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A federal appellate court decision striking down the Texas “IOLTA” program as unconstitutional has rekindled concerns about the future of the multimillion-dollar state programs, which help finance legal services for the poor. IOLTA stands for “interest on lawyer trust accounts.” State programs use the interest from pooled accounts to pay for indigent legal services. A panel of the 5th U.S. Circuit Court of Appeals on Oct. 15 ruled that the Texas IOLTA program violates the Fifth Amendment prohibition on government’s taking property without just compensation. Washington Legal Foundation v. Texas Equal Access To Justice Foundation, No. 00-50139. “Obviously what happens in Texas is going to have an effect on the rest of the country,” says Robert Long of Washington, D.C.’s Covington & Burling, who defended the program before the panel. “There are IOLTA programs in every state and the District of Columbia. In 2000, I believe, $140 million was generated by the programs for legal services for the poor. Even apart from the significant effect this will have on takings law, IOLTA itself is very important.” A survey by the Legal Services Corp. (LSC) found that between 1983 and 1993 IOLTA programs contributed $405.8 million to LSC-funded programs. The programs also pay for a significant portion of budgets for bar association-sponsored pro bono programs. According to the American Bar Association, IOLTA programs represent the second-largest funding source for U.S. civil legal services to the poor. And the programs are unquestionably unconstitutional, insists longtime IOLTA opponent Charles Rounds Jr. of Suffolk University Law School in Boston. He says that he knows of at least two other challenges in the planning stages — in Massachusetts and Florida — that will be buttressed by the 5th Circuit ruling. “Since the program got going in the late ’70s, we may now be up to around $2 billion generated,” he says. “That’s a lot of money that has been taken from a client class. It’s a vast transfer of property from the client class to the legal community.” The Texas challenge, in the pipeline since 1994, has already made one trip to the U.S. Supreme Court, and its journey probably didn’t end on Oct. 15. Covington’s Long says that his clients intend to seek review by the full 5th Circuit and if that is denied will go again to the Supreme Court. The Texas Supreme Court created a voluntary IOLTA program in 1984. Attorneys could place client funds that were “nominal in amount” or “reasonably anticipated to be held for a short period of time” in an interest-bearing bank account. The interest was paid to the Texas Equal Access to Justice Foundation, which had been created by the state supreme court, to distribute the funds. The voluntary IOLTA program generated about $1 million per year. In 1988, the Texas Supreme Court, as in a number of states, made the program mandatory. The revenue increased to more than $5 million a year. Under federal banking rules, not all client deposits are eligible to be put into IOLTA accounts. Excluded is any client money that can earn more interest in a non-IOLTA account than would be consumed by bank administrative costs. THE CHALLENGE In 1994, Texas attorney Michael J. Mazzone, one of his clients with funds in an IOLTA account and the conservative Washington Legal Foundation challenged the program in federal court. A district court upheld the program, finding that clients lacked property rights in the interest generated by their funds. The 5th Circuit disagreed, and it was on that issue — whether the interest is the property of the client or the lawyer — that the case went to the Supreme Court. In 1998, a divided high court held that the interest income is the private property of the client for purposes of the Takings Clause. Phillips v. Washington Legal Foundation, 521 U.S. 1117. The justices sent the case back to determine whether a taking without just compensation had occurred. After a bench trial in 1999, the district court held that it had not because there was no identifiable and compensable loss. A client’s IOLTA-deposit funds, the court noted, can’t generate “net interest” without the IOLTA program. The court concluded that the only plaintiff with funds in the Texas IOLTA account had suffered no loss. In fact, the plaintiff-client himself had testified to that effect. The court found that the plaintiffs proved no loss under any of three accounting methods that they offered. At a minimum, the court said, they had to show that the plaintiff client was materially worse off because of IOLTA, but the client had testified that he was not. “The difficulty is the amount of loss is not great,” says Richard Samp, chief counsel of the Washington Legal Foundation. “And some judges take the view that so long as nobody is really suffering a lot of harm, there’s no reason for courts to step in and stop the government from doing what it wants to do. “On the other hand, there are many people who think these are precisely the kind of cases where you need to draw a line in the sand and say the takings