ETHICS OPINION 665-1985 ESCROW AGREEMENT: ATTORNEY’S RETENTION OF ACCRUED INTEREST; CLIENT’S PRIOR WRITTEN CONSENT.

New York County Lawyers’ Association Opinion No. 665

In answering questions, this Committee acts by virtue of the By-laws of the Association, Article 54, Section 3:

“This Committee shall have power, when consulted, to advise inquirers respecting questions of proper professional conduct, reporting action to the Board of Directors from time to time.”

It is understood that this Committee acts on specific questions submitted ex parte and in its answers bases its opinion on such facts only as are set forth in the question.

QUESTION NO. 665

TOPIC: ESCROW AGREEMENT: ATTORNEY’S RETENTION OF ACCRUED INTEREST; CLIENT’S PRIOR WRITTEN CONSENT.

DIGEST: AN ATTORNEY MAY NOT RETAIN THE INTEREST EARNED ON ESCROW FUNDS AS AN ADMINISTRATIVE CHARGE EVEN THOUGH HIS CLIENT HAS PREVIOUSLY CONSENTED IN WRITING.

May an attorney representing a client for the purchase of a house and serving as the escrow agent for the transaction, keep the interest earned on the escrow funds as a “carrying charge” or “accounting charge” if the client, the seller, and the seller’s attorney have consented beforehand in a written agreement?

ANSWER TO QUESTION NO. 665

The question comes to this Committee in the following factual context: The attorney for a prospective house purchaser serves as the escrow agent, pursuant to a written agreement between the parties, for a $10,000 fund placed with him by his client. The purchaser’s attorney then deposited the fund in an interest-bearing bank account. The escrow agreement, signed by all parties before the purchaser placed the fund with his attorney, provides that the purchaser’s attorney shall retain the interest to be earned on the fund as a “carrying charge” or “accounting charge”.

In the opinion of the Committee, it would be ethically improper for the attorney-escrow agent to seek or accept the interest earned on escrow funds without regard to the work performed or charges actually incurred in establishing or managing such an account.

The propriety of retaining interest earned on escrow funds has been considered previously by several other ethics committees. Despite some variation in approach, each committee has reached similar conclusions. There has been some difference of opinion regarding the effect and form of client’s prior consent to the anticipated retention of the interest by the attorney. See N.Y. State 532 (1981); N.Y. City 79-48 (1979), 81-68 (1982); Queens Cty. Opinion 36 (1983); Nassau Cty. Opinions 84-2 (1984), 80-5 (1980).

The leading New York opinion arises from a strikingly similar interest retention clause in a real estate purchase escrow agreement. N.Y. State 532 (1981). The agreement there provided that the attorney-escrow agent need not account to either party for the amount or disposition of the interest. The New York State Bar Association, in a thorough and thoughtful opinion, concluded:

Such a fee arrangement presents so great a danger of unfairness, deception, overreaching and conflict of interest, or the appearance thereof, that we find any such arrangement per se improper under the standards incorporated in such Code provisions as Canon 5 and 9, EC 2-17, EC 2-18, EC 5-3, EC 9-5, EC 9-6, DR 2-106(A) and DR 9-102(A) and(B) Cf. DR 5-104(A).

While adopting a per se prohibition of such interest retention agreements like that which is in issue here, it did recognize that a lawyer may permissibly provide in an escrow agreement for a reasonable charge for escrow or administrative expenses.

The Association of the Bar of the City of New York has historically taken a less restrictive position. In a 1931 situation, where the agreement was silent as to both the amount of the attorney’s compensation and the disposition of the interest, the Association advised that the attorney may not “arbitrarily” retain the interest. N.Y. City 181 (1931). More recently, the Association of the Bar held retention of escrow interest improper without the client’s consent, but did not extend a per se prohibition to all interst retention agreements. The Association relied on the absence of specific prohibitory language on the Code of Professional Responsibility. N.Y. City 79-48, 81-68, supra. It did recognize, however, the potential dangers of deception, overreaching, conflict of interest and appearance of impropriety posed by any such agreement.

It is for this reason that agreements between attorneys and clients, if challenged, are subject to very strict scrutiny. The attorney bears the burden of demonstration that the agreement was fair and that it was made by the client with full knowledge of all material circumstances known to the attorney.

N.Y. City 81-68 (1982).

The Nassau County Bar Association initially viewed retention of interest as improper, even if done, pursuant to prior consent, in the absence of full disclosure and a written agreement containing “all the terms and conditions under which any interest earned will be paid and to whom it will be paid.” Nassau Cty. Opinion 80-6 (1980). However, after considering N.Y. State 532, the Nassau Bar recently adopted a position in accord with the New York State Bar Association, holding such a broad interest retention agreement per se improper. Nassau Cty. Opinion 84-2 (1984).

The Queens County Bar Association has held improper a broad interest retention provision similar to that at issue here. It also indicated that any agreement permitting the attorney- escrowee to be paid a specified administrative fee from the accrued interest was “fraught with problems . . . [which] would include: (a) fairness of escrow attorney’s compensation, (b) possible conflict of interest, and (c) adequacy of disclosure of compensation for administrating the escrow account.” Queens Cty. Opinion 36 (1983).

This Committee concludes that an agreement permitting an attorney to retain all of the interest accrued on an escrow account, without regard to the attorney’s expenses or labor in establishing or administering the account, is per se improper. This Committee agrees with the reasoning of N.Y.State 532 and its conclusion, viz., that escrow compensation may not be permissibly measured only by the amount or rate of the interest. We believe that the spirit of the Code of Professional Responsibilty, and the ethical and practical requirements of preserving the attorney’s fiduciary role and the client’s confidence in it, require the adoption of a per se prohibition. Furthermore, this Committee believes that the specific agreement at issue, by its very nature, poses two serious ethical problems which cannot be resolved within the context presented:

1. Fairness of Escrow Attorney’s Compensation. An attorney may not charge a clearly excessive fee. He may only charge or accept a fee commensurate with his services See DR 2-106(2) In a typical real estate transaction, it would be extremely difficult for an attorney to justify receiving all of the interest earned on the escrow security deposit as an administrative fee. Only in an extraordinary situation would the actual cost of administering the account even approach a significant proportion of the total amount of interest earned. There appears to be no apparent nexus between the undisclosed amount of the anticipated interest and either the attorney’s labor and expenses or the bank’s service charges.

Absent such a nexus, the fee would be prima facie unreasonable. See DR 2-106(A) and (B); EC 2-16; 2-18.

2. Conflict of Interest. An attorney may not represent a client when he has an interest in the litigation, economic or otherwise, adverse to the interest of his client. See DR 5-104; EC 5-3. Where, as here compensation is measured by the amount or rate of interest, rather than by independent and proper criteria related to the attorney’s actual work or expenses, the attorney effectively acquires an economic interest in the litigation, potentially adverse to his client. In the situation presented, the attorney would receive a greater “administration fee” the longer the escrow remains on deposit. It would obviously be in the attorney’s interest to delay the happening of the event which is to terminate the escrow. Such an inherent conflict undermines the fiduciary nature of the attorney-client relationship as well as that of the escrow arrangement. It should Moreover, since the attorney’s duty is owed to his client, the consent of his adversary or others is not relevant here.

The Committee does believe, however, that there would be no ethical impropriety if the attorney were reimbursed for any disbursements made by the attorney on behalf of the client for administration fees actually charged the attorney by the bank. The Committee sees no objection to the attorney charging legal fees for services actually rendered administering such an account provided that the client has been fully informed and has agreed.

 

May 16, 1985