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New Jersey Law Journal
October 22, 2002
Tim O'Brien
This term, after eight years of national litigation, the
U.S. Supreme Court will hear arguments on whether IOLTA programs
are constitutional. The issue is whether Washington state's
program -- and by extension, all similar programs that siphon
off interest from attorney trust accounts -- violates the
Fifth Amendment prohibition against a governmental taking
without just compensation.
Potentially at stake are IOLTA funds in all 50 states and
the District of Columbia. Since its inception in 1981 in Florida,
IOLTA has generated close to $2 billion nationwide. New Jersey's
program has collected $145 million since it began in 1988.
Annually, IOLTA programs take in about $150 million nationwide
and about $18 million in New Jersey, where 75 percent goes
to legal services for the poor.
If those with a vested interest in those objectives are just
a little worried, they nevertheless insist that recent proposed
changes in the state supreme court's IOLTA rules are not aimed
at a potentially devastating U.S. Supreme Court ruling.
David Satz Jr., chairman of the IOLTA Board of the Bar of
New Jersey, says the proposed changes, which are largely to
nomenclature, have been in the works for a year.
Specifically, they would replace the word "interest"
with "income." Interest-bearing accounts would become
non-interest-bearing accounts. The program would change to
the Income on Non-Interest-Bearing Lawyers Trust Accounts
Fund, or IOLTA for short.
Moreover, according to an explanatory statement, the rule
changes would be clarifying that "income realized from
the IOLTA trust accounts" is not the client's, and certainly
not the lawyer's, but "initially is the property"
of the bank.
"Since its inception, the New Jersey IOLTA program has
been premised on the fact that under New Jersey law there
can be certain statutory or regulatory exceptions to the general
rule that interest on principal stays with the principal,
and in certain defined situations a portion of that interest
may be retained by government to serve important public purposes,"
the statement runs.
Melville Miller Jr., executive director of Legal Services
of New Jersey who sits on the IOLTA board ex-officio, says
the changes are not being offered "as a cure to the national
litigation" but rather to "clear up the limited
issue of state property law."
But critics of IOLTA say the move is an effort to play with
semantics to protect the state's program in case the U.S.
high court finds Washington's program violates the Fifth Amendment
takings clause.
"There is no real substantive change. It's camouflage,"
says Michael Horn, who represents the New Jersey League of
Community Bankers, the former Savings League. Horn, a partner
with Newark, N.J.'s McCarter & English, says "it
appears that the Supreme Court will hold that it's an unconstitutional
taking, so just to call it a noninterest-bearing account by
a wave of the typewriter is wrong. A rose by any other name
is still a rose."
GROUNDED IN TEXAS
"That won't fly," says Richard Samp, chief counsel
to the Washington Legal Foundation, the conservative policy
organization that is the plaintiff in the Washington state
case and in another IOLTA challenge in Texas. "Texas
tried the same thing. It was a major part of their argument,
but the 5th Circuit put the back of their hand to that argument."
It was the property law of Texas that sunk that state's IOLTA
program in Phillips v. Washington Legal Foundation,
521 U.S. 1117 (1998), the only IOLTA case to reach the U.S.
Supreme Court. The Court upheld the 5th U.S. Circuit Court
of Appeal's conclusion that "any interest that accrues
belongs to the owner of the principal" and that the owner
is the client. The Court, in a 5-4 decision written by Chief
Justice William Rehnquist, held that "the interest income
generated by funds held in IOLTA accounts is the 'private
property' of the owner of the principal."
The justices concluded that under Texas state law, the interest
income is the property of the client for the purposes of the
takings clause. They remanded the case to the district court
to determine whether the funds were taken by the state and
if so whether there was just compensation.
The district judge found no taking because there was no identifiable
and compensable loss to the client. In other words, without
an IOLTA progam there never would have been any interest,
as IOLTA accounts are just for small amounts, or amounts held
for short periods of time, that never generated interest pre-IOLTA.
Last October, the 5th Circuit reversed in a 2-1 opinion,
finding that a per se taking existed because the state permanently
appropriated the client's interest against his will. The court
said it could not find a "just compensation" remedy,
but nevertheless said the IOLTA opponents were entitled to
declaratory or injunctive relief, and remanded the case to
the district court. Washington Legal Foundation v. Texas
Equal Access to Justice Foundation, No. 00-50139.
The Texas Equal Access Foundation, which runs IOLTA in that
state, has petitioned for certiorari to the U.S. high court
but the justices have not yet acted on that petition.
Samp says the Texas IOLTA proponents argued on the remand
that the interest was the property of the banks, but they
were rebuffed by the 5th Circuit on that point, and have not
made that claim in their certiorari petition.
