We’ve all been taught that we need to wait until funds “clear” to distribute them. How do I know when “clear”?
As attorneys, we take CLEs from time to time, and some of those have to be about ethics. So, to get our ethics credits, we often look for practical CLEs we can put to good use in the real world, like trust accounting CLEs. Now in those trust accounting CLEs, the presenter always – almost without fail – reminds us that we need to wait for funds to “clear” into our trust accounts before we’re allowed to take those funds back out.
Unfortunately, what most of those CLEs aren’t teaching us is that “cleared” funds are a myth.
What are “cleared” funds?
Understanding what “cleared” funds are – and aren’t – is critical to understanding why most attorneys’ concept of “cleared” funds is a myth. “Cleared” funds are simply money that is in the bank account and available for withdrawal. When funds aren’t available for withdrawal – for example, you just deposited them five minutes ago – they’re pending. Then, once they become available, they’re “cleared”. Most deposits “clear” within one business day.
Unfortunately, “cleared” does not mean that those funds are there to stay. “Cleared” does not mean that funds won’t get unilaterally and unexpectedly yanked back out of your bank account. It does not mean the funds are somehow settled and irrevocable. All it means is that the bank is willing to let you spend that money.
And that’s what makes both the myth and the legend about “cleared” funds: All that we’ve learned about banking and trust accounting implies that “cleared” funds are somehow safe and protected in our account, and they’re there to stay. They’re not.
Some funds really do “clear,” in the permanent sense.
Now that we know what “cleared” really means, let’s take a step back and see what funds, if any, really do “clear” into our accounts permanently. In other words, let’s first look at the kinds of deposits that can’t get yanked back without any warning, consent, or approval. Because luckily, there are a few.
Wire Transfers. Once a wire appears in your account, it’s there to stay. This is one reason savvy attorneys insist on wires for large trust deposits and for deposits of settlement funds. There’s no risk that your depositor will develop buyer’s remorse, yank the funds back out without warning, and leave your trust account with a negative balance while your bank reports you to the state bar.
Cash. Cash is another kind of deposit that is in your bank account to stay – or at least, it won’t be removed from your bank account without your knowledge or approval. Of course, cash deposits are at risk while they’re in transit, so many attorneys tend to stay away from them, despite cash being a great and otherwise secure medium for trust deposits. They’re also inconvenient for many clients.
Cashier’s Check. These are almost as good as cash. I say “almost,” because there is a small chance that a payor can cancel a cashier’s check in transit, before it’s deposited. But, once deposited into your trust account, the funds are safe and secure, and the payor can’t stop payment or cancel the cashier’s check to yank the funds back out.
What deposits are at risk, even after they “clear”?
As mentioned, some deposits are at risk of disappearing from your account without any warning or approval. When this happens, you may find your IOLTA balance negative, and your bank making a mandatory report to the state bar. Unfortunately, these are some of the most common payment methods that attorneys accept into their trust accounts.
Checks. Whether they’re personal checks or business checks, accepting checks as trust deposits does put your firm at some risk. Whether you wait three business days, two weeks, or a month after the check “clears” before distributing those trust funds back out, you can never guarantee the bank won’t yank those funds back out of your account without telling you. This can happen when the check is fraudulent, or simply when the payor gets buyer’s remorse and puts a stop payment on it. So, accepting trust payments via check always comes with some risk.
Credit Cards. You’ve probably disputed charges on your credit card, and you’ve probably gotten your money back pretty much every time. Well, when clients pay you with a credit card, they can dispute the charge, and they usually get their money back, too. And it doesn’t just happen with buyer’s remorse; scammers can use stolen credit cards to steal tens of thousands from your trust account if you’re not careful.
How Can I Keep My IOLTA and Trust Funds Safe?
We’ll be taking a look at this question in our next few posts. So, be sure to check back here (on our blog) regularly, and also be sure to sign up for our newsletter to make sure you don’t miss a post.