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End-of-life notice: American Legal Ethics Library

As of March 1, 2013, the Legal Information Institute is no longer maintaining the information in the American Legal Ethics Library. It is no longer possible for us to maintain it at a level of completeness and accuracy given its staffing needs. It is very possible that we will revive it at a future time. At this point, it is in need of a complete technological renovation and reworking of the "correspondent firm" model which successfully sustained it for many years.

Many people have contributed time and effort to the project over the years, and we would like to thank them. In particular, Roger Cramton and Peter Martin not only conceived ALEL but gave much of their own labor to it. We are also grateful to Brad Wendel for his editorial contributions, to Brian Toohey and all at Jones Day for their efforts, and to all of our correspondents and contributors. Thank you.

We regret any inconvenience.

Some portions of the collection may already be severely out of date, so please be cautious in your use of this material.


Arizona Legal Ethics

1.15   Rule 1.15 Safekeeping Property

1.15:100   Comparative Analysis of Arizona Rule

1.15:101      Model Rule Comparison

The 2003 amendments to this Rule more closely aligned a lawyer's duties with the provisions of Rules 43 and 44, RASC, dealing with lawyer trust accounts. A new paragraph (b) permits lawyers to deposit their own funds into client trust accounts, but only to the extent necessary to pay bank service charges. A new paragraph (c) specifies that unearned fees and expenses must be deposited into a trust account.

Former paragraph (c), which was relettered as paragraph (e), was amended to clarify a lawyer's duties when the lawyer has possession of funds or property in which two or more persons (one of which may be the lawyer) claim an interest. When a dispute arises, the Rule requires the lawyer to promptly distribute those portions of the funds or property not in dispute, attempt to resolve the dispute and, if the dispute cannot be resolved, commence an interpleader action.

There are some differences between AZ-ER 1.15 and MR 1.15. AZ-ER 1.15(d) uses the phrase "agreement between the client and the third person" to describe one of the exceptions to the Rule's requirements, while MR 1.15(d) uses the phrase "agreement with the client." The final sentence of AZ-ER 1.15(e): "as to the portion of the property in dispute, the lawyer shall commence an interpleader action if otherwise not able to resolve the dispute.", does not appear in MR 1.15(e).

This difference between paragraph (e) of the Rules is also reflected in paragraph 4 of the accompanying Comments. In addition, the final two sentences in paragraph 6 of the Comment to AZ-ER 1.15 concerning a lawyer's professional obligation to participate in collective efforts to reimburse clients damages by dishonest conduct by lawyers does not appear in the Comment to MR 1.15. Neither does paragraph 7 of the Comment to AZ-ER 1.15.

1.15:102      Model Code Comparison

DR 9-102(A) requires that funds of a client must be maintained in an identifiable bank account in the state in which the lawyer's office is located. DR 9-102(B)(2) requires a lawyer to "[i]dentify and label securities and properties of a client promptly upon receipt and place them in a safe deposit box or other place of safekeeping as soon as practicable." In addition, a lawyer is required under DR 9-102(B)(3) to "[m]aintain complete records of all funds, securities and other properties of a client . . . ". Unlike ER 1.15(a), the provisions of DR 9-102 do not apply to property or funds of a "third person" that are in the lawyer's possession.

The lawyer's obligation to notify a client upon receiving property of a client and to promptly deliver the property to the client as set forth in AZ-ER 1.15(e), is substantially similar to the requirements imposed by former DR 9-102(B)(1) and (4). AZ-ER 1.15(c) is also substantially similar to former DR 9-102(A)(2), except that, again, AZ-ER 1.15(c) applies to situations in which a third person claims an interest in property held by a lawyer, while former DR 9-102(A)(2) did not.

1.15:110      Arizona IOLTA Plan

By Rule, the Supreme Court of Arizona has established an Interest on Lawyers' Trust Accounts ("IOLTA") program, which requires a lawyer or law firm receiving client funds to maintain a "pooled interest-bearing or dividend-earning trust account for deposit of client funds where the interest or dividends reasonably expected to be earned thereon are nominal in amount." Rule 44(c)(2), RASC. The interest or dividends earned by such monies, minus service charges, are to be paid by the depository institution holding them to the Arizona Bar Foundation, and are to be used solely for the following purposes: (a) to pay for the actual administrative costs of the IOLTA Program; (b) to fund programs to assist in delivering legal services to the poor; (c) to support law-related education programs; (d) to fund programs to improve the administration of justice; and, (e) to maintain a reserve. Id.

Under the Program, all client funds received by Arizona lawyers are to be deposited into a pooled interest-bearing or dividend-earning trust account, unless those funds are deposited: (1) into a separate interest-bearing or dividend-earning trust account for a particular client or client matter, and the interest or dividends earned by such account are paid to the client, or (2) into a pooled interest-bearing or dividend-earning trust account for several clients, the interest or dividends from which are paid proportionately to the clients. Rule 44(c)(3), RASC. For a discussion of additional requirements applicable to these, and other types of, trust accounts maintained by lawyers practicing in Arizona, see Section 1:15:200, infra.

1.15:120      Arizona Client Security Fund

Under Rule 32(d)(8), RASC, the Board of Governors of the State Bar of Arizona has the responsibility, inter alia, for maintaining the Client Security Fund, the creation of which was authorized by the membership of the State Bar in 1961. This Fund is available to reimburse clients who have suffered a financial loss due to the dishonest conduct of a member of the State Bar of Arizona. A portion of each Arizona lawyer's annual membership dues is used to fund the Client Security Fund. Rule 31(c)(7), RASC.

