How To Handle Trust Account Overdrafts
We’ve said it before: the key word in “trust accounting” is “trust”. Mistakes that might be acceptable in other kinds of financial management are disastrous when administering a trust. For example, if you overdraft your business account you might be embarrassed when a vendor has to berate you about a bounced check, but if you overdraft your escrow you could be in serious legal trouble. Your practice needs policies for avoiding overdrafts and handling overdrafts.
Avoid overdrafts by maintaining a minimum balance or cushion in the account. There is no easy formula for a proper cushion so you will have to determine the right amount through experience. A large account or an account with a volatile balance will need a larger minimum than accounts that are small and/or stable. Your legal billing and accounting software should be able to alert you when trust balances are running low so you can request more money from the source funding the trust.
Stay on top of any deposits and withdrawals in an account so overdrafts don’t take you by surprise. Remember that just because you enter an amount in your trust account software doesn’t mean the transaction actually goes through on that date. Take into account delays that might affect how long it takes for transactions, especially deposits, to clear an account.
No matter how careful you are, overdrafts happen. Whether it’s an error from your office or something out of your control, you need to deal with the overdraft immediately. First the escrow must be sufficiently funded, even if that means you have to deposit money from your own practice’s resources. Once you have solved the problem you can reimburse the practice for the “loan” you made to the trust fund, but you can’t let the account remain in delinquency.
Check with your state bar for reporting requirements. Even a momentary shortage of funds that is corrected the same day must be reported to the bar. Document everything in your law practice management software even if it makes your office look bad because it will ultimately help you by making it clear this was an honest mistake rather than deliberate misappropriation.
If the escrow account is one of several matters combined into a single bank account, as most escrow accounts are, then you need to check for overdrafts of either the overall bank account or the individual matter. Either type of overdraft needs to be addressed quickly.
Scrupulous attention to detail is essential to proper trust administration. Use dedicated escrow software to stay on top of any trust accounts placed in your care.