Chapter 1 - § 1.5 • DOING BUSINESS WITH A CLIENT

JurisdictionColorado
§ 1.5 • DOING BUSINESS WITH A CLIENT

§ 1.5.1—Investing in or With Clients

Lawyers may seek to invest in a client's business or to join with a client in exploring a potential business activity. Investing in or engaging in other businesses with clients falls squarely under Colo. RPC 1.8(a), which prohibits lawyers from entering into business transactions with clients or knowingly acquiring "an ownership, possessory, security or other pecuniary interest adverse to the client" unless:

1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner that can be reasonably understood by the client;
2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and
3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.

Note that Colo. RPC 1.8(b) further prohibits a lawyer from using client information to the disadvantage of the client without the client's consent, unless otherwise permitted or required by the Rules.

In addition, Colo. RPC 1.7 is implicated when a lawyer considers doing business with a client. The commentary to Colo. RPC 1.7(b), concerning a lawyer's own interests, cautions that "[a] lawyer may not allow related business interests to affect representation, for example, by referring clients to an enterprise in which the lawyer has an undisclosed interest."

Several Colorado lawyers have received discipline, including multi-year suspensions and disbarment, for failing to comply with Colo. RPC 1.8 and/or 1.7(b).158

While Colo. RPC 1.8(a) requires a lawyer to make full disclosure to clients, it does not specify how lawyers are to ensure that terms are fully disclosed. In People v. Bennett,159 a case involving the predecessor to Colo. RPC 1.8, the Colorado Supreme Court indicated that full disclosure "requires a clear explanation of the differing interests of the lawyer and client, the advantages of seeking independent advice, and a detailed explanation of the risks and disadvantages to the client entailed in the business agreement." The ABA Ethics Committee has noted that "[a] good faith effort to explain in understandable language the important features of the particular arrangement and its material consequences as far as reasonably can be ascertained at the time of the stock acquisition should satisfy the full disclosure requirements of Rule 1.8(a)."160

The CBA Ethics Committee has opined that the Colorado Rules of Professional Conduct allow a lawyer to acquire an equity interest in the lawyer's client.161 In its opinion, it adopted the reasoning of the ABA Ethics Committee with regard to a lawyer's ethical duties in connection with such a transaction, subject to some limitations and additions.162

§ 1.5.2—Taking an Equity Interest as a Fee

One type of investment in clients occurs when a lawyer takes an equity interest in a client in lieu of a cash fee. In the economic good times of the 1990s, it became common for clients to offer their lawyers an equity stake in the client as a way of paying the lawyer's fee. This type of arrangement is especially attractive to start-up companies with little cash. For the lawyers, the arrangement offers not only potentially lucrative financial opportunities, but also a means to promote client relations by showing confidence in and support for the client. But it also is a source of potential ethical problems.163

Colo. RPC 1.8(a) is again relevant in this type of arrangement; the lawyer should ensure that the terms are fair and reasonable to the client, that the terms are fully disclosed to the client in writing, and that the client consents to the transaction. Further, the lawyer should also ensure that he or she is in compliance with Colo. RPC 1.7(b).

In addition, because the equity interest is a fee for legal services, lawyers should be mindful of Colo. RPC 1.5 and other fee restrictions. In order to be considered fair and reasonable to the client, an equity interest that serves as a fee should meet the general standards for fees established in Colo. RPC 1.5, including the requirements that the fee not be excessive.164 The lawyer should further ensure that he or she is not improperly taking a "nonrefundable" retainer in violation of Colo. RPC 1.5(f) and (g) and the Colorado Supreme Court's teachings in In re Sather.165

Both the CBA Ethics Committee and the ABA Ethics Committee have opined that the Model Rules do not prohibit a lawyer from obtaining an ownership interest in a client in lieu of taking a cash fee.166 In each Committee's opinion, "only the circumstances reasonably ascertainable at the time of the transaction should be considered" in determining the reasonableness of the fee.167 The lawyer must consider the risk of failure and the stock's marketability along with any other relevant factors.168 The ABA Ethics Committee further noted that acquisition of a substantial ownership interest in a client may implicate Model Rule 1.8(j) (now 1.8(i)) by amounting to acquiring a proprietary interest in the subject matter of litigation.169

§ 1.5.3—Securing Payment of an Attorney's Fee

A lawyer who is uncertain about a client's ability to pay the lawyer's fees may wish to consider taking a security interest in the client's property or filing a statutory lien to help ensure payment.

Security Interest

Under Colo. RPC 1.8(a), a lawyer is permitted to take a security interest in a client's property, so long as the lawyer complies with the requirements of that rule: the transaction must be fair and reasonable to the client, the client must be advised in writing to seek independent counsel, and the client must consent in writing.

The CBA Ethics Committee has recognized that Colo. RPC 1.8(a) allows a lawyer to take a security interest in a client's property to secure payment of the lawyer's fee.170 The ABA Ethics Committee has also recognized the ethical propriety of securing a fee.171 It is preferable, however, that the security interest be taken at the outset of the representation, rather than later in the relationship. As recognized in the Report of the ABA Task Force on the Independent Lawyer:

Because the dynamic between attorney and client is fundamentally different before and during their professional relationship, a security interest in property taken after representation has commenced warrants even closer review than is applied to a security interest acquired in a written fee arrangement executed before the start of the fiduciary relationship. After the attorney-client relationship has begun, the fiduciary relationship exists and cannot be shelved temporarily; thus, the lawyer is limited in his or her negotiation of a security agreement. On the assumption that, once the representation has begun, the client's trust in and reliance on the attorney has increased, the client will be more susceptible to the attorney's influence if the security agreement is acquired during the course of the representation.172

Note that if the security interest involves taking possession of client property as collateral (for example, stock certificates), Colo. RPC 1.15(a) requires the lawyer to hold client property separate from the lawyer's own property, to identify client property as such, and to safeguard it.173 In addition, lawyers must keep complete records regarding their handling of client property.174

As explained by the ABA, the Rules of Professional Conduct place some restrictions on the lawyer's ability to take a security interest in the client's property: the lawyer should not seek to establish a right greater than the client's right in a piece of property, and the lawyer should not take a security interest solely to deprive third parties of legitimate rights to the property.175 Moreover, a lawyer should take steps to release a security interest to the extent that the interest exceeds the monies due and owing the lawyer.176 Upon sale or disposal of the collateral, the lawyer should generally return any amounts exceeding the amounts owed to the lawyer for services rendered.177

In addition to Colo. RPC 1.8, lawyers should also be sure that they are in compliance with the conflict-of-interest provisions of Colo. RPC 1.7(b) when they perfect or foreclose the security interest, as such action could easily put a lawyer and a client at odds.178

Liens

Generally, a lawyer may not acquire an interest in the subject of litigation.179 Colo. RPC 1.8(i)(1) does provide an exception, however, for "a lien authorized by law to secure the lawyer's fee or expenses."180 The ABA Ethics Committee has concluded that the Model Rule on which Colo. RPC 1.8(i)(1) is based "should not be applied to prohibit acquisition of an otherwise legally and ethically obtained lien" and it "expressly permits such a lien to be acquired."181

Lawyers are not among the class of persons entitled to the protection of the general mechanics' lien statute,182 but Colorado law provides attorneys with two other types of liens: charging liens and retaining...

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