Reporting Checks Drawn On Escrow Accounts With Insufficient Funds

• Published date: 02 November 2022
• Subject Matter: Finance and Banking, Financial Services
• Law Firm: Gallet Dreyer & Berkey
• Author: Jay L. Hack

The ethical principle behind escrow funds is simple'the funds belong to a client or a third party, not the attorney. The attorney, who is a fiduciary, cannot commingle escrow funds with the attorney's own funds. Escrow funds cannot be used for any personal purpose of the attorney. 22 NYCRR 1.15(a).

Appellate Division rules (22 NYCRR 1300.1) set forth requirements for dishonored and overdraft check reporting. Banks must agree to report any case in which an instrument (almost always a check, so I will use that term) drawn on an escrow account is presented for payment and there are insufficient funds to pay the check, regardless of whether the bank pays or bounces the check. The rule applies only if the check is otherwise properly payable. See Monreal v. Fleet Bank, 95 N.Y.2d 204 (2000); UCC 4-401.

Roping in the Banks

New York courts have no authority to regulate banks. The Appellate Division does so indirectly by prohibiting attorneys from depositing escrow funds at a bank unless the bank agrees to file a report (an NSF Report) when an escrow check is presented against insufficient funds. A list of banks who have so agreed, and thus are authorized to accept escrow accounts, is available at http://www.nylawfund.org/APPLST%20140.pdf. Each attorney must make sure that its bank is authorized to accept escrow accounts before maintaining an escrow account at that bank.

What Triggers NSF Reports?

If an escrow check is presented for payment and the check would create an overdraft if it were paid, then even if the bank elects to pay the check, the bank must file an NSF Report with the Lawyers' Fund for Client Protection, unless the check is not otherwise properly payable. The Lawyers' Fund sends the report to the attorney disciplinary committee unless the bank withdraws the report within 10 days because of a bank mistake.

Common Misunderstandings

The rule has been fraught with misunderstandings. Here are some common issues.

1. Can an attorney link an operating account with an escrow account so that funds in the operating account cover any overdraft in the escrow account? Linking an operating account could allow an attorney to hide the misuse of escrow funds by covering a check with his or her own funds. Attorneys argue that this is in the best interests of the client, but experience indicates that it merely postpones the inevitable.

2. What if the attorney deposits cash to cover a check the morning after the check is presented for payment? As the rule was amended in...