November 2020 – Adapted by Peggy Gruenke – Originally Published in Attorney at Work
As an attorney, you’ve built up your skillset with years of education and training. Clients rely on you to protect some of their most sensitive information. It only stands to reason that with this trust comes a higher standard of accountability when it comes to the financial aspects of your relationship with your clients.
When we talk about ethics, it’s so easy to focus on widely-known issues: embezzlement, misrepresentation, undisclosed conflict of interest. We all know to avoid those issues and stick to the straight and narrow. The simple reality is this: you are far more likely to run into ethics trouble in many small and seemingly mundane ways when you handle your billing incorrectly. Though they may appear to be “minor” issues compared to misrepresentation or undisclosed conflicts of interest, they can still have just as devastating of an impact on your firm’s success.
Don’t fall into these five common traps whenever money changes hands.
PITFALL #1. FEES
As stated by the ABA Model Rule 1.5(b), lawyer fees are bound by ethical requirements to be “reasonable.” The pitfall comes when determining if a fee is reasonable or unreasonable? There are many factors to consider; lawyer experience, the time required by a case, client demands, and market conditions all play a role. With all of these variables in mind, it’s not difficult to understand why what is considered reasonable at the start of a case might change due to the course of events that transpire throughout the client relationship.
You can run into issues with fees in many different situations, however, it is especially common at the termination of client relationships. It can be tempting to allow a little extra to be billed for the “PITA” (aka. pain-in-the-ass) factor and advance the firm’s interests rather than those that fulfill obligation to the client. Don’t fall into this trap. Always for by the book when it comes to billing.
We also caution against rushing through the contractual parts of the engagement for several reasons. Even if the client is pushing for speed, a quicker pace can lead to errors, ambiguity, and questions down the road, particularly concerning as fees. Clients must give informed consent to fees. Start your relationship off ethically and get consent in writing at the start, by disclosing terms of the fee agreement and the associated risks.
PITFALL #2. MISMANAGING TRUST ACCOUNTS
Trust accounts aren’t something that the layperson thinks about. That being said, client trust funds are a crucial piece of law firm financial management. As you were learning to manage your money or books, chances are you didn’t start with learning how to properly manage retainers and trust accounts. As a result, client trust accounts can be one of the biggest ethics traps for firms. Especially for those who don’t properly manage client retainers. Depending on where your firm is located, your state bar association likely requires the use Trust accounts. Although clients pay retainers into these accounts, it is money lawyers have NOT actually earned yet. As you record your cash flow you cannot count those funds as income until they have been earned as no payment can be taken out of the trust fund until it is earned. In this context, earned means services have been completed and approved by the client, usually through an invoicing process.
As with most firms, you won’t be working with one client at a time. If you’re working with multiple clients via a retainer, you have multiple trust funds! This adds a layer of complexity as there’s an additional challenge of keeping funds separated. Client trust funds CANNOT be commingled. This also means they can not be used to pay for services rendered for another client nor for the firm’s general business expenses.
How does a law firm meet requirements? Here are a few basics to help you get started with your compliance guidelines:
- Don’t overdraft client ledger at the transaction level
- Always post transactions to the correct account
- Perform a three-way reconciliation monthly
And, of course, proper accounting plays a crucial role, too. Having a good bookkeeper or accountant can make or break your firm.
PITFALL #3. PROPER ACCOUNTING
Similar to what we mentioned above, the standard accounting principles used by most households and businesses simply aren’t enough for a law firm. Law firms have unique accounting needs that need to be addressed with intention.
A good example of where you will see the difference is in your firm’s billing costs. Law firms require much more segmentation when it comes to billing costs to clients. Not all costs are the same. Depending on the type of case, case costs typically need to be treated as either “advanced client costs” or “reimbursable client costs.” This distinction is important because these two types of costs are recorded differently: advanced client costs treated as an asset, reimbursable client costs are not. This means that advanced client costs are included on your balance sheets while reimbursable client costs are added to profit-and-loss statements.
Correctly attributing costs isn’t the only challenge a law firm faces. Your accounting practices need to correctly differentiate between income and revenue. When invoices are paid, part of that revenue needs to be allocated to incurred costs first. This is important to do on an invoice by invoice basis because it’s hard to determine revenue covering incurred costs from their actual income. Not taking the time to do so creates inaccurate books, compliance issues, and difficulty analyzing the ROI of cases and matters.
PITFALL #4. CREDIT CARD FEES
In today’s increasingly digital society, taking credit cards for payment doesn’t seem like a difficult question for lawyers at first glance. As we mentioned in Pit Fall #1, ethically speaking clients must understand everything they’re being billed, and that includes credit card fees. As a result, processing credit cards for legal payments has some unique requirements. When clients pay with credit cards, you must make it clear which invoices are being paid, especially when you use different systems for accounting and billing. Another challenge you’ll face with credit card fees is batching — some credit card and payment platforms batch (aka. combine) payments together when depositing funds into your bank accounts this can lead to commingling funds. To avoid this issue, accounting departments need to reconcile credit card payments DAILY to keep them from being lumped into a single deposit. If you have multiple payments over the course of the day, you’ll need to be very aware of that issue and make sure to correctly distribute the funds to the appropriate accounts as soon as possible.
PITFALL #5. BAD DATA
Incorrect information can really be detrimental to your process. To help avoid data errors, your billing and accounting systems should operate from the same sets of data, ideally, one CRM/billing platform like Clio, integrated with QuickBooks. If you are using two separate systems, you must take extra steps and use extra caution to accurately input information in both systems.
Cash flow is crucial to any business, but it’s important to remember legal professionals have more intensive ethics requirements than other professionals. Watching out for these five pitfalls can help your firm prevent mistakes and avoid problems with both clients and state ethics regulators. When it comes to money, especially clients’ money, it pays to be careful.