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Brown v. Legal Foundation of Washington

March 26, 2003

ALLEN D. BROWN AND GREG HAYES, PETITIONERS
v.
LEGAL FOUNDATION OF WASHINGTON ET AL.



On Writ Of Certiorari To The United States Court Of Appeals For The Ninth Circuit Court Below: 271 F. 3d 835

SYLLABUS BY THE COURT

Every State uses interest on lawyers' trust accounts (IOLTA) to pay for legal services for the needy. In promulgating Rules establishing Washington's program, the State Supreme Court required that: (a) all client funds be deposited in interest-bearing trust accounts, (b) funds that cannot earn net interest for the client be deposited in an IOLTA account, (c) lawyers direct banks to pay the net interest on the IOLTA accounts to the Legal Foundation of Washington (Foundation), and (d) the Foundation use all such funds for tax-exempt law-related charitable and educational purposes. It seems apparent from the court's explanation of its IOLTA Rules that a lawyer who mistakenly uses an IOLTA account for money that could earn interest for the client would violate the Rule. That court subsequently made its IOLTA Rules applicable to Limited Practice Officers (LPOs), non-lawyers who are licensed to act as escrowees in real estate closings. Petitioners, who have funds that are deposited by LPOs in IOLTA accounts, and others sought to enjoin respondent state official from continuing this requirement, alleging, among other things, that the taking of the interest earned on their funds in IOLTA accounts violates the Just Compensation Clause of the Fifth Amendment, and that the requirement that client funds be placed in such accounts is an illegal taking of the beneficial use of those funds. The record suggests that petitioners' funds generated some interest that was paid to the Foundation, but that without IOLTA they would have produced no net interest for either petitioner. The District Court granted respondents summary judgment, concluding, as a factual matter, that petitioners could not make any net returns on the interest accrued in the accounts and, if they could, the funds would not be subject to the IOLTA program; and that, as a legal matter, the constitutional issue focused on what an owner has lost, not what the taker has gained, and that petitioners had lost nothing. While the case was on appeal, this Court decided in Phillips v. Washington Legal Foundation, The opinion of the court was delivered by: Justice Stevens

Argued December 9, 2002

The State of Washington, like every other State in the Union, uses interest on lawyers' trust accounts (IOLTA) to pay for legal services provided to the needy. Some IOLTA programs were created by statute, but in Washington, as in most other States, the IOLTA program was established by the State Supreme Court pursuant to its authority to regulate the practice of law. In Phillips v. Washington Legal Foundation, 524 U. S. 156 (1998), a case involving the Texas IOLTA program, we held "that the interest income generated by funds held in IOLTA accounts is the `private property' of the owner of the principal." Id., at 172. We did not, however, express any opinion on the question whether the income had been "taken" by the State or "as to the amount of `just compensation,' if any, due respondents." Ibid. We now confront those questions.

I.

As we explained in Phillips, id., at 160-161, in the course of their legal practice, attorneys are frequently required to hold clients' funds for various lengths of time. It has long been recognized that they have a professional and fiduciary obligation to avoid commingling their clients' money with their own, but it is not unethical to pool several clients' funds in a single trust account. Before 1980 client funds were typically held in non-interest-bearing federally insured checking accounts. Because federal banking regulations in effect since the Great Depression prohibited banks from paying interest on checking accounts, the value of the use of the clients' money in such accounts inured to the banking institutions.

In 1980, Congress authorized federally insured banks to pay interest on a limited category of demand deposits referred to as "NOW accounts." See 87 Stat. 342, 12 U. S. C. §1832. This category includes deposits made by individuals and charitable organizations, but does not include those made by for-profit corporations or partnerships unless the deposits are made pursuant to a program under which charitable organizations have "the exclusive right to the interest."*fn1

In response to the change in federal law, Florida adopted the first IOLTA program in 1981 authorizing the use of NOW accounts for the deposit of client funds, and providing that all of the interest on such accounts be used for charitable purposes. Every State in the Nation and the District of Columbia have followed Florida's lead and adopted an IOLTA program, either through their legislatures or their highest courts.*fn2 The result is that, whereas before 1980 the banks retained the value of the use of the money deposited in non-interest-bearing client trust accounts, today, because of the adoption of IOLTA programs, that value is transferred to charitable entities providing legal services for the poor. The aggregate value of those contributions in 2001 apparently exceeded $200 million.*fn3

In 1984, the Washington Supreme Court established its IOLTA program by amending its Rules of Professional Conduct. IOLTA Adoption Order, 102 Wash. 2d 1101. The amendments were adopted after over two years of deliberation, during which the court received hundreds of public comments and heard oral argument from the Seattle-King County Bar Association, designated to represent the proponents of the Rule, and the Walla Walla County Bar Association, designated to represent the opponents of the Rule.

In its opinion explaining the order, the court noted that earlier Rules had required attorneys to hold client trust funds "in accounts separate from their own funds," id., at 1102, and had prohibited the use of such funds for the lawyer's own pecuniary advantage, but did not address the question whether or how such funds should be invested. Commenting on then-prevalent practice the court observed:

"In conformity with trust law, however, lawyers usually invest client trust funds in separate interest-bearing accounts and pay the interest to the clients whenever the trust funds are large enough in amount or to be held for a long enough period of time to make such investments economically feasible, that is, when the amount of interest earned exceeds the bank charges and costs of setting up the account. However, when trust funds are so nominal in amount or to be held for so short a period that the amount of interest that could be earned would not justify the cost of creating separate accounts, most attorneys simply deposit the funds in a single noninterest-bearing trust checking account containing all such trust funds from all their clients. The funds in such accounts earn no interest for either the client or the attorney. The banks, in contrast, have received the interest-free use of client money." Ibid.

