IOLTA victory in U.S. Supreme Court sets up Mass. court battle

Issue May 2003 By Jayne Tyrrell

On March 26, the U.S. Supreme Court issued its decision in Brown v. Legal Foundation of Washington upholding the constitutionality of the Washington state Interest on Lawyers Trust Accounts (IOLTA) program.

Justice Stevens authored the 5-4 majority decision, in which Justices O'Connor, Souter, Ginsburg and Breyer joined. In its ruling, the Supreme Court upheld the Washington IOLTA program against the claim that it constitutes a taking of property without just compensation.

The court reasoned that because just compensation is measured by the client's pecuniary loss - which it found to be zero under the Washington IOLTA program - there was no violation of the Just Compensation Clause. As a result, the court found that the operation of the IOLTA program in Washington does not violate the Fifth Amendment.

A few days later, the court issued a consistent ruling in a case challenging the constitutionality of the Texas IOLTA program. These decisions will inform the pending federal court challenge to the Massachusetts IOLTA program, which last year distributed more than $15 million to critically needed civil legal services to the indigent and for improvements to the administration of justice in the commonwealth.

The court's analysis in Brown began by noting that the Fifth Amendment "confirms the state's authority to confiscate private property," so long as two conditions are met: "the taking must be for a 'public use' and 'just compensation' must be paid to the owner." The court quickly disposed of the "public use" question. "(T)he overall, dramatic success of these programs in serving the compelling interest in providing legal services to literally millions of needy Americans certainly qualifies the Foundation's distribution of these funds as a 'public use' within the meaning of the Fifth Amendment."

Turning next to the issue of the type of "taking," if any, involved in the case, the court dealt separately with the placement of funds in a law firm's IOLTA account and the later transfer of the interest to the IOLTA foundation.

The former, the court said, did not confiscate any interest and did not effect a "regulatory taking," because it did not interfere with any investment-backed expectation. As to the transfer of interest to the IOLTA program, the court indicated that the per se analysis used in Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419 (1982) was appropriate to the facts of this case and consistent with the finding in Phillips that the interest is the property of the clients. Because the case could be disposed on the just compensation issue, however, the court simply assumed, rather than held, that the interest was "taken" when it was transferred to the IOLTA program.

The court held that there was no constitutional violation because no just compensation was due. The court found that the plaintiffs in the case lost nothing of value because transactional costs would have outweighed the small amount of gross interest that their individual funds would have earned absent IOLTA or did earn in an IOLTA account. In reaching its conclusion, the court applied a long line of Fifth Amendment cases on just compensation, stating: "[J]ust compensation required by the Fifth Amendment is measured by the property owner's loss rather than the government's gain." Since the taking of the clients' property was for a public purpose and there was no loss of a reasonable investment-backed expectation of pecuniary gain, there was no Fifth Amendment violation.

Finally, the court disposed of the plaintiffs' argument that funds could have mistakenly been deposited in an IOLTA account when the interest generated would actually have exceeded the transactional costs involved. While recognizing that mistakes might occur, the court pointed out that the responsibility of ensuring that only qualifying funds are deposited in IOLTA accounts rests with the firm making the deposits, not the IOLTA program that ultimately receives the interest. While the property owner might have a claim against the entity making a faulty deposit, no state action would be involved in such an erroneous deposit so as to subject the transaction to Fifth Amendment protections.

Justice Scalia authored the primary dissent, which was joined by Chief Justice Rehnquist and Justices Thomas and Kennedy. He argued that the gross fair market value of the interest earned by the clients' principal while it was still in the IOLTA account should be the measure of the compensation due rather than the net interest approach used by the majority.

Justice Kennedy issued a brief additional dissent in which he raised First Amendment concerns regarding IOLTA. He wrote: "The First Amendment consequences of the State's action have not been addressed in this case, but the potential for a serious violation is there … One constitutional violation (the taking of property) likely will lead to another (compelled speech)."

The First Amendment issue may be closer to the heart of the challenges to IOLTA than the Fifth Amendment "taking" argument. Before 1981, when the first IOLTA program became operational in Florida, neither clients nor lawyers ever received any economic benefit from interest when lawyers held client funds, which were nominal in amount or held for a short period of time. The Supreme Court oral arguments in Brown discussed nominal sums like $2 and $5 that the appellants claimed to have "lost" (the court rejected this argument). The litigation appears not economically, but ideologically driven. The real issue is whether the poor have access to the courts.

The First Amendment claims are still before several federal courts. In Massachusetts, for example, Citizens for the Preservation of Constitutional Rights (CPCR), the Small Property Owners Association (SPOA) and three individuals filed a lawsuit in January 2002 challenging the constitutionality of the Massachusetts IOLTA program. The defendants are the justices of the Supreme Judicial Court and Anthony Doniger as chair of the Massachusetts IOLTA Committee. Assistant Attorney General William Porter, Assistant Attorney General Amy Spector, Special Assistant Attorneys General Richard Johnston and Denise Barton of Hale and Dorr are representing the defendants. The case is before Judge Mark L. Wolf in U.S. District Court in Boston.

The same claims were previously determined in May 1993 when the U.S. Court of Appeals for the First Circuit rejected a challenge to the Massachusetts IOLTA program. That lawsuit was entitled Washington Legal Foundation v. Massachusetts Bar Foundation, et. al. The court dismissed arguments that IOLTA violated the Fifth Amendment, by taking property without just compensation, or the First Amendment, by forcing lawyers and clients to support views with which they do not agree.

The First Amendment claims also remain in both the Washington and Texas cases. In the Washington litigation, the Ninth Circuit Court of Appeals sitting en banc, after ruling that no Fifth Amendment violation existed, remanded the First Amendment issue to the District Court in Seattle to consider "what speech, if any, is at issue and whether the IOLTA program violated any rights Appellants may have emanating from the First Amendment." In the Texas case, the District Court found that no violation of the First Amendment existed and dismissed the claim. The Fifth Circuit, finding that a Fifth Amendment violation existed, decided that it did not need to address the First Amendment.

Both the Washington and Texas cases have been remanded by the U.S. Supreme Court and resolution of the First Amendment issues awaits. While the IOLTA litigation continues, however, the Brown decision remains a remarkable victory for low-income clients who desperately need free legal services - they are the real beneficiaries.
The article is based in part on analysis written by Bev Groudine, counsel, ABA Commission on IOLTA. Jayne Tyrrell is the executive director of the Massachusetts IOLTA Committee.