Attorneys as Escrow Holders or, “No Problem. We’ll Just Deposit the Sale Proceeds into my Trust Account.”
It’s just another day at my office. Let’s assume that my client (let’s call her Judith) calls me with the good news that a buyer wants the Witkin Avenue residence that she and her husband, Stephen, jointly own. It’s mid-case. Judith asks me if I will hold the anticipated $250,000 in sale proceeds in my trust account until the remaining issues in her case are settled. I’ve done that before for clients but never involving anything close to $250,000. She says that Stephen trusts me and that he’s okay with me holding the funds in trust. I like my client and I want to say yes, no problem. Something tells me, though, to proceed with caution. I just don’t know what I don’t know.
Attorneys often serve as escrow holders. We agree to temporarily hold funds of the parties in our cases. We hold not just funds but also deeds, stock certificates, and other important papers pending satisfaction of certain agreed conditions. We are exempt under state law from the licensing rules that would otherwise apply to us as escrow holders. See Cal. Fin. Code § 17006(a)(2). We are accustomed to matters going smoothly in our handling of escrowed property. They generally do. But California case law (including cases involving damage suits and attorney discipline cases) informs us that not every attorney escrow in California has gone well. The purpose of this article is not to alarm the reader. It is to alert the reader to some of the potential pitfalls that could, at least in theory, await the attorney escrow holder; to suggest ways to minimize risk to the attorney who provides escrow services; and, to suggest some practical options to the attorney asked to serve as escrow holder.
The author does not claim to have all of the answers to the legal and ethical questions that arise when an attorney agrees to serve as escrow holder. The absence of clear guidelines is, in itself, a reason for caution when an attorney is asked to provide escrow services. Although there are California State Bar ethics opinions to guide us, and reported cases that have dealt with situations where attorneys have served as escrow holders, many unanswered questions remain.
What should I be asking myself before agreeing to serve as escrow holder?Some of the issues addressed in this article are:
- If I agree to hold in trust funds belonging to both sides, am I an escrow holder? If all I do is agree to hold a deed sent to me by opposing counsel, am I nevertheless, an escrow holder?
- If I’m an escrow holder, what are my duties to the party on the other side of the case? What are the ramifications of assuming fiduciary duties to both my own client and the opposing party with respect to the subject matter of the escrow?
- Do I have to have a written agreement to serve as an escrow holder? If I don’t have a written agreement, have I violated the Rules of Professional Conduct?
- Do the Rules of Professional Conduct require that I notify my client of the conflict of interest in serving as escrow holder? Do the Rules require that I obtain my client’s written consent? Just what do the Rules require that I disclose?
- If a dispute arises over the funds that I hold in escrow, am I permitted to represent my client in a dispute over the funds I hold without the written consent of the other party to the escrow to whom I owe a fiduciary duty?
- If I recommend that the parties deposit jointly owned funds into an account requiring two signatures to withdraw funds, is my client adequately protected? Is the bank responsible if a mistake is made and funds are withdrawn with just one signature? What do I need to tell my client to protect myself?
- If I decide that I don’t want to be in the position of escrow holder, is there another option, perhaps a licensed company that will serve as the escrow holder for a fee?
- Does my malpractice insurance cover me if I am sued by the party to the escrow whom I don’t represent?
The scenarios that follow are intended to illustrate certain important considerations the attorney who has been asked to provide escrow services should bear in mind.
SCENARIO ONE: EASY. ALL I HAVE TO DO IS DEPOSIT THE FUNDS IN TRUST. RIGHT?
My client, Judith, calls me. She tells me about the pending sale of the Witkin Avenue residence. I believe that the sale is very much in Judith’s best interest. I’m aware of the importance of safeguarding the $250,000 net proceeds of the sale after the close of escrow and until the issues in the case are resolved. The case has gone smoothly and amicably. I have a good working relationship with Stephen’s attorney. I’ve never had a problem holding funds in trust under similar circumstances in the past. I agree to hold the funds in trust. I receive a letter from Stephen’s attorney expressing consent to my serving as escrow holder pending written agreement of the parties for disposition of the funds or order of the court. I set up a trust account at a bank to receive the funds, receive the $250,000 proceeds of sale, then, without further ado, I deposit the $250,000 into the trust account. For reasons discussed below, by doing this, I have probably just violated the Rules of Professional Conduct.