As required by Rule 32, RASC, the Board of Governors has adopted The Client Protection Fund of the State Bar of Arizona Declaration of Trust. The Declaration of Trust sets forth the rules and procedures for submitting a claim for reimbursement from the Client Security Fund. Generally, all claims must have been caused by the dishonest conduct of a lawyer and must stem from a client-lawyer relationship, or a fiduciary relationship customary and related to the practice of law. The claim must also be filed within three (3) years after the claimant knew or should have known of the lawyer's dishonest conduct. The Declaration of Trust also establishes a Board of Trustees, which is responsible for holding, managing and disbursing the fund monies. Payment of claims from the fund is made in the sole and absolute discretion of the Board of Trustees.

1.15:200   Safeguarding and Safekeeping Property

AZ-ER 1.15(a) requires a lawyer who holds property of a client or a third person in connection with a representation to hold such property separate from the lawyer's own property. This obligation continues even if the client moves without leaving a forwarding address and fails to communicate with the lawyer. Arizona Ethics Opinion No. 2002-08. If a lawyer receives funds or other property of a client or a third person, then the lawyer must promptly notify the client or third person of the lawyer's receipt of such funds and/or property. A lawyer should also promptly return to the client or third person the funds or other property that the client or third person is entitled to receive. AZ-ER 1.15(d). If a lawyer and another person claim an interest in funds or property in the lawyer's possession, the lawyer must keep such property or funds separate until the ownership rights have been resolved. AZ-ER 1.15(e). As the Comment to the Rule explains:

A lawyer should hold property of others with the care required of a professional fiduciary. Securities should be kept in a safe deposit box, except when some other form of safekeeping is warranted by special circumstances. All property which is the property of clients or third persons should be kept separate from the lawyer's business and personal property and, if monies, in one or more trust accounts. Separate trust accounts may be warranted when administering monies or acting in similar fiduciary capacities. A lawyer should maintain on a current basis books and records in accordance with generally accepted accounting practice and comply with any recordkeeping rules established by law or court order. See Supreme Court Rules 43(I) and 44.

Comment, AZ-ER 1.15, š 1.

The requirements imposed by AZ-ER 1.15 are both buttressed and supplemented by Rules 43 and 44 of the Rules of the Arizona Supreme Court. Rule 44 provides that Arizona lawyers have a duty to deposit all client funds into one or more identifiable trust accounts, which shall be maintained in accordance with the Rule's requirements. Rule 44(a), RASC. Rule 44 also provides that no funds of a lawyer or law firm shall be deposited into a trust account unless such funds (1) are used to pay service charges imposed by the financial institution, or (2) are owned in part by the client and the lawyer. Rules 44(a)(1) and (2), RASC. In addition, all trust account funds must be maintained in an interest-bearing account or a money market account at a regulated financial institution in accordance with Rule 44(c)(1), RASC.

Rule 44 also provides that Arizona lawyers have a duty to safeguard client property. Rule 44(b), RASC. This includes (1) notifying a client of the lawyer's receipt of client property, (2) identifying, labeling and placing client property in a place of safekeeping upon receipt, (3) maintaining complete records of the client's property and rendering an accounting to the client, and (4) promptly delivering the property to the client upon request. Rules 44(b)(1), (2), (3) and (4), RASC.

Rule 43 sets forth additional requirements for establishing, maintaining, and handling trust accounts in accordance with AZ-ER 1.15. Rule 43, RASC. This Rule provides that all lawyers have a duty to maintain complete records for the handling of client funds, security and/or assets that are in the lawyer's possession. Id. In addition, each Arizona lawyer must submit a yearly certificate certifying compliance with Arizona Supreme Court Trust Account Rules and Guidelines. Rule 43(b), RASC. A lawyer's trust account may be audited if there is some indication that AZ-ER 1.15 or these Rules have been violated. Rule 43(c), RASC. Rule 43 also includes minimum guidelines adopted by the Board of Governors of the State Bar of Arizona to ensure Arizona lawyer's compliance with AZ-ER 1.15. Generally, these guidelines list requirements for reporting to clients, and the maintenance of records.

Both the Arizona Supreme Court and the Disciplinary Commission have unhesitatingly imposed discipline upon lawyers who have commingled their funds with their clients' funds and/or converted their clients' funds to their own use. In In re Baker, 102 Ariz. 346, 429 P.2d 665 (1967), the Arizona Supreme Court upheld the disbarment of an attorney who commingled his clients' funds with his own funds, and converted a portion of such funds to his own use. See also In re Block, 103 Ariz. 508, 446 P.2d 237 (1968) (lawyer disbarred for commingling his client's restitution funds and the assets of an estate he was administering with his own funds). In addition, the Supreme Court disbarred a lawyer when he, as executor and attorney for an estate, commingled $71,000 from the estate and converted a portion of such monies to his own personal use. In re Moore, 110 Ariz. 312, 518 P.2d 562 (1974). See also Matter of Davis, 129 Ariz. 1, 628 P.2d 38 (1981) (lawyer disbarred who commingled his clients' settlement funds with his own and used them for his own benefit).

In Matter of Retter, 180 Ariz. 515, 885 P.2d 1080 (1994), a lawyer was suspended for one hundred twenty days for mistakenly depositing personal funds into his trust account, withdrawing the funds from such account, and leaving a deficit of client monies in the account for only one day. Disbarment, however, continues to remain an appropriate remedy "when a lawyer knowingly converts client property and causes injury or potential injury to a client." Matter of Henry, 168 Ariz. 141, 144, 811 P.2d 1078, 1081 (1991).

