Can a real estate lawyer let a title insurer audit the lawyer's trust account, and can the lawyer use an outside reconciliation service?

Plain-English summary

In North Carolina real estate closings, an approved lawyer disburses loan proceeds from a trust account, and title insurers issue closing protection letters that reimburse lenders and buyers for loss caused by an approved lawyer's fraud or dishonesty. To manage their growing exposure, title insurers want to audit approved lawyers' trust accounts and review reconciliation reports. The opinion addresses whether a lawyer may permit that consistent with confidentiality.

A lawyer may voluntarily permit a title insurer to audit a trust account used solely for real estate closings, provided the audit is limited to transactions the insurer insured and the lawyer obtains certain assurances. Rule 1.6 protects all information acquired during the representation, including trust-account records, but disclosure is permitted when impliedly authorized to carry out the representation. Real estate clients (the lender and the buyer/borrower) impliedly consent to disclosure necessary to prevent defalcations, including information a title insurer needs to audit the account. That implied consent does not extend to non-real-estate clients or to title companies that did not insure the client's transaction, so absent express consent the audit must be limited to specified records: for the trust account, bank statements and deposit tickets for three months (no copies of checks), reconciliation reports for three months (client information redacted), and the general ledger for six months (payee names redacted); and for insured transactions, the enumerated closing records and the client-specific ledger. The opinion distinguishes 98 FEO 10 (insurance-defense legal-bill audits), explaining that the title insurer's interest in preventing theft of closing funds aligns with the buyer's and seller's, and that the limited trust-account information, though confidential, is probably not privileged, so the risk of waiving privilege is remote.

Before the audit, the lawyer must obtain the insurer's written assurances that the information will be used only to confirm proper use of funds and compliance with Rule 1.15, not for marketing or non-risk-management business purposes; that access is limited to employees who need it for risk-management decisions; and that the information will not be shared with any third party except the State Bar, with disclosure to the State Bar or other authorities if a defalcation is found. The lawyer's own Rule 8.3(a) duty to report a known defalcation applies regardless of the insurer's duty. The lawyer may let the insurer's audit conclusions be released to a third party such as another title insurer. The same analysis allows the insurer to review reconciliation reports (whether prepared in-house or by an outside service), allows a lawyer to seek approved-lawyer status conditioned on agreeing to such audits, and is unchanged when multiple lawyers in a firm share the real estate trust account. Finally, a lawyer may delegate reconciliation to an outside company or nonlawyer if the lawyer makes reasonable efforts to ensure they understand the Rule 1.15 and Rule 1.6 duties; the lawyer remains professionally responsible (Rule 5.3).

In practice

Under the North Carolina rules as they stood at the time of the opinion, a lawyer may voluntarily permit a title insurer to audit a trust account used solely for real estate closings, limited to transactions the insurer insured and to the specified, partly redacted records the opinion lists, on the theory of real estate clients' implied consent to disclosure that prevents defalcations (Rule 1.6). Per the opinion, the lawyer must first obtain the insurer's written assurances restricting the use, access, and sharing of the information, and the lawyer's own Rule 8.3(a) duty to report a known defalcation still applies.

Per the opinion, the same conditions allow review of reconciliation reports and allow a lawyer to accept approved-lawyer status conditioned on audits, and the answer does not change when a firm shares the trust account. A lawyer may delegate reconciliation to an outside service or nonlawyer provided the lawyer makes reasonable efforts to ensure they understand the Rule 1.15 and Rule 1.6 duties and remains responsible for the account (Rule 5.3).

Common questions

Q: Can I let a title insurer audit my real estate trust account?

A: Yes, voluntarily, if the account is used solely for real estate closings, the audit is limited to transactions the insurer insured and to the records the opinion specifies (some redacted), and you obtain the insurer's written assurances protecting client confidences (Rule 1.6).

Q: What about confidential information of my other clients in the account?

A: The opinion concludes implied consent does not extend to non-real-estate clients or to title companies that did not insure a transaction, so the audit must be limited to the enumerated, partly redacted records absent those clients' express consent.

Q: What written assurances must the title insurer give before the audit?

A: That the information will be used only to confirm proper use of funds and Rule 1.15 compliance, not for marketing or other business purposes; that access is limited to employees who need it for risk management; and that it will not be shared with third parties except the State Bar (and authorities if a defalcation is found).

Q: Does the audit relieve me of any duty to report a problem?

A: No. The opinion concludes that regardless of the insurer's duty, a North Carolina lawyer who knows of a defalcation must report it to the State Bar under Rule 8.3(a).

Q: Can I use an outside company to reconcile my trust account?

A: Yes. The opinion concludes a lawyer may delegate reconciliation to an outside service or nonlawyer if the lawyer makes reasonable efforts to ensure they understand the Rule 1.15 and Rule 1.6 duties; the lawyer remains professionally responsible under Rule 5.3.

