NYCLA COMMITTEE ON PROFESSIONAL ETHICS

FORMAL OPINION

No. 732

TOPIC:

OBLIGATIONS TO THIRD PARTIES; CONFIDENCES AND SECRETS; WITHDRAWING A REPRESENTATION TO A THIRD PARTY; CLIENT’S RIGHT TO RECEIVE FUNDS HELD BY ATTORNEY MAY BE SUBJECT TO ATTORNEY’S OBLIGATIONS TO THIRD PARTIES; FILING AN INTERPLEADER ACTION TO DETERMINE RIGHTS TO FUNDS HELD IN AN IOLA ACCOUNT.

DIGEST:

A LAW FIRM MAY ETHICALLY DECLINE TO RELEASE FUNDS HELD IN ITS IOLA ACCOUNT TO ITS FORMER CLIENT WHEN THE LAW FIRM, AT THE CLIENT’S REQUEST, MADE A REPRESENTATION TO A THIRD PARTY THAT THOSE FUNDS WOULD BE USED TO SATISIFY THE CLIENT’S LIABILITY TO THE THIRD PARTY. A LAW FIRM MAY REVEAL SECRETS OR CONFIDENCES TO DEFEND ITSELF AGAINST ACCUSATIONS MADE BY A FORMER CLIENT, OR IF PERMITTED BY THE DISCIPLINARY RULES OR COURT ORDER OR LAW, OR TO THE EXTENT IMPLICIT IN WITHDRAWING A MATERIALLY INACCURATE OPINION OR REPRESENTATION STILL BEING RELIED UPON BY A THIRD PARTY. ON THE FACTS PRESENTED, A LAW FIRM IS NOT ETHICALLY OBLIGATED TO FILE AN INTERPLEADER ACTION TO DETERMINE THE OWNERSHIP OF FUNDS HELD AT THE CLIENT’S REQUEST IN AN IOLA ACCOUNT.

CODE:

DR 4-101(A); DR 4-101(B)(1)-(3); DR 4-101(C)(2), (4), (5); DR 9-102(C)(1)(4); EC 4-1; EC 4-5.

QUESTIONS:

Whether a law firm would be acting unethically if it declined to release IOLA funds to a client, after making a representation to a claimant at the direction of the client that the client would pay the claimant out of settlement proceeds (now being held by the law firm in its IOLA account), without confirmation that the claimant is no longer relying on the law firm’s prior representation to the claimant? And

Whether a law firm would be acting unethically if it filed an interpleader action to resolve the issue of entitlement to the IOLA funds, if the client asserts that an interpleader action would violate client confidentiality by notifying the claimant of the IOLA funds?

OPINION:

The inquiring law firm represented a corporate client in commercial litigation to collect monies owed to the corporation for services rendered. Shortly after the law firm was retained, the client advised the law firm that the Internal Revenue Service (the “IRS”) was threatening to close the company because of its failure to pay payroll withholding taxes to the IRS. At the client’s request, the lawyer advised the IRS, orally and in writing, that the client was in the process of settling the litigation and intended to use the settlement proceeds to pay the delinquent withholding taxes owed to the IRS. The IRS did not shut down the client’s business, but, as requested, advised the lawyer that the client owed back taxes.

The litigation settled several months later and, with the client’s consent, the law firm received and deposited funds into its IOLA account. The client instructed the law firm to distribute a portion of the funds to the New York State tax authorities to satisfy its back tax liability and to pay charging liens to prior counsel and to the law firm. The client advised the law firm that it was in the process of settling its back tax liabilities with the IRS and instructed the law firm to continue holding the balance of the funds in its IOLA account.

More than a year later, the client informed the law firm that the IRS was no longer seeking the IOLA funds and demanded the return of the funds. The IRS has not filed a lien or executed any other valid security interest in the IOLA fund. The law firm asked the client to provide confirmation that the IRS had no claim on the IOLA funds, but the client declined to provide such confirmation. Thus, the law firm cannot be certain whether the IRS has an interest in or is entitled to receive funds held in the law firm’s IOLA account.

