As part of the handling of trust accounts, lawyers are required to properly manage client funds, including making payments on their behalf and returning money as needed. But what happens when a client can’t be found or a transaction never clears? Dealing with these situations correctly is essential for ethical and compliant trust account management. Not dealing with these challenges as they arise, leads not only to compliance issues but bookkeeping headaches and financial implications for the law firm as well.
HOW IT HAPPENS
As part of trust accounting, regular reconciliations should be performed. In addition to a two-way reconciliation of the bank statement and general ledger, a three-way reconciliation should also be performed. This type of reconciliation compares the sum of the individual client trust ledgers, the book balance and the bank statement to make sure they are all equal.
These reconciliation reports make it easy to see what transactions have cleared and what hasn’t. While it’s typical for there to be some uncleared items at the end of every month, they shouldn’t carry over month after month. If they do, then lawyers have a duty to look into these uncleared funds.
There are also instances where law firms need to return trust account funds to their clients. Often a lawyer is retiring from their practice and wants to close any outstanding accounts, or perhaps a matter has remained untouched for a significant period of time. In this process, firms often run into the issue of being unable to locate their client, making it impossible to return the funds if their whereabouts are unknown.
WHAT TO DO
It is the responsibility of the law firm to promptly address ongoing uncleared funds. Once an uncleared transaction is noted on more than one reconciliation report it should be investigated and addressed as necessary. The individual who received the funds should be contacted to determine the reason why they haven’t been deposited.
There are many possible reasons as to why a transaction hasn’t been completed. The check may have been lost in the mail and never received or the individual is simply holding onto the check. Whatever the reason, a firm should make all attempts necessary to fix the problem. For example, if the issue is a missing check then the firm should contact the bank to cancel the original check and reissue the check to the recipient.
When seeking to return unclaimed funds to their proper and rightful owner, law firms should be able to prove that they have performed adequate due diligence in attempting to contact their client or locate a new address for them if necessary. Once all reasonable efforts to locate the client have been exhausted, lawyers can move to treat the funds as unclaimed. However, these funds cannot be simply claimed as income or donated directly to a charity.
If funds remain unclaimed and the law firm has tried and failed to contact their client, the firm must follow their state bar association’s or respective Law Society’s guidelines for where the funds should be sent. In the U.S., each state has different laws as to the length of time the funds must be held by the firm before they can be deemed unclaimed and then disbursed. Canadian Law Societies’ timelines also vary, so it’s important to check the rules and regulations for your particular Law Society or bar association to determine the proper steps.
Often times the funds will wind up being deposited into an association or Law Society account to be used in a charitable capacity. Some associations will attempt to locate the client themselves prior to utilizing the funds, while others deposit the funds directly into the charitable account. Regardless, lawyers should be prepared to show documentation of the steps taken in the attempt to locate the client.
ENSURE PROPER HANDLING
Both unclaimed and uncleared funds require law firms to take certain steps in order to adhere to best practices and maintain compliance. Lawyers should take note of the requirements and be prepared to implement them if transactions continue to show up uncleared on reconciliation reports or if clients are unable to be found. Having a protocol set in advance will make it easier for the entire firm to know how to handle these situations correctly and avoid the compliance and financial implications that could occur if ignored.
Want to learn more about other trust accounting challenges and how to address them? Check out Beyond the Basics: Advanced Trust Accounting Challenges for Law Firms.