim survives the test.

Exam Analysis Steps

Because the first answer determines whether the second question is ever reached, run the problem as a sequence:

Ask whether the client agreed to pay the third person from the expected funds and has not withdrawn that instruction. If so, distribute as agreed.
If the client never consented or has countermanded, identify exactly what interest the third person claims in these particular funds: a lien, a security interest, an escrow arrangement, or only a debt.
Test that claim against the substantive law of property rights and security interests, including whether it was properly presented.
Follow the client's direction unless the claim proves to be a secured interest in specific funds. In that event, keep the claimed portion separate under paragraph (e) and promptly distribute the rest.

Hypothetical Illustration

At intake in an injury case, a client signs a note telling the lawyer to pay a hospital $7,000 out of any settlement. The case settles for $50,000, the client confirms the instruction, and the lawyer sends $7,000 to the hospital and $43,000 to the client. The client's agreement carried the third person's share, and the lawyer followed it.

In another matter the client gives the same intake instruction. After a billing quarrel with the clinic, though, the client tells the lawyer in writing to send the entire $50,000 to the client. The agreement no longer governs, and the lawyer cannot pay the clinic merely because the clinic asked. The lawyer must find out what the clinic holds: a lien perfected by notice, a judgment, a security interest in the recovery, or only an unpaid bill. The answer, drawn from property and security-interest law, decides whether the clinic's $7,000 stays in trust or goes to the client with the rest.

The intake note, the settlement, and the amount owed are the same in both matters. Only the client's current direction differs. The countermand does not decide the clinic's rights. It removes the agreement that made evaluation unnecessary and sends the lawyer to the second step. The next two subsections give the two possible results: a secured claim binds the lawyer, and a bare creditor's demand does not.

An exam stem in which a third person demands payment from a client's funds while the client insists on receiving them tests the order of the analysis. The tempting errors are to assume that any demand letter freezes the money and to assume that the client's insistence settles everything. Both skip the property-law step that decides whether a genuine competing interest exists.

Perfected Liens and Escrow Terms

Rule 1.15(e) commands that disputed property “shall be kept separate by the lawyer until the dispute is resolved.”¹⁰ The preceding subsection showed how a lawyer tests an outsider's claim against the client's directions and the law of property and security interests. This subsection takes up the result in which the claim survives that test. Comment 4 to Rule 1.15 gives the illustration of a client's creditor who has obtained a lien on funds recovered in a personal injury action: where “the third-party claim is not frivolous under applicable law, the lawyer must refuse to surrender the property to the client until the claims are resolved.”¹¹

A perfected interest outranks the client's demand because of what perfection accomplishes. A perfected security interest or lien is a legally enforceable property interest in particular funds, and it limited the client's own right to those funds before the lawyer received any money. A client who demands the full sum is therefore asking the lawyer to deliver something the client does not wholly own, and a lawyer who complies releases the claimed portion in disregard of an obstacle the law has imposed.¹² The exposure runs deeper than a missed procedural step, because ignoring a perfected interest can amount to a fraud on creditors or on the court that rendered the judgment.¹³ The hold does not reach everything the lawyer has. It covers the claimed portion, and the second command of paragraph (e) still sends every undisputed portion promptly to its owner.¹⁴

State law commonly gives liens of this kind to payers who funded something the recovery now compensates. An employer or insurer that paid workers' compensation benefits to an injured employee, a hospital that furnished medical care, and a state agency that paid for care under a medical assistance program may each obtain a lien against the injured person's recovery from third parties.¹⁵ The payer supplied the care or benefits that the recovery in part pays for, and the lien lets the payer be repaid from that fund so the client does not keep both the benefits and a recovery covering the same losses. When such a lien is perfected by proper notice, the lawyer must retain the claimed funds and distribute them to neither the client nor the lienholder until any underlying dispute is resolved.¹⁶ A state agency that paid for a client's medical care and holds a perfected lien on the injury recovery shows the rule at work. The claim is not frivolous, so the lawyer holds the lienable portion and does not give it to the client.¹⁷ If the underlying dispute ends in the lienholder's favor, the lawyer must honor that ripened property interest.¹⁸

A letter may arrive from someone who calls itself a lienholder. The duty to refuse the client depends on the claim being not frivolous under applicable law, so a claim that is frivolous under that law does not trigger it.¹⁹ The threshold is modest. A claim need not be certain to prevail, because the hold exists precisely while the outcome is unresolved, but it must have some footing in the law that governs the lien. Without that limit, anyone able to write a letter could freeze a client's recovery. Frivolousness is judged under the applicable law, which sends the lawyer back to the property-law inquiry described in the preceding subsection.