The client also objected to the law firm’s offer to file an interpleader action and pay the IOLA funds into court, claiming that the law firm would breach its duty of confidentiality if it revealed to the IRS that it was holding funds belonging to the client. The client has threatened to file a disciplinary complaint if the law firm does not release the funds in the IOLA account. The law firm seeks guidance from this Committee.

Releasing IOLA Funds to a Client

The law firm is not an escrow agent under any formal arrangement, nor, notwithstanding its prior representation to the IRS, was it formally advised by the IRS (or the client) that the IRS had a claim on any funds received on behalf of the client. Thus, Disciplinary Rule 9-102 does not apply, except insofar as the law firm is required to hold funds received on behalf of a client separate from its own property and operating accounts. The law firm has complied with the rule by depositing the client’s funds in its IOLA account.

The inaction by the IRS subsequent to the law firm’s representation to it that its client would apply the anticipated settlement proceeds to its back tax liability suggests that the law firm’s representation was instrumental in averting more serious steps that the IRS might have taken at the time, including filing tax liens that would have applied to the settlement proceeds.

The law firm believes that the client’s present demand that the law firm turn over the IOLA funds places the law firm in a difficult position. The law firm does not know whether the IRS is still relying on its prior representation that the funds would be used to satisfy the client’s back tax liability and the client refuses to provide any satisfactory evidence on this point.

Thus, the issue is whether the law firm is obliged to risk a future claim by the IRS that it made a material misrepresentation (that the client would use the settlement proceeds to resolve its back tax liability) in order to obtain a benefit (that the IRS would not take more drastic enforcement action against the client). See Bank of India v. Weg & Meyers, P.C., 691 N.Y.S. 439 (1st Dep’t 1999)(concluding that a bank could seek recovery from a law firm when the law firm had notice of a bank’s interest in certain funds but distributed the funds notwithstanding the bank’s interest).

If the law firm releases the funds to the client without confirmation that the IRS is no longer relying on its prior representation, it acts at its peril, for it may later be held financially and professionally responsible for the improper distribution of the IOLA funds. See, e.g., Leon v. Martinez, 84 N.Y.2d 83 (1994); see also Simon’s New York Code of Professional Responsibility Annotated, at 839, 41-42 (West 2003). The client may not compel the law firm to take a professional risk of such significance and we therefore conclude that the law firm may ethically insist on written confirmation that its prior representation to the IRS is no longer being relied upon before it releases the IOLA funds to the client.

Client Confidentiality

A lawyer is obliged to maintain a client’s confidences and secrets. Canon 4 of the Lawyer’s Code of Professional Responsibility (the “Code”) generally prohibits an attorney from revealing a client’s confidences or secrets. See DR 4-101(B); 22 NYCRR § 1200.19(b); EC 4-1; EC 4-5. The client has asserted that the confidence or secret that the law firm is duty-bound to preserve is its receipt of the monetary settlement.

The duty of a lawyer to preserve a client’s confidences and secrets is one of the most solemn and significant obligations imposed by the Code. See NYCLA Op. 722 (1997)(citing N.Y. City Op. 1986-7 (1986)). However, it is not absolute.

The exceptions to the rule of confidentiality are set forth in DR 4-101(C); 22 NYCRR § 1200.19(c). Without client consent or authorization, a lawyer may reveal client confidences only in limited circumstances. For example, a lawyer may reveal confidences or secrets “when permitted under Disciplinary Rules or required by law or court order.” DR 4-101(C)(2); 22 NYCRR § 1200.19(c)(2).