For other situations where a lawyer's failure to properly handle and/or account for client or third party funds or other property that have come into the lawyer's custody and possession resulted in the imposition of a disciplinary sanction, see Matter of Brady, 186 Ariz. 370, 923 P.2d 836 (1996); Matter of Woltman, 181 Ariz. 525, 892 P.2d 861 (1995); Matter of Kobashi, 181 Ariz. 253, 889 P.2d 611 (1995); Matter of Peartree, 180 Ariz. 518, 885 P.2d 1083 (1994); Matter of Feeley, 180 Ariz. 41, 881 P.2d 1146 (1994); Matter of Secrist, 180 Ariz. 50, 881 P.2d 1155 (1994); Matter of Struthers, 179 Ariz. 216, 877 P.2d 789 (1994); Matter of Shannon, 179 Ariz. 52, 876 P.2d 548 (1994); Matter of Merrill, 178 Ariz. 469, 875 P.2d 128 (1994); Matter of Woltman, 178 Ariz. 548, 875 P.2d 781 (1994); Matter of Miller, 178 Ariz. 257, 872 P.2d 661 (1994); Matter of Peartree, 178 Ariz. 114, 871 P.2d 235 (1994); Matter of Augenstein, 177 Ariz. 581, 870 P.2d 399 (1994); Matter of Wurtz, 177 Ariz. 586, 870 P.2d 404 (1994); Matter of Riggs, 177 Ariz. 494, 869 P.2d 170 (1994); Matter of Elowitz, 177 Ariz. 240, 866 P.2d 1326 (1994); Matter of Redondo, 176 Ariz. 334, 861 P.2d 619 (1993); Matter of Feeley, 176 Ariz. 196, 859 P.2d 1329 (1993); Matter of Evans, 175 Ariz. 404, 857 P.2d 1258 (1993); Matter of Soelter, 175 Ariz. 139, 854 P.2d 773 (1993); Matter of LaPaglia, 173 Ariz. 379, 843 P.2d 1271 (1992); Matter of Garnice, 172 Ariz. 29, 833 P.2d 700 (1992); Matter of Engan, 170 Ariz. 409, 825 P.2d 468 (1992); Matter of Grant, 169 Ariz. 498, 821 P.2d 159 (1991); Matter of Espino, 168 Ariz. 139, 811 P.2d 1076 (1991); Matter of Young, 164 Ariz. 502, 794 P.2d 135 (1990); Matter of Castro, 164 Ariz. 428, 793 P.2d 1095 (1990); Matter of MacAskill, 163 Ariz. 354, 788 P.2d 87 (1990); Matter of Galbasini, 163 Ariz. 120, 786 P.2d 871 (1990); Matter of Blankenburg, 143 Ariz. 365, 694 P.2d 195 (1984). In addition, failure to honor the obligations imposed by AZ-ER 1.15 with regard to the handling of client funds may expose the lawyer to claims of breach of fiduciary duty, in addition to claims for malpractice. Ross v. Bartz, 158 Ariz. 305, 762 P.2d 592 (App. 1988).

1.15:210      Status of Fee Advances [see also 1.5:420]

As discussed in the preceding Section, Rule 44, RASC requires lawyers to deposit client funds into a trust account that complies with the requirements of that Rule and those of Rule 43, RASC. Most fee advances or initial retainers represent advance payments for services to be rendered by the lawyer during the course of the engagement. See Matter of Engan, 180 Ariz. 13, 881 P.2d 345 (1994). Since these funds belong to the client until the lawyer actually performs the services for which the lawyer has been retained, they should be deposited into a trust account maintained by the lawyer, and not transferred into the lawyer's personal or "operating" account until they are actually earned. That principle has now been codified with the adoption of AZ-ER 1.15(c), which provides that: "A lawyer shall deposit into a client trust account legal fees and expenses that have been paid in advance, to be withdrawn by the lawyer only as fees are earned or expenses incurred."

Under AZ-ER 1.5, a lawyer may set a fixed fee for an engagement, provided that fee is "reasonable" under the tests established by that Rule. In Arizona Ethics Opinion No. 86-06, the Committee on the Rules of Professional Conduct held that a lawyer may charge a fee that is termed to be "earned upon receipt," but only if the fee meets the "reasonableness" requirement of AZ-ER 1.5(a).

In Arizona, it is probably a misnomer, however, to characterize any fee as "earned upon receipt," because of several factors. Initially, the doctrine of In re Swartz, 141 Ariz. 266, 686 P.2d 1236 (1984), which requires that the reasonableness of a fee be examined both prospectively and retroactively, applies to all fee arrangements, not just contingent fees. As the Court itself noted: "Either a fixed or contingent fee, proper when contracted for, may later turn out to be excessive." Id., 141 Ariz. at 273, 686 P.2d at 1243. The Court expressly indicated that, regardless of the nature of the fee arrangement agreed upon at the inception of the engagement, if a fee which seemed reasonable at that point becomes excessive, under the criteria of AZ-ER 1.5(a), due to unforeseen circumstances, such as an unanticipated and sudden settlement, the lawyer must reduce the fee to a level which is reasonable under the circumstances. Id.

Indeed, one of the specific requirements imposed by AZ-ER 1.16(d) upon termination of a representation, is that the lawyer refund "any advance payment of fee that has not been earned." In a number of cases in which lawyers have been found to have violated AZ-ER 1.5(a) by accepting advance retainers and not completing the engagement, the Disciplinary Commission has routinely ordered restitution to the wronged clients of the unearned fees. See Matter of Brady, 186 Ariz. 370, 923 P.2d 836 (1996); Matter of Woltman, 181 Ariz. 525, 892 P.2d 861 (1995); Matter of Secrist, 181 Ariz. 526, 892 P.2d 862 (1995); Matter of Engan, 180 Ariz. 13, 881 P.2d 345 (1994); Matter of Secrist, 180 Ariz. 50, 881 P.2d 1155 (1994); Matter of Woltman, 178 Ariz. 548, 875 P.2d 781 (1994); Matter of Peartree, 178 Ariz. 114, 871 P.2d 235 (1994); Matter of Wurtz, 177 Ariz. 586, 870 P.2d 404 (1994); Matter of Elowitz, 177 Ariz. 240, 866 P.2d 1326 (1994).

