State Bar of Arizona Ethics Opinions

11-03: Liens; Safekeeping Client Property; Third-Party Interest in Settlement Funds
12/2011

A lawyer holding property in which both the client and a third person have an “interest” must account for the property, pay undisputed sums to the proper party, and abide resolution of any disputes.  Arizona Rules of Professional Conduct (“ERs”) 1.15(d), (e).  ER 1.15(d) requires a lawyer with knowledge of claims against the client to protect those with an “interest” in funds in the lawyer’s control.  An “interest” is a matured legal or equitable claim.  The ethical rules do not require a claimant’s lawyer to search public records or other sources for medical liens or claims in order to acquire knowledge of an “interest.”



FACTS

Lawyers representing plaintiffs in personal injury or property damage matters may face conflicting claims of third parties who assert a right to proceeds recovered in such matters senior to the interests of the client.  Those interests may (or may not) be evidenced by liens or have priority under applicable law (for example, arising from support orders).
 
The client or the third party claimant may or may not have disclosed the existence of such liens and claims to the lawyer.
 
QUESTION PRESENTED
 
What inquiry must the claimant’s lawyer undertake with respect to potential competing liens or claims of which the lawyer is unaware?
 
APPLICABLE ARIZONA RULES OF PROFESSIONAL CONDUCT (“ER __”)
 
ER 1.0  Terminology
 
. . .
 
(f) “Knowingly,” “known,” or “knows” denotes actual knowledge of the fact in question.  A person’s knowledge may be inferred from circumstances.
 
. . . .
 
ER 1.2  Scope of Representation and Allocation of Authority between Client and Lawyer
 
(a) Subject to paragraphs (c) and (d), a lawyer shall abide by a client’s decisions concerning the objectives of representation and, as required by ER 1.4, shall consult with the client as to the means by which they are to be pursued.  A lawyer may take such action on behalf of the client as is impliedly authorized to carry out the representation.  A lawyer shall abide by a client’s decision whether to settle a matter.  In a criminal case, the lawyer shall abide by the client’s decision, after consultation with the lawyer, as to a plea to be entered, whether to waive jury trial and whether the client will testify.
 
. . .
 
(d) A lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent, but a lawyer may discuss the legal consequences of any proposed course of conduct with a client and may counsel or assist a client to make a good faith effort to determine the validity, scope, meaning or application of the law.
 
ER 1.7  Conflict of Interest: Current Clients
 
(a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest.  A concurrent conflict of interest exists if:
 
(1) the representation of one client will be directly adverse to another client; or
(2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.
 
. . . .
 
ER 1.15  Safekeeping Property
 
(a) A lawyer shall hold property of clients or third persons that is in a lawyer’s possession in connection with a representation separate from the lawyer’s own property. Funds shall be kept in a separate account maintained in the state where the lawyer’s office is situated, or elsewhere with the consent of the client or third person. Other property shall be identified as such and appropriately safeguarded. Complete records of such account funds and other property shall be kept by the lawyer and shall be preserved for a period of five years after termination of the representation.
 
. . .
 
(d) Upon receiving funds or other property in which a client or third person has an interest, a lawyer shall promptly notify the client or third person. Except as stated in this Rule or otherwise permitted by law or by agreement between the client and the third person, a lawyer shall promptly deliver to the client or third person any funds or other property that the client or third person is entitled to receive and, upon request by the client or third person, shall promptly render a full accounting regarding such property.
 
(e) When in the course of representation a lawyer possesses property in which two or more persons (one of whom may be the lawyer) claim interests, the property shall be kept separate by the lawyer until the dispute is resolved. The lawyer shall promptly distribute all portions of the property as to which the interests are not in dispute.
 
ER 2.1  Advisor
 
In representing a client, a lawyer shall exercise independent professional judgment and render candid advice.  In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social and political factors, that may be relevant to the client’s situation.
 
RELEVANT ARIZONA ETHICS OPINIONS
 
Ariz. Ethics Ops. 88-02, 88-06, 97-02, 98-06, 03-05
 
OPINION
 
Obligations of a lawyer as to funds held by the lawyer subject to competing interests
 
The Committee has addressed in several prior opinions the responsibility of plaintiff’s lawyers with respect to funds due to the claimants and potentially to third parties in injury cases. 
 
In Op. 03-05, the Committee determined that a claimant’s lawyer may not ethically enter into any settlement agreement that would require the lawyer to indemnify or hold a released party harmless from any lien claims against settlement proceeds, as such an agreement would create an ER 1.7 conflict of interest between the client and lawyer. 
 
In Op. 98-06, the Committee determined that the obligations of ER 1.15 with respect to the interest of a third person in funds or other property in which a client has an interest are triggered by the lawyer’s actual knowledge.  The relevant term is defined in the ethical rules.  “Knowingly,” “known,” or “knows” denotes actual knowledge of the fact in question.  A person’s knowledge may be inferred from circumstances.  Applying the definition of knowledge, in Op. 98-06 the Committee determined that the lawyer must have “actual knowledge” of the interest of a third party in order to implicate then ER 1.15(b).[1]  The rule does not equate notice provided generally with the lawyer’s actual knowledge.
 
