STOCK FOR FEES?
Guidance for ownership interests in clients
By George A. Riemer
The ABA Standing Committee on Ethics and Professional Responsibility issued Formal Ethics Opinion 00-418 on July 7, 2000. Entitled 'Acquiring Ownership in a Client in Connection with Performing Legal Services,' the opinion provides very helpful guidance on staying on the right side of the ethics line when lawyers are paid in stock for legal services provided to clients.
The topic of stock ownership as compensation for legal services has received quite a bit of attention in recent legal publications. Consider the following:
'For any members of the audience [at a recent California State Bar Statewide Ethics Symposium] who thought the discussion would be whether lawyers should invest with clients at all, panelist Joseph Troy outlined just how outdated such an idea is. Among 24 large firms surveyed, 22 have programs for buying stock in clients, said Troy, founder of Troy & Gould and co-author of Advising and Defending Corporate Directors and Officers. Further, he said, one-third of all law firms that do initial public offerings own stock in them. Both Troy and [Donald] Bradley [general counsel to a large California law firm actively involved in investments in clients] said the practice of taking stock in return for general legal services is not nearly as popular and is more likely to make them 'uncomfortable' - particularly, Bradley added, when the clients are just founding the firm and may be 'unsophisticated techies.'
The question for many lawyers is not whether to take stock for attorney fees, but how to do so in accordance with applicable disciplinary rules. The timely advice in the ABA's new formal ethics opinion on this topic, while analyzing the question under the ABA Model Rules of Professional Conduct only, should help Oregon lawyers stay on the right side of the corresponding rules in Oregon's Code of Professional Responsibility. There may be many reasons a stock for legal services agreement is reached with a client. The client may be an Internet or e-commerce startup and cash-poor. The client may request such an arrangement as a vote of confidence by the client's lawyers in the success of the enterprise. Lawyers may be inclined to seek stock for legal services as a way of remaining competitive in the ongoing search for new partners and associates. Any or all of these considerations could result in a stock for fees arrangement being considered between a lawyer or law firm and a client.
ABA Formal Opinion 00-418 indicates that 'a lawyer who acquires stock in her client corporation in lieu of or in addition to a cash fee for her services enters into a business transaction with a client, such that the requirements of Model Rule 1.8(a) must be satisfied.' (Footnote omitted.) ABA Model Rule 1.8(a) requires lawyer-client business transactions to be 'fair and reasonable to the client and . . . fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client.' The client must also be 'given a reasonable opportunity to seek the advice of independent counsel in the transaction.' The client must also consent to the transaction in writing. Footnote 7 of ABA Formal Opinion 00-418 states, however, that 'Rule 1.8(a) does not, however, apply when the lawyer acquires the stock in an open market purchase or in other circumstances not involving direct intervention by the client.' The text of the full opinion should be consulted concerning the nature and extent of the disclosures appropriate in these circumstances. The corresponding rule to ABA Model Rule 1.8(a) in Oregon is DR 5-104(A). DR 5-104(A) provides that 'A lawyer shall not enter into a business transaction with a client if they have differing interests therein and if the client expects the lawyer to exercise the lawyer's professional judgment therein for the protection of the client, unless the client has consented after full disclosure.''Full disclosure' is defined in DR 10-101(B) to mean 'an explanation sufficient to apprise the recipient of the potential adverse impact on the recipient, of the matter to which the recipient is asked to consent.' And, for the purposes of DR 5-104(A), 'full disclosure' is also to include 'a recommendation that the recipient seek independent legal advice to determine if consent should be given and shall be contemporaneously confirmed in writing.' Note that the consent of the client is not required to be in writing under DR 10-101(B) though obtaining the client's consent in writing is recommended to document compliance with the other requirements of the rule.
Note also that the Professional Liability Fund coverage plan provides, in part, as follows:
This Plan does not apply to any CLAIM based upon or arising out of any business transaction subject to DR 5-104(A) in which YOU participate with a client unless a disclosure in the form of Disclosure Form DR 5 attached as Exhibit A to this Plan has been properly executed prior to the occurrence giving rise to the CLAIM and forwarded to US in a timely manner.
Additional commentary and information is contained in the PLF coverage plan on this topic. See pages 371 and 377 of the 2000 Oregon State Bar Membership Directory.
ABA Formal Opinion 00-418 also states that 'In determining whether Rule 1.8(a)'s first requirement of fairness and reasonableness to the client is satisfied, the general standard of Rule 1.5(a) that '[a] lawyer's fee shall be reasonable' and the factors enumerated under that Rule are relevant.' (Footnote omitted.) Footnote 9 of ABA Formal Opinion 00-418 notes that 'Rule 1.5 would not apply if the opportunity to invest was not offered in connection with undertaking to provide legal services.'