So-called "non-refundable retainers," which upon analysis are frequently simply "earned upon receipt" fees given a different name, have historically been subjected to special scrutiny by both the Supreme Court and the disciplinary authorities of the State Bar of Arizona. Matter of Hirschfeld, 192 Ariz. 40, 960 P.2d 640 (1998) involved an appeal from a unanimous recommendation of the Disciplinary Commission that the respondent attorney be disbarred for a number of ethical violations, including the use of what he referred to as "non-refundable retainer" agreements. According to the Court, Hirschfeld's practice was to obtain a significant retainer at the beginning of an engagement pursuant to a fee agreement that stated that the retainer was earned upon receipt and non-refundable, and then rely on this agreement to keep the full retainer paid, no matter how long the engagement lasted or how much work he actually performed. The Hearing Committee which considered the charges, the Disciplinary Commission, and the Supreme Court all found this practice to violate the requirement of AZ-ER 1.5 that a lawyer's fee be reasonable. The Court was careful to point out, however, that is was not adopting a rule that non-refundable retainers were per se unethical:

We do not hold that non-refundable retainers are per se violations of Ethical Rule 1.5. A retainer, in its classic sense, is a fee paid to secure a lawyer's availability, and it may be appropriate in certain circumstances. Similarly a flat fee charged for specific legal services can be proper. Regardless of how the fee is characterized, however, each situation must be carefully examined on its own facts for reasonableness. Under Swartz, lawyers are obligated to review the services they have rendered to determine whether the fees ultimately collected are reasonable. 141 Ariz. at 273, 686 P.2d at 1243.

Id., 192 Ariz. at 43-44, 960 P.2d at 643-644.

Former Ethics Counsel for the State Bar of Arizona, however, also viewed with favor the somewhat more restrictive treatment given so-called "non-refundable retainers" in the decision in In re Cooperman, 83 N.Y.2d 465, 633 N.E.2d 1069, 611 N.Y.S.2d 465 (Ct.App. 1994). Cooperman involved a situation almost identical to that presented in Hirschfeld - an attorney entering into special so-called "non-refundable retainer" agreements with clients, and then refusing to refund any portion of the retainer paid, regardless of the length of the resulting engagement or the amount of work performed. The New York Court of Appeals found such agreements to be against public policy, and subject to discipline under the former Code of Professional Responsibility, because they compromised the client's absolute right to terminate the unique attorney-client relationship:

Our holding today makes the conduct of trading in special nonrefundable retainer fee agreements subject to appropriate professional discipline. Moreover, we intend no effect or disturbance with respect to other types of appropriate and ethical fee arrangements . . . Minimum fee arrangements and general retainers that provide for fees, not laden with the nonrefundability impediment irrespective of any services, will continue to be valid and not subject in and of themselves to professional discipline.

Id., 83 N.Y.2d at 476, 633 N.E.2d at 1074, 611 N.Y.S.2d at 470. State Bar Ethics Counsel has also said the following concerning arrangements of this nature:

A "general" retainer is a payment by a client in exchange for a lawyer's promise to be available to perform legal services or a defined period of time. Courts have concluded that such a general retainer is a payment for a promise of availability and not advance payment for services and, as such, is earned upon receipt. Such a retainer should be clearly explained in the retainer agreement.

Fees that have been earned do not go into the firm trust account; they go into the general business account. If the money is placed in the trust account, a court must presume that the amount is not a general retainer but in fact is an advance payment on fees to be earned.

Shely, Contingent Fees and "Non-refundable" Retainers (State Bar of Arizona 1998), p. 2.

The propriety of such fees now must also take into account new AZ-ER 1.5(d)(3), which provides that a lawyer may not enter into an arrangement for, charge or collect "a fee denominated as äearned upon receipt,' änonrefundable' or in similar terms unless the client is simultaneously advised in writing that the client may nevertheless discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee based upon the value of the representation pursuant to paragraph (a)." The Comment to this aspect of the Rule explains the scope and reasons for this provision, and the fact that it is not intended to apply to "true retainers":

Advance fee payments are of at least four types. The "true" or "classic" retainer is a fee paid in advance merely to insure the lawyer's availability to represent the client and to preclude the lawyer from taking adverse representation. What is often called a retainer but is in fact merely an advance fee deposit involves a security deposit to insure the payment of fees when they are subsequently earned, either on a flat fee or hourly fee basis. A flat fee is a fee of a set amount for performance of agreed work, which may or may not be paid in advance but is not deemed earned until the work is performed. A nonrefundable fee or an earned upon receipt fee is a flat fee paid in advance that is deemed earned upon payment regardless of the amount of future work performed. The agreement as to when a fee is earned affects whether it must be placed in the attorney's trust account, see ER 1.15, and may have significance under other laws such as tax and bankruptcy. But the reasonableness requirement and application of the factors in paragraph (a) may mean that a client is entitled to a refund of an advance fee payment even though it has been denominated "nonrefundable," earned upon receipt" or in similar terms that imply the client would never become entitled to a refund. So that a client is not misled by the use of such terms, paragraph (d)(3) requires certain minimum disclosures that must be included in the written fee agreement. This does not mean that the client will always be entitled to a refund upon early termination of the representation (e.g., factor (a)(2) might justify the entire fee), nor does it determine how any refund should be calculated (e.g., hours worked times a reasonable hourly rate, quantum meruit, percentage of the work completed, etc.), but merely requires that the client be advised of the possibility of the entitlement to a refund based upon application of the factors set forth in paragraph (a). In order to be able to demonstrate the reasonableness of the fee in the event of early termination of the representation, it would be advisable for lawyers to maintain contemporaneous time records for all representations undertaken on any flat fee basis.

