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Back-to-back rulings by state and federal courts during the week of Jan. 8 haven’t eased concerns about the Interest on Lawyers Trust Accounts program. On Jan. 10, the 9th U.S. Circuit Court of Appeals in Seattle ruled that the IOLTA program in Washington state is unconstitutional. A three-judge panel of the court held that interest generated by IOLTA accounts is the property of the clients whose money is being held in trust and that a government appropriation of the interest for public purposes is a “taking,” entitling clients to just compensation under the Fifth Amendment. However, the appeals court said in Washington Legal Foundation v. Legal Foundation of Washington that just compensation “may be less than the amount of the interest taken, or nothing, depending on the circumstances” and remanded the case to a federal trial court for a determination of the remedy. The day after the 9th Circuit ruled, the 3rd Court of Appeals in Austin held that a Texas law professor can lose his license to practice law for refusing to turn over IOLTA interest to the Texas Equal Access to Justice Foundation, which funds legal services for the poor in civil matters. Ruling in Paulsen v. State Bar of Texas, a three-judge panel said that South Texas College of Law Professor James Paulsen failed to show that withdrawing from the IOLTA program was the only way to resolve his ethical dilemma over what to do about the interest. Paulsen argues that, if the U.S. Supreme Court was correct in a 1998 ruling, participating in the IOLTA program is unethical. “It makes me a party in theft of my client’s property,” he says. But Justice Mack Kidd, author of the 3rd Court’s opinion, wrote that lawyers can make full disclosure to clients about the use of IOLTA accounts and the clients’ property interest they contain. Joining Kidd in the opinion were Justices Lee Yeakel and retired Senior Justice John Powers. The 3rd Court didn’t tackle the issue of whether the nation’s highest court erred when it ruled in Phillips v. Washington Legal Foundation that the interest income in a lawyer’s IOLTA account is the “private property” of the owner of the principal: the lawyer’s client. Since that 5-4 ruling, the issue has been tossed around in the courts and will be considered by the 5th U.S. Circuit Court of Appeals in New Orleans on Feb. 6. Frank Newton, dean of Texas Tech University School of Law and an Equal Access to Justice Foundation board member, predicts that the state will win at the 5th Circuit but admits that the 9th Circuit’s ruling is troubling. “If the 9th Circuit is correct, we’ll have to redo all banking law in the United States of America,” Newton says. “It’s going to be a horrendous mess.” Newton says the people who should be the most worried are the bankers. If anyone with an account in a bank has a proprietary interest in that account, the bank can’t earn interest off the money, he says. Richard Samp, chief counsel of the Washington Legal Foundation, which filed the IOLTA challenge in 1992, sees the 9th Circuit’s ruling as a sign of what is likely to happen before the 5th Circuit. “I am confident of victory,” Samp says. Samp’s group appealed to the 5th Circuit after U.S. District Judge James Nowlin of Austin ruled last year that it is not unconstitutional for the Equal Access to Justice Foundation to collect the interest from IOLTA accounts to provide legal aid for low-income Texans. MORE PAPERWORK The Texas Supreme Court created a voluntary IOLTA program in 1984. Participation became mandatory in 1988, which resulted in a tenfold increase in funds forwarded to the foundation, according to the 3rd Court’s opinion. Lisa Melton, the foundation’s executive director, says that about $5.3 million is collected annually from IOLTA accounts. Terry Scarborough, an Austin lawyer who serves as special counsel for the State Bar of Texas, says the U.S. Supreme Court appears to have “overlooked, if not misstated, Texas law” in its Phillips decision. In Texas, there is a distinction between a general and a special account and, if it is a general account, the bank is the owner of the funds, says Scarborough, a partner in Hance, Scarborough & Wright. Scarborough says efforts were made to persuade Paulsen against stopping his compliance with IOLTA rules. The 3rd Court’s ruling indicates there are ways for Paulsen to handle the ethical dilemma “other than to slap the State Bar in the face,” he says. The opinion should help Paulsen, Scarborough says, because it enables him to take the case to the state’s supreme court. But Samp says it’s inappropriate for the case to be in state courts because the issue involves a federal constitutional issue. Paulsen says he will appeal to the Texas Supreme Court “because the ruling is quite obviously incorrect.” A supporter of the IOLTA program, Paulsen says he doesn’t think most Texas lawyers are aware there’s a problem. “They’re accustomed to believing what the Bar tells them and the Bar has told them, ‘Don’t worry; be happy,’ ” he says. But Paulsen says he fears the 3rd Court’s decision will kill the IOLTA program in Texas. Lawyers will have to disclose to clients regarding the use of IOLTA accounts and the interest that is generated, he says. That means lawyers will have to do paperwork on small amounts of interest money, Paulsen says. The only way the IOLTA program works, he says, is if lawyers aren’t required to do anything other than set up accounts. The opinion says a lawyer must withdraw a client’s funds from an IOLTA account if directed to do so by the client. But in a footnote, Kidd says: “It must be noted that lawyers would be remiss if they led clients to believe that they will actually receive interest on nominal or short-term funds. Clients must be made aware that exercising any control over investment of these funds subjects the client to bank fees, accounting costs and possible income taxation. This may actually result in a net loss to the client.” Newton says he doesn’t believe that requiring lawyers to make disclosures about IOLTA accounts will hurt the program. “My guesstimate is it would not have much of an impact,” he says. Clients must be told that the money can be put in an IOLTA account to help provide legal services for the poor, or that it can go into in a separate account and the client still won’t get the money and could pay taxes on it, Newton says. He predicts that most clients will rely on their attorney’s judgment. This is the second time that the 3rd Court has looked at Paulsen’s arguments on the IOLTA program. In December 1999, a three-justice panel of the court dismissed a suit filed by Paulsen and three banking associations against the Equal Access to Justice Foundation, saying there was no justifiable controversy among the parties.

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