THE ATTORNEY WHO HOLDS FUNDS IN TRUST FOR THE CLIENT BECOMES AN ESCROW HOLDER. AS ESCROW HOLDER, THE ATTORNEY OWES FIDUCIARY DUTIES TO BOTH THE CLIENT AND TO THE THIRD PARTY CO-OWNER OF THE ESCROWED FUNDS.
The court of appeal in the case of Peterson Development Company, Inc. v. Torrey Pines Bank defined an escrow as, “a transaction in which one person, for the purpose of effecting a sale, transfer or encumbrance of real or personal property to another person, delivers any written instrument, money, evidence of title or other thing of value to a third party, the escrow holder or depository, to be held by him for ultimate transmittal to the other person upon the happening of an event or the performance of certain specified conditions.” 233 Cal. App. 3d 103, 118 (1991) (citation omitted). The court continued, “[t]he usual purpose that prompts the creation of an escrow is the desire of persons dealing at arm’s-length with each other to have their conflicting interests handled by one person in such a manner as to adequately protect the rights of each of the parties to the transaction” Id. (citation omitted).
Applying the above definition of an escrow, the attorney who holds funds for his/her client and for the spouse of his/her client for the purpose of affecting the sale of the parties’ real property serves as an escrow holder.
The attorney who serves as an escrow holder owes a fiduciary duty to both his or her client and to that client’s spouse. The case Virtanen v. O’Connell dramatically illustrates the point. See 140 Cal. App. 4th 688 (2006). In that case, attorney O’Connell represented the buyer of stock and agreed to serve as the escrow holder in the transfer of the stock from Virtanen to O’Connell’s client. Id. A detailed stock purchase agreement was signed and Virtanen’s attorney delivered the share certificates to O’Connell together with a cover letter specifying the conditions under which O’Connell was authorized to deliver the certificates to O’Connell’s client. Id. Thereafter, Virtanen rescinded the transaction. Id. Despite the rescission and in contravention of the terms of the conditional delivery of the certificates to him, O’Connell delivered the certificates to the transfer agent for delivery to O’Connell’s client. Id. A jury later found that O’Connell and his law firm had converted the shares of stock. Id. A judgment of $1,985,000 plus costs was entered against O’Connell and his firm. Id. The court of appeal said, “’[a]n escrow holder is the agent of all the parties to the escrow at all times prior to performance of the conditions of the escrow [citations]; bears a fiduciary relationship to each of them [citation]; and owes an obligation to each measured by an application of the ordinary principles of agency.’” Id. (quoting Diaz v. United California Bank, 71 Cal. App. 3d 161, 168 (1977)) “Although [O’Connell] owed [Virtanen] no professional duty, his acceptance of [Virtanen’s stock certificates gave] rise to a duty of care. The wellspring of this duty is the fiduciary role of an escrow holder. [Citations.] The fiduciary obligations of an escrow holder, and an attorney acting as an escrow holder, are well settled.”
Id. at 703.
RULE OF PROFESSIONAL CONDUCT 3-310 “AVOIDING THE REPRESENTATION OF ADVERSE INTERESTS”
Rule 3-310(B) provides in pertinent part:
(B) A member shall not accept or continue representation of a client without providing written disclosure to the client where:
(1) The member has a legal, business, financial, professional, or personal relationship with a party or witness in the same matter;
Rule 3-310(C) provides in pertinent part:
C) A member shall not, without the informed written consent of each client:
(1) Accept representation of more than one client in a matter in which the interests of the clients potentially conflict; or
(2) Accept or continue representation of more than one client in a matter in which the interests of the clients actually conflict; or
Recall that in this scenario, I agreed to hold the proceeds of sale of the Witkin Avenue residence in trust for the parties, received instructions from Stephen’s attorney, and, without more, I deposited the proceeds of sale in trust. I believe that, in so doing, I violated Rule of Professional Conduct 3-310(B) and 3-310(C). Here’s why: In holding the funds in trust, I became an escrow holder. As escrow holder, I assumed a fiduciary duty not only to my own client but also to Judith’s husband, Stephen. Upon assuming a fiduciary duty to Stephen, I failed to disclose the conflict to my client, Judith. I also failed to obtain Judith’s written consent.
