THE PARTNERSHIP MYSTIQUE: LAW FIRM FINANCE AND GOVERNANCE FOR THE 21ST CENTURY AMERICAN LAW FIRM.

• Author: Steinitz, Maya

INTRODUCTION

The drawbridge is down. The barbarians are through the gates. The ship has sailed. While the legal profession was asleep at the switch, nonlawyer "takeover" of law firms--resisted strenuously by the bar for at least a century (1)--has become a reality. This has been true de facto for a number of years, and, as of January 1, 2021, it became true de jure in the state of Arizona. It is now widely acknowledged that litigation finance has, in the past decade, without any change to black letter law, felled the centuries-old champerty prohibition (2)--the prohibition on a nonparty funding a party's claim for a profit. (3) This Article will show, for the first time, that litigation financiers have accomplished the same with respect to the similarly entrenched prohibition on nonlawyer participation (ownership and management) in law firms, which the profession has alternately considered and rejected in a cycle that has persisted for more than a century.

Over the past three or so years, litigation finance firms have refocused from providing third-party financing to plaintiff's for single cases to financing portfolios of cases and providing the financing directly to law firms. (4) In addition, litigation finance firms are incubating new law firms and affiliating themselves with such law firms. (5) Financing pools of cases is economically functionally equivalent, or at least a very close approximation, to outright investment in a law firm. And, critically, it creates all the same governance challenges as does allowing nonlawyers to directly own stock in law firms: conflicts of interest, disclosure requirements that conflict with the attorney-client privilege, potential short-termism, incentive to interfere in the attorneys' independent judgment, and more. (6)

Meanwhile, the Supreme Court of Arizona recently unveiled revolutionary changes to the rules governing the practice of law in that state.' Although this experiment is in its infancy, its effects are sure to permanently change the character of the legal profession in the United States. The new regime abolishes the longstanding prohibition on fee-sharing between lawyers and nonlawyers, explicitly allowing nonlawyers to hold an economic interest in, and even to manage, law firms. (8)

Market trends and forces, both domestic and international, have helped bring about these changes, and they will continue to propel the legal industry in the direction of nonlawyer participation in the business of providing legal services. Direct competitors of American firms, importantly in London, can not only seek investments but may also go public and list on stock exchanges. (9) The so-called Big Four accounting firms have resurged in the global legal services markets and are predicted to increasingly compete with large, multinational law firms (BigLaw). (10) At least one U.S.-based "legal staffing" firm, Axiom, recently embarked on the process of making an initial public offering--though it ultimately opted for private equity investment instead. (11)

As these changes become more entrenched and more clearly on the sunny side of the law, the need for litigation finance boutiques--that specialize in investment in the esoteric and hard-tovalue asset that is a lawsuit (12)--will likely fade because investments in law firms do not require any expertise beyond what traditional investors such as banks and hedge funds already have (perhaps with the assistance of lawyer-analysts). Cinema did not eliminate theater, Kindle did not extinguish books, and (for those who grew up in the '80s) video did not "kill the radio star." (13) Lawsuit financing will also likely survive law firm financing, but its market share is likely to shrink significantly.

These inevitable changes have begun to provoke some attempts at regulation, falling mainly into one of two categories: disclosure or licensing-and-ethics. In response to the rise of portfolio financing, at least one prominent group, the New York City Bar Association (NYCBA), has proposed that the practice be legalized and regulated through a disclosure regime. (14) The Arizona experiment, by contrast, creates a licensing regime which imposes attorneys' ethical obligations on Alternative Business Structures (ABSs) and on the nonlawyer participants. (15)

While the Arizona model is much preferable to the NYCBA's disclosure proposal--a vast body of literature has shown that disclosure is ineffective in protecting consumers (lfi)--both fail to adequately address deep-rooted concerns about the effect of allowing nonlawyer participation on the core values of the legal profession. Decades of discourse have drawn out those concerns in detail. Mainly, the worry is that allowing nonlawyer participation would create conflicts of interest, compromise lawyers' ability to exercise independent judgment, erode clients' trust, undermine the ability of the profession as a whole to deliver public goods like upholding the rule of law, and diminish the dignity of the profession and the wellbeing of its practitioners.

