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Ethics Advisory Opinion 06-02

April 13, 2006

South Carolina Bar Ethics Advisory Opinion 06-02

RULES 1.5 (c), 1.15 and 8.4(c)

Date: January 20, 2006

Facts:
ABC Law Firm limits its practice to residential real estate sale and refinance transactions. On a monthly basis, it processes a high volume of such transactions involving real estate in both the county where its office is located and in contiguous counties. 

Lenders’ instructions often require the recording of documents prior to disbursement of loan proceeds. A number of the lenders providing financing to ABC’s clients require the closing lawyer to estimate the settlement charges and disbursements, including courier and recording costs, prior to the issuance of the final loan package. Once the loan package is issued, the closing lawyer is not permitted to deviate from the figures specified in the loan package because the lenders are subject to scrutiny, and potential liability, for deviations between their “good faith estimate” of closing costs and the actual closing costs. Not infrequently, however, the actual costs for recording and overnight mail/couriers exceed the initial estimates.

ABC Law Firm plans to adopt the following procedure to address the above-described situation:

1. ABC established with its depository bank a depository account called the “Recording Account;”

2. ABC prepares for each real estate client, each of whom reviews and signs prior to closing, a closing affidavit making various disclosures, including the following:

I/we hereby acknowledge and agree that certain charges on my HUD-1 Settlement Statement are best estimates, such as charges involving taxes, interest, overnight, courier recording, title updating and accounting related fees.  These charges may not reflect the actual costs and in fact may be more or less than the actual costs to the settlement agent(s). Any additional amount(s) may vary and are understood to help cover the administrative aspects of handling the particular item or service. I/we hereby consent to and accept the above-referenced charges by signing our HUD-I Settlement Statement(s) and by signing this disclosure.

3. ABC marks up the estimated overnight/courier fees and recording fees it provides to lenders by anywhere from $2.00 to $15.00, and reflects the marked-up amount on the HUD-1 Settlement Statement on line 1201, denominated as “Recording Fees.”

4. When the transaction closes, the amount reflected on the HUD-1 Settlement Statement as “Recording Fees” is transferred from ABC’s trust account to ABC’s Recording Account, and disbursements to recording offices and for reimbursement for overnight/courier fees are made from the Recording Account.

5. All amounts reflected on the HUD-1 Settlement Statement which are payable to ABC, including the Recording Fees, are reported by ABC as business income, and all disbursements from the Recording Account for overnight/courier fees and recording charges are reported as business expenses.

6. ABC considers all funds in the Recording Account to be funds of ABC, and from time to time, surplus funds are drawn from the Recording Account and transferred to the firm’s Operating Account, or if necessary, funds are transferred from the Operating Account to the Recording Account.

In the event the structure and use of the Recording Account set forth above is improper, ABC does not want the Recording Account to be a trust account. Therefore, ABC would deposit its own money into the Recording Account. Checks for the recording and overnight/courier fees for a closing would be written from this account. At closing, the line item for these closing costs on the HUD-1 reflects payment to the law firm to reimburse the firm for advancing these costs. After the closing and the recording of the documents, ABC would deposit the check to the firm from the closing into the Recording Account to reimburse the firm for advancing the funds to cover these costs.

Questions
1.         After a closing but before the recording of the documents, may ABC transfer the amount for Recording Fees, as reflected on the HUD-1, from the law firm trust account to the Recording Account and write a check to the Register of Deeds (and courier/overnight service) against those funds to tender to the Register of Deeds when the documents are recorded?

2.         To the extent the initial scenario is improper, does the alternate proposed operation of the Recording Account comply with the trust accounting rules?

3.         ABC would like to avoid advancing the funds of the law firm to cover the recording and courier/overnight fees. If the closing lawyer tenders a firm trust account check, written against the loan proceeds on deposit in the trust account, to the Register of Deeds at the time that the documents are recorded, has the lawyer complied with the lender’s requirement that documents be recorded before the loan proceeds are disbursed?

