Can the government combine and take the interest earned on the short-term deposits of client funds and put it to use for legal aid without compensating the clients? Government's Hand in IOLTA Cookie Jar

Four years ago, the U.S. Supreme Court established that interest generated on client funds deposited in lawyers' trust accounts is the private property of the clients. But in arguments heard December 9, several justices seemed skeptical of following that decision to its logical conclusion by declaring that the Takings Clause of the Fifth Amendment constitutionally prohibits states from siphoning off the interest accrued on client funds in order to support legal aid programs for the poor.

Interest on Lawyers' Trust Accounts (IOLTA) programs, at work in all 50 states and the District of Columbia, require attorneys to deposit client funds held for short periods of time, such as legal settlements and jury awards, in specially designated and segregated accounts. These IOLTA accounts earn interest, and the interest accrued is enormous--more than $200 million last year. For instance, in California, IOLTA accounts earned $8.3 million in interest that was promptly collected and given to legal aid projects.

Although the principal funds are returned to their rightful owners--the clients--the interest does not accrue to the owners' benefit. In an age of multi-million dollar jury awards, legal settlements and real estate transactions, IOLTA programs present a serious constitutional problem: Can the government combine and take the interest earned on the short-term deposits of client funds and put it to use for legal aid without compensating the clients?

The answer to this question is, of course, "no." The plain text of the Takings Clause clearly establishes that such a blind grab without compensating the owners is constitutionally impermissible. After all, the U.S. Supreme Court already ruled that the accrued interest is the property of the clients, and no one questions that the interest is being taken for public use without sending even a "thank you" card to the clients.

Nevertheless, at oral argument in Washington Legal Foundation v. Legal Foundation of Washington, No. 01-1325, several justices seemingly ignored the $200 million of property being taken. Instead, they dwelled on whether the client-owners of IOLTA money would be able to reap any interest if their funds were deposited in separate short-term bank accounts as opposed to being combined with other IOLTA funds in long-standing interest-bearing accounts.

Because individual client's funds are deposited for only a short period of time, the accrued interest for each client is small. For instance, the two clients represented by the Washington Legal Foundation, which brought the challenge, earned $2 and $5, respectively, on their IOLTA deposits.

These small amounts of interest at stake for individual IOLTA depositors led some justices to openly question whether the states were unconstitutionally taking private property at all by redirecting the accrued interest en masse to public interest legal services. Specifically, several justices wondered how there could be an unconstitutional taking if each client's interest gains might be wiped out by bank fees and transactions costs associated with depositing funds in separate short-term accounts.

For instance, Justice Sandra Day O'Connor asked: "How is it a taking if the compensation is zero?"

Other justices were even more unequivocal. "The interest never gets to the person who gets the principal," Justice David Souter remarked. "The bank gets to keep it." Justice Stephen Breyer echoed the same sentiment in noting that, without IOLTA programs, the clients "couldn't have earned any interest" at all.

Such questions completely miss the point.

The Takings Clause states "nor shall private property be taken for public use without just compensation" and focuses on the private property actually being taken rather than hypothetical gains or losses that may occur if the owner had the opportunity to make choices about the property himself. Thus, the sole concern should be the interest that actually accrues on IOLTA accounts and to whom that money belongs.

In other words, Justice Antonin Scalia got it right when he attempted to shine the High Court's light on the real constitutional injury. "Whose money earned the interest?" he rhetorically asked. But even Justice Scalia echoed some of the other justices' misdirection, at one point observing: "It's not a lot of money, but it's their money."

Actually, the 50 states and the District of Columbia are taking a lot of money.

A little or a lot, amount does not matter when it comes to the Fifth Amendment's Taking Clause--a taking is a taking is a taking. At least that's what the text says.

December 12, 2002
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