This Article argues that while the focus on incentives and agency costs (conflicts of interest) is correct, it overlooks a key cause for concern, which can be traced back to a particular conception of corporate governance, one that has dominated U.S. law and discourse for much of the last century: shareholder primacy. This Article then suggests a way to resolve that tension by taking advantage of new laws that permit entities to organize according to an alternative conception of corporate governance: stakeholder primacy.

Under shareholder primacy, by operation of law, the interests of the shareholders reign supreme. The interest of all other stakeholders--consumers, employees, society at large, and others--are subordinate and, in fact, inappropriate for managers to consider when they directly compete with profit maximization. Shareholders' (or "economic interest holders" in the parlance of the Arizona reform (17) ) interests, according to this doctrine, are generally understood to exclusively mean profit maximization. (18) Thus, lawyers' ethical duties to clients, the courts, or the public good, to the extent that they could compel choices that would decrease profits, would be in direct competition with economic interest holders' interests.

While the NYCBA's proposed disclosure-focused regime gestures in the direction of resolving this tension by mentioning lawyers' obligation to exercise independent judgment, (19) disclosure, by itself, cannot change the structure of corporate law and the interests it privileges. And the NYCBA's proposal could even be read to favor shareholder (economic interest holder) primacy, as long as clients have been presented with some fine print. The Supreme Court of Arizona's rules explicitly provide for client primacy and impose legal ethical duties on ABSs and nonlawyer participants. (20) But the Supreme Court of Arizona did not directly address the clear contradiction between its new legal ethics regime and the well-established business law on shareholder primacy, setting up a conflict between the two. (21) Nor is it clear that the court could resolve that contradiction on its own. The Supreme Court of Arizona has the power under the state constitution to regulate the practice of law, but it is not clear that it can, sua sponte, alter the fundamental structure of corporate law or abandon an established norm like shareholder primacy. (22) In a nutshell, because the reform was done by way of regulations promulgated by the Supreme Court of Arizona, not by the legislature, the effect is to create an inevitable collision between shareholder and stakeholder primacy in the new economy for legal services.

Fortunately for the future of nonlawyer participation in providing legal services (which is here whether one likes it or not), shareholder primacy is no longer the only available way to conduct business. The rise of benefit entities is the culmination of a years-long project to construct a viable model of stakeholder primacy that, while turning the fundamental principle of shareholder primacy on its head where it applies, in all other ways coheres with settled U.S. business law. (23) Permitting and requiring entities in which nonlawyers participate in the business of law to organize as "legal benefit entities" (LBEs) would preserve client primacy. Doing so not only "fixes" existing, incomplete regimes, but also clears up a powerful objection to a practice that is otherwise normatively desirable for both clients and the legal profession. Liberalizing participation in providing legal services could not only promote access to justice--the main reason rightfully cited by its proponents over the years--but also reduce barriers for advancement for women and minorities and increase work-life balance for members of the profession. (Yes, that last bit is not an error.)

Therefore, this Article advocates that nonlawyer participation in law firms, including direct ownership and public trading (which would go further than Arizona's reform), be permitted under certain conditions and that one of those conditions be that law firms that opt to proceed on that route organize as LBEs. This would mean that they bind themselves, through their organizational documents enforced by statute, to govern themselves for the benefit of their clients and the courts, not only their investors. In states that do not yet allow benefit entities and that do not wish to make them broadly available but still want to liberalize the legal profession, legislatures could pass limited legislation legalizing LBEs but not making benefit entities available more broadly.

Finally, this argument also implies an important proposition for the business (corporate) law of the professions more generally. In the context of professional services, where the interests of the client or patient should, as a matter of ethics, be placed above the profitmaking interests of...