clause applies to petty theft as well as grand larceny.” The 5th Circuit, in its Oct. 15 opinion by Judge Rhesa Hawkins Barksdale, said that because the state permanently appropriated the client’s interest against his will, “there is a per se taking.” The panel, however, also found that there was no “just compensation” remedy. Because the purpose of IOLTA is to take the interest and use it to fund legal services for the poor, the court explained, there is no provision for paying just compensation. But, the panel majority held, there is declaratory and injunctive relief. Judge Jacques L. Wiener Jr. dissented. The Fifth Amendment, he wrote, is not violated by a taking, but by a taking without just compensation. “This constitutional truism convinces me that even if the Texas IOLTA program should involve the government’s ‘taking’ of ‘property,’ it would not violate the plaintiffs’ constitutional rights because just compensation for zero is zero,” he wrote. “It’s pretty clear from the opinion that the 5th Circuit expects the district court to enter broad injunctive relief,” says Samp. “That means an end to IOLTA on a mandatory basis. We have never objected to IOLTA on a voluntary basis. I would expect it to continue on a more limited basis with not as much money.” Texas would still be able to run voluntary IOLTA programs, agrees Dean W. Frank Newton of Texas Tech University School of Law, who once ran the IOLTA program. “But it would require that the client choose to participate,” he says. “That gets complicated because of IRS rulings. Clients could actually owe a small amount of tax.” IOLTA supporters have “simply gone into collective denial” in the face of the Supreme Court’s 1998 ruling, says Harvey M. Alper of Alper, Walden & Miller in Altamonte Springs, Fla. Alper opposes mandatory IOLTA programs and was counsel in a key high court property rights precedent, Webb’s Fabulous Pharmacies v. Beckwith, 449 U.S. 155 (1980). He is considering a challenge to Florida’s mandatory IOLTA program. “There is a natural institutional desire to prolong the existence of these programs for a variety of reasons — some good, some not as good,” he says. “The National IOLTA Clearinghouse has a direct interest in continuing this process because it is somebody’s job. “The IOLTA program has picked up where Congress left off with the Legal Services Corp. And finally many state bar associations or foundations have also created an institutional power base, not in an evil sense, in their respective states because they are handing out money.” Some IOLTA supporters believe the challenges spring from hostility to legal services, not concern over clients’ theoretical losses. “Frankly this is such a weak argument — that somebody who can prove no financial loss has suffered a deprivation of a fundamental constitutional right,” says Professor Brian Serr of Baylor University School of Law, who assisted the counsel for the Texas program. ‘LOSING ZIP MONEY’ “Why was the argument raised in the first place?” Serr asks. “Are there a bunch of clients out there who are losing zip money but who are up in arms that their constitutional rights are being violated? Of course not. “These judges are frankly among the most difficult to persuade that there is a violation of constitutional rights. For the life of me, the only way I can reasonably explain the lawsuit and the decision is there are strong feelings about how that money is being spent.” Legally, Serr, Long and others find troubling the 5th Circuit’s use of a “per se” takings analysis in this type of property rights case. “That analysis has been pretty much confined to physical invasions of property and land, or something functionally equivalent to a physical invasion is considered a per se taking,” Serr says. “That’s important because in deciding whether there has been a taking, when it’s not a per se taking, there is a multifactor analysis which includes the property owner’s investment-backed expectations. “The per se analysis allows judges to disregard the economic reality of the situation facing the client.” Long agrees, saying, “If that ruling is left in place, it could have mischievous consequences. Once you start saying that when the government makes you pay money that is a per se taking, that is potentially a very broad ruling and a big step beyond what the Supreme Court has held today.” IN THE 9TH CIRCUIT While some of the facts are different, the 9th Circuit has pending a challenge, to the Washington state IOLTA program brought by the Washington Legal Foundation. A 9th Circuit panel ruled unanimously that the IOLTA program was a per se taking, says Samp. The case was argued en banc in June. “Whether or not this issue makes it to the Supreme Court, I suspect, depends primarily on whether there ends up being a split among the circuits,” Samp says. “We have won in the 5th and if we win in the 9th, I suspect that will be the end of the matter.” If there is no circuit split, “It may be harder for us to get the Supreme Court to hear our case,” Newton concedes, “but we will try.”

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