A second source of binding obligation needs no lien. If the lawyer is party to an advance agreement about how funds are to be distributed, and the client has consented, the lawyer serves as an escrow agent and must fulfill the agreement's terms.²⁰ The lawyer has made an undertaking, with the client's authorization, on which another person is entitled to rely, and a client's later demand cannot cancel a commitment the client approved the lawyer in making. This differs from a client's bare promise to pay a third person out of expected funds. That promise creates no security interest and does not by itself stop the lawyer from following a later directive from the client.²¹ What distinguishes the escrow case is that the lawyer is a party to the arrangement, in a role the client consented to.

An exam stem on this subject usually pairs a client who insists the money is the client's own with a third person who has served notice of a claim. The instinct to follow the client, because the client retained the lawyer, fails once the lien is perfected and not frivolous. The opposite instinct, to pay the lienholder at once, fails as well, because the claimed funds stay in trust until the underlying dispute is resolved. The same stem may describe an advance escrow agreement that the client approved, and the lawyer's duty then comes from the agreement's terms.

General Creditors Without Claims

Paragraph (e) of Rule 1.15 applies when a lawyer holds property in which two or more persons “claim interests,” and its two commands attach only once such a competing claim exists.²⁴ The preceding subsection described the outsider whose claim does bind the lawyer: a lienholder with a perfected, non-frivolous interest in the funds. At the opposite pole stands the third person who merely wants to be paid. That person may be owed a genuine debt by the client, yet the debt gives no claim of interest in the particular funds in the lawyer's trust account unless something more attaches to those funds.²⁵ The line runs between a claim against the client, which the creditor pursues against the client, and a claim to the funds, which alone makes the lawyer a custodian of contested property.

The facts of Gianetti v. Gerardi show the first kind of outsider. A child had been bitten by a dog, and the dog owner's insurance carrier paid funds to settle the personal injury lawsuit. The doctor who had treated the child then looked to the proceeds for payment.²⁶ A Connecticut court held that the child's lawyer had no duty to distribute any portion of the funds to the doctor.²⁷ No judgment concerned the disposition of the funds, no perfected lien (a lien made enforceable against others by completing the steps the law requires, such as proper notice) had been placed against them, and the parties had not agreed that the doctor would be paid from them. The lawyer therefore acted properly in delivering the insurance proceeds to the client.²⁸ The doctor's bill was a cognizable obligation of the client, yet the case stands for a general principle: a third person's wish to be paid, even on such an obligation, does not necessarily amount to a plausible claim of an actual interest in those particular funds.²⁹

An unsecured debt gives the creditor a remedy against a person and no right to any particular dollar. A general creditor, one whose only entitlement is the client's promise to pay, has no claim of right to possession of any specific funds.³⁰ A lien or security interest changes that by tying the creditor's right to identified property, which is why the law of secured transactions supplies the test when a third person says a debt should be satisfied from the specific funds the lawyer holds.³¹ If a demand letter alone could freeze a client's money, every creditor who wrote one would gain priority over the client's other creditors, and over the client's own use of the money, without taking any of the steps the law requires to secure a claim. The lawyer would also be drawn into deciding contract disputes between the client and strangers to the representation, a job the rule leaves to the claimants and to tribunals. Requiring a genuine property interest keeps the lawyer from setting aside the client's instructions without a legal reason.

A client's promise to pay from money not yet received does not close that gap. Even when the client has agreed to transfer an anticipated payment to a third person, that promise alone creates no security interest in the funds, and the lawyer remains free to follow a later directive from the client to distribute them differently.³² A promise to pay out of a particular source commits the client to a performance without conveying any right in the source itself. Failing to apply the funds as promised may be a breach of contract, but the client's taking of funds that are not subject to a lien or other property interest is not a conversion.³³ That is why the lawyer is safe in following the client. The creditor owned nothing in these funds, so the creditor's remedy is a contract action against the client. The debt itself may be entirely genuine, and the creditor keeps every remedy against the client.

A creditor becomes a claimant by acquiring an interest in the funds. The steps that do so are the ones missing in Gianetti: a judgment concerning disposition of the funds, a perfected lien, or an agreement on payment from them.³⁴

The debt, the settlement, and the client's demand look alike in the two settings, and the lien alone changes the doctor's standing and, with it, the lawyer's duty. In the dog-bite case as decided, the lawyer owes the doctor nothing and the whole recovery goes to the client. With the lien in place, the same lawyer must hold the lienable slice. The next subsection takes up the situation in which the funds plainly belong to a third person from the start.

