Daily Development for Friday, February 11, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

ATTORNEY/CLIENT; ESCROWS; INVESTMENT DECISIONS: New York Appeals court reverses trial court ruling exposing attorney to liability for investing escrow monies in failed bank.

Basinet v. Kluge, 2005 WL 22693 (N.Y. App. 1/6/05)

The trial court opinion in this case was reported as the DD for 7/178/03.  The cite for that opinion is   Bazinet v. Kluge, 196 Misc.2d 231, 764 N.Y.S.2d 320, 2003 WL 21361746,(N.Y.Sup.2003).

Attorney represented an elderly widow in the sale of two New York co-apartments.  Upon obtaining a contract for the sale, attorney received and deposited into his IOLTA account a ten percent earnest money deposit - $1,450,000 (yes - that was just the deposit).  That deal failed to close, and disputation ensued as to whether the earnest money should be returned.  In the meantime, the attorney kept the earnest money in the account (a non-interest bearing account).  Then the seller entered into a second sale of the apartments, and deposited the second earnest money deposit, $1,280,000, into the same IOLTA account - for a total of $2,760,000 in an account in a small bank insured for $100,000, non-interest bearing.

When the lawyer called the bank to order that the second earnest money deposit be released for the closing, however, he discovered to his dismay that the bank had failed a few days before.  The account was insured for $100,000, and through that, and through sale of the bank’s assets, the attorney recovered about a third of the missing funds.

This lawsuit started as a claim by the first buyer seeking reimbursement of the first deposit.  The seller crosscomplained against her lawyer for malpractice.

The trial court refused to grant a summary judgment until it had heard expert testimony as to whether the lawyer should have had a duty to (1) be more selective in the choice of banks for deposits of this size; (2) make an arrangement of accounts that would have provided greater insurance; (3) arrange for interest bearing accounts when the monies were to be held for a relatively long time.

The attorney argued that he did nothing but comply with the escrow instructions, but the trial court found that, functioning as a an lawyer for his client, the attorney had duties that went beyond the bare formalities of compliance with the escrow agreement.

On this appeal, the New York Appellate Division, in a very brief opinion, states simply that [t]here is no requirement imposed by law that an attorney-escrow agent place escrow funds in an account fully insured by the FDIC, and, there are no allegations that [the attorney] knew that [the depositary bank] was in danger of closing.  The proximate cause of [seller’s] injury, if any, was [the depository bank’s] unforseen demise.”

This case did not address the issue of whether the attorney should have had a duty to use interest bearing accounts or whether the attorney was protected by the provisions of the escrow instructions.  The lower court noted that, although IOLA accounts do not generate interest for the parties interested in the funds, and although such accounts are appropriate for most cases,  attorneys have a duty to exercise discretion as to whether the amounts of money and periods of time involved are such as to require that separate interest bearing accounts be used.  The lower court noted that interest on the deposit of the earnest money on the first sale would have generated in excess of $150,000.   It refused to dismiss a claim based upon breach of that discretion here.  The appellate court did not address this claim.

Comment 1:  This may end the litigation, of course.  The parties seeking money from the lawyer, faced with this opinion, may elect not to appeal.  (No appeal shows yet in the computer reports.)  Also, more money may have been squeezed out of the failed bank’s assets to ease the settlement.   In any event, as the editor said in this first DD on this case, the notion that lawyers should have a duty to anticipate bank failures is certainly a stretch.  If there is no duty to anticipate these failures, then likely there is no duty to seek greater security than insured accounts.

The editor would like to see a more definitive opinion on these issues - particularly on the notion that the lawyer’s duties go beyond the escrow agreement - a clear holding below that the appeals court sidestepped.

Comment 2:  The editor is still intrigued by the notion that a lawyer can deposit several millions of dollars for substantial periods of time with no duty to see to it that his client or his client’s transaction obtains the interest benefits from such a deposit.

Comment 3:  The editor gave this case a lot of play as a “scary scenario” in his continuing effort to discourage lawyers from volunteering to serve as escrows in connection with their clients’ real estate transactions.  This particular lawyer now is off the hook, apparently, but the editor’s concerns remain.  Other cases have imposed significant liabilities on attorneys in these cases.  See, e.g. Iacobellis v. Mainardi, A-6034-01T5 (N.J. App. 5/19/03) (unpublished opinion) (Lawyer who receives monies from non-client in connection with real estate closing has duty to protect interest of party providing such monies when lawyer releases them to others, where there was indication that fraud was going on,  notwithstanding lawyer’s argument that he did nothing more than perform the terms of the escrow agreement exactly.)

The editor’s real concern here, of course, is that clients agree to their lawyers serving as escrows for precisely the reason that lawyers should not so serve.  Clients think that they get an “edge” because their lawyers will “tilt” toward their interest in the performance of the escrow responsibilities.  If the lawyer does so tilt, clearly this is an actionable breach of escrow duties.  If the lawyer doesn’t tilt, the attorney/client relationship is frustrated.

Lawyers in the eastern states, where most of this goes no, argue that there is no institution of professional closing service or escrow companies in a position to provide the service, and therefore they have no choice but to do so when the transaction so requires.  This may be true, but the likely reason is that lawyer’s groups in these states have lobbied long and hard to prevent such organizations from coming into their states, since they dominate the closing businesses in other states.  Surely there’s a better way to store the money in these deals than to create the ethical dilemmas that currently exist.

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