Meanwhile, the Washington state case will be argued Dec.
9. There, the Legal Foundation of Washington, which operates
IOLTA, lost 3-0 before a panel of the 9th U.S. Circuit Court
of Appeals, but the full court reversed en banc, 7-4, in a
June 2001 ruling, concluding that the use of interest from
IOLTA accounts did not constitute a taking.
IOLTA opponents speculate that if the Court rules against
IOLTA in the Washington case, it will remand the Texas case
to the district level to adhere to its ruling.
And that's not all. "If we win in Washington, then there
will be many IOLTA programs around the country that will be
looking for what is distinguishable in their program,"
says Samp, who is counsel on both cases. He says the foundation
will go after every IOLTA program nationwide.
OLD LANGUAGE, NEW LANGUAGE
Charles Rounds Jr., a professor at Suffolk University Law
School in Boston and a witness for the Washington Legal Foundation,
criticizes the New Jersey proposed rule change for a separate
reason.
He says by changing interest to income, and by calling the
accounts non-interest-bearing and ordering banks to hand over
a protion of their income, the state court is in effect regulating
the banks.
"Aren't banks in New Jersey regulated by the state government?
Where is the statatory authority for the court to say to a
bank that it 'must from its income on such IOLTA accounts
remit to the Fund' some of that income?" he says referring
to the wording of the proposed rules change.
He and Horn of McCarter & English say if the interest
is the bank's from the start, then the bank in effect is charging
itself interest, which they maintain is absurd.
Miller, of Legal Services of New Jersey, who played a key
role in developing the rule changes, says the court is just
regulating the practice of law by stipulating what must be
done with trust funds.
Miller says it is should be obvious that when New Jersey
set up its IOLTA program there was an understanding that money
generated by such accounts cannot be the property of the client.
He makes the same point that all the states have made as amicus
in the IOLTA wars: but for IOLTA there wouldn't be any interest.
Moreover, even if there is a taking, there cannot be any just
compensation because the value of nothing is nothing.
IOLTA opponents answer by again citing the Supreme Court,
which said in Phillips that "a physical item is not 'property'
just because it lacks positive economic or market value."
Rehnquist wrote, "it is not that the client funds to
be placed in IOLTA accounts cannot generate interest, but
that they cannot generate net interest."
If Washington state loses before the Supreme Court, and if
that leads to a suit against New Jersey's seven justices by
the Washington Legal Foundation, IOLTA opponents are likely
to use the initial language of New Jersey's rule, while the
state will rely on the anticipated changes.
The rule was the result of a 1987 recommendation and report
of the Supreme Court Committee on IOLTA.
The committee wrote that the concept of "pooling funds
to produce interest income" for the program "derives
from the conclusion that it is economically impractical to
identify the interest earned as the property of any one client,"
implying that the interest does indeed belong to clients.
In a question and answer part of the report, the question
of whether the program will "deprive my clients of their
interest money," was answered: "The program was
not meant to utilize interest money from all clients' trust
deposit ... only from those which are nominal in amount or
to be paid for a short period of time."
Miller, who has been on the board since its inception and
who derives 35 percent of the $38.5 million annual Legal Services
budget from IOLTA, signed the report as a committee member.
A portion of the existing rule that is dropped under the
changes instructs participating attorneys to maintain "an
interest-bearing IOLTA account for all clients' funds ...
[which] otherwise are not likely to realize income for the
clients ... ."
And another part of the current rule, which is not being
revised, says that it's the IOLTA fund itself, not the bank,
that "will be the owner of any interest generated by
the funds deposited ... ."
Miller says that though it sounds contradictory, it is not.
"That's a declaration that the Fund is the owner, and
is not in fact new."
As for the other language from 1987 and 1988, Miller reiterates
that because there ordinarily would not be any interest for
the client, there was never any understanding that the client
owned it. "The bank always claimed the interest,"
he said.
Samp of the Washington Legal Foundation says, finally, he
believes the rule changes are an effort at an end-run that
will not work. He cites the Supreme Court in Phillips,
which was quoting from Webb's Pharmacies v. Beckwith, 449
U.S. 155, 162, the 1980 case that reiterated the notion that
interest follows principal.
In Webb's Pharmacies, the Court said, "A state, by ipse
dixit, may not transform private property into public property
without compensation simply by legislatively abrogating the
traditional rule that 'earnings of a fund are incidents of
ownership of the fund itself and are property just as the
fund itself is property.' In other words, at least as to confiscatory
regulations, a state may not sidestep the Takings Clause by
disavowing traditional property interests long recognized
under state law."
Miller counters by saying a line of cases in the state show
that there can be exceptions to interest following principal,
and that IOLTA funds fall within that line.
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