Few law practices consider investing in clients as a method of payