Last month "Ethically Speaking" demystified the inner workings of the dreaded compliance audit. This month we explore the imminent changes to the books and record keeping requirements. The rules regarding both fees and record keeping were recently revised. Rule 1.5 of the Delaware Lawyers' Rules of Professional Conduct ("DLRPC") deals with fees. As we all know, that Rule requires that the fee be reasonable and in writing in contingency fee cases. In addition, contingency fees are barred for certain types of cases. The Rule also sets out the circumstances under which lawyers who are not in the same firm may divide or share fees.
Effective January 1, 1999, a new sub-section (f) has been added. It states:
(f) A Lawyer may require the client to pay some or all of the fee in advance of the lawyer undertaking the representation provided that:
(1) The lawyer shall provide the client with a written statement that the fee is refundable if it is not earned
(2) The written statement shall state the basis under which the fees shall be considered to have been earned whether in whole or in part, and
(3) All unearned fees shall be retained in the lawyer's trust account, with statement of the fees earned provided to the client at the time such funds are withdrawn from the trust account.
This Amendment may require a dramatic change in the billing practices of many practitioners. Providers of "flat fee" services such as criminal defense, domestic relations and bankruptcy are especially likely to be affected.
Martin Zukoff, CPA, the Auditor for the Trustees of the Lawyers' Fund for Client Protection, warns that beginning January 1, 1999, his compliance audits will review retainer agreements for a statement of the billing rate, the deposit of the retainer into escrow and a disclaimer that any unearned portion of the fee is refundable. While the current Rule 1.5 does not require written fee agreements in all cases, the new Rule by implication does.
The Amendment raises a serious question as to whether a "non-refundable" retainer is permissible. As discussed in a previous column, if the fee paid is for future attorney services, this amendment ends the debate. "Ethically Speaking", Fees (Made) Simple: Absolutely, IN RE: October 1994. However, a somewhat tortured reading of the new Rule might still permit the immediate deposit of fees paid to secure the attorney's availability or even earned-when-paid fee arrangements into an operating account.
Attorneys charging a flat fee may now be required to maintain time records in order to comport with the new sub-section (f)(3). An alternative may be a fee agreement which specifies the transfer of stated sums from the escrowed retainer to the operating account based on a schedule of completed tasks or stages of the representation. For example, in a criminal case, a refundable retainer of $5,000.00 would be deposited into escrow. Transfers of $1,000.00 could be made after the attorney's Entry of Appearance, after the Preliminary Hearing, Case Review, etc. The new Rule would require a statement or notice to the client of each transfer.
Similarly, Rule 1.15 and Interpretive Guideline 2 to that Rule have been revamped. By Supreme Court Order dated September 28, 1998 (effective January 1, 1999), Rule 1.15(d) and Interpretive Guideline No. 2 of the DLRPC are amended by their deletion.
Replacing the former Rule and its Guideline is a new Rule 1.15(d) which incorporates much of the current Guideline into that sub-section. However, important additions to the former Guideline include, but are not limited to, the following:
Codifying previous rulings in Delaware disciplinary cases, no funds which should have been disbursed shall remain in the account, including earned legal fees which must be transferred to the lawyer's non-fiduciary account on a prompt and timely basis when earned. DLRPC Rule 1.15(d)(9)(E).
If a lawyer maintains financial books and records by a computer system, the lawyer must print a hard copy of all monthly journals, ledgers, reports and reconciliations monthly. These printouts must be reviewed and preserved in the same manner as the other financial records described in the Rule. DLRPC Rule 1.15(d)(10).
The former sub-section (5) to the "Fiduciary funds" section of Guideline No. 2 required a record showing all property, other than cash, received from clients or others. The new Rule adds the requirement that the records must describe with specificity the identity and location of such property. DLRPC Rule 1.15(d)(4).
Monthly reconciliations for each bank account (matching the totals from the cash receipts and cash disbursement journals with the ending check register balance) are still required. However, under the new Rule, reconciliations are not required for lawyers using a computer accounting system or a general ledger. DLRPC Rule 1.15(d)(7).
The reconciled total cash balance must agree with the total of the client or third party balance listing. In addition, "There shall be no unidentified client or third party funds." For a bank reconciliation for a fiduciary account to be complete, there must be an agreement with the total of all client or third party accounts. DLRPC Rule 1.15(d)(9)(D).
The current section (8) of the Guideline regulates participation in the Delaware IOLTA Program. The new Rule 1.15(f)-(g) covers the same requirements with important additions.
Lawyers must now consider at reasonable intervals whether changed circumstances would warrant a transfer of client funds from a non-interest bearing account to an interest bearing account. The Office of Disciplinary Counsel and the Lawyers' Fund for Client Protection have recently questioned (after an audit) whether an attorney has a fiduciary duty to select the higher yielding vehicle when comparable accounts are readily available.
The Comment to Rule 1.15 has also been extensively re-written. The former "Code Comparison" has been deleted. Instead there is an extensive new Comment which defines the terms used in the rule. An example of a reconciled monthly cash balance to a check register is also provided. The Comment is tantamount to a narrative restatement of the new Rule and should be required reading for all Delaware attorneys, their accountants and bookkeepers.
The comment points out that, implicit in the principles of Rule 1.15 is the strict prohibition against the misappropriation of client or third party funds. A knowing misappropriation may also be a violation of Rule 8.4(b) (criminal conduct in the form of theft) and 8.4(c) (general dishonest or deceptive conduct). The Comment warns of the traditionally severe sanctions for intentional misappropriation even for benign reasons or with the intent to replenish the funds. Finally, the Comment cautions that misappropriation by mistake, neglect or recklessness may still result in suspension. (Name Withheld), Del. Supr., 652 A.2d 1071 (1995).
The September 28, 1998 Order of the Court tidies up the Rules volume by directing the appropriate amendments to cross-referenced rules. Supreme Court Rules 65(b) (regarding the function of the Advisory committee on Interest on Lawyers Trust Accounts) and 66(c)(10) (regarding the Powers and Duties of the Trustees of the Lawyers' Fund for Client Protection) were amended to delete references to the Interpretive Guideline. Regulations V.1, V.2, V.5 and Regulation VII of the Trustees of the Lawyers' Fund for Client Protection were amended to reflect the merger. The DLRPC have also been amended where appropriate to delete references to the now obsolete Interpretive Guideline No. 2 and the re-numbering of the other Guidelines.
Finally, the Certification of Compliance required as part of the Annual Registration requirement has already been revised to incorporate these changes. A note of caution - Read and comply with these changes before signing this affidavit. Books and records violations can be compounded by charges of Rule 8.4(c) false statements.
Next month, Ethically Speaking will provide its annual index to past columns. In February, look for "Compliance Audits - Part Three" providing a review of the case law resulting from compliance audits which revealed books and records violations.
Lawyers' Fund for Client Protection of the Bar of Delaware
200 West Ninth Street, Suite 300-B, Wilmington, DE 19801
Phone: (302) 577-7034 * Fax: (302) 577-1006 * E-mail: Bunny.James@state.de.us