The corresponding rules to ABA Model Rule 1.5(a) in Oregon are DR 2-106(A) and (B). An Oregon lawyer's fees cannot be 'clearly excessive.' A fee is clearly excessive 'when, after a review of the facts, a lawyer of ordinary prudence would be left with a definite and firm conviction that the fee is in excess of a reasonable fee.' Various factors are set forth in DR 2-106(B) 'as guides in determining the reasonableness of a fee . . . .' ABA Formal Opinion 00-418 offers helpful advice on ways lawyers can minimize the ethical risks associated with taking fees for legal services in stock and the reasonableness of any such transaction:
1. Law firms should consider adopting policies governing investments in clients.
a. The policies could limit any investment to an insubstantial percentage of stock or the amount invested in any single client to a nonmaterial sum.
b. The policies could require that decisions concerning any firm member's client conflict issues be made by someone other than the lawyer who was the principal client contact and also that any client billing or supervision of work issue be given to a partner with no stock ownership in the client for decision.
c. A policy could require that no lawyer could invest in a client without prior executive committee approval.
d. A policy could require that firm investments in nonpublic clients be allotted among firm members as investment opportunities or placed in a pooled investment fund or allocated to a bonus plan.
2. Consider establishing a reasonable fee for the legal services anticipated to be rendered and then accept stock that at the time of the transaction was worth that reasonable fee (value the stock at a per share price that knowledgeable cash investors have paid during the relevant time).
3. In cases where a cash value cannot be readily determined, 'the percentage of stock agreed upon should reflect the value, as perceived by the client and the lawyer at the time of the transaction, that the legal services will contribute to the potential success of the enterprise. The value of the stock received by the lawyer will, like a contingent fee permitted under Rule 1.5(c), depend upon the success of the undertaking.' (Footnote omitted.)
While ABA Formal Opinion 00-418 notes that '[a] lawyer's representation of a corporation in which she owns stock creates no inherent conflict of interest under Rule 1.7[,]' it also discusses the potential for conflicts between the interests of lawyers and clients after lawyers have acquired stock ownership in their clients. 'For example, the lawyer might have a duty when rendering an opinion on behalf of the corporation in a venture capital transaction to call upon corporate management to reveal material adverse financial information that is being withheld, even though the revelation might cause the venture capital investor to withdraw.' (Footnote omitted.) Or 'the stock of the client might be the lawyer's major asset so that the failure of the venture capital opportunity could create a serious financial loss to her. The lawyer's self-interest in such a case probably justifies a reasonable belief that her representation of the corporation would be affected adversely. This would disqualify her under Rule 1.7(b) from providing the opinion even were the client to consent.' (Footnote omitted.)
The corresponding rule to ABA Model Rule 1.7(b) in Oregon is DR 5-101(A). That rule, in pertinent part, provides as follows: Except with the consent of the lawyer's client after full disclosure, a lawyer shall not accept or continue employment if the exercise of the lawyer's professional judgment on behalf of the lawyer's client will be or reasonably may be affected by the lawyer's own financial[,] business, property, or personal interests.
Again, the definition and requirements of 'full disclosure' in DR 10-101(B) must be consulted concerning compliance with the requirements of DR 5-101(A).
If, as discussed above, an Oregon lawyer found herself in a situation where her professional judgment on behalf of a client would be, or reasonably could be, affected by the lawyer's concerns about the value of her ownership interest in her client, the lawyer, at a minimum, would have to make full disclosure to and obtain the consent of the client in order to continue providing legal services to the client in that matter. While the literal language of DR 5-101(A) suggests that any personal interest conflict can be waived after full disclosure to and the consent of the client, at least one Oregon Supreme Court case suggests that some personal conflicts can be so great as not to be waivable by the client. See In re Carey, 307 Or. 315, 767 P.2d 438 (1989).
In conclusion, when an Oregon lawyer accepts stock or options to acquire stock in a client corporation in connection with the provision of legal services to the corporation, the lawyer should comply with the requirements of DR 2-106(A) and (B) and DR 5-104(A). Oregon legal fees must be reasonable, and before a lawyer can enter into a business transaction with a client the lawyer must make full disclosure to the client and obtain the client's consent to the transaction.
While an argument can be made that DR 5-104(A) does not apply to a fee agreement entered into by a lawyer or law firm with a new client at the inception of the relationship, prudent lawyers may still wish to dot their i's and cross their t's by complying with the requirements of DR 5-104(A) when accepting stock or options to purchase stock as payment for legal services provided the client. +
George Riemer is general counsel of the Oregon State Bar. He can be reached by phone at (503) 620-0222, ext. 405, or toll-free in Oregon at (800) 452-8260, ext. 405, or by e-mail at email@example.com.