Thus, the firm would be permitted to reveal the client’s receipt of a monetary settlement, if permitted to do so under the Disciplinary Rules or required by law or court order. DR 4- 101(C)(2); 22 N.Y.C.R.R. § 1200.19(c)(2). If the IRS had filed a formal lien, the law firm properly could have notified the IRS of its receipt of funds on behalf of the client, notwithstanding the client’s objection. Similarly, if the client opposed payment of the IRS’s lien, the law firm could ethically file an inter pleader action to determine ownership of the funds, particularly if the client refused to provide satisfactory confirmation that the IRS claim had not been satisfied. See, e.g., Nassau County Opinion 96-13 (1996)(“If the attorney cannot determine the amount to which the third person is entitled, then the attorney may . . . take action to determine the rights of the third person . . . to the funds”); NYCLA Op. 717 (citing Nassau County 94-19 (1994) and 91-21.3 (1991)); Alabama State Bar, Op. RO 86-63 (1986); Los Angeles County Bar Ass’n, Op. 478 (1994); Oregon State Bar Op. 1991-52 (1991); Rhode Island Sup. Ct, Op. 94-50 (1994) and Op. 93-16 (1993)(dispute between attorney’s client and third party concerning entitlement to funds held by attorney may be resolved through interpleader action).

A law firm may ethically file an interpleader action to determine who is entitled to receive the IOLA funds when the ownership of such funds is disputed. However, given the client’s confidentiality concerns, in this Committee’s view, the law firm would not run afoul of the disciplinary rules by continuing to hold the IOLA funds and waiting for the client to take the next action or pursuing other legal remedies. See Simon’s New York Code of Professional Responsibility Annotated, at 839, 41-42 (West 2003).

Revealing Confidences Necessary to Defend Against an Accusation of Wrongful Conduct

The Code permits a lawyer to reveal client confidences “necessary to . . . defend the lawyer . . . against an accusation of wrongful conduct.” DR 4-101(C)(4); 22 N.Y.C.R.R. § 1200.19(c)(4). In this matter, the law firm indicated that the client threatened to file a disciplinary complaint against the law firm if the law firm refused to release the balance of the settlement to the client. In such circumstances, the law firm would be entitled to disclose confidences or secrets necessary to defend itself against the client’s accusations.

Similarly, if the client sues the law firm or asserts a counterclaim against the law firm alleging improper refusal to release the settlement balance, the law firm may disclose those confidences or secrets necessary to defend itself against the client’s accusations.

Withdrawing a Prior Opinion or Representation

Finally, there is another exception to the rule of client confidentiality that warrants discussion as the law firm’s professional dilemma arises primarily as a result of the representations it made on the client’s behalf to the IRS. Although the law firm did not ask the question, it is implicit in the inquiry made to the Committee. May the law firm withdraw its prior representation to the IRS and then proceed to disburse the IOLA funds to the client?

The Disciplinary Rules permit a lawyer to reveal “confidences or secrets to the extent implicit in withdrawing a written or oral opinion or representation previously given by the lawyer and believed by the lawyer still to be relied upon by a third person where the lawyer has discovered that the opinion or representation was based on materially inaccurate information or is being used to further a crime or fraud.” DR 4-101(C)(5); 22 NYCRR § 1200.19(c)(5); See NYCLA Op. 686 (1991)(a lawyer may disclose an oral representation made by the lawyer in the course of a negotiation that was based on information supplied by the client that the lawyer later learns is materially inaccurate and is still being relied on by a third party).

This exception to client confidentiality has several important requirements. The lawyer’s opinion or representation must have been based upon “materially inaccurate information” which the lawyer learned of after issuing the opinion or making the representation, or it must have been used to further a crime or fraud. Further, the lawyer’s opinion or representation must still be relied upon by “a third person.” Clearly, if the crime or fraud is completed, the lawyer may not withdraw the opinion or representation.

