Resolving third-party claims to client funds
By Sylvia Stevens
Lawyers routinely act as custodians, conduits and safekeepers of client money. As such, they have a duty to notify the client upon receipt of the money and to account for and deliver it when the lawyers' custodial obligations are concluded and the client is entitled to receive the money.
This duty is expressly articulated in DR 9-101(C), which requires a lawyer to 'promptly notify a client of the receipt of the client's funds,' to keep the funds safe,2 to maintain proper records regarding receipt and disbursement, and to 'promptly pay or deliver to a client as requested by the client the funds…in possession of the lawyer which the client is entitled to receive.'
ABA Model Rule 1.15(b) contains the same mandate, but extends the obligation to third persons as well as clients: 'Upon receiving funds…in which a client or third person has an interest, a lawyer shall promptly notify the client or third person.' The rule requires prompt delivery to the client or third person of any funds the client or third person is entitled to receive, together with an accounting.
The Model Rule recognizes that third parties, such as a client's creditors, may have just claims to funds in the lawyer's custody and that the lawyer may have a duty under applicable law to protect such third-party claims against wrongful interference by the client. '…accordingly [the lawyer] may refuse to surrender the [funds] to the client.'
Where the third party's entitlement to the money is undisputed, the absence of a clear statement in DR 9-101 of the lawyer's obligation to third parties is irrelevant.3 However, when both the client and the third-party claim an interest in the same funds, neither the Oregon Code of Professional Responsibility (the 'DRs') or the ABA Model Rules offer much guidance. DR 9-101(C)(4) merely directs the lawyer to deliver to the client 'that which the client is entitled to receive.' Presumably, property rightfully claimed by another is not property the client is 'entitled to receive.'
How does a lawyer determine what the client is entitled to receive when both the client and a third-party claim a right to the funds?4 It bears noting here that the lawyer's primary duty is to the client and the lawyer must avoid getting caught in the middle of a dispute between the client and a third party over the funds. Generally, then, the lawyer should deliver the disputed funds to the client unless the lawyer knows that a third-party has a valid claim under applicable law. Obvious examples of valid third-party claims are statutory liens,5 perfected security interests or court orders directing distribution of the funds. Much less clear are the situations where there is only a contract or agreement between the client and the third-party regarding payment from the funds.
Ethics opinions in many jurisdictions direct lawyers to honor contracts or agreements between the client and a third-party.6 OSB Formal Opinion No. 1991-52 offers the same guidance, albeit obliquely. There, the facts are that a lawyer handling a personal injury case has knowledge of a PIP lien and a perfected security interest in the litigation proceeds. The lawyer also, with the client's authorization, assures a physician that he will be paid if the recovery is sufficient. The opinion relies on former DR 9-101(B)(now DR 9-101(B)), for the conclusion that '[a]bsent a colorable or plausible argument on the client's behalf as to why Plaintiff's Insurer, Doctor and Creditor are not entitled to be paid by Attorney beyond the mere fact that Plaintiff does not wish to pay them, the funds at issue are not funds that Plaintiff is 'entitled to receive' and Attorney may therefore pay Plaintiff's Insurer, Doctor and Creditor.' The opinion does not mention contracts or agreements, but the lawyer's assurances to the physician, on the client's instruction, might rise to that level.
On the other hand, a lawyer has no obligation to a third party who has only an 'expectation' of being paid out of the funds.7 A lawyer need not honor mere assertions of third-party interests or where the claimant has not taken proper steps to formalize the right to payment.8 In those situations, if the lawyer delivers the funds to the client, the lawyer should advise the client of the risks involved in disregarding the third party's claim.
Complicating these situations further is the widely accepted premise that a lawyer should not disburse funds to a third party, even one who is rightfully entitled to the funds, over the specific objections of the client. In other words, funds that are subject to a valid legal claim of a third party cannot be delivered to the client, but if the client contests the third party's right to payment, the lawyer also cannot pay the funds to the third party. Rather, the lawyer must hold the disputed funds in trust pending the resolution of the dispute or interplead the funds into court.9 Of course, any portion of the funds that is not in dispute or validly claimed by a third party must be delivered promptly to the client. A lawyer cannot delay distribution of undisputed funds pending the resolution of a dispute over another part of the funds.
The lawyer's obligation to protect funds claimed by third parties is heightened when the lawyer makes promises or assurances directly to the third party. In that situation, the authorities suggest that the lawyer may pay the third party even over the client's objections unless the lawyer believes there is a good faith dispute over the amount or validity of the debt.10
In addition to the ethical obligation that may be violated when a lawyer ignores a duty to a third party and pays the disputed funds directly to the client, the lawyer may be held liable to the non-client. In Bank of India v. Weg and Myers, PC, 257 App Div2d, 691 NYS2d 439 (1999), the defendant law firm was held liable to the client's secured lender for the value of insurance proceeds paid directly to the client in violation of the lender's security interest in those proceeds. To the same effect, see Kaiser Foundation Health Plan, Inc. v. Aguiluz, 47 Cal App 4th 302, 54 Cal Rptr 2d 665 (1996) (lawyer liable to medical provider for paying settlement proceeds to client in knowing disregard of client's agreement with provider); Herzog v. Irace, 594 A2d 1106 (Me.1991)(lawyers liable to assignee for breach of assignment, despite argument that they were ethically bound to follow client's instruction to ignore valid assignment); and Romero v. Earl, 111 NM 789, 810 P2d 808 (1991) (client's purported revocation of assignment did not justify lawyer's paying assigned funds to client).