The fact that I am not Stephen’s attorney does not preclude application of Rule 3-310. The Court of Appeal in the case of American Airlines, Inc. v. Sheppard, Mullin, Richter & Hampton, addressing Rule 3-310(C) said, “[a]pplication of Rule 3-310(C) does not require representation of both clients as an attorney. The discussion section which follows Rule 3-310 states: ‘Subparagraphs (C)(1) and (C)(2) are intended to apply to all types of legal employment, including the concurrent representation of multiple parties in litigation or in a single transaction or in some other common enterprise or legal relationship.’” 96 Cal. App. 4th 1017, 1032-33 (2002).
How, in the real world, might such a conflict between my client and the other party to the escrow arise? A plausible scenario: Let’s assume that I deposited the $250,000 proceeds of sale into the trust account; that Judith calls me to tell me that she has just learned that Stephen secretly drained $100,000 from a community property investment account; and Judith instructs me to take $50,000 of the $250,000 I hold in trust and pay the $50,000 to her. She provides me with irrefutable documentation that she is correct. Stephen, through his attorney, objects to the removal of any funds from the trust account without Stephen’s written consent or court order. Judith insists that, as her attorney, I have a duty to pay the funds over to her. At that point, I explain to her, for the first time, that I have a conflict of interest; that I have a fiduciary duty to Stephen not to release funds over his objection; and that, in the absence of Stephen’s written consent to the release of funds or a court order, I cannot comply with her instructions for the release of funds to her. She is very upset. It seems to her that she has provided proof that the $50,000 should be paid to her and that my duty to her as her attorney comes before any duty that I have to Stephen. She’s also upset that I never explained these things to her before I agreed to serve as escrow holder. I review Rules 3-310(B) and (C) and realize that I failed to disclose the conflict of interest and to obtain Judith’s written consent to proceed despite the conflict. For the first time in my career, I’m very worried that I could be in trouble with the State Bar.
SCENARIO TWO: OFF TO COURT TO REPRESENT MY CLIENT IN A DISPUTE OVER ESCROWED FUNDS—OR, MAYBE, I CAN’T DO THAT. MIGHT I NOW HAVE A STATE BAR PROBLEM?
Let’s assume it’s my client, Judith’s, divorce case as described above. Assume that I prepared and the parties and counsel signed an agreement by which I am authorized to hold the $250,000 in trust pending written agreement of the parties or order of the court. I disclosed in the agreement that in serving as an escrow holder, I owe a fiduciary duty to both parties and that, because I owe them both a fiduciary duty with respect to the escrowed funds, I have a conflict of interest. I obtained in the agreement the express written consent of both parties to proceed as escrow holder despite the conflict of interest. Let’s assume that in so doing, I believe that I have fully complied with Rule 3-310.
Next comes the immutable, “It’s always something” rule of the practice of law. Judith calls me to tell me she has learned that Stephen secretly drained $100,000 from a community property investment account. She wants $50,000 from Stephen’s share of escrowed funds. I explain that a court order will be needed to obtain compensation for her from Stephen’s share of the funds. I inform Stephen’s attorney that I intend to proceed with a Request for Order seeking authorization to release the funds to Judith. Stephen’s attorney objects. He takes the position that I may not represent Judith in such a proceeding that involves the funds I hold in escrow without violating my fiduciary duty to Stephen. He says that if I wanted to preserve the right to represent Judith in any dispute over the funds that I hold in escrow, I should have addressed that in the written escrow agreement and obtained Stephen’s consent in that document.
Might Stephen’s attorney be correct? After all, I acknowledge that I have a fiduciary duty to both parties as to the escrowed funds. Might a judge find that representing Judith in a contest over the funds is inconsistent with my fiduciary duty to Stephen? I do the research but can’t find anything directly on point in reported California authorities. I do, however, find language right on point in an ethics opinion by the Committee on Professional and Judicial Ethics of the New York City Bar. After reading the opinion, although dealing with New York law, I am impressed by its logic. I take Stephen’s attorney’s position more seriously. In Formal Opinion 1986-5, the Committee stated:
As a general rule, it is ethically permissible for a lawyer to represent a client and to act as escrow agent in the same transaction if all interested parties have consented after full disclosure by the lawyer of the possible effect of his dual role on the interests of each party, and if it is obvious that the lawyer can adequately represent the interests of all parties. See DR 5-105(C); N.Y. County 573 (1969). Such consent must be fully informed. A consent based upon the contemplated discharge of routine escrow instructions, without taking into account potential disputes among the parties, is not sufficient to override a conflict of interest in the event of a dispute.