Comment, Az-ER 1.5, š 7. See also In re Connelly, 203 Ariz. 413, 55 P.3d 756 (2002).

1.15:220      Surrendering Possession of Property

Both AZ-ER 1.15(d) and Rule 44(b) of the Arizona Supreme Court Rules provide that a lawyer has a duty to promptly notify a client or third party of the lawyer's receipt of property of the client or third party. AZ-ER 1.15(b), Rule 44(b), RASC. In addition, a lawyer must promptly deliver to the client or third person any property which the clientor third person is entitled to receive. Id.

In Matter of Struthers, the Arizona Supreme Court approved the disbarment of a lawyer for, among other things, failing to notify clients of the receipt of payments made on their behalf. Id., 179 Ariz. 216, 877 P.2d 789 (1994). The lawyer argued that since the payments were to be wholly applied to the payment of legal fees, he had no obligation to notify his clients because his clients had no interest in the funds. The Court rejected that contention, holding that, since the funds initially belonged to the client and became fees of the lawyer only when distributed to the lawyer, the lawyer had a duty to notify the client and make an accounting to the client. Id., 179 Ariz. At 221, 877 P.2d at 794. See also Matter of Murray, 159 Ariz. 280, 767 P.2d 1 (1988) (a lawyer was suspended for failing to promptly deliver settlement proceeds to a client); Matter of Sadacca, 172 Ariz. 173, 836 P.2d 386 (1992) (a lawyer was placed on probation for failing to forward checks to his client); and Matter of LaLonde, 172 Ariz. 60, 834 P.2d 146 (1992) (a lawyer was disbarred for failing to notify clients that he had received settlement funds and failing to deliver the funds to his clients). The Supreme Court has recognized, however, that when a client instructs a lawyer to hold the client's money for a period of time, the lawyer does not violate his duty to promptly deliver property to his client, by complying with the client's instructions. Matter of Brooks, 15 Ariz. 142, 854 P.2d 776 (1993).

1.15:230      Documents Relating to Representation

Both AZ-ER 1.15 and Rule 44 also provide that lawyers have a duty to promptly deliver documents and other property to clients upon request. AZ-ER 1.15(b), Rule 44(b), RASC. In Matter of Redondo, 176 Ariz. 334, 861 P.2d 619 (1993), the Arizona Supreme Court found that a lawyer had violated AZ-ER 1.15 because he lost his client's documents for a period of five years. Although the client's rights had not been affected by the loss because the statute of limitations on the client's claim had run prior to the lawyer's receipt of the documents, the Court concluded that the lawyer failed to properly safeguard client property. Id., 176 Ariz. at 336, 861 P.2d at 621. See also Matter of Galusha, 164 Ariz. 503, 794 P.2d 136 (1990) (lawyer disbarred for failing to return client documents after admitting he could not perform the legal work, among other things).

The Committee on the Rules of Professional Conduct ("the Committee") has issued a comprehensive Arizona Ethics Opinion, No. 98-07, which addresses the issue of an attorney's obligations with respect to the retention, return and/or destruction of client files. The Opinion announces the following rules and/or guidelines concerning the retention of client files:

1. Materials in a client's file which were obtained from the client are generally owned by the client, and a lawyer is under an ethical obligation to use reasonable efforts to return all client property, including such materials, upon termination of the representation. Materials owned by the client may not be destroyed until, and if, a reasonable effort has been made to return such property and a reasonable notice of destruction has been given. After reasonable notice, such materials must be safeguarded for a period of time equal to that under Arizona law for the abandonment of personal property, which is currently five (5) years. See A.R.S. § 44-301 et seq.

2. The balance of the client's file belongs to the lawyer, but subject to the client's interest in and right to access to it, based upon the client's reasonable expectation that the lawyer will act to minimize possible harm to the client's interests. Consequently, the lawyer has an ethical duty to allow former clients access to their files, including internal memoranda and "work product" relating to the representation, unless there is substantial satisfaction for denying such access. The burden is on the lawyer to demonstrate justification for denying access.

3. Lawyers and law firms should establish a written client file retention and destruction policy, which complies with all case law, rule and statutory restrictions, and takes into consideration the client's foreseeable interests in securing access to materials in the client's files.

4. The client file retention and destruction policy should include an individual file review at the conclusion of a matter for a client.

5. Written notice of the lawyer's or law firm's client file retention and destruction policies should be given to the client at or before the termination of the representation, or if not given to the client at that point, prior to the destruction of the client's file.

6. In some circumstances, the lawyer may fulfill the lawyer's ethical obligations by simply tendering to the client the entire file at the termination of the representation. If that is not done, then for probate and estate matters and for certain types of criminal cases, retention of the file for an indefinite period is appropriate. For most other matters, a file retention period of five (5) years will be appropriate, but that period may vary depending upon the lawyer's judgment as to the client's reasonable need for the file materials.

7. Specified portions of a client's file may be withheld only upon a showing of a valid attorney's lien or other substantial justification.