The court then described the four essential features of its IOLTA program: (a) the requirement that all client funds be deposited in interest-bearing trust accounts, (b) the requirement that funds that cannot earn net interest for the client be deposited in an IOLTA account, (c) the requirement that the lawyers direct the banks to pay the net interest on the IOLTA accounts to the Legal Foundation of Washington (Foundation), and (d) the requirement that the Foundation must use all funds received from IOLTA accounts for tax-exempt law-related charitable and educational purposes. It explained:

"1. All client funds paid to any Washington lawyer or law firm must be deposited in identifiable interest-bearing trust accounts separate from any accounts containing non-trust money of the lawyer or law firm. The program is mandatory for all Washington lawyers. New CPR DR 9-102(A).

"2. The new rule provides for two kinds of interest-bearing trust accounts. The first type of account bears interest to be paid, net of any transaction costs, to the client. This type of account may be in the form of either separate accounts for each client or a single pooled account with subaccounting to determine how much interest is earned for each client. The second type of account is a pooled interest-bearing account with the interest to be paid directly by the financial institution to the Legal Foundation of Washington (hereinafter the Foundation), a nonprofit entity to be established pursuant to the order following this opinion. New CPR DR 9-102(C)(1), (2).

"3. Determining whether client funds should be deposited in accounts bearing interest for the benefit of the client or the Foundation is left to the discretion of each lawyer, but the new rule specifies that the lawyer shall base his decision solely on whether the funds could be invested to provide a positive net return to the client. This determination is made by considering several enumerated factors: the amount of interest the funds would earn during the period they are expected to be deposited, the cost of establishing and administering the account, and the capability of financial institutions to calculate and pay interest to individual clients. New CPR DR 9-102(C)(3).

"5. Lawyers and law firms must direct the depository institution to pay interest or dividends, net of any service charges or fees, to the Foundation, and to send certain regular reports to the Foundation and the lawyer or law firm depositing the funds. New CPR DR 9-102(C)(4).

"The Foundation must use all funds received from lawyers' trust accounts for tax-exempt law-related charitable and educational purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, as directed by this court. See Articles of Incorporation and Bylaws of the Legal Foundation of Washington, 100 Wash. 2d, Advance Sheet 13, at ii, vi (1984)." Id., at 1102-1104.

In its opinion the court responded to three objections that are relevant to our inquiry in this case. First, it rejected the contention that the new program "constitutes an unconstitutional taking of property without due process or just compensation." Id., at 1104. Like other State Supreme Courts that had considered the question, it distinguished our decision in Webb's Fabulous Pharmacies, Inc. v. Beckwith, 449 U. S. 155 (1980), on the ground that the new " `program creates income where there had been none before, and the income thus created would never benefit the client under any set of circumstances.' " 102 Wash. 2d, at 1108 (quoting In re Interest on Trust Accounts, 402 So. 2d 389, 395 (Fla. 1981)).

Second, it rejected the argument that it was unethical for lawyers to rely on any factor other than the client's best interests when deciding whether to deposit funds in an IOLTA account rather than an account that would generate interest for the client. The court endorsed, and added emphasis, to the response to that argument set forth in the proponents' reply brief:

" `Although the proposed amendments list several factors an attorney should consider in deciding how to invest his clients' trust funds, ... all of these factors are really facets of a single question: Can the client's money be invested so that it will produce a net benefit for the client? If so, the attorney must invest it to earn interest for the client. Only if the money cannot earn net interest for the client is the money to go into an IOLTA account.'

"Reply Brief of Proponents, at 14. This is a correct statement of an attorney's duty under trust law, as well as a proper interpretation of the proposed rule as published for public comment. However, in order to make it even clearer that IOLTA funds are only those funds that cannot, under any circumstances, earn net interest (after deducting transaction and administrative costs and bank fees) for the client, we have amended the proposed rule accordingly. See new CPR DR 9-102(C)(3). The new rule makes it absolutely clear that the enumerated factors are merely facets of the ultimate question of whether client funds could be invested profitably for the benefit of clients. If they can, then investment for the client is mandatory." 102 Wash. 2d, at 1113-1114.

The court also rejected the argument that it had failed to consider the significance of advances in computer technology that, in time, may convert IOLTA participation into an unconstitutional taking of property that could have been distributed to the client. It pointed to the fact that the Rule expressly requires attorneys to give consideration to the capability of financial institutions to calculate and pay interest on individual accounts, and added: "Thus, as cost effective subaccounting services become available, making it possible to earn net interest for clients on increasingly smaller amounts held for increasingly shorter periods of time, more trust money will have to be invested for the clients' benefit under the new rule. The rule is therefore self-adjusting and is adequately designed to accommodate changes in banking technology without running afoul of the state or federal constitutions." Id., at 1114.

Given the court's explanation of its Rule, it seems apparent that a lawyer who mistakenly uses an IOLTA account as a depositary for money that could earn interest for the client would violate the Rule. Hence, the lawyer will be liable to the client for any lost interest, however minuscule the amount might be.

In 1995, the Washington Supreme Court amended its IOLTA Rules to make them applicable to Limited Practice Officers (LPOs) as well as lawyers. LPOs are non-lawyers who are licensed to act as escrowees in the closing of real estate transactions. Like lawyers, LPOs often temporarily control the funds of clients.

II.

This action was commenced by a public interest law firm and four citizens to enjoin state officials from continuing to require LPOs to deposit trust funds into IOLTA accounts. Because the Court of Appeals held that the firm and two of the individuals do not have standing,*fn4 Washington Legal Foundation v. Legal Foundation of Washington, 271 F. 3d 835, 848-850 (CA9 2001), and since that holding was not challenged in this Court, we limit our discussion to the claims asserted by petitioners Allen Brown and Greg Hayes. The defendants, respondents in this Court, are the justices of ...


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