It is advisable therefore, to include in the escrow agreement carefully drafted provisions making clear that the non-client party agrees that, in the event of a dispute between the parties with respect to the escrow or the underlying transaction, the lawyer may represent his client in the dispute. Such a provision clarifies the scope of the non-client’s consent and therefore lessens the likelihood of confusion and delay that might be caused by the lawyer’s attempting to obtain such consent after a dispute occurs, or having to resign as escrow agent or being disqualified from representing his client.
Lawyer as Escrow Agent, Formal Opinion 1986-5 (N.Y. City Bar, Comm. on Prof’l and Judicial Ethics, July 14, 1986) (emphasis added) (citation omitted).
I tell Judith that I’m not certain how a judge would rule on the issue of whether I may represent her in a dispute over release of escrowed funds to her. Judith is upset that I failed to warn her that I might not be able to represent her in a dispute over the funds. Now I’m also worried that I may have had a duty to disclose to my client that I might not be able to represent her in the event of a dispute over the escrowed funds. I research the Rules of Professional Conduct and find Rule of Professional Conduct 3-310(A)(1) which provides, “(A) For purposes of this rule: (1) ‘Disclosure’ means informing the client or former client of the relevant circumstances and of the actual and reasonably foreseeable adverse consequences to the client or former client.” It seems to me that, in the absence of a provision in the agreement allowing me to represent Judith in a dispute over escrowed funds, I may have had a duty under Rule 3-310(A)(1) to disclose to Judith the potential problem in representing her in any such dispute.
SCENARIO THREE: I HOLD THE DEED AS ESCROW HOLDER THEN REFUSE MY CLIENT’S DEMAND TO DELIVER THE DEED TO HER.
It’s post judgment. In this scenario, assume that the marital settlement agreement provides that Judith will keep the Witkin Avenue residence; that she will pay Stephen $125,000 for his interest; and that Stephen will provide Judith with an Interspousal Transfer Deed in exchange for payment to him of the $125,000. Stephen’s attorney sends me a letter enclosing the deed and instructing me to deliver the deed to Judith only when I hold her check payable to Stephen for $125,000. Without giving it much thought, I decide that I don’t need a written agreement signed by the parties authorizing me to serve as escrow holder as to the deed. Why would a written agreement be needed when all I’m asked to do is hold a deed until certain conditions are satisfied? Next, Judith tells me that Stephen has failed to pay a $50,000 debt that he was ordered by the judgment to pay and that the creditor required her to pay the $50,000, which she did to avoid being sued. She provides me with solid proof. She credits herself with the $50,000, provides me with a check for Stephen in the amount of $75,000, and asks me to turn over the deed to her. Something tells me that, even though I’m sure that Judith only owes Stephen $75,000, there could be a problem if I turn the deed over to Judith without Stephen’s consent.
I research my duties. I review the Vertanen case (supra) in which attorney O’Connell took possession of Mr. Vertanen’s share certificates as escrow holder and then was successfully sued for wrongfully turning the certificates over to his client. I also find the case of Wasmann v. Seidenberg. 202 Cal. App. 3d 752 (1988). In that case, attorney Peter Seidenberg represented Wife in her divorce case. Id. Husband’s (Wasmann’s) attorney sent Mr. Seidenberg a final draft property settlement and a grant deed signed by Husband together with a letter authorizing recordation of the deed only when Seidenberg provided the agreed amount of consideration to Husband. Wife obtained the grant deed and recorded it without paying Husband. Id. Husband sued Seidenberg. Id. The Court of Appeal said:
Having accepted the deed from Wasmann, Seidenberg was bound to comply strictly with the escrow instructions. Specifically, he was obligated to prevent recordation of the deed until Barbara deposited into escrow the sum due to Wasmann. Violation of an escrow instruction gives rise to an action for breach of contract; similarly, negligent performance by an escrow holder creates liability in tort for breach of duty.