By contrast, however, in Farmers Insurance Exchange v. Zerin, 53, Cal App 4th 445, 61 Cal Rptr 2d 707 (1997), the lawyer was held not liable to the client's medical insurer despite a provision in the insurance contract requiring reimbursement from any third-party recovery and specifying that the insured would hold the recovered fund in trust for the insurer. The insurer sued the insured's lawyer, alleging conversion, breach of equitable lien, breach of trust, and interference with contract. The court found that there was no conversion because the insurer had only a contractual right of payment and breach of contract is not conversion. The court also found that no equitable lien or trust was created by the insured's contractual promise to pay a debt from a particular fund. The court found it significant that the insured's lawyer had not made any promises to the insurer and that the insurer had not relied to its detriment on the contractual promise. On the contrary, the court viewed the insurer's claim against the lawyer as nothing more than an attempt to avoid having to seek reimbursement from the insured.11
Oregon authority on these issues is sparse. There is no reason to believe, however, that any of the same factual situations mentioned herein would be decided differently in Oregon. While it is not the author's intent to describe the entire universe of a lawyer's obligations when a client and a third-party claim a right to the same funds,12 it is clear that lawyers must exercise caution and good judgment in the face of such a dispute. Except where the funds are those that the client is unequivocally 'entitled to receive,'13 delivery to the client may expose the lawyer to liability to the third party. At the same time, when the client objects even to a facially valid third-party claim, delivery to the third party may violate the lawyer's ethical obligation to the client. When entitlement to the funds is unclear, the lawyer is well-advised to seek 'safe harbor' by holding the disputed funds in trust pending resolution of the dispute, or interpleading them into court.
Insistent demands of anxious clients and impatient third parties may make it difficult for the lawyer to remain clear-headed and deliberate about these issues. Some of the problem can be avoided by having a clear understanding with the client at the beginning of the representation (preferably in writing) as to how the lawyer will handle disputes over the settlement funds and the extent to which the lawyer will be involved in making assignments or other promises to third parties on behalf of the client. +
2. DR 9-101(A) requires that all funds of clients be maintained in a trust account.
3. Some authorities suggest that the obligation to third parties is implicit in DR 9-101. See discussion at §45:1101, ABA/BNA Lawyer's Manual on Professional Conduct.
4. This problem seems to occur frequently on conclusion of personal injury claims where the settlement proceeds will cover only some or all of the client's obligations to medical providers and leave little or nothing for the client. Despite earlier assurances that the client wanted all the providers to be paid from the settlement, the client may instruct the lawyer to ignore the third-party claims and disburse all proceeds to the client.
5. In In re Bowersox, 11 DB Rptr 91 (1997), the lawyer was found to have acted improperly in failing to pay a state aid lien because the client didn't want to pay and hoped the six-month lien period would expire without the state enforcing its rights.
6. Arizona Ethics Op. 98-06 (1998) has a good discussion of various situations and how to resolve them. See, also, California Formal Ethics Op. 1988-101 (lawyer whose client had agreed to pay recovery proceeds to health care provider may not ignore the agreement and disburse funds to client); Maryland Ethics Op. 94-19 (1992) (lawyer may not ignore client's valid agreement with creditor to satisfy creditor from settlement); Ohio Ethics Op. 95-12 (1995) (lawyer must pay physician where client earlier agreed to pay medical expenses from proceeds).
7. See, 1 G. Hazard & W. Hodes, The Law of Lawyering, §1.15:301-302 (the lawyer's 'special duty' to a client requires that all funds be paid to the client even though a third person expects funds held by the lawyer).
8. Philadelphia Ethics Op. 86-134 (1984)(lawyer need not pay physician in the absence of agreement between physician and client regarding proceeds of settlement); So. Carolina Ethics Op. 89-13 (1989)(lawyer not required to pay half of injury settlement to client's ex-wife under divorce decree where lawyer not served with process required by decree); Maryland Ethics Op. 97-20 (1997) (lawyer may disburse funds to client where hospital failed to timely submit bills to insurer and had no legally valid claim).
9. See OSB Formal Op. No. 1991-52. See also, Alaska Ethics Op. 92-3 (1992) (lawyer cannot follow client's instructions to ignore facially valid assignment, but must hold the funds until the dispute is resolved); Los Angeles County Ethics Op. 478 (1994) (lawyer cannot turn over disputed funds either to client or creditor but must hold in trust or initiate interpleader action); Maryland Ethics Op. 96-16 (1996) (lawyer whose client instructs lawyer to ignore client's agreement with creditor must hold funds in trust until dispute resolved); Ohio Ethics Op. 95-12 (1995) (lawyer must hold disputed portion of funds until resolved by parties or court).
10. See, e.g., So. Carolina Ethics Op. 93-14 (1993) (lawyer who agreed to honor all statements signed by client for medical services may ignore client's instructions to do otherwise); Washington Ethics Op. 185 (if lawyer guaranteed payment to creditor, lawyer must pay creditor unless there is good faith dispute as to amount owed, after advising client of the effect of the guarantee); Iowa Ethics Op. 89-32 (1989) (lawyer may agree to withhold amount client owes physician and pay physician directly from settlement).
11. Using a similar analysis, the OSB Legal Ethics Committee concluded in Informal Opinion No. 93-14 that a lawyer has no duty to inform client's insurance trust of client's recovery in an injury action even thought the lawyer was aware of the client's contractual obligation to reimburse the trust for medical care. The opinion distinguishes OSB Formal Op. No. 1991-52 because the contractual obligation is not a lien or security interest in the proceeds and because it is not unethical for a lawyer to assist a client in breaching a contract.
12. Opinions expressed in this article are only those of the author; they are not the official position of the Oregon State Bar.
13. See, DR 9-101(C)(4).
Sylvia Stevens is assistant general counsel of the Oregon State Bar. She can be reached at (503) 620-0222 Or (800) 452-8260,, ext. 359, or by e-mail at firstname.lastname@example.org.