8. If the client requests the entire file, the lawyer may deliver it or provide a full copy. In the latter event, or if the lawyer delivers to the client the original file and elects to retain a copy, the client should not be charged any copying costs.

9. The client may be charged for any additional copying costs incurred in responding to client requests after the original or one full copy of the file has been given to the client.

The latter two "guidelines" appear to be inconsistent with, and probably overrule, the Committee's Arizona Ethics Opinion No. 93-03, where the Committee opined that, where an attorney, at the conclusion of a representation, returns to the client all original documents and any other documents in the file belonging to the client, it is not improper to charge the client for the expense of making additional copies of the file. The Opinion should also be read in conjunction with Arizona Ethics Opinion No. 91-01, where the Committee ruled that an attorney who is in possession of client documents must determine if the documents have been legally abandoned before disposing of them. Similarly, in Arizona Ethics Opinion No. 97-03, the Committee determined that a lawyer holding excess funds in a trust account whose ownership cannot be determined after reasonable efforts to do so, should dispose of the funds in accordance with the provisions of Arizona's Unclaimed Property Act, A.R.S. § 44-301, et seq.

A closely related issue concerns whether a lawyer has the right to withhold all or any portion of a client's file to secure, or coerce, payment of the lawyer's fees. AZ-ER 1.16(d) concludes with the thought that: "The lawyer may retain papers documents reflecting work performed for the client to the extent permitted by other law only if retaining them would not prejudice the client's rights." AZ-ER 1.8(i)(2), on the other hand, provides that, notwithstanding the general prohibition on a lawyer acquiring a proprietary interest in the subject matter of litigation, a lawyer may "acquire a lien granted by law to secure the lawyer's fees or expenses ..." There is obviously a potential conflict between a lawyer's obligation upon termination of representation to "take steps to the extent reasonably practicable to protect a client's interests," AZ-ER 1.16(d), and a lawyer's exercise of a right to retain the client's papers as security for the payment of the lawyer's fees.

An attorney may, with the agreement of the client, accept a lien on property as security for the payment of fees. Thus, in Skarecky & Horenstein, P.A. v. 3605 North 36th Street Co., 170 Ariz. 424, 825 P.2d 949 (App. 1991), a law firm had accepted, as security for payment of its fees, the assignment of its clients' beneficial interest in a deed of trust. The Court of Appeals agreed with the firm's contention, on an appeal from a Superior Court's determination that the assignment was void and unenforceable, that it did not operate to give the firm an improper proprietary interest in a cause of action, but was rather a legally and ethically permissible lien acquired as security for the payment of the firm's fees. Similarly, in Arizona Ethics Opinion No. 86-12, the Committee ruled that a lawyer representing a client in a marital dissolution proceeding may secure the payment of the lawyer's fees and costs by taking a lien on community funds after the preliminary injunction contemplated by A.R.S. § 25-315 is issued.

The two principal categories of "nonconsensual" lawyer liens that have been recognized in Arizona are "charging liens" and "retaining liens." National Sales & Service Co., Inc. v. Superior Court of Maricopa County, 136 Ariz. 544, 667 P.2d 738 (1983). "Charging liens" attach to the funds or other property created or obtained by the attorney's efforts. Id. The Supreme Court has held that a "charging lien" arises only when it appears that the parties agreed to look to the fund itself for the payment of the attorney's fees. Linder v. Lewis, Roca, Scoville & Beauchamp, 85 Ariz. 118, 333 P.2d 286 (1958).

"Retaining liens," on the other hand, attach to the files, books and records that come into an attorney's possession, or are generated by the attorney, during the course of an engagement. The issue of the propriety of an attorney asserting a "retaining lien" as security for the payment of fees was first addressed in Arizona Ethics Opinion No. 81-32. The Committee essentially avoided the issue, ruling that if an attorney had a retaining lien "as a matter of law," the attorney could assert the lien, as security for the payment of fees, on client property in the attorney's possession.

The issue of whether Arizona would recognize the existence and propriety of a "retaining lien" "as a matter of law" was first (and finally) addressed in National Sales & Service Co., Inc. v. Superior Court of Maricopa County, 136 Ariz. 544, 667 P.2d 738 (1983). The Court initially pointed out that no Arizona appellate court had previously addressed the issue of whether such liens were valid, but noted that such liens were contemplated by DR 5-103(A)(1) of the Code of Professional Responsibility, which was then in effect in Arizona. The Court also noted that, in the absence of prior decisional or legislative authority to the contrary, Arizona courts were usually inclined to follow the principles of the Restatement of the Law, and that both § 62 of the Restatement of Security and § 464(b) of the Restatement (Second) of Agency recognized retaining liens in favor of an attorney as security for the payment of fees and recovery of advances. Accordingly, the Court determined:

We therefore hold that an attorney has a retaining lien as security for the general balance due him for professional services and disbursements upon the papers and other chattels of his client which come into his possession in his professional capacity.

Id., 136 Ariz. at 546, 667 P.2d at 740.

After encouraging attorneys and clients to negotiate and resolve fee disputes without resorting to the assertion of liens and/or litigation, the Court noted that there would clearly be circumstances where it would be inconsistent with the lawyer's duties to the client to assert a lien right with respect to portions of the client's file. Laboring without a detailed record that would permit it to give definitive guidance on this issue, the Court could only announce general guidelines as to when the assertion of a lien would be proper. Thus, it pointed out that it would be proper for the lien to attach to the lawyer's, and the lawyer's staff's, research notes and internal memoranda concerning the engagement. Such work product was, in the Court's view, the lawyer's property and remained the lawyer's property at least until the lawyer was paid. The Court then observed:

On the other hand, we believe it is improper for the lien to attach to a document given by the client to the lawyer for a purpose inconsistent with the fixing of a lien upon it. If, for example, a client brings an original document or instrument to a lawyer for delivery to another, then the client's purpose is inconsistent with the fixing of a lien upon the document or instrument ... Likewise, if a client brings some book, document or other chattel to his lawyer for use as an exhibit at an impending trial, the client's purpose is inconsistent with the fixing of a lien upon the document. In either of the above cases the lawyer's duty to seek his client's lawful objectives and to avoid prejudice or damage to his client are inconsistent with his assertion of a retaining lien.

