Professor William F. Harvey*

Early in its 1997-98 Term, the U.S. Supreme Court will address an issue that could affect millions of legal consumers and millions of their dollars. This issue is whether the interest earned on clients’ money that their lawyers deposit into a trust account is the property of those clients. The resolution of this seemingly technical issue will have broad implications for the First and Fifth Amendment freedoms of clients and the programs that states use to fund so-called legal services or legal aid organizations. This article discusses these Interest on Lawyers’ Trust Account ("IOLTA") programs, explains why they are, as the U.S. Court of Appeals for the Fifth Circuit termed them, "modern day attempts at alchemy," and urges the Supreme Court to protect client’s rights by upholding the lower court decision.

What is IOLTA? IOLTA is an elaborate scheme conceived by organized bar authorities and mostly created by state Supreme Courts. Forty-nine states and the District of Columbia have some form of an IOLTA program, and in 27 states it is mandatory.

Under these programs, lawyers are compelled or permitted to establish a bank account where they commingle certain nominal funds that they hold, for a short time, in trust for a client. The client’s money produces small amounts of interest, with which the IOLTA money pool begins. Generally, a bank "rakes and takes" the client’s interest, held in the lawyer’s account in the bank, and pours it (usually) into a state-wide money pool.

The money pool is controlled by a state-wide board or panel appointed by the state Supreme Court. The board or panel, subject to very general guidelines, makes distributions from the money pool to groups and individuals engaged in legal aid projects.

An examination of the regular recipients of this IOLTA money reveals that they are largely powerful special interest groups and causes (with impressive national networks) that advance specific, often highly politicized, causes and litigation projects. Many of the special interests are charitable in name only, in I.R.S. designation, and in the passions of their adherents. IOLTA programs annually generate more than $150 million.

One should note that even in those states where IOLTA is not mandatory for the lawyer, every IOLTA program is mandatory for the client. If a client’s lawyer chooses to participate in the IOLTA program, the client has no access to the interest that is accruing on his or her money, and no choice as to how this interest will be utilized. Thus, as an acronym, IOLTA is a misidentification. It should be IOCTA, or Interest on Clients Trust Accounts. It might be called RIPUP, or Retained Interest and Property from Uninformed Persons -- uninformed small clients and lower income persons in particular.

Constitutional Challenges to IOLTA. The Washington Legal Foundation (WLF), on behalf of itself and several of its members that are lawyers, have challenged IOLTA programs in Massachusetts and Texas. The lawsuits argued that the IOLTA programs, because they use interest earned from clients’ money to support legal aid groups and their agendas, violate the First Amendment rights of citizens in those states by forcing them to associate with political causes with which they disagree. For example, in 1992 the overseer of the Texas IOLTA program granted $100,000 to the Texas Appellate Practice and Educational Resource Center to represent death row inmates seeking to overturn their death sentences. Other recipients of Texas IOLTA funds fight to expand the rights of undocumented aliens and support unconstitutional gerrymandering of electoral districts. WLF’s suits also claimed that the programs violate citizens’ Fifth Amendment rights by taking their property without just compensation.

Prior to reaching the constitutional issues in the challenge to Massachusetts’ IOLTA program, the U.S. Court of Appeals for the First Circuit examined whether the client had a property interest in the money earned from their clients’ principal. In Washington Legal Foundation v. Massachusetts Bar Foundation, 993 F.2d 962, 980 (1st Cir. 1993), the appellate court concluded that "[t]he interest generated by funds deposited in IOLTA accounts is not the clients’ money." As support for its conclusion, the First Circuit cited to a U.S. Court of Appeals for the Eleventh Circuit decision that similarly held that IOLTA money is not the clients’ property. Cone v. State Bar of Florida, 819 F.2d 1002 (11th Cir), cert. denied, 484 U.S. 917 (1987).

