Phillips v. Washington Legal Foundation

• Decision Date: 15 June 1998
• Docket Number: 961578
• Citation: 524 U.S. 156,141 L.Ed.2d 174,118 S.Ct. 1925
• Parties: Thomas R. PHILLIPS, et al., Petitioners, v. WASHINGTON LEGAL FOUNDATION et al
• Court: U.S. Supreme Court

524 U.S. 156

118 S.Ct. 1925

141 L.Ed.2d 174

Thomas R. PHILLIPS, et al., Petitioners,

v WASHINGTON LEGAL FOUNDATION et al.

No. 96-1578.

Supreme Court of the United States

Argued Jan. 13, 1998.

Decided June 15, 1998.

Syllabus^*

Under Texas' Interest on Lawyers Trust Account (IOLTA) program, an attorney who receives client funds must place them in a separate, interest-bearing, federally authorized "NOW'' account upon determining that the funds "could not reasonably be expected to earn interest for the client or [that] the interest which might be earned . . . is not likely to be sufficient to offset the cost of establishing and maintaining the account, service charges, accounting costs and tax reporting costs which would be incurred in attempting to obtain the interest.'' IOLTA interest income is paid to the Texas Equal Access to Justice Foundation (TEAJF), which finances legal services for low-income persons. The Internal Revenue Service does not attribute such interest to the individual clients for federal income tax purposes if they have no control over the decision whether to place the funds in the IOLTA account and do not designate who will receive the interest. Respondents-a public-interest organization having Texas members opposed to the IOLTA program, a Texas attorney who regularly deposits client funds in an IOLTA account, and a Texas businessman whose attorney retainer has been so deposited-filed this suit against TEAJF and the other petitioners, alleging, inter alia, that the Texas IOLTA program violated their rights under the Fifth Amendment, which provides that "private property'' shall not "be taken for public use, without just compensation.'' The District Court granted petitioners summary judgment, reasoning that respondents had no property interest in the IOLTA interest proceeds. The Fifth Circuit reversed, concluding that such interest belongs to the owner of the principal.

Held:

1.Interest earned on client funds held in IOLTA accounts is the "private property'' of the client for Takings Clause purposes. The existence of a property interest is determined by reference to existing rules or understandings stemming from an independent source such as state law. Board of Regents of State Colleges v. Roth, 408 U.S. 564, 577, 92 S.Ct. 2701, 2709, 33 L.Ed.2d 548. All agree that under Texas law the principal held in IOLTA accounts is the client's "private property.'' Moreover, the general rule that "interest follows principal'' applies in Texas. See Webb's Fabulous Pharmacies, Inc. v. Beckwith, 449 U.S. 155, 162, 101 S.Ct. 446, 451, 66 L.Ed.2d 358. Petitioners' contention that Webb's does not control because examples such as income-only trusts and marital community property rules demonstrate that Texas does not, in fact, adhere to the general rule is rejected. These examples miss the point of Webb's. Their exception by Texas from the "interest follows principal'' rule has a firm basis in traditional property law principles, whereas petitioners point to no such principles allowing the owner of funds temporarily deposited in an attorney trust account to be deprived of the interest the funds generates. Petitioners' further contention that "interest follows principal'' in Texas only if it is allowed by law does not assist their cause. They do not argue that Texas law prohibits the payment of interest on IOLTA funds, but, rather, that interest actually "earned'' by such funds is not the private property of the principal's owner. Regardless of whether that owner has a constitutionally cognizable interest in the anticipated generation of interest by his funds, any interest that does accrue attaches as a property right incident to the ownership of the underlying principal. Petitioners' final argument that the money transferred to the TEAJF is not "private property'' because IOLTA funds cannot reasonably be expected to generate interest income on their own is plainly incorrect under Texas' requirement that client funds be deposited in an IOLTA account "if the interest which might be earned'' is insufficient to offset account costs and service charges that would be incurred in obtaining it. It is not that the funds to be placed in IOLTA accounts cannot generate interest, but that they cannot generate net interest. This Court has indicated that a physical item does not lack "property'' status simply because it does not have a positive economic or market value. See, e.g., Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419, 435, 437, n. 15, 102 S.Ct. 3164, 3175-3176, 3177, n. 15, 73 L.Ed.2d 868. While IOLTA interest income may have no economically realizable value to its owner, its possession, control, and disposition are nonetheless valuable rights. See Hodel v. Irving, 481 U.S. 704, 715, 107 S.Ct. 2076, 2083-2084, 95 L.Ed.2d 668. The United States' argument that "private property'' is not implicated here because IOLTA interest income is "government-created value'' is factually erroneous: The State does nothing to create value; the value is created by respondents' funds. The Federal Government, through its banking and taxation regulations, imposes costs on this value if private citizens attempt to exercise control over it. Waiver of these costs if the property is remitted to the State hardly constitutes "government-created value.'' In any event, this Court rejected a similar argument in Webb's, supra, at 162, 101 S.Ct., at 451. Pp. ____-____.