The type of “interest” protected under ER 1.15 is a matured legal or equitable claim.  Comment 4 explains:
 
The Rule also recognizes that third parties may have just claims against specific funds or other property in a lawyer’s custody, such as a client’s creditor who has a lien on funds recovered in a personal injury action.  A lawyer may have a duty under applicable law to protect such third-party claims against wrongful interference by the client.  In such cases, when the third-party claim has become a matured legal or equitable claim, the lawyer must refuse to surrender the property to the client until the claims are resolved.  A lawyer should not unilaterally assume to arbitrate a dispute between the client and the third party, but, when there are substantial grounds for dispute as to the person entitled to the funds, the lawyer may file an action to have a court resolve the dispute.
 
Opinion 98-06 concludes that once a lawyer has actual knowledge of a third party’s interest in the funds, the lawyer must promptly notify the third person, and promptly deliver to the client and third person only funds or property the party is entitled to receive.  In the event of a good-faith doubt as to who is entitled to disputed funds, the lawyer must notify the third party, investigate the competing claims with reasonable diligence, promptness and competence, hold only the disputed funds in trust, and, if the dispute is not resolved by negotiation or other proceedings, file an interpleader action. 
 
Lawyer’s duty of inquiry as to funds held by the lawyer subject to competing interests
 
The inquiring lawyer asks about the extent to which a lawyer must investigate possible claims in order to determine the existence of an “interest” in a third person.
 
After concluding that the standard under ER 1.15 is actual knowledge, Op. 98-06 addresses medical liens provided by A.R.S. § 33-931 et seq.  In Arizona, a provider of medical services may have a lien, which is recorded in the county where the health care provider is located.  Opinion 98-06 concludes that a lawyer’s mere knowledge that the client received medical services, including receiving an unsigned medical lien or a demand for payment of a medical bill, does not create knowledge of an “interest” of the medical provider.  Conversely, a lawyer who acknowledged the lien has knowledge of the medical lien signed by the client, who orally agreed that the claim would be paid, received an incomplete but recorded medical lien, or has signed or received an assignment or “letter of protection” in favor of a medical provider, has knowledge of a “matured legal or equitable claim.” 
 
Opinion 98-06 contains some language that could be interpreted to suggest that the mere recording of a statutory lien by a medical provider provides constructive notice to the lawyer, triggering the obligations of ER 1.15.  [See Op. 98-06 (Question 5)]  That portion of Op. 98-06, however, is addressing what constitutes a “matured legal or equitable claim” under ER 1.15.  The opinion concludes that even though the recorded lien may later be found to be invalid, “the ethical issue is whether a recorded health care provider lien is an ‘interest’ protected by ER 1.15, and the Committee finds that it is such an interest.”  Hence, this portion of Op. 98-06 does not directly address or conclude that such a recordation by itself would provide “actual knowledge” required to trigger the obligations of ER 1.15.  There is a difference between actual knowledge and constructive knowledge or notice, and mere recording of a lien in the public records, without more, does not provide “actual knowledge” to the lawyer.
 
A creditor’s right to payment from a client may be created by statute.  For example, Op. 97-02 addressed the statutory subrogation claim under the Federal Employees Health Benefits Act (FEHBA), 5 U.S.C. § 8901, et seq., and Op. 98-06 considered a similar regime under the Federal Medical Care Recovery Act, 42 U.S.C. § 265 et seq., finding it creates a protected interest under then ER 1.15, such that the lawyer must comply with the requirements of the rule regarding notice and distribution of settlement monies in which the statute is implicated.  The Committee believes that a fair reading of opinions 98-06 and 97-02 limits their conclusion to circumstances in which the lawyer is aware that the client is a beneficiary under such a contract or plan, and thus charged with knowledge of a right to subrogation. 
 
Other law may impose obligations on the lawyer and/or client, and if it does, the lawyer’s duties of competence and diligence (and perhaps other ERs, such as 1.2(d)) may require additional action — an inquiry beyond this opinion’s scope.
 
However, nothing in the applicable ethics rules or previous opinions suggests that a lawyer has an obligation to discover or inquire about claims, contracts, liens or other encumbrances that would constitute an interest within the meaning of ER 1.15(d).  Nor would recording a medical lien without actual notice to the lawyer give the lawyer knowledge of the lien.  Further, the Committee has made it clear that contractual or other obligations of the client that do not rise to the level of an “interest” are outside the scope of ER 1.15(d). 
 
CONCLUSION
 
Only matured legal or equitable claims of which the lawyer has actual knowledge are protected by ER 1.15(d).  There is no requirement under ER 1.15 or any other provision of the ethics rules that a lawyer investigate the possibility of claims of which the lawyer has no actual knowledge, including medical liens.  We express no opinion, however, on whether a lawyer may have such a duty under applicable substantive law.
 
Formal opinions of the Committee on the Rules of Professional Conduct are advisory in nature only and are not binding in any disciplinary or other legal proceedings. This opinion is based on the Ethical Rules in effect on the date the opinion was published. If the rule changes, a different conclusion may be appropriate. © State Bar of Arizona 2011

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[1] Now revised and renumbered as ER 1.15(d).