Id., 136 Ariz. at 546, 667 P.2d 740 (citations omitted). Briefly summarized, the rule which emanates from the National Sales decision is that an attorney has, and may assert, a "retaining lien" with respect to work product generated by the lawyer or the lawyer's staff during the course of an engagement. With respect to other papers received and retained by the lawyer during the course of an engagement as part of the client's "file," the attorney may assert a "retaining lien" as security for the payment of fees, but not if to do so would be inconsistent with the lawyer's obligations to accomplish the client's objectives or if the assertion of a lien with respect to all or any portion of the file would damage or prejudice the client's interests.

The Court in National Sales based its decision upon two separate grounds: (1) the fact that former DR 5-103(A)(1) of the Rules of Professional Responsibility (which is no longer in effect in Arizona) seemed to contemplate "retaining liens," and (2) the fact that sections of two separate Restatements, which Arizona courts are inclined to follow in the absence of contrary Arizona authority, but neither of which specifically addressed the obligations of lawyers, also seemed to recognize them.

In that regard, it is interesting to note that § 43 of the American Law Institute's Restatement of the Law Governing Lawyers takes a somewhat different approach to the issue of retaining liens. Section 43(1) does permit a lawyer to retain documents prepared by the lawyer or at the lawyer's expense as security for the payment of fees if retaining such materials would not unreasonably harm the client's or former client's interests, which is consistent with National Sales. That Section also provides, however, that a lawyer may not retain possession of, or assert a lien with respect to, a client's property, unless a statute or rule authorizes that, or the client has agreed to such an arrangement. This seems more restrictive than the rule announced in National Sales, but the issue has not been considered by the Supreme Court since the promulgation of the Restatement.

Exercise of such a "retaining lien" is, quite obviously, only proper where there are unpaid fees which the lawyer has properly earned. Thus, in Matter of Martinez, 174 Ariz. 197, 848 P.2d 282 (1993), the Disciplinary Commission imposed the sanction of public censure and probation upon the respondent for a variety of ethical violations, including violations of AZ-ER 1.16. The violation of AZ-ER 1.16 was based on the fact that Martinez, after failing to keep several clients informed as to the status of their matters and receiving requests from those clients for the return of their files, failed to turn them over. In Matter of Struthers, 179 Ariz. 216, 877 P.2d 789 (1994), the Supreme Court approved the disbarment of Struthers for a host of ethical violations, most of which grew out of his operation of a child support collection practice. In one instance, the Disciplinary Commission had found that Struthers had violated AZ-ER 1.16(d) when, after one of his clients had terminated his representation, he refused the client and her new attorney access to her file. Struthers defended this action on a variety of bases, including making the contention that he was merely exercising his lien rights with respect to the file. The Court found that it need not address that issue, because it had already found that Struthers was using an ambiguous and facially invalid fee agreement, so that in this particular instance: "Struthers collected more than a fair fee and thus had no lien and no arguable right to retain the client's file." Id., 179 Ariz. at 225, 877 P.2d at 798.

 

1.15:300   Holding Money as a Fiduciary for the Benefit of Clients or Third Parties

The Comment to AZ-ER 1.15 provides, in pertinent part, that "[a] lawyer should hold property of others with the care required of a professional fiduciary." Comment, AZ-ER 1.15, š 1. A lawyer's fiduciary obligations under AZ-ER 1.15 apply not only to the care of client property, but also to the property of third persons which comes into a lawyer's possession in connection with a representation. AZ-ER 1.15(a). Failure to honor the obligations imposed by AZ-ER 1.15 with regard to the handling of client or third party funds or property may expose the lawyer to claims of breach of fiduciary duty, in addition to claims for malpractice. Ross v. Bartz, 158 Ariz. 305, 762 P.2d 592 (App. 1988).

In Matter of Shannon, 179 Ariz. 52, 876 P.2d 548, modified 181 Ariz. 307, 890 P.2d 602 (1994), the Arizona Supreme Court disciplined a lawyer for, inter alia, failing to act as a fiduciary to a third party. The lawyer had received a settlement check from opposing counsel, which was to be used to satisfy a judgment against the opposing counsel's clients. The lawyer, however, cashed the check, and refused to return the satisfaction of judgment to opposing counsel. The Court held that, by cashing the check without meeting opposing counsel's conditions on the payment, the lawyer had violated AZ-ER 1.15 by failing to act as a fiduciary to the opposing lawyer's clients. Id., 179 Ariz. at 65, 876 P.2d at 562. See also Matter of Secrist, 180 Ariz. 50, 881 P.2d 1155 (1994) (a lawyer was disbarred for failing to protect and deliver settlement funds to a health care provider, who had a medical lien).

