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Bank Failure Exposes Lawyer to Liability for Trust Fund Loss

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A New York lawyer representing the seller deposited a total of $2,730,000 earnest money for the purchase of condominiums in his IOLTA trust account. The sale proved difficult and took longer than anticipated. As a result the funds were still on deposit when the bank was placed into receivership. After being sued by the purchaser, the client cross-claimed against the lawyer for improperly depositing the money in a non-interest bearing account and negligently exposing the funds to bank failure – a fiduciary breach and malpractice. The lawyer moved for dismissal primarily on the basis that he was only an escrow agent.

The court found that the lawyer served as both escrowee and lawyer, noting that the lawyer had deposited the funds in his trust account. The client, therefore, had properly alleged an issue of malpractice by complaining that the lawyer was negligent in depositing the money in a relatively small bank without protection beyond the FDIC insurance of $100,000 per account and was entitled to offer expert testimony on the standard of care for this transaction.

It remains to be seen if a lawyer has a duty to anticipate a bank failure, but the lessons to be learned from this matter are ripe now. Representing a client in a transaction in which the lawyer also provides escrow service exposes a lawyer to greater risk than someone who acts only in a neutral escrow capacity. A nonclient may misunderstand the lawyer’s duty of loyalty to the client and allege a conflict of interest. The lawyer must be sure to comply with SCR 3.130 (1.15(c), Safekeeping Property) when a dispute arises between a client and another person over entitlement to the funds. Finally, the lawyer must apply good business sense when depositing funds in a trust account. The best practice when the amount to be deposited is large and will be held more that few days is to get client instructions on how the funds are to be deposited and with what security. Document the file and never disburse the proceeds of a real estate transaction until the title search is updated, the transaction documents recorded, and all checks providing funds for the transaction deposited to a trust account have cleared.

Sources: Bazinet v. Kluge, 764 N.Y.S.2d 320(2003); Client Funds – Liability For Depositing Funds In A Bank That Failed, Hinshaw & Culbertson Newsletter, The Lawyer’s Lawyer, Jan. 2004, Vol. 9, Issue 1.

 


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