Id. at 756 (citations omitted).
Based upon my research, I conclude that having accepted the deed and having received the letter of instructions of Stephen’s attorney, I, like attorneys O’Connell and Seidenberg, in fact, took on the role of escrow holder. I now realize that I have a legal duty to Stephen not to turn over the deed to Judith without Stephen’s consent or an order of the court. I realize that even though I accepted a deed as distinguished from money belonging to the parties, I am, nevertheless, serving as an escrow holder. Now I wish that I had given more thought to the matter before I agreed to hold the deed. I conclude that I should have had a written agreement to serve as escrow holder, should have disclosed to Judith the conflict of interest that I undertook in agreeing to hold the deed, and should have obtained Judith’s written consent to the conflict of interest. I wish I had told Judith that I might not be able to turn over the deed to her without Stephen’s consent or court order in the event of a dispute between Judith and Stephen regarding the subject matter of the escrow. I also wish that I had obtained the consent of both parties to represent Judith in contested proceedings relating to the escrow.
Query whether the result would be the same if the judgment had provided that Stephen was to provide the deed to me, that Judith was to provide the $125,000 payment to me, and that I was then to deliver the $125,000 payment to Stephen and release the deed to Judith. Perhaps, under those circumstances, I would not have assumed the role of escrow holder with the attendant duties.
SCENARIO FOUR: I SUGGEST THAT JUDITH TRY TO REACH AN AGREEMENT WITH STEPHEN TO DEPOSIT THE NET PROCEEDS OF SALE OF THE WITKIN AVENUE RESIDENCE INTO AN ACCOUNT REQUIRING TWO SIGNATURES FOR WITHDRAWAL.
In this scenario, it’s mid-case. Judith calls me with the good news about the sale of the house. My instincts tell me to avoid holding the proceeds of sale of the Witkin Avenue residence in trust myself. I recommend to Judith that she try to reach an agreement with Stephen to deposit the proceeds of sale into a bank account requiring the signature of both parties to withdraw. Judith calls me back a few weeks later to tell me that Stephen agreed to open an account requiring two signatures to withdraw funds. She’s not happy, though, that she called more than ten banks before she found one that would set up that type of account. I was unaware that most banks no longer offer two-signature accounts. Three months later, Judith calls me to tell me that Stephen has unilaterally withdrawn all of the funds from the account that was supposed to require two signatures for withdrawal. She says the bank acknowledges its error in allowing the withdrawal on only Stephen’s signature, sincerely apologizes, but disclaims any responsibility on the basis of the terms of the written agreement under which the account was opened. That agreement, in the small print, absolves the bank of liability in the event it inadvertently releases funds on only one signature. Judith is disappointed that, when I suggested an account requiring two signatures to withdraw funds, I didn’t warn her that she would not have recourse against the bank if it mistakenly released funds on just one signature.
SCENARIO FIVE: I DON’T WANT TO SERVE AS ESCROW HOLDER. I’M SURE THAT THERE MUST BE SOME OTHER WAY TO HOLD FUNDS IN AN ESCROW PENDING WRITTEN AGREEMENT OF THE PARTIES OR ORDER OF THE COURT.
Fortunately, I’m right. After some online looking, I discover that there are private escrow companies in California licensed by the California Department of Business Oversight that will provide professional escrow services for a fee. I suggest to Judith that she research these companies online, identify several to check out, find out what she can about each of them, and ask each one about the fees they would charge for escrow services in her situation. I tell Judith that the charges quoted can be steep. I urge her to ask whether the charges are negotiable.
SCENARIO SIX: STEPHEN IS ANGRY ENOUGH AT ME TO SUE ME. WILL MY MALPRACTICE INSURANCE COVER THE CLAIM?