2.This Court leaves for consideration on remand the question whether IOLTA funds have been "taken'' by the State, as well as the amount of "just compensation,'' if any, due respondents. P. ____.

94 F.3d 996, affirmed.

REHNQUIST, C. J., delivered the opinion of the Court, in which O'CONNOR, SCALIA, KENNEDY, and THOMAS, JJ., joined. SOUTER, J., filed a dissenting opinion, in which STEVENS, GINSBURG, AND BREYER, JJ., joined. BREYER, J., filed a dissenting opinion, in which STEVENS, SOUTER, AND GINSBURG, JJ., joined.

Darrell E. Jordan, Dallas, TX, for petitioners.

Edwin S. Kneedler, Washington, DC, for United States as amicus curiae by special leave of the Court.

Richard A. Samp, Arlington, VA, for respondents.

Chief Justice REHNQUIST delivered the opinion of the Court.

Texas, like 48 other States and the District of Columbia, ¹ has adopted an Interest on Lawyers Trust Account (IOLTA) program. Under these programs, certain client funds held by an attorney in connection with his practice of law are deposited in bank accounts. The interest income generated by the funds is paid to foundations that finance legal services for low-income individuals. The question presented by this case is whether interest earned on client funds held in IOLTA accounts is "private property'' of either the client or the attorney for purposes of the Takings Clause of the Fifth Amendment. We hold that it is the property of the client.

I

In the course of their legal practice, attorneys are frequently required to hold client funds for various lengths of time. Before 1980, an attorney generally held such funds in non-interest bearing, federally insured checking accounts in which all client trust funds of an individual attorney were pooled. These accounts provided administrative convenience and ready access to funds. They were non-interest bearing because federal law prohibited federally insured banks and savings and loans from paying interest on checking accounts. See 12 U.S.C. §§371a, 1464(b)(1)(B), 1828(g). When a lawyer held a large sum in trust for his client, such funds were generally placed in an interest-bearing savings account because the interest generated outweighed the inconvenience caused by the lack of check-writing capabilities.

In 1980, Congress authorized the creation of Negotiable Order of Withdrawal (NOW) accounts, which for the first time permitted federally insured banks to pay interest on demand deposits. §303, 94 Stat. 146, as amended, 12 U.S.C. §1832. NOW accounts are permitted only for deposits that "consist solely of funds in which the entire beneficial interest is held by one or more individuals or by an organization which is operated primarily for religious, philanthropic, charitable, educational, political, or other similar purposes and which is not operated for profit.'' §1832(a)(2). For-profit corporations and partnerships are thus prohibited from earning interest on demand deposits. See ibid. However, interpreting §1832(a), the Federal Reserve Board has concluded that corporate funds may be held in NOW accounts if the funds are held in trust pursuant to a program under which charitable organizations have "the exclusive right to the interest.'' Letter from Federal Reserve Board General Counsel Michael Bradfield to Donald Middlebrooks (Oct. 15, 1981), reprinted in Middlebrooks, The Interest on Trust Accounts Program: Mechanics of its Operation, 56 Fla. B.J. 115, 117 (Feb. 1982) (hereinafter Federal Reserve's IOLTA Letter). ²

Beginning with Florida in 1981, a number of States moved quickly to capitalize on this change in the banking regulations by establishing IOLTA programs. Texas followed suit in 1984. Its Supreme Court issued an order, now codified as Article XI of the State Bar Rules, providing that an attorney who receives client funds that are "nominal in amount or are reasonably anticipated to be held for a short period of time'' must place such funds in a separate, interest-bearing NOW account (an IOLTA account). Tex. State Bar Rule, Art. XI, §5(A); Rules 4, 7 of the Texas Rules Governing the Operation of the Texas Equal Access to Justice Program. Client funds are considered "nominal in amount'' or "held for a short period of time'' if the attorney holding the funds determines that

"such funds, considered without regard to funds of other clients which may be held by the attorney, law firm or professional corporation, could not reasonably be expected to earn interest for the client or if the interest which might be earned on such funds is not likely to be...