DR 4-101(C)(5) permits only a limited disclosure of confidential information. A lawyer may reveal a client’s confidences or secrets, but only “to the extent implicit in withdrawing a written or oral opinion or representation.” The rule “does not permit disclosure of the truth.” Simon’s New York Code of Professional Responsibility Annotated, at 442 (West 2003). The purpose of the permissive disclosure under DR 4-101(C)(5) is to allow an attorney whose services have been misused by a client to disassociate himself or herself from the client’s conduct or misconduct, but only when the lawyer’s opinions or representations are still being relied upon by third parties. Permissive withdrawal of an opinion or representation may be particularly efficacious in circumstances when a quiet withdrawal from the representation of the client may be insufficient to avert potential harm to third parties who are still relying on the lawyer’s statement or opinion or when withdrawal is no longer possible because the lawyer no longer represents the client. See, e.g., New York State Bar Association Report of the Special Committee to Consider Adoption of ABA Model Rules of Professional Conduct (December 14, 1984) at 22 (explanation of change to Rule 1.6(b)(3)).

Here, the law firm has not been able to ascertain whether the IRS is still relying on its prior representation that upon settlement of the client’s litigation, the proceeds would be used by the client to satisfy its back tax liability to the IRS. Nor does the law firm know whether its prior representation as to the future disposition of the settlement proceeds constitutes “materially inaccurate information,” as DR 4-101(C)(5) requires. See Mary C. Daly, “Noisy Withdrawal” From a Client’s Fraud, N.Y. Prof. Res. Rep., August 2000, at 5 (recommending steps an attorney should take to employ the permissive disclosure option under DR 4-101(C)(5)). Since the rule only permits withdrawal of a “materially inaccurate” representation which is still being relied upon by a third party, the Committee does not believe that the law firm may communicate with the IRS to withdraw its prior representation, absent client consent.

CONCLUSION:

This Committee believes that the law firm would not be acting unethically, if it declined to release the funds it has been holding, at its client’s request, in its IOLA account, until the client provides adequate confirmation that the IRS is no longer relying on the law firm’s prior representation that the funds received from the anticipated settlement would be used by the client to satisfy the client’s back tax liability. If the law firm paid the funds in its IOLA account to the client without such assurance, the IRS might reasonably claim that the law firm had breached its representation that such funds would be used by the client to satisfy its back tax liability. The law firm might be held responsible for such breach and might face serious civil and disciplinary consequences.

If the client declines to provide written confirmation that the IRS no longer has an interest in the funds being held in the law firm’s IOLA account, then the law firm may properly decline to release the funds to the client. The law firm is not ethically required to risk civil liability or disciplinary sanctions, which might result if the law firm were found to have violated its prior representation to the IRS that the client would use the proceeds from the litigation settlement to pay its delinquent back taxes to the IRS.

The law firm may not withdraw its prior oral and written representations to the IRS because it does not know whether those representations are still being relied upon. The rules permitting disclosure of client confidences should be read restrictively and a law firm should not unnecessarily disclose protected client information. However, the law firm may disclose information necessary to defend itself if the client files a complaint or claim against the law firm.

The law firm is not ethically required to file an inter pleader action to determine the question of entitlement to the funds it is holding in its IOLA account. The law firm may simply continue to hold the funds in escrow and wait for the client to take the next step.

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Addendum: The law firm recently advised the Committee that it had received a notice of garnishment from the New York State Department of Taxation and Finance, demanding payment of funds held by the law firm on behalf of its former client. The law firm further asks whether it may file a federal inter pleader action, with notice to the IRS, to determine proper ownership of the funds held in its IOLA account. The Committee’s analysis of the law firm’s obligations under these new facts is that the law firm may ethically file an inter pleader action (presumably in state court, pursuant to the CPLR), to determine ownership of the funds in its IOLA account. If so, the law firm may seek the court’s guidance as to whether the IRS should be made a party to the inter pleader action in light of the law firm’s prior representations to the IRS, at the client’s direction, that the client would use those funds to pay its back tax obligations to the IRS. Our opinion is otherwise unchanged.

NYCLA Committee on Professional Ethics Formal Opinion 732: Obligations to Third Parties Confidences and Secrets Withdrawing