Let’s assume in this scenario that Judith is transferring title to the Witkin Avenue residence to Stephen in return for Stephen’s payment of $125,000 to Judith. I have agreed in a writing signed by Judith, Stephen, opposing counsel, and by me that, as a condition of releasing funds to Judith, I will obtain the signed deed from Judith, warranties to the various appliances remaining in the house, the remote for the garage, and two sets of keys to the house. I do all that I’m supposed to do, release the deed to Stephen, transfer Stephen’s $125,000 check to Judith, and close my file. Next, I receive a letter from a new attorney, a plaintiff’s tort attorney, who represents Stephen. Stephen claims that a retaining wall at the home has failed and that expensive repairs are needed. Stephen says that Judith told him that she had informed me about the problem with the retaining wall and thought I had informed Stephen’s attorney. Stephen claims that as escrow holder, I had a fiduciary duty to him to disclose all significant information I knew relating to the real property subject to the escrow. I know that my malpractice insurance will cover claims by my own client. I’m not so sure about coverage if Stephen sues me. I call my carrier. I am told that whether I’m covered may depend upon how the complaint is framed. If the complaint alleges only that I breached the escrow contract, I might not be covered. If the complaint alleges that I negligently handled escrow services, I probably will be covered. (Author’s note: What I’ve said about possible coverage is based on a conversation I had with my own carrier when I said I was writing this article and asked about coverage under my own policy if I were to serve as an escrow holder. I have not completed an industry-wide survey. I raise the question of insurance coverage in escrow situations but do not have general answers. I cannot begin to answer the coverage question for you, the reader.)
I could change the scenario to hold back $50,000 at Judith’s request, or introduce other complications. The uncertainty about insurance coverage grows.
WHAT SHOULD THE ATTORNEY WHO WILL SERVE AS ESCROW HOLDER CONSIDER INCLUDING IN A WRITTEN ESCROW AGREEMENT?
Following are my suggestions (certainly not a complete list) for provisions to include in a written agreement for an attorney to serve as escrow holder:
- Disclose the relevant circumstances and the actual and reasonably foreseeable adverse consequences to the client. (Rule 3-310(A))
- Clearly describe what the attorney as escrow holder is to do and all specific conditions of the escrow. (Rule 3-300(A))
- Advise the client that he/she should consult an independent attorney with respect to the written agreement. (Rule 3-300(B))
- Disclose that the attorney assumes a fiduciary duty to each party as to the subject matter of the escrow; that having a fiduciary duty to both parties creates an inherent conflict of interest; that both parties are aware of the conflict of interest and expressly waive that conflict (Rule 3-310(B) and (C)); that the attorney must comply with the terms of the written escrow agreement; and that the attorney will not be able to comply with any unilateral instructions of either party that are inconsistent with the provisions of the escrow agreement or the written instructions of the other party.
- Disclose that in the event of a dispute between the parties with respect to the subject matter of the escrow the attorney-escrow holder may have to seek instructions from the court by way of a Request for Order or interpleader. If the attorney-escrow holder intends to look to escrowed funds for payment of reasonable fees arising from any such court proceedings, the intent should be clearly stated.
- Disclose that the attorney will continue to serve as attorney for the client at the same time as serving as escrow holder.
- Disclose that assuming fiduciary duties to both parties might compete with the attorney’s fiduciary duties to the attorney’s client.
- Provide that, in the event of any dispute over the subject matter of the escrow, the parties to the escrow agree that the attorney-escrow holder may represent the client of that attorney in the dispute and, that the parties waive the conflict of interest.
- If the attorney-escrow holder will look to escrowed funds for payment of fees, describe in detail how such fees will be charged, against whose share of funds fees will be charged, and other relevant details.
(The author thanks attorney Ellen R. Peck who wrote about attorneys providing escrow services and, in particular, the question of provisions to include in an attorney escrow agreement in an article titled “Duties to Third Parties” that appeared in the February 2007 edition of the California Bar Journal.)
After doing the research necessary for this article, I very much doubt that I will agree to serve as escrow holder of funds in my cases. I will probably suggest that my client find a licensed escrow company to handle the escrow. In making that suggestion, I will urge my client to contact several such companies to compare fees charged and to ask each company contacted about the negotiability of fees. If I do decide to serve as escrow holder, I will carefully draft the written escrow agreement. Finally, even if I simply agree with opposing counsel to hold a deed pending satisfaction of some condition, I will carefully consider the implications of serving as attorney-escrow holder as to the deed.
I cannot answer the question of what you the reader should do if asked to serve as attorney-escrow holder. The purpose of this article is only to provide you with food for thought. ■