CHAPTER 7 COMPENSATION FOR LEGAL SERVICES IN THE COMPETITIVE 21ST CENTURY: LEGAL FEES, COSTS AND FEE AGREEMENTS

• Jurisdiction: United States

Ethics And Professional Responsibility In The New Millennium
(2000)
CHAPTER 7
COMPENSATION FOR LEGAL SERVICES IN THE COMPETITIVE 21ST CENTURY: LEGAL FEES, COSTS AND FEE AGREEMENTS
Amon Burton
University of Texas School of Law
Austin, Texas

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I. ACQUIRING OWNERSHIP INTERESTS IN A CLIENT IN CONNECTION WITH LEGAL SERVICES

Hypothetical: Lawyer served as legal counsel to XYZ Corporation, a successful closely held software company. Lawyer learned about an opportunity for his client to acquire a competing software company; he arranged a meeting of the two parties, negotiated the transaction on behalf of XYZ, and drafted the acquisition documents. Prior to closing, Lawyer met with the Board of Directors of XYZ and suggested that rather than receiving cash for his legal services, XYZ could convey to him at closing shares of capital stock in the acquired company. Lawyer drafted an agreement between himself and XYZ whereby he will receive for legal services shares equal to 2% of the capital stock of the acquired company. The Board of Directors of XYZ approved the fee arrangement, executed the agreement and issued such stock to Lawyer at closing.

A. American Bar Association Formal Ethics Opinion 00-418

In July 2000, the ABA's Standing Committee on Ethics and Professional Responsibility issued an ethics opinion addressing the growing practice of law firms who represent start-up businesses accepting an ownership interest in the client in lieu of a cash fee for legal services. In addition, these fee arrangements often grant the law firm a right to participate in any future financings by the client prior to a public offering.

The opinion states that acquiring stock in a client constitutes a "business transaction" that invokes ABA Model Rule 1.8(a). Moreover, the fee arrangement must satisfy the general standard of ABA Model Rule 1.5(a) that requires a lawyer's fee to be reasonable. Under the higher standard of ABA Model Rule 1.8(a), the transaction must be fair and reasonable. One way to minimize the risk is to establish a reasonable fee for the services based on the factors enumerated in Rule 1.5(a) and then accept an ownership interest that at the time of the transaction is worth the reasonable fee.

Full disclosure of the lawyer's conflict of interest is required and the opinion explores the specifics of appropriate disclosure. Finally, the client must also have a reasonable opportunity to seek the advice of independent counsel. The opinion recommends that the written documentation should include a recommendation to the client that it obtain separate counsel to review the transaction. The client's consent to the transaction must be in writing.

B. Recent State Ethics Opinions

1. New York City Bar Op. 2000-3 was issued after ABA Opinion 00-418 was released. The New York City opinion reaches essentially the same conclusion as ABA Op. 00-418, but it is more lenient in the sense that it provides the lawyer does not have to comply with the higher standard of N.Y. DR 5-104(A) (the version of Model Rule 1.8(a) incorporated into the New York Code of Professional Responsibility) unless the client is relying upon the advice of the lawyer with respect to the fee transaction itself. Thus, the opinion finds that there may

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be instances in which a lawyer take stock in lieu of cash fees where it would be appropriate to treat the arrangement as any other fee arrangement. This may be determined by the sophistication of the client and the complexity of the transaction.

2. District of Columbia Bar Opinion 300 (July 25, 2000) mentions ABA Op. 00-418 and New York City Bar Op. 2000-3 in a footnote and indicates that D.C. Opinion 300 reaches the same conclusions as those two opinions. However, D.C. Opinion 300 does not discuss situations that might not be subject to Rule 1.8(a) or its New York counterpart, DR 5-104(A).

C. Rule 1.8(a) of ABA Model Rules of Professional Conduct

The basic fiduciary standard for any business transaction between a lawyer and his client has been incorporated into Rule 1.8(a) of the ABA Model Rules. Rule 1.8(a) provides:

(a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a 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 to the client in a manner which can be reasonably understood by the client;

(2) the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and

(3) the client consents in writing thereto.

It is important to remember that the disclosure and client consent requirements in any business transaction between a lawyer and client are in addition to the fair and reasonable standard applied to the transaction. Rule 1.8(a) further requires that both the lawyer's disclosure and the client's consent be in writing.

