Nowhere to hide — Implementation of a Massachusetts payee notification rule

Issue Vol. 10 No. 1 January 2008 By Alan E. Brown

Note: Since this article was written, the Massachusetts Division of Insurance issued a bulletin requiring insurers to provide written notice to claimants of any settlement disbursements of $5,000 or more. See DOI Bulletin 2007-15 (December 20, 2007).

In 2006, the Massachusetts Clients’ Security Board (CSB) launched a campaign to promote adoption of a Payee Notification Rule. This proposed rule would require insurers paying third party liability claims to notify claimants directly at the time they disburse settlement proceeds to claimants’ attorneys. The purpose of the rule is to reduce the likelihood that an attorney will misuse or misappropriate client settlement funds.

The CSB’s campaign generated considerable debate among members of the bar, including opposition by some county bar associations. Notwithstanding this criticism, in September 2006, the Massachusetts Bar Association endorsed in principle the adoption of a Payee Notification Rule. Since then, however, the implementation of a Payee Notification Rule in Massachusetts has received little attention.

What are the strengths and weaknesses of a Payee Notification Rule? Will adoption of a Payee Notification Rule benefit Massachusetts clients and improve the bar’s image? How should such a rule be implemented? Answering these questions requires a look at both the Payee Notification Rule itself and how the rules adopted in other states have impacted attorney theft claims.

Adoption of a Payee Notification Rule in Twelve States
To date, California, Connecticut, Delaware, Georgia, Hawaii, Kansas, Maryland, Nevada, New Jersey, New York, Pennsylvania and Rhode Island have adopted rules substantially similar to the ABA Model Rule for Payee Notification, which states:

Written Notice to Claimants of Payment of Claims in Third Party Settlements

A. Upon the payment of [insert desired dollar amount] or more in settlement of any third-party liability claim, the insurer shall provide written notice to the claimant where: (1) the claimant is a natural person, and (2) the payment is delivered to the claimant's lawyer or other representative by draft, check or otherwise. Such notice shall be required when payment is made to a claimant by the insurer or its representative, including the insurer's lawyer.

B. This rule shall not create any cause of action for any person against the insurer, other than a government agency, based upon the insurer's failure to provide notice to a claimant as required by this rule; nor shall this rule create a defense for any party to any cause of action based upon the insurer's failure to provide such notice.

The model rule, adopted in 1991, allows each jurisdiction to establish a dollar amount that triggers compliance. Among those states that have adopted payee notification rules, the minimum amount triggering notice for mandatory notification ranges from any amount in Hawaii to a high of $10,000 in Connecticut. Maryland is the only state to have adopted a voluntary payee notification rule, which provides that an insurer “may” give notice to the claimant of its payment of any claim in excess of $2,000. If an insurer chooses to provide notification, the Maryland rule requires that notice be made by regular mail no sooner than five days after payment is sent to the claimant’s attorney.

In Favor of a Payee Notification Rule
Supporters of the Payee Notification Rule in Massachusetts take a “why not” approach. They argue that the rule has already been successfully adopted in other states, that it can only help clients, and that any burden on insurance companies and lawyers is de minimus. As the former chair of the CSB wrote in April 2006, “[h]ow can we tell the public and our clients that we have passed up an opportunity to protect clients? How can we not support the Payee Notification Rule?”

In its campaign to adopt a Payee Notification Rule, the CSB has cited to multiple instances where attorneys’ defalcations were not discovered until after the statute of limitations had run on the underlying liability claims, thus preventing clients from filing suit and pursuing their claims. Likewise, the CSB referenced cases in which attorneys’ defalcations were discovered when it was too late to pursue UCC claims against the banks that cashed settlement checks with forged client signatures. These examples seem to support the CSB’s claim that, had clients been notified when settlement proceeds were disbursed, as through a Payee Notification Rule, the defalcations could have been prevented or, at the very least, discovered sooner. The CSB also believes that the mere existence of a Payee Notification Rule would discourage attorneys who might otherwise attempt to steal client funds from doing so.