Issues concerning a lawyer's obligations toward third parties with a claim to funds or other property which have come into the lawyer's possession have frequently arisen with respect to medical liens on the proceeds of the lawyer's client's monetary recovery. In Arizona Ethics Opinion No. 88-06, the Committee on the Rules of Professional Conduct ("the Committee") opined that an attorney holding the proceeds of a client's personal injury claim, against which a third party is asserting a lien, may disburse the funds to the third party if the lawyer is satisfied that the third party is entitled to receive them. The Committee went on to point out, however, that an attorney who doubts the validity of such a lien should hold the disputed funds in trust until the dispute can be resolved and, if it is not resolved within a reasonable time, the attorney should seek a resolution through an interpleader action or some equivalent formal proceeding. See also Arizona Ethics Opinion No. 88-02. In Arizona Ethics Opinion No. 97-03, the Committee determined that a lawyer holding excess funds in a trust account whose ownership cannot be determined after reasonable efforts to do so, should dispose of the funds in accordance with the provisions of Arizona's Unclaimed Property Act, A.R.S. § 44-301, et seq.

In Arizona Ethics Opinion No. 97-02, the Committee addressed several ethical issues raised by the situation where a lawyer is representing a client who has a federal health insurance contract that has a right of recovery/subrogation against the proceeds of the client's personal injury settlement. The Committee initially advised that the policy's right of subrogation created an "interest" in the proceeds, so that the lawyer, consistently with the obligations imposed by AZ-ER 1.15, could not counsel the client to sign a release that might extinguish the insurer's claim unless the attorney intends to honor the claim from the proceeds. The Committee also noted that the lawyer could not disburse the settlement proceeds without notifying the plan and delivering to the insurer any portion of the proceeds to which it was entitled.

In Arizona Ethics Opinion No. 98-06, which was not limited in its application to "medical liens," the Committee concluded lawyers are not to "unilaterally assume to arbitrate" matters between a client and third party creditors, and an attorney's obligations under AZ-ER 1.15(b) are triggered only when the attorney has "actual knowledge" of a "matured legal or equitable claim" to all or any part of the funds or other property held by the attorney. Where those conditions are satisfied, however, the attorney holding funds does have a fiduciary obligation to third parties who have such a matured claim and, once on notice of such a claim, the attorney must:

1. Promptly notify the third party of the attorney's receipt of funds subject to the third party's claim;

2. Promptly deliver to the client and to the third party only funds or property the party is entitled to receive; and

3. If the attorney has any "good faith doubt" as to who is entitled to receive any disputed funds, the attorney must notify the third party, investigate with reasonable diligence, promptness and competence, hold only the disputed funds in trust pending resolution of the dispute, and resolve the dispute by negotiation, arbitration or, if necessary, by filing an interpleader action.

In Arizona Ethics Opinion No. 03-05, the Committee concluded that an attorney for a plaintiff or claimant may not ethically enter into any settlement agreement that would require that attorney to indemnify the settling and released parties from any lien claims against the settlement proceeds.

1.15:400   Dispute Over Lawyer's Entitlement to Funds Held in Trust

In the event a lawyer holds property in which both the lawyer and a client or third person claim an interest, AZ-ER 1.15 requires the lawyer to hold such property separate until there is an accounting and a severance of interests. AZ-ER 1.15(c). In addition, if a dispute arises concerning the payment of the lawyer's fees, the disputed fees must be kept separate until the dispute is resolved. AZ-ER 1.15(e). Paragraph 3 of the Comment to the Rule specifies that all undisputed fees must be returned to the client.

The Comment also acknowledges that lawyers often receive money from third parties out of which their fees are paid. In that circumstance:

Lawyers often receive funds from which the lawyer's fee will be paid. The lawyer is not required to remit to the client funds that the lawyer reasonably believes represent fees owed. However, a lawyer may not hold funds to coerce a client into accepting the lawyer's contention. The disputed portion of the funds must be kept in a trust account and the lawyer should suggest means for prompt resolution of the dispute, such as arbitration. The undisputed portion of the funds shall be promptly distributed.

Comment, AZ-ER 1.15, š 3.

In Arizona Ethics Opinion No. 88-06, the Committee on the Rules of Professional Conduct ("the Committee") opined that an attorney holding the proceeds of a client's personal injury claim, against which a third party is asserting a lien, may disburse the funds to the third party if the lawyer is satisfied that the third party is entitled to receive them. The Committee went on to point out, however, that an attorney who doubts the validity of such a lien should hold the disputed funds in trust until the dispute can be resolved and, if it is not resolved within a reasonable time, the attorney should seek a resolution through an interpleader action or some equivalent formal proceeding. See also Arizona Ethics Opinion No. 88-02.

Similarly, in Arizona Ethics Opinion No. 98-06, the Committee concluded that lawyers are not to "unilaterally assume to arbitrate" matters between a client and third party creditors, and an attorney's obligations under what was then AZ-ER 1.15(b) are triggered only when the attorney has "actual knowledge" of a "matured legal or equitable claim" to all or any part of the funds or other property held by the attorney. Where those conditions are satisfied, however, the attorney holding funds does have a fiduciary obligation to third parties who have such a matured claim and, once on notice of such a claim, the attorney must:

1. Promptly notify the third party of the attorney's receipt of funds subject to the third party's claim;

2. Promptly deliver to the client and to the third party only funds or property the party is entitled to receive; and

3. If the attorney has any "good faith doubt" as to who is entitled to receive any disputed funds, the attorney must notify the third party, investigate with reasonable diligence, promptness and competence, hold only the disputed funds in trust pending resolution of the dispute, and resolve the dispute by negotiation, arbitration or, if necessary, by filing an interpleader action.

The final conclusion of that Opinion has now in effect been codified in AZ-ER 1.15(e). As relettered and amended in 2003, that paragraph now requires that if the lawyer cannot successfully obtain a resolution of the dispute as to funds or property held by the lawyer, then "the lawyer shall commence an interpleader action . . ."