Background and rules framework

The opinion applies North Carolina Rule 1.6 (confidentiality, including the implied-authorization exception), Rule 1.15 (safekeeping property and trust-accounting requirements), Rule 8.3(a) (duty to report misconduct), and Rule 5.3 (responsibilities regarding nonlawyer assistants). These are the North Carolina analogues of Model Rules 1.6, 1.15, 8.3, and 5.3. It distinguishes 98 FEO 10 on the conflicting-interests rationale for legal-bill audits.

Citations and references

Rules of Professional Conduct:

• MR 1.6 / NC Rule 1.6 (confidentiality; implied authorization to carry out the representation)
• MR 1.15 / NC Rule 1.15 (safekeeping property; trust-accounting requirements)
• MR 8.3 / NC Rule 8.3(a) (duty to report misconduct, including a defalcation)
• MR 5.3 / NC Rule 5.3 (responsibilities regarding nonlawyer assistants and outside services)

Statutes:

• N.C. Gen. Stat. 58-26.1 (title insurer issuance of assurances to approved lawyers).

Cases:

• State v. McIntosh, 336 N.C. 517, 444 S.E.2d 438 (1994), elements and qualified nature of the attorney-client privilege.

Other opinions cited:

• NC 98 FEO 10: an insurance-defense lawyer may not disclose confidential information in bills submitted to an outside auditor without the insured's consent (distinguished).

See also

• NC State Bar 2013 FEO 3: Expense Funds in Trust
• NC State Bar 2009 FEO 4: Credit Card Trust Acct
• ABA Formal Op. 475: Safeguarding Divided Fees

Source

• Landing page: https://www.ncbar.gov/for-lawyers/ethics-and-governing-rules/ethics-opinions/opinions/2008-formal-ethics-opinion-13/

Original opinion text

Reproduced from the official source for research purposes. The linked source is authoritative.

Inquiry #1:

Under North Carolina law, title insurance policies are issued upon receipt of title certification from a licensed North Carolina lawyer. A title insurer will only issue title assurances to approved lawyers as provided by N.C. Gen. Stat. §58-26.1. In the vast majority of real estate closings, the lender delivers the proceeds of the new loan (for the purchase or refinancing of the real estate) to the approved lawyer to be disbursed from the approved lawyer's trust account upon the closing of the transaction. Lenders and buyers/borrowers in real estate transactions frequently request title insurance coverage in the form of a closing protection letter in which the title insurer agrees to reimburse the lender and/or the buyer/borrower for, among other things, actual loss on account of the fraud or dishonesty of the approved lawyer in handling the lender's funds. Closing protection letters are necessary to facilitate real estate transactions in North Carolina as lenders are unwilling to risk their funds without these assurances from title insurers.

Title insurers are experiencing increasing liability for lawyer defalcations pursuant to closing protection letters and title insurance policies issued in connection with real estate transactions. In addition, parties to real estate transactions who are not covered by title insurance are suffering losses related to the misuse of funds deposited in real estate trust accounts.

To provide the assurances required by lenders and buyer/borrowers, title insurers need a way to assess whether funds from real estate trust accounts are being disbursed and accounted for properly. Real estate lawyers may use outside reconciliation services to reconcile their trust accounts. Title insurers would like to request either an audit of an approved lawyer's trust account and/or review of the lawyer's trust account reconciliation reports to ensure the safety of the funds and protect the interests of those whose funds are placed in the trust account and rely upon the appropriate disbursement of those funds.

Lawyer A is an approved lawyer with Title Insurer. Title Insurer has issued at least one closing protection letter for Lawyer A. May Lawyer A voluntarily permit Title Insurer to audit his trust account?

Opinion #1:

Yes, Lawyer A may voluntarily permit Title Insurer to audit any trust account used solely for real estate closings provided the audit is limited to transactions insured by Title Insurer and, further provided, Lawyer A obtains certain assurances from Title Insurer.

Rule 1.6 requires a lawyer to protect from disclosure all information acquired during the professional relationship including information about a client contained in the lawyer's trust account records. Nevertheless, confidential information may be revealed when the client gives informed consent, disclosure is impliedly authorized to carry out the representation, or a specific exception allowing disclosure set forth in paragraph (b) of Rule 1.6 applies. Although the specific exceptions are not applicable here, the general exception that permits disclosure to carry out the representation is applicable. A self-evident objective of both the lender and the buyer/borrower, the clients in a real estate transaction, is that the loan proceeds will be used for the purpose for which they were intended and not misused or misappropriated by the closing lawyer. Therefore, there is implied consent by real estate clients to disclose such information as may be necessary to prevent defalcations including information necessary for a title insurer to perform an audit of the lawyer's trust account.