Recent headlines publicizing the sordid stories of client theft seem to support the CSB’s position that action is needed:

“Disbarred Attorney Sentenced to Prison in Theft of More than $1 Million”
“Former Cape Cod Lawyer is Sentenced in Client Theft”

Who can doubt these headlines affect the bar and its image? Why, then, would anyone oppose a Payee Notification Rule?

A Critical Eye
Critics of a Payee Notification Rule in Massachusetts argue that any such rule would foster distrust between attorneys and their clients. They claim that requiring direct communication from an insurance company to a claimant upon the disbursement of settlement proceeds in order to deter attorney theft would signal to clients that their attorneys cannot be trusted to handle client funds. In addition, this communication would seem to alter a fundamental principle of the attorney client relationship: no direct contact with a claimant represented by counsel. Indeed, many clients seek counsel for the express purpose of ending their direct contact with an insurance company, preferring to leave such communications in the hands of a capable attorney.

Critics of a Massachusetts Payee Notification Rule also argue that any potential benefit of the rule would be limited to the small minority of clients that have their insurance settlement proceeds stolen. In fiscal year 2006, for example, the CSB paid roughly 19% of its claims related to improper settlement practices. This compares with roughly 57% for unearned retainer claims. Why not, critics argue, focus attention on adopting a rule that targets areas of even greater concern?

Others view a Massachusetts Payee Notification Rule as a further step toward the overregulation of attorneys. Trust account overdraft notification and mandatory disclosure of malpractice insurance are already in effect in Massachusetts. Further regulation might include adoption of the ABA Model Rule that imposes random audits on client trust accounts, a rule currently adopted in eleven states, as well as mandatory fee arbitration and mediation of non-fee disputes, neither of which have been adopted by Massachusetts.

Finally, critics of a Massachusetts Payee Notification Rule question how the administrative cost of such a requirement would be addressed. Would the burden of added paperwork only delay payment of claims, thereby causing more harm than good to claimants? Should insurance companies be allowed to defray the cost of complying with a Payee Notification Rule by including advertising in their notices to claimants? How else might insurance companies ultimately pass the cost of a Payee Notification Rule on to consumers?

An Imperfect Solution
Whether viewed as an obvious aid or a potential hindrance to clients and their attorneys, one thing is certain: the Payee Notification Rule is, at best, an imperfect solution. Take Pennsylvania, for example, which implemented a Payee Notification Rule in 1992. According to Attorney Kathryn Peifer, executive director of the Pennsylvania Lawyers Fund for Client Security, while the Pennsylvania Payee Notification Rule appears to deter defalcations of settlement proceeds, actual results are very difficult to quantify because it is not possible to track thefts that never occur. Interestingly, Pennsylvania has seen an increase in the conversion of settlement proceeds in recent years, despite the existence of a Payee Notification Rule. In fiscal year 2005-2006, embezzlement of settlement proceeds accounted for approximately 22% of the Fund’s awards. This represents an increase from 5% in 2004-2005 and 8% in 2003-2004. Peifer notes, however, that although these statistics appear to suggest that embezzlement of settlement proceeds is on the rise, almost 70% of those awards in 2005-2006 resulted from the defalcations of two attorneys who practiced in the same firm.

The Payee Notification Rule is by no means foolproof and does not guarantee the protection of claimants’ settlement proceeds. Peifer cites to cases in which attorneys have reported false addresses for their clients to insurance companies to prevent clients from receiving notification. Similarly, attorneys have told their clients that settlement checks have to be held for an extended period of time in order for the funds to clear and be processed, thus affording the attorneys an opportunity to misuse the funds. The Pennsylvania Lawyers Fund for Client Security’s annual report notes that attorneys also circumvent the Payee Notification Rule by misusing client funds earmarked to satisfy medical or other liens on the settlement proceeds, funds that a client would not be expecting to receive personally, but the defalcation of which obviously has severe implications for clients. The Payee Notification Rule has no way of preventing these types of frauds. According to Peifer, “if an attorney wants to steal client funds, he [or she] will find a way around the Payee Notification Rule”.