WLF achieved success, however, in its challenge to the Texas IOLTA program. The U.S. Court of Appeals for the Fifth Circuit held that clients whose money is placed into IOLTA accounts have property rights in the interest generated by the accounts. The Fifth Circuit expressly rejected the previously discussed rulings of the First and Eleventh Circuits.

In response to the arguments of the Texas Supreme Court and the Texas Equal Access to Justice Foundation that the interest from the client’s trust funds was not property, and thus could be designated as belonging to the state, the Fifth Circuit stated:

"It has been suggested that the IOLTA program represents a successful, modern-day attempt at alchemy. [Citing the American Bar Associations’ Civil Justice: Agenda for the 1990s, pp. 56-72 as the principal alchemist’s pot.] While legends abound concerning the ancient, self-professed alchemists who worked tirelessly towards their goal of changing ordinary metal into precious gold, modern society generally scoffs at their attempt to create ‘something from nothing.’ The defendants in this case denounce such skepticism, declaring that they have unlocked the magic that eluded the alchemists. * * * According to the defendants’ theory, the interest proceeds generated by Texas’s IOLTA accounts exist solely because of an anomaly in banking regulations and, until the creation of the IOLTA program, that interest belonged to no one. * * * We, however, view the IOLTA interest proceeds not as the fruit of alchemy, but as the fruit of the client’s principal deposits."

Washington Legal Foundation v. Texas Equal Access to Justice Foundation, 94 F.3d 996, 1000 (5th Cir. 1996).

The Fifth Circuit remanded the case to the federal district court for trial, rather than holding IOLTA unconstitutional. Both parties, no doubt, believed that the Texas program would have been struck in the federal district court because the Fifth Circuit rejected all of the State’s arguments. Thus, the defeated IOLTA defenders decided to ask the U.S. Supreme Court to reverse the Fifth Circuit’s ruling.

The Supreme Court Appeal. On June 27, 1997, the Court granted the Texas IOLTA defenders’ writ of certiorari. The petitioners are the individual Justices of the Texas Supreme Court, the Texas Equal Access to Justice Foundation ("TEAJF"), and the Chairman of the Texas Equal Access to Justice Foundation (collectively, the "State of Texas.") Although it prevailed in the Fifth Circuit, Washington Legal Foundation joined the "State of Texas" in asking the Supreme Court to review the lower court decision.

The Court limited the grant of certiorari to one question: Is interest earned on client trust funds held in IOLTA accounts a property interest of the client, cognizable under the Fifth Amendment in the U.S. Constitution? In the Supreme Court, the petitioners offer this description of all IOLTA programs:

The fundamental precept of these programs is that client funds are not eligible for deposit into an IOLTA account if there is any reasonable expectation that interest can otherwise be earned on these funds for the client. * * * A client whose funds are placed in an IOLTA account has no less money, or earning power, or resources, because the money was placed in an IOLTA account. The client’s balance sheet does not change according to whether IOLTA-eligible funds are placed in an IOLTA account or a non-IOLTA account.

Petition, p. 3.

The petitioners, and other IOLTA proponents in amicus briefs, argue that the client’s nominal interest is a new form of property or "non-property property" to which no person may make a claim. They urge the Court to follow the First and Eleventh Circuits’ reasoning that the interest is not property and thus, no Fifth Amendment rights are implicated. WLF and its clients argue the Fifth Circuit’s view that "the IOLTA interest proceeds [are] not the fruit of alchemy, but [are] the fruit of the client’s principal deposits," Washington Legal Foundation, 94 F.3d at 1000, should be upheld.

The Court should be much more persuaded by WLF’s argument. The money at issue is not "non-property property" that may be seized and pooled in IOLTA accounts. This property right inheres to the owner of the principal regardless of whether for practical banking reasons, the interest earned in trust accounts could never accrue to the clients.