It cannot be assumed that non-real estate clients impliedly authorize the disclosure of confidential information about their deposits to a lawyer's general trust account to a title insurance company. Moreover, it cannot be assumed that a real estate client's implied consent extends to title companies that did not insure the client's transaction. Absent the express consent of those clients whose confidential information may be disclosed, a lawyer may only allow an audit that is limited to certain financial records related to a trust account used solely for real estate closings and to certain financial records related to real estate transactions insured by the title insurer. Specifically, the audit must be limited to review of the following records on the trust account: bank statements and deposit tickets for three months (not including copies of checks); reconciliation reports for three months (confidential client information redacted); and the general ledger for six months (names of payees redacted). The audit shall also be limited to the following records of real estate transactions insured by the title insurer: copies of cancelled checks; copies of deposited checks; cash receipts (if any); disbursement receipts; closing instructions; settlement statements (all drafts and final versions); pay-off statements; wiring instructions and wire confirmations; all recorded documents; the client-specific ledger; and the bank statement from any open interest-bearing account used for the transaction.

This opinion can be distinguished from 98 FEO 10 which holds that an insurance defense lawyer may not disclose confidential information about an insured's representation in bills submitted to an independent audit company at the insurance carrier's request unless the insured consents. That opinion provides that a lawyer should not ask for the consent of the insured "[w]hen the insured could be prejudiced by agreeing and gains nothing" such that "a disinterested lawyer would not conclude that the insured should agree in the absence of some special circumstance." 98 FEO 10 presumes that the interests of the insured and the insurance carrier relative to the payment of legal fees are in conflict because the insured wants the best defense money can buy and the insurance carrier wants to limit its expenditures on legal fees. This is not the case with regard to audits of real estate trust accounts where a title insurer's interest in preventing the theft of closing funds by a lawyer can be presumed to be the same as that of the buyer and the seller of the property. Another distinction resides in the type of information that would be obtained in an audit of a bill for legal services and in the audit of trust account records for a real estate closing. The legal bill often contains detailed information about the representation which is clearly confidential and may also be privileged under the law of evidence. Although the limited client information gained in an audit of a real estate trust account is confidential, it is probably not privileged.1 Therefore, the risk that the privilege will be waived as a consequence of the audit is remote.

To further protect confidential client information during the audit process, prior to an audit, Lawyer A must obtain written assurances from the title insurer of the following: (1) the information disclosed will be used for no other purposes than to confirm the proper use of funds and the lawyer's compliance with the trust accounting requirements in Rule 1.15; (2) the information will not be used by the title insurer for marketing or business purposes other than risk management; (3) access to the information will be limited to those employees of the title insurer who need the information to make risk management decisions; and (4) the disclosed information will not be shared with any third party except the State Bar and, in the event a defalcation is discovered, the information will be disclosed to the State Bar or other appropriate authorities. See Rule 1.15. Regardless of the title insurer's duty to report evidence of a defalcation to the State Bar, any North Carolina lawyer who has such knowledge is also required to report to the State Bar pursuant to Rule 8.3(a).

Although Lawyer A must obtain title insurer's written assurances relative to protecting confidential client information, he is not prohibited from allowing the title insurer's conclusions as a result of the audit to be released to a third party such as another title insurer.

Inquiry #2:

May Lawyer A voluntarily permit Title Insurer to examine and review Lawyer A's reconciliation reports whether generated by Lawyer A and his staff, or generated by an outside reconciliation service employed by Lawyer A?

Opinion #2:

Yes, provided the reconciliation reports are for a trust account that is used solely for real estate closings and the required written assurances from the title insurer set forth in opinion #1 are obtained. See opinion #1 above.

Inquiry #3:

Title Insurer conditions designation as an approved lawyer on the lawyer's agreement that Title Insurer may audit the lawyer's trust account and review the lawyer's reconciliation reports upon request. May a lawyer seek designation as an approved lawyer for Title Insurer?

Opinion #3:

Yes, provided the audit is limited to trust accounts, or the reconciliation reports therefore, that are used solely for real estate closings and the required written assurances from the auditor and the title insurer set forth in opinion #1 are obtained. See opinion #1 above.

Inquiry #4:

Would the responses to any of the preceding inquiries be different if multiple lawyers in the same firm use the same real estate trust account?

Opinion #4:

No.

Inquiry #5:

As noted above, many real estate lawyers use outside reconciliation services to reconcile their trust accounts. Is this practice permitted under the Rules of Professional Conduct?

Opinion #5:

Yes, a lawyer may delegate reconciliation to a company or to a non-lawyer who is not employed in the lawyer's firm provided the lawyer makes reasonable efforts to ensure that the person(s) providing the reconciliation services understands the lawyer's professional duties with regard to the management of the trust account under Rule 1.15 and also with regard to the protection of client confidences under Rule 1.6. The lawyer remains professionally responsible for the proper management and reconciliation of the account. See Rule 5.3.

End Notes

• A privilege exists if (1) the relation of attorney and client existed at the time the communication was made, (2) the communication was made in confidence, (3) the communication relates to a matter about which the attorney is being professionally consulted, (4) the communication was made in the course of giving or seeking legal advice for a proper purpose although litigation need not be contemplated, and (5) the client has not waived the privilege. It is, however, a qualified privilege subject to the general supervisory powers of the trial court. State v. McIntosh, 336 NC 517, 444 S.E.2d 438 (1994).