Guideposts for Implementation
In the face of critics and often confusing data, what should Massachusetts do with the Payee Notification Rule? According to Karen O’Toole, CSB associate board counsel, the Board intends to consider a draft Payee Notification Rule in late 2007. O’Toole notes that the Massachusetts Bar Association has established a committee to review any proposed rule in order to address the many concerns of MBA members. What, then, should policy makers have in mind as they consider a Payee Notification Rule for Massachusetts?

One Small Step
If a Payee Notification Rule is to be adopted in Massachusetts, it is critical for policy makers to keep in mind that such a rule will, at best, only address a small percentage of those claims awarded annually by the CSB. Thus, adoption of a Payee Notification Rule is only one small step toward reducing attorney theft.

Another way to empower clients and attempt to reduce the incidence of attorney theft is through client education. Clients need basic education about the claims process, including when and how claims are settled and the proceeds disbursed, so that they are not so easily exploited by dishonest lawyers. Organizations such as the Massachusetts Bar Association need to take the lead in educating these clients. One option would be to have the MBA lawyer referral service, which has made over 450,000 referrals since its inception in 1974, educate clients about the claims process in a form similar to its current brochure entitled “Tips on Choosing a Lawyer”.

Language of the Rule
The language of any proposed Payee Notification Rule deserves careful consideration. While a mandatory rule would seem to go farthest in ensuring clients know when their settlement proceeds have been disbursed, a voluntary rule should not be rejected without thoughtful analysis. A voluntary rule would give insurance companies an option to avoid the administrative and other expense involved with complying with the rule. This would allow insurance companies to weigh the costs of compliance against the risk of non-compliance, and make their own decision about whether compliance makes economic sense while still affording clients a certain level of protection. However, arguably where an insurer chooses not to notify the client and theft of the settlement funds results, claimants may attempt to assign some degree of culpability to the insurer.
Maryland’s rule requiring that notification be sent five days after settlement proceeds are disbursed might offer several benefits. This rule would seem to alleviate, at least in part, the concern that Payee Notification fosters distrust between lawyers and their clients. In addition, allowing attorneys to communicate with their clients in advance of a notification would seem to minimize the impact of this communication on the fundamental protections that the attorney client relationship affords to clients. If notification occurs after settlement proceeds are disbursed, attorneys can seize this opportunity to reassure their clients that their claims are in safe hands. Consider the attorney who sends the following notice to clients upon receipt of settlement proceeds:

Dear Client:

In the next few days you will receive notice from the insurance company that your settlement funds have been disbursed to us. We want to take this opportunity to assure you that they have been received and deposited into our client account, and will be disbursed to you promptly in the next seven days. We have enjoyed working with you to resolve this matter and hope we will be able to serve you again in the future.

This example demonstrates how a Massachusetts Payee Notification Rule could actually strengthen, rather than weaken, attorney client relations. However, given that the payee notification constitutes a communication with a represented party, limitations on what insurance companies can include in their payee notifications, such as advertisements or other information, should be carefully considered.

A Payee Notification Rule offers some promise to the bar and to the public as we work together to attack the problem of attorney theft. The Payee Notification Rule is one of many options, such as increasing client education, that should be considered. If a Payee Notification Rule is proposed, the language of the rule must be crafted carefully to maximize the rule’s potential benefit while minimizing its costs to clients and the profession. Attorney theft, however, is a sufficiently important issue to merit consideration from policy makers and members of the bar on a much broader level. The Payee Notification rule is aimed at reducing the window of opportunity for theft of client funds in limited circumstances. With leadership from the bar, and in the tradition of self-regulation that sets the legal profession apart, we can tackle the “cause” of the problem in order to reduce client theft across the board and strengthen public trust in the profession.

Alan E. Brown is an associate in the Boston office of Morrison Mahoney LLP, where he concentrates his practice in the areas of professional liability and general liability defense. Prior to joining the firm, he served for four years as an Investigator in the Office of the Bar Counsel at the Massachusetts Board of Bar Overseers.