An exam stem on this topic will describe a client who owes a doctor, landlord, or lender, a settlement or sale that has put money in the lawyer's trust account, and a creditor's letter demanding payment from that money. The question underneath is whether the creditor holds an interest in these particular funds or only a claim against the client. Look for a judgment concerning the funds, a perfected lien or security interest, or an agreement on payment from them. A stem that offers only a demand letter, an acknowledged debt, or the client's earlier promise to pay “out of the settlement” supplies none of these, and the lawyer follows the client's directions. The tempting error is to treat the creditor's letter as a dispute that freezes the client's money, which would make every unsecured creditor a lienholder by correspondence.

Vested Claims and Joint Checks

Rule 1.15(e) freezes property only when “two or more persons (one of whom may be the lawyer) claim interests” in it, so the duty to keep property separate presupposes a genuine dispute.³⁶ Where none exists, the ordinary delivery duty of Rule 1.15(d) governs, and the lawyer must promptly deliver to the client or third person any funds or other property that person is entitled to receive.³⁷ The preceding subsections placed two kinds of outsider on either side of the freeze: the holder of a perfected, non-frivolous lien, whose claim makes the lawyer hold the claimed funds, and the general creditor, whose claim does not. A third kind of outsider has an interest that is already complete. The property is that person's own, ownership is not in contest, and the lawyer has nothing to hold while claimants sort it out.

Property that plainly belongs to a third person as a matter of vested property rights must go to that person whatever the client now prefers, because a lawyer may not assist a client in converting the property of others.³⁸ Three situations show how such a right comes into being. A formal transfer of title in a real estate or personal property transaction vests ownership in the transferee.³⁹ A lien placed on funds the lawyer holds ripens into a vested interest when the underlying dispute is resolved in the lienholder's favor, and the lawyer must then honor it.⁴⁰ And property that a client presents to the lawyer after taking it from another belongs to the victim and must be returned to its rightful owner.⁴¹ The lien example ties this subsection to the last one. While the lien's validity was contested, the lawyer held the claimed funds. Once the contest ends in the lienholder's favor, the rule's own phrase “until the dispute is resolved” ends the freeze and leaves only the delivery duty.⁴²

The client's wishes lose their force here because of why they carry force at all. A client directs property because the client owns it. That explains the general-creditor result: the creditor owned nothing in the funds, so the lawyer in Gianetti rightly delivered the insurance proceeds to the client and not to the doctor.⁴³ The vested owner is the mirror image. The client owns nothing in the property, so the client's preference has no legal weight, and obeying it would make the lawyer a participant in the conversion. A freeze would accomplish nothing either, because a freeze protects a contested ownership and ownership here is uncontested. Holding the property would only keep a person from receiving what is theirs.

The buyer and the repair shop each stand behind an obligation the client acknowledges. Only the buyer owns the thing the lawyer holds, and that single fact decides who controls where it goes.

A check made out jointly to the client and a third person presents a more everyday case of shared ownership. The lawyer may negotiate it by depositing it into the trust account only with the legitimate endorsement of both payees.⁴⁴ The joint payee line confirms that both persons have common property interests in the funds, so neither can be bypassed by the other.⁴⁵ A lawyer who deposited the check on the client's signature alone would be dealing with the third person's property interest on a single payee's say-so. Once both have endorsed, the lawyer responds to their compatible directions in distributing the money.⁴⁶ If the two agree on how it divides, no dispute exists, and the lawyer distributes accordingly without any freeze at all.

The hold in that scene is exactly as wide as the quarrel, which is what the second sentence of paragraph (e) requires: “The lawyer shall promptly distribute all portions of the property as to which the interests are not in dispute.”⁴⁷ The same transaction would have produced no hold if the payees had agreed on the whole division, and no deposit at all if only one of them had endorsed. Three outcomes therefore sit side by side: the vested owner is paid regardless of the client, joint payees are paid as they jointly direct, and only a real disagreement between them leaves a contested slice in trust.⁴⁸

An exam stem in which a client demands property while a third person stands nearby tests whether you ask who owns the property before asking who is asking for it. Two instincts mislead. Obeying the client because the client retained the lawyer fails when the property already belongs to someone else. Freezing everything because a third person is involved fails when that person's interest is either plainly vested, so that delivery is owed, or shared jointly and agreed on, so that nothing is contested. Look for the word jointly on a check, for a completed title transfer, and for a lien whose underlying dispute has ended, because each of those facts removes the dispute that paragraph (e) exists to protect.