Steps to follow for a valid trust account

Q: We recently started a tour operator company. We plan to place client deposits in a bank account that we will call our “trust account.” Checks payable to our company will be endorsed by us to the trust account, and credit card payments will go directly into that account. Can we mention the trust account in our marketing materials? Can we say that the funds in that account are protected from creditors’ claims? If we have to put the tour operator company in bankruptcy, would the funds in the account be subject to the claims of all creditors, or could they be used for refunds only? Finally, what’s the difference between a trust account and an escrow account?

A: If you call the account a “trust account” in your marketing materials, you need to be very careful about how you characterize it. You cannot state or even imply that the funds are protected unless you take certain steps that I will cover here.

To protect the funds against creditors such as the IRS, employees, banks and your landlord, you need to treat the funds differently from the way you treat funds in your other bank account or accounts. Essentially, you need to treat the funds as though they did not belong to you.

You must use the funds only for the benefit of clients. So you can pay the direct costs of the tours, and you can pay refunds due to clients. After each tour, you can withdraw your profits. 

Conversely, you must refrain from putting any other money in the trust account, and you may not use the account to pay for any administrative or operational expenses such as salaries, rent or utilities.

These are the same rules reflected in the trust account requirements of the seller of travel laws in California, Hawaii and Washington state. However, the rules apply in every state for any business that wants to protect customer deposits.

In my experience, it is very rare to find a bankrupt tour operator or other travel supplier that followed these rules. In every case that I know of, it turns out that the company used the trust account funds for regular, operational expenses, especially when under financial pressure.

A recent example is the Vantage Deluxe Travel bankruptcy case in Boston, where a committee of creditors strongly objects to the company’s plan to treat a trust account that was set up in May as in any way different from the rest of the company’s money. The company wants to transfer the $2.1 million in the account to the buyer, but the committee wants a trustee to be appointed to administer the funds for the benefit of all creditors.

If you advertise that client deposits are protected from creditors and do not follow the steps set forth here, you are probably committing fraud, or at best, negligent misrepresentation.

Finally, an “escrow account” differs from a trust account in that the former requires a third party, such as a bank, to control the funds. 

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