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Untrustworthy Trust Accounts

Most Americans have never heard the acronym “IOLTA,” but if you’ve ever been involved in a real estate closing or had an attorney hold your funds in escrow, than you’ve probably been affected by IOLTA. What does that mean? It means the government is taking money from you without your knowledge or consent. And your lawyer–the person who is supposed to represent your interests–is ethically required to help the government steal your money.

IOLTA stands for “interest on lawyer trust accounts.” Attorneys often manage their client’s funds for short periods of time. Traditionally, these funds were held by a bank in a non-interest bearing checking account. But starting in the late 1970s, state bars got the idea to compel lawyers to put their client’s funds in an IOLTA account, an interest-bearing account which would could pool several small client deposits together. Alone, the individual client’s funds would not earn much interest, but combined with other clients, there could be substantial interest generated.

On its own, this sounds like a pretty good idea: make a little extra money for the client through creative accounting. But the state bars had something else in mind when they implemented IOLTA plans. As it turns out, the interest earned on IOLTA accounts would not go to the clients, but to a nonprofit corporation controlled by the state bar. This corporation, in turn, would dispense the funds to a favored cause of the bar: legal services for the poor and “disadvantaged.” Thus, thousands of clients throughout the country, without their notice or consent, have been financing a legal services slush fund for more than two decades.

The Washington Legal Foundation, a conservative public interest firm, has been at the forefront of challenging the legality of IOLTA schemes throughout the country. This past week, WLF suffered a setback when the U.S. Supreme Court upheld Washington state’s IOLTA scheme. WLF brought suit against the Washington Supreme Court and the Legal Foundation of Washington, the nonprofit IOLTA corporation setup by that court. WLF argued the IOLTA scheme amounted to a taking of private property for state use, and that under the Fifth Amendment, the state must compensate the clients whose interest was appropriated.

By a 5-4 margin, the Supreme Court held that while IOLTA interest was the property of individual clients, they were entitled to no compensation under the Fifth Amendment. The Court, led by Justice John Paul Stevens, said that assuming the IOLTA plan amounted to a “taking” of private property for public use, in the absence of the IOLTA scheme, there would be no interest to claim in the first place. In other words, since the state forced lawyers to put their clients’ funds into IOLTA accounts, the state’s taking of the resulting interest did not create a “net loss” for the clients, thus there was nothing to compensate them for.

If this sounds like judicial trickery, it is. In dissent, Justice Antonin Scalia opined:

The Court today concludes that the State of Washington may seize private property, without paying compensation, on the ground that the former owners suffered no “net loss” because their confiscated property was created by the beneficence of a state regulatory program. In so holding the Court creates a novel exception to our oft-repeated rule that the just compensation owed to former owners of confiscated property is the fair market value of the property taken. What is more, the Court embraces a line of reasoning that we explicitly rejected in Phillips v. Washington Legal Foundation, 524 U.S. 156 (1998). Our precedents compel the conclusion that petitioners are entitled to the fair market value of the interest generated by their funds held in interest on lawyers’ trust accounts (IOLTA).

What’s interesting about this case is the extent to which the Court’s majority extols the inherent virtue of the IOLTA program’s objective–financing legal services to the poor. In a footnote to the Court’s opinion, Justice Stevens cites the following accolades from the Ninth Circuit’s earlier review of WLF’s case:

As the dissenters in the Ninth Circuit observed in their original panel opinion: “IOLTA programs spread rapidly because they were an exceedingly intelligent idea. Money that lawyers deposited in bank trust accounts always produced earnings, but before IOLTA, the clients who owned the money did not receive any of the earnings that their money produced. IOLTA extracted the earnings from the banks and gave it to charities, largely to fund legal services for the poor. That is a very worthy purpose.” 236 F.3d 1097, 1115 (2001). In his dissent from the en banc opinion, Judge Kozinski wrote: “It is no doubt true that the IOLTA program serves a salutary purpose, one worthy of our support. As a citizen and former member of the bar, I applaud the state’s effort to provide legal services for the poor and disadvantaged.” 271 F.3d 835, 867 (CA9 2001).

Justice Scalia retorts that a good intention does not make good constitutional law:

Perhaps we are witnessing today the emergence of a whole new concept in Compensation Clause jurisprudence: the Robin Hood Taking, in which the government’s extraction of wealth from those who own it is so cleverly achieved, and the object of the government’s larcenous beneficence is so highly favored by the courts (taking from the rich to give to indigent defendants) that the normal rules of the Constitution protecting private property are suspended. One must hope that that is the case. For to extend to the entire run of Compensation Clause cases the rationale supporting today’s judgment–what the government hath given, the government may freely take away–would be disastrous.

Clearly, the Court’s decision was motivated by pragmatic concerns over the fate of IOLTA schemes. After all, if the state had to compensate owners for taking their interest–as the Constitution requires–than the IOLTA program itself would be rendered unable to function. Since the Court’s majority was unwilling to face the unpleasant prospect of finding a voluntary, non-coercive means of financing legal services to the poor, they simply invented a loophole to the Fifth Amendment, and hoped no one would notice or care.

Still, the underlying ethical value of IOLTA itself went unchallenged even by Justice Scalia. And this is a question of ethics, given the Washington program (and all other state IOLTA programs) incorporates the scheme utilizing the state bar’s rules of professional practice. This means lawyers must ethically support IOLTA as a condition of being permitted to practice law. Indeed, a side issue in the Washington case was the fact non-lawyers who performed real estate closings were compelled to use IOLTA accounts when the state supreme court decided to expand their definition of “practice of law” to include said real estate closings. In this sense, IOLTA has proven to be a useful weapon in expanding the lawyer monopoly.

It’s hard to see how any state bar can ethically require a lawyer to steal his or her clients funds, no matter how small the amount. Furthermore, financing legal services for the poor is not a compelling state interest. It’s a worthy charitable cause, but it’s one that should be financed by those volunteering to pay for it. Certainly the lawyers who supervise the theft of their clients’ funds could pay for indigent legal services out of their own pockets. Or, if the courts feel strongly about this issue, they could ask litigants to donate a portion of their own judgments to a special fund, much as jurors can donate their stipends to the court to defer administrative expenses. There is simply no need for underhanded schemes like IOLTA.

Despite the Supreme Court’s decision to ignore the facts and the law, individual attorneys have an ethical obligation to speak out and oppose IOLTA. This is certainly not a matter which calls for street protests or civil disobedience, but nor is this an issue which should be confined to appellate courtrooms and the offices of the Washington Legal Foundation. For too long, the lawyer monopoly has sought new ways to enrich themselves–and their power–at the expense of the American people. The time has come to resist the entrenched interests of the state bars, and repealing the IOLTA schemes would be a good place to start.