The IOLTA supporters will vigorously argue that "practical banking reasons" continue to prevent earned interest from accruing to the depositor-client, and thus the state has the right to declare this unclaimed money for itself. It is now clear that, if once there were "practical banking reasons" that supplied a patina of justification for the vast IOLTA scheme, there are none today.

A type of bank account known as an "escrow product" account, or a "daily-sweep-the-interest" account (hereafter "sweep or escrow accounts") would allow clients to receive their interest. This is something that one commentator noted is known by "auctioneers, financial consultants, real estate brokers and even mortiticians," but apparently not by lawyers, bar authorities, and Supreme Court Justices. Donais, Craig, Little-Known Accounts Save Lawyers Time, Trouble, Mass. Lawyers Wkly, Sept. 30, 1996. These accounts are available to professionals, such as lawyers, who have commercial (trust) accounts in which they place money that is the property of their clients.

Under this fully automated or computerized sweep-accounting system, banks provide to commercial accounts detailed subaccount statements each month indicating deposits to and disbursements from the client’s subaccount. This accounting system will distribute a Form 1099 directly to the client; the lawyer need never see it. The lawyer’s client receives all interest due, whether it is $2 or $20 during the deposit-accounting period. Moreover, attorneys are not forced to establish their own accounting procedures for client funds within their pooled accounts, which is what they must do under IOLTA.

In essence, "sweep-accounting" for commercial accounts totally removes the asserted practical justification for the IOLTA system and its compelled accounting. It would return to clients the millions of dollars that annually are hidden and taken from them.

Conclusion. Without the "practical banking reasons" as support for their arguments, the Texas IOLTA defenders can only hope that the Supreme Court will overlook that fact and remain wedded to the First and Eleventh Circuits’ rational that a client does not have a right to interest earned from his or her principal. They must also hope that the asserted purposes to which the IOLTA monies are devoted — purportedly benign legal aid to the underserved — will motivate the Justices to overturn the Fifth Circuit and deny WLF and its clients its chance to prove constitutional violations.

The Court will positively serve the law, and the public interest, however, if it upholds the Fifth Circuit. IOLTA’s asserted justification — aiding the poor — makes it easy to overlook state judges’ use of raw power to raise funds to seek solutions. Their doing so expands the judiciary’s ability to define that which is well and good and then finance those good causes (a power that constitutionally belongs to the legislative branch). These judges, and others, may be blind not only to IOLTA’s impact on Separation of Powers, but also to the practical consequences of IOLTA. They ironically hear the cry, "help the poor or those in poverty," while at the same time oversee a program that picks citizens’ accounts clean of those small sums of interest that might indeed buy a loaf of bread, a sack of groceries, a child’s dress or hat, a pair of shoes, or a few school books.

If the IOLTA bureaucracy is successful in the U.S. Supreme Court, then IOLTA is frozen in place not only in Texas, but in nearly every state in America. The legal principle developed — that clients who own the principal of money held in trust do not own the interest earned — will freeze lawyers and clients in the past, regardless of the development of a computer system that returns small interest payments to their rightful owners. And judges and bar authorities’ power to do "good," even if it violates constitutional liberties and deprives citizens of money they could use, would be firmly solidified.

*Professor William F. Harvey, after teaching law for 35 years, six of which he acted as the Dean of the Law School at the University of Indiana, retired from the active faculty effective January 1, 1997. In his career, he was recognized as an outstanding teacher on seven occasions. Professor Harvey has written 19 volumes published by West Publishing. He was often engaged as counsel in cases, several of which reached the U.S. Supreme Court. His success as the lead attorney in In Re The Matter of Public Law No. 154-1990 (H.E.A. 1944), 561 N.E.2d 791 (Ind. 1990), in which the Indiana Supreme Court invalidated a state statute that would have established IOLTA in Indiana, is widely-known.

Reprinted with permission of the Washington Legal Foundation (WLF). WLF, a national, non-profit public interest law and policy center, originally produced this article as part of their education publishing program.