“Attorneys carry substantial responsibility, but it is folly to suggest it is limitless,” said the New Jersey Supreme Court last week. The court ruled that when the Fox Rothschild firm complied with its client’s disbursement instructions it did not thereby convert funds that a non-client had wired to the firm’s trust account — even though, unbeknownst to the firm, its client made fraudulent use of the funds.

The unanimous decision provides some reassurance to law firms that when they have no knowledge of any competing claim to trust account money (a fact conceded in the case), they can follow their client’s instructions on what to do with it.

“Ponzi schemer” funds

The non-client wired some $2 million to the firm’s trust account through an intermediary payment facility, without identifying the non-client as the funds’ owner, and without any instructions or limitations on disbursement. The funds were to be part of a real-estate deal between the non-client and the firm’s client. The firm distributed the funds as the client later directed.

As described in reporting from Law360 and the New Jersey Law Journal, the funds were part of the client’s massive Ponzi scheme in which he promised investors large returns on real estate sales but kept the money for himself. (The client is reported to be attempting to set aside his 24-year prison sentence.)

Among other claims, the non-client sued the firm for conversion of the funds. The trial court dismissed the conversion claim, but the intermediate court of appeals reversed. The Garden State supreme court reinstated the dismissal.

No dominion, no demand

The non-client argued that the law firm exercised wrongful dominion and control over the trust account funds he had wired, and that demand for their return would have been futile, as the funds had already been wrongfully transferred.

The supreme court rejected the argument, primarily because the firm received the funds with no indication that they belonged to the non-client, and without any limiting instructions or conditions. “Funds held in an attorney’s trust account for its client are the client’s funds, not the firm’s,” said the court. With no knowledge of a competing claim, or even any knowledge about the non-client and his role in the real estate deal, the court said, “the firm acted appropriately in adhering to the client’s directions” and “in accordance with its reasonable understanding of who did control the direction of the funds’ use — the client.”

Further, the supreme court held that the demand obligation under the circumstances was not a futile one that could be jettisoned. Rather, the “demand is the linchpin that transforms an initial lawful possession into a setting of tortious conduct,” the court said. While there are exceptions to the demand requirement, this was not one of them. Demand was even more essential here, said the court, because “it would have been the means to alert the firm that a competing claim existed and would have triggered the firm’s obligation to reasonably inquire further” before complying with its client’s disbursement instructions.

And because money is fungible, the court ruled, this was not a situation where demand would have been excused because the chattel had already been wrongfully transferred. (In other words, the demand could have been satisfied with money other than the specific funds that had been transferred to the firm’s trust account.)

Rules of conduct and client instructions

In addition to the conversion claim, the non-client also asserted a claim for breach of fiduciary duty. Fox Rothschild argued that if lawyers could not follow a client’s instructions on disbursing funds, they would be burdened in their ability to comply with New Jersey’s version of Model Rule 1.2, requiring lawyers to “abide by a client’s decisions concerning the scope and objectives of representation.”

The court seemed to agree, and also rejected the proposition that the firm had fiduciary duties to the non-client. Because the non-client used an intermediary in the funds transfer, the firm did not even know that the non-client existed.

This opinion from New Jersey’s high court repays reading, and the reasoning upholds the ability to rely on a client’s disbursement instructions when a firm doesn’t know (and has no duty to know) of competing claims to trust account funds.