Trust Accounts and Bank Failures: What You Need to Know

Recent bank failures have caused concerns for lawyers holding client funds in their trust accounts. Many of our insureds have contacted Lawyers Mutual to ask questions about their ethical and malpractice exposure and any steps that they can take to protect themselves and their clients. 

1. What are your ethical duties as a lawyer in selecting a depository institution for your trust account?

If you are holding client funds in your trust account with a depository institution, you need to be familiar with Rule 1.15 of the Rules of Professional Conduct. You should also have a copy of the North Carolina State Bar’s Trust Account Handbook. Section XII: FDIC Insurance of the Trust Account Handbook provides as follows:

What is a lawyer’s professional responsibility when choosing the depository bank for a trust account?

A lawyer is acting as a fiduciary when holding client funds in his or her trust account. This means that the lawyer must be prudent when making financial decisions relative to those funds, including the decision as to the depository bank for the lawyer’s trust account. However, in the absence of information tending to suggest the imminent failure of a bank, a lawyer is presumed to be acting ethically if the lawyer establishes his or her trust account at a financial institution insured by the Federal Deposit Insurance Corporation (FDIC). In other words, if the government has made the determination that the institution is insurable, the lawyer may rely upon the government’s assessment.   

2. Do you have any malpractice exposure if the depository bank for your trust account fails?

There are no reported decisions from any state where a lawyer has been held liable to a client for failure to safeguard client funds against uninsured losses arising from a bank failure. There is only one reported case that considered the issue. In Bazinet v. Kluge, 14 A.D.3d 324, 788 N.Y.S.2d 77 (2003), a lawyer was sued after his trust account depository bank failed and the plaintiff/client lost a substantial sum of money. In reversing the trial court’s refusal to grant the lawyer’s motion to dismiss, the court noted that “there are no allegations that [the lawyer] knew that [the bank] was in danger of closing.” 

It seems highly unlikely that a court would impose liability on a lawyer who has selected a depository bank that the government has determined to be insurable by the FDIC. This does not mean that a lawyer should ignore warning signs. If a lawyer becomes aware of information that would suggest that the depository institution might fail, that lawyer should take steps to protect the client funds. That might include transferring the funds to a different bank. 

If a lawyer/law firm wants to add an extra layer of protection, they can contact their trust account bank(s) and ask them periodically for a copy of their rating with one of the major financial institution rating agencies (Standard & Poor’s, A.M. Best, Moody’s, and Fitch). If the lawyer has any concerns about the rating, it might be a good idea to discuss this with any client who has more than $250,000 deposited in the trust account.

3. How much of my clients’ funds are protected by FDIC insurance?

If a lawyer maintains an IOLTA, attorney trust, or fiduciary account that indicates in its description and the bank’s deposit account records that it is such an account AND the lawyer keeps records that identify the name and ownership interest of each client whose funds are maintained in the account, then each individual client’s funds are insured up to the $250,000 FDIC limit. Note here that, to get the full $250,000 FDIC protection for each client, the identities and interests of each client must be ascertainable from deposit account records of the bank or records maintained in good faith and in the regular course of business by the lawyer/law firm.

So, if you had 10 clients each with $250,000 deposited in your trust account with properly kept records and the bank failed, each of those clients would be protected by the FDIC. There is one exception or catch to this rule, though. If a client has their own funds on deposit with the institution that fails, those funds would count against the $250,000. If one of the 10 clients in the previous example also had $50,000 on deposit with the bank, they would be uninsured for $50,000 of their total deposits.

Lawyers have asked whether they should hold a client’s funds in multiple financial institutions when the deposited trust funds for that client exceed $250,000. For example, if a lawyer is holding $500,000 in trust for a client, could the lawyer deposit the funds in Bank A and Bank B to get the full protection?  By making a deposit of $250,000 in Bank A and $250,000 in Bank B, the client’s funds would be fully insured by the FDIC. However, as a practical matter, this may not be a feasible solution. A better practice seems to be for a firm to exercise due diligence in selecting a trust account depository institution and then monitoring the financial health of that institution.