Spotlight on Ethics: Where to Deposit Advance Payments

August 2020

By Suzanne Burke Spencer

May lawyers accept and keep a client retainer payment even if no legal services are ever provided to the client? May they accept flat fees for legal services paid in advance, before any legal services are provided? If so, must the flat fee be deposited into a client trust account, or may it go directly into the lawyer’s operating account? How about advance retainer payments against which lawyers will bill for legal services? Must they be deposited into a client trust account? If you are unsure about the answers to any of these questions, read on.

As is well known by now, on November 1, 2018, new Rules of Professional Conduct became effective in California that in some cases changed the prior rules, in some cases clarified them, and in some cases addressed issues never before expressly dealt with by California’s Rules of Professional Conduct. The rules governing fees for legal services (rule 1.5) and safekeeping of client funds (rule 1.15) fall within each of these categories. The manner in which advance payment of legal fees (probably the most typical form of client “retainer”) must be handled has changed in the new rules. The rules further expressly address flat fees and “true” retainers – two forms of payment that have been in common use for decades, but which were not expressly addressed in the former Rules of Professional Conduct. These rules further clarify whether and when any advance payment of legal fees or costs by a client must be deposited into a trust account or instead may be deposited into a general account and what exactly a “true” retainer is.

Although a long-time common practice for most practitioners, prior to November 1, 2018, there was no ethical obligation to deposit a client’s advance retainer payment for legal fees into a client trust account. Advance payments for costs to be incurred were required to be deposited into a client trust account, but advance payments of legal fees were not. (See rule 4-100 (eff. prior to November 1, 2018)). Under rule 1.15(a), however, the general rule is that both advance payments of fees and costs must be deposited into a client trust account. Funds may be transferred out of that account to pay for fees or costs only after they are incurred, earned and due under the engagement agreement. There is an exception to this general rule for flat fees, discussed below.

Although not prohibited by it, the former rule governing fees for legal services did not expressly address flat fees or “earned on receipt” or “non-refundable” retainers. Rule 1.5 expressly permits such payments and rule 1.15 expressly addresses the circumstances in which they may be deposited into an operating account. A flat fee is defined by the rule as “a fixed amount that constitutes complete payment for the performance of described services regardless of the amount of work ultimately involved.” Rule 1.5(e). All or part of such fees may be paid before the lawyer performs those services. Fees that are “earned on receipt” or “non-refundable” are permitted as long as they are “true” retainers and the client agrees to it in writing after disclosure that the client is not entitled to a refund of any part of the fee charged. It is unclear whether this disclosure must also be in writing, but as a matter of risk management, it should be. A true retainer is defined as “a fee that a client pays to a lawyer to ensure the lawyer’s availability to the client during a specified period or on a specified matter.” Rule 1.5(d). A true retainer may not be compensation “to any extent” for legal services provided or to be provided. Some lawyers who charge non-refundable fees agree that the client will receive a credit in the amount of all or part of the “non-refundable” fee if the retained legal services are later actually performed. This type of arrangement likely would not be a true retainer permitted under rule 1.5 because to at least some extent, the fee is being paid for legal services, even if only as a credit against services later provided.

True retainers are exempted from the requirement that advance payments of fees must be refunded upon termination of the representation. That exemption seems to apply only to true retainers “paid solely for the purpose of ensuring the availability of the lawyer for the matter.” Rule 1.16(e)(2). This exemption does not specifically refer to true retainers paid to ensure a lawyer’s availability for a specified time period, as opposed to for a specific matter, leaving some ambiguity as to whether both are within the exemption. Interpreting Rule 1.16(e)(2) to apply only to specific matter true retainers, however, would defeat the purpose of rule 1.5(d), which expressly permits non-refundable retainers for both specific matters and specified time periods.

Because true retainers are earned on receipt and are not compensation for legal services, they belong to the lawyer when paid. It is therefore not necessary to deposit true retainer payments into a client trust account. In fact, to do so would violate the prohibition on co-mingling the lawyer’s and client’s property in a trust account. See Rule 1.15(c). In contrast, flat fees paid in advance before legal services are provided may be deposited into a lawyer or firm’s operating account, but only if (1) the client is informed by the lawyer in writing (a) that the client has the right to require that the flat fee be deposited into a client trust account until earned and (b) that the client is entitled to a refund of any unearned portion of the fee if the representations ends before the services are completed; and (2) if the flat fee is greater than $1,000, the client signs the disclosures required under number (1). Rule 1.15(b). If these requirements are satisfied, a flat fee may then be deposited into a firm’s operating account; however, the obligation to refund any unearned portion still exists. Thus, even if the flat fee is properly deposited into an operating account, if the representation terminates before the legal services are completed, the unearned portion of the flat fee must still be refunded to the client. A general rule of thumb for determining the unearned portion of a flat fee is to determine a reasonable percentage of the amount of legal services actually provided against the total legal services the lawyer agreed to provide and applying that percentage pro rata to the flat fee. If, for example, 50% of the total work was completed when the representation ended, 50% of the flat fee would be refunded.

Applying these principles to a simple hypothetical: Suppose Lawyer charges a flat fee of $20,000 for preparing basic entity formation documents and being “on-call” to answer any legal questions the client may have about how to organize and set up the new business during the first year of operation. The client fee agreement provides that the fee is non-refundable and payable in full upon execution of the agreement. Client signs the agreement and pays the full fee. Lawyer deposits the $20,000 fee into her general operating account. Does Lawyer’s fee agreement and deposit into her general account violate rules 1.5 or 1.15? Probably.

Leaving aside the potential unconscionability of the fee, which would depend in part on the amount of legal services Lawyer actually provided over the year of being “on-call,” the fee itself likely runs afoul of rule 1.5. This is because a “non-refundable” fee may be charged only if it is a true retainer, which means it cannot be compensation for legal services rendered or to be rendered. Here, Lawyer agreed to provide legal services in exchange for the “non-refundable” fee. Specifically, Lawyer agreed to prepare basic entity formation documents and to answer legal questions “on-call” over the next year. Those are legal services. Had Lawyer simply agreed in exchange for $20,000 to make herself available over the next year should corporate legal services be required, and then charged in addition to that hourly or otherwise for any legal services actually performed, the fee could have been a true retainer and permitted by rule 1.5. But the fee in the hypothetical is not.

If the “non-refundable” language in the fee agreement was omitted, and instead the agreement provided the $20,000 was a flat fee, Lawyer could otherwise be permitted to deposit it into her operating account only if she made the disclosures in writing as required by rule 1.15(b) and obtained the client’s signature on the writing. A more challenging aspect of treating this fee arrangement on a flat-fee basis is presented by the open-ended nature of the services to be performed. It is unclear exactly what legal services Lawyer is actually agreeing to provide. She has agreed to provide services “on-call” for a year. But if she is never called upon within that year, it would be difficult to make the case that she had earned any fee over a reasonable amount for creating the formation documents. Is simply being available to give advice enough to “earn” this full fee once the year elapses? Some could argue such a fee would be unconscionable. Also, because there is no set amount of legal services to be performed, it would be difficult to determine how much of the agreed-upon services had been rendered for purposes of either drawing down on the fee as earned or calculating a refund, if the representation ends before the year expires.

Read together, rules 1.5 and 1.15 provide much needed clarity on the proper handling of flat and non-refundable fees. They may, however, also present challenges to the validity of some more creative, or hybrid, fee arrangements. A careful reading of both rules, keeping in mind that these rules are aimed at client protection, is required before attempting to charge these fees.

Suzanne Burke Spencer is the managing shareholder of Sall Spencer Callas & Krueger APC in Laguna Beach. She practices in the areas of professional malpractice and attorney ethics and serves on the California Lawyers Association’s Ethics Committee.