4.         In light of the Fourth Circuit’s decision in Boulware v. Crosland Mortgage, 291 F.3d 261 (4th Cir. 2002), the Seventh Circuit’s decision in Krzalic v. Republic Title Company, 314 F.3d 875 (7th Cir. 2002), and the Eighth Circuit’s decision in Haug v. Bank of America, 317 F.3d 832 (8th Cir. 2003) that “up charges,” or markup, by mortgage lenders and settlement agents for recording fees and other expenses of settlement is not a violation of the Federal Real Estate Settlement Procedures Act, if there is disclosure to its clients as set forth above, may ABC inflate its estimate of the costs for recording and overnight/couriers fees that will be incurred in closing a transaction and, if the actual costs prove to be less than the estimated costs, retain the overcharges?

Summary
Unless the Recording Account is maintained as a lawyer’s trust account in accordance with applicable rules, the transfer of the funds from ABC’s trust account to the Recording Account after closing, but prior to disbursement of the funds in accordance with client requirements and the requirements of the closing, is improper.  Until disbursement, the funds remain client funds and must be segregated from the lawyer’s funds and be deposited and disbursed in accord with trust accounting rules.  Under the alternate scenario, where the Recording Account is composed of the law firm’s funds only, trust accounting rules do not apply.  Reimbursement of closing expenses may be disbursed to the Recording Account from ABC’s trust account.  ABC may tender a firm trust account check directly to the clerk of court or other appropriate recording official at the time of recording and satisfy the client requirement that loan funds not be disbursed until recording.  Provided the practice is not prohibited by law, the disclosure is made to the lender as well as the seller, the overcharges are not in violation of Rule 1.5, and the clients are not misled about the fact that the overcharges will be kept by the law firm as profit, ABC may retain an overcharge as profit.  However, the law firm may not establish its schedule of fees with the intent of creating a profit.  The mere fact that the surcharges are minimal is not in and of itself determinative of reasonableness.  See ABA Comm. on Ethics and Prof. Resp., Formal Op. 93-379.

Opinion
In light of the lender’s instructions, although the transaction has closed, the funds to cover costs of the closing, including recording and overnight/courier fees, remain client funds until disbursed.  Under Rule 1.15 of the Rules of Professional Conduct and Rule 417, SCACR, such client funds must be segregated from the lawyer’s funds and be deposited and disbursed in accordance with trust accounting rules. See Rule 1.15; Rule 417, SCACR.  As a trust account, the funds in the Recording Account would be client funds and not the funds of ABC. Funds could not be transferred from the Recording Account to the firm’s operating account unless earned by the firm or payable to the firm as reimbursement for costs advanced.

Under the alternate proposed scenario, the Recording Account contains only the funds of the law firm and not client funds.  As stated in the facts, the funds transferred to the Recording Account from ABC’s trust account are not disbursed until after recording to reimburse ABC for expenses incurred to record documents.  The Recording Account does not have to be maintained as a lawyer’s trust account. 

ABC may tender a trust account check directly to the Clerk of Court or other recording official at the time documents are presented for recording and thereby comply with the lender’s instructions that disbursements not be made until recording.  ABC must assure that the disbursement is properly recorded or accounted for in accordance with the rules governing lawyer trust accounts.  Rule 1.15; Rule 417, SCACR.

ABC may retain as profit any overcharges provided this practice is not prohibited by law, the disclosure is made to the lender as well as the seller, the overcharges are not in violation of Rule 1.5(a), and the clients are not misled, in violation of Rule 8.4(c), about the fact that the overcharges will be kept by the law firm as profit.  See ABA Comm. on Ethics and Prof. Resp., Formal Op. 93-379 (noting that in absence of disclosure to the contrary, it is improper to assess a surcharge on disbursements over and above the amount actually incurred unless the lawyer had incurred additional expenses beyond the actual cost of the item or to charge more than the direct cost plus a reasonable allocation of overhead for in-house service charges such as photocopying).  The disclosure set forth in the facts does not, in the opinion of the Committee, make it clear that ABC intends to keep the overcharges, if any, as profit and, therefore, potentially violates Rule 8.4(c).  However, the law firm may not establish its schedule of fees with the intent of creating a profit.  The mere fact that the surcharges are minimal is not in and of itself determinative of reasonableness.  See ABA Comm. on Ethics and Prof. Resp., Formal Op. 93-379.print