IOLTA   I.O.U.?

By: Jay Hollander
Date: 1998

Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.

The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances.

Article

One of the common services provided by lawyers is to serve as escrow agents on behalf of clients in connection with transactions in which they are retained. Historically, large amounts or amount which had a long deposit time horizon were kept in separate interest bearing accounts. Short term or smaller amounts were normally held in non interest bearing checking accounts in which many other clients' escrow funds were also kept.

While not paying interest, such accounts had the convenience of ready access without fees. Equally importantly, until 1980, there was no interest paying alternative to such accounts since federal law prohibited payment of interest in such demand deposit checking accounts by federally insured banks and savings and loans.

In 1980, however, things changed with passage of legal authorization for what came to be known as Negotiable Order of Withdrawal or "NOW" accounts, which, for the first time, allowed interest in such accounts. The catch was that interest was only allowed to be paid in checking accounts where the beneficiary of the interest were non-profit organizations, funding charitable, educational, political or similar causes. On its face, then, regular corporate checking accounts, like a law firm's generic pooled escrow account, still didn't qualify for interest.

In stepped the Federal Reserve, which interpreted the law to say that regular corporate accounts could be NOW accounts if the exclusive beneficiary of the interest payments was the type of non-profit organization described above.

As word of this Banking Regulation interpretation spread, forty eight states and the District of Columbia, beginning with Florida, eventually moved to mandate programs through their state Bar licensing authorities to require that small, short term escrow funds be deposited in IOLTA accounts, the exclusive beneficiaries of which would be foundations which funnel the money to provide legal assistance to the poor.

IOLTA, an acronym which stands for "Interest on Lawyers Trust Accounts", is named after the foundations which provides grants to non-profit providers of civil legal assistance to the poor. New York's IOLTA fund, for example, gave over $12,000,000.00 of such grants to non-profit providers in 1997 alone. The entirety of this money comes from revenues raised from the interest earned on client deposits in IOLTA accounts, which lawyers are required to have and use under appropriate circumstances.

Many have long complained that these programs are an unauthorized taking of property without compensation in violation of the Fifth Amendment of the Constitution. They argued that the interest generated in these accounts represented moneys which rightfully belong to the private parties involved in the transaction, on whose behalf the monies were deposited.

Recently, the US Supreme Court, in Phillips v. Washington Legal Foundation, reviewed a challenge to the Texas version of the IOLTA fund and, in vindication of these complaints, concluded that the private parties whose funds were deposited in such accounts had a property interest in the interest generated by them.

Relying on the established common law maxim that "interest follows principal", the Court issued a limited ruling which conceptually sided with the complainant:

"In sum, we hold that the interest income generated by funds held in IOLTA accounts is the "private property" of the owner of the principal. We express no view as to whether these funds have been 'taken' by the State; nor do we express an opinion as to the amount of 'just compensation,' if any, due respondents. We leave these issues to be addressed on remand."

What does this mean for all the moneys that were deposited in these accounts until now? Does this money now revert to the original owners/depositors? If so, who is obligated to repay them? What if the rightful beneficiaries can no longer be found? Equally important, what time frame and interest rate should be used to calculate such interest?

Unfortunately, the Supreme Court did not answer these questions, instead leaving the remedy to be initially decided on remand to the lower court from whence the case arose. Moreover, since the case only binds the parties to it, its precedential effect -- and real world influence--is still to be determined.

It does not seem possible, however, that some change will not occur, even though it may not come without a fight from the states who would be hard pressed to replace the funds generated by these accounts. Only then, will you know whether you are holding a valid I.O.U. from your state's IOLTA program.

Copyright © Jay Hollander, 1998. All Rights Reserved.