Elements of proper disclosure by the lawyer in transactions with clients have been deemed to include:

• all relevant circumstances of the transaction known to the lawyer,¹

• the lawyer's interest in the transaction and any potential adverse effects the transaction could have on the client,²

• that an inherent conflict of interest exists and entering into the transaction might complicate the client's future business activities,³

• specific advice about the need to seek independent counsel,⁴

• the kind of advice the client would have received if he or she had been a stranger,⁵ and

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• if future circumstances affect the lawyer's independent professional judgment renewed disclosure and consent must precede continued representation.⁶

D. Presumptions and Burden of Proof

If an attorney-client relationship exists at the time a lawyer enters into a business transaction with a client there is a presumption of unfairness or invalidity to any agreement between the lawyer and client. The burden is on the attorney to prove the "perfect fairness and equity" of the transaction or agreement.⁷

E. Passante v. McWilliams

It is instructive to consider what being a "fiduciary" meant to the California attorney in Passante v. McWilliams ⁸ who received stock for his services. Passante was the corporate attorney for a start-up business known as Upper Deck Company, a manufacturer of baseball cards. In 1988, Upper Deck was desperate for cash. Passante rescued his client from its financial crisis by arranging a $100,000 loan to Upper Deck from his law partner's brother, a wealthy physician. At the meeting to approve the loan, Upper Deck's Board of Directors agreed that if the loan came through then Passante would get three percent of the company's stock. The loan was funded, but Passante never received his shares. He eventually sued and at the time of the trial in 1993, three percent of Upper Deck's stock was worth $32,000,000. The jury awarded Passante the full amount. The trial judge, however, granted Upper Deck's motion for judgment notwithstanding the verdict, in part because Passante had violated his ethical duty as a lawyer to his client.

The appellate court affirmed and held that if the promise of stock was bargained for, then Passante had an obligation to comply with Rule 3-300 of the California Rules of Professional Conduct which forbids an attorney from entering into a business transaction with a client without first advising the client "in writing that the client may seek the advice of an independent lawyer of client's choice." The court stated that a lawyer is obligated to give his client all the reasonable advice against himself that he would have given the client against a third person. In response to Passante's argument that the stock was virtually thrust at him in return for all he had done to help the client, the court noted:

For better or worse, there is an inherent conflict of interest created by any situation in which the corporate attorney for a fledgling company in need of capital accepts stock as a reward for past service. As events in this case proved out, had the gift of 3 percent of the company's stock been completed, it would have made the subsequent capital acquisition much more difficult.⁹

Passante's fiduciary obligations as a result of his existing attorney-client relationship with Upper Deck meant that he could not deal with his client as if it were a third party—even if the offer of stock was initiated by the client.

Likewise, in DiLuglio v. Providence Auto Body, Inc., 2000 R.I. LEXIS 159 (R.I., June 30, 2000), the Rhode Island Supreme Court held that a lawyer's failure to comply with Rule 1.8(a) in contracting with a client could entitle the client to rescind the contract. However, the court denied rescission in DiLuglio, because the client waited six years to raise the issue. In Rhodes

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v. Buechel, 685 N.Y.S.2d 65 (N.Y. App. 1999) the court held that recission was appropriate where disclosures were not adequate). In a related case to Rhodes v. v. Buechel, the court addressed a federal regulation (37 CFR 10.64(a)(3) ) which allows lawyers to take an interest in a patent as a legal fee. Buechel v. Bain, 2000 N.Y. App. Div. LEXIS 9976 (N.Y. App. 2000). The court held that the regulation did not excuse lawyers from the disclosure requirements of New York's DR 5-104(A). This federal regulation provides that regulations issued by the Patent and Trademark Office do not preempt the right of states to regulate the practice of law.

To the contrary, a New York court recently refused to grant summary judgment to a client even though the client's California lawyer violated California's version of Rule 1.8(a). See Day v. Meyer, 2000 U.S. Dist. LEXIS 13470 (S.D.N.Y. 2000).

F. Other Cases and Materials Dealing with Investing in or with Clients¹⁰

1. Cases include: Avianca, Inc. v. Corriea, 705 F. Supp. 666 (D.D.C.), a...