U.S. Supreme Court Narrowly Upholds IOLTA Rules

The Supreme Court noted four "essential features" of the Washington IOLTA program:

(a) the requirement that all client funds be deposited in interest-bearing trust accounts, (b) the requirement that funds that cannot earn net interest for the client be deposited in an IOLTA account, (c) the requirement that the lawyers direct the banks to pay the net interest on the IOLTA accounts to the Legal Foundation of Washington (Foundation), and (d) the requirement that the Foundation must use all funds received from IOLTA accounts for tax-exempt law-related charitable and educational purposes.

The question is whether it violates the Just Compensation clause of the Fifth Amendment to the U.S. Constitution for a state government ever to mandate a program that transfers interest on client money to someone else. In upholding the program, the majority focused on Washington's rule that lawyers were to place client funds in an IOLTA account only if the money could not earn net interest in a separate account. This logic focuses on the fact that if it would cost more money to create and maintain a separate account than the client would earn in interest, then the client has lost nothing as a practical matter by receiving no interest at all.

First, it's important to understand that the Constitution does allow states to take private property. Some people read only half of the Fifth Amendment's "takings clause" and think that the case is closed. They read, "Nor shall private property be taken for public use," and think that no government may take private property. However, that's only half the sentence. The rest reads, "without just compensation." Or, in other words, the government may take property, but only if the property is to be used for public use and the government provides just compensation to the property owners. Brown, slip op. at 13.

The majority found that legal aid services were a very good example of a "public use," but the question of "just compensation" remained. The majority concluded that as long as the program allowed the lawyer to use an IOLTA account only when a separate account would yield no net interest for the client, the program did not in fact lead to a client losing something she or he otherwise would have obtained, precisely because the separate account would have yielded no net interest. The client has not lost anything he or she otherwise would have received when the lawyer closed out the client's accounts. There is no loss to compensate.

The magic word here is "net." If I open an interest-bearing checking account as a trust account, it will earn some interest. But I can't maintain that account for free. My bank doesn't charge me to open a lawyer's trust account, but it will charge for check printing and for other transactions. It's not clear whether the time it costs me to maintain the account factors into the equation here, but clients generally end up paying for that, too, in the form of setup fees or hourly rates -- the overhead costs will get passed on to the client somehow.

What if the lawyer mistakenly deposits client funds into an IOLTA account when those funds could have earned net interest in a separate account? In that case, it seems to me that the responsibility for that mistake belongs to the lawyer, not to the IOLTA organization. The Court majority agreed.

Justice Scalia wrote a dissenting opinion joined by Justices Kennedy and Thomas and Chief Justice Rehnquist. Justice Scalia disagrees with the majority's attention to the client's "net loss." Scalia's formalism rails against the majority's pragmatism. He reasons that a taking for public use happens the moment the state transfers a client's earned interest (however small an amount) to another entity, and the right to just compensation in the amount taken accrues at that moment. This would effectively neutralize the transaction. This theory's formal, mathematical cleanliness makes it attractive. What's more, it has roots in precedent. Scalia cites numerous cases and also says that the Phillips case itself "flatly rejected the notion that just compensation may be reduced by transaction costs the former owner would have sustained in retaining his property." Brown, Scalia, J., dissenting, slip op. at 9-10. The rules have steps, Scalia says, concluding that the Court followed the wrong steps in this case, and must follow the right steps regardless of their practical, real-world impact.

Scalia says that if transaction costs matter at all, they only matter to the extent of the transaction costs to the the plaintiffs of removing from the IOLTA accounts the interest that they are due. I can say that if those accounts held money for more than a very few clients, the time it would take me to figure out the interest due to the plaintiffs on those accounts would far exceed the value of the interest due to those clients -- which, let us not forget, was something on the order of $5.

Let us imagine that Justice Scalia's theory had prevailed. I would go to the bank and close my COLTAF account. It's at a zero balance right now, so that would present no accounting trouble to me or clients. Henceforth, I would put all client money in separate accounts. I would not pool client money in a trust because of the astounding headache (i.e. time cost) of dividing the interest among clients whose money had passed through the account. I would pass all of the account creation and maintenance fees on to the client as directly as possible so as to ensure that no clients cross-subsidized the cost of other clients' accounts. This would leave clients who would have had separate accounts under the IOLTA system in exactly the financial situation they would have been in before. Clients whose money would have gone into my COLTAF account would find themselves with a few dollars in interest but a higher bill, though, because of what it costs to create and maintain the account. Scalia's approach would in fact impose higher accounting costs on clients, especially on clients with cases that involve less attorney money-handling.

Scalia accuses the majority of engaging in "the Robin Hood Taking, in which the government’s extraction of wealth from those who own it is so cleverly achieved, and the object of the government’s larcenous beneficence is so highly favored by the courts (taking from the rich to give to indigent defendants) that the normal rules of the Constitution protecting private property are suspended." The IOLTA system is clever, but it's not a clever theft. Properly applied, this clever system offers lawyers and clients a cost-saving device -- a pooled trust account that would be practically unmanageable for many lawyers if they had to divide the interest pro rata among clients in the account. The pooled account offers few cost advantages if I have to expend time and money to handle the complex interest accounting that arises when different clients' money passes through one account for varying periods of time. In a way, the interest pays for that convenience. Meanwhile the IOLTA system accumulates tiny sums of interest from accounts throughout the state to fund crucial legal aid services for the indigent. The system is economically clever because it takes money that would otherwise have been frittered away, one way or another, in transaction or administrative costs, and puts that money to socially beneficial uses. Clients whose money goes into an IOLTA account lose nothing and escape with lower bills than if their money had gone into a separate account.

This is an example of why I'm much more of a pragmatist than a formalist.

There is more to talk about here, and I know that this first look at the case is very rough around the edges. However, I'm out of time (incidentally, I have some work to do for my local partially-IOLTA-funded legal aid agency). Justice Kennedy wrote a separate dissent with a few remarks rooted in the First Amendment. Problems remain on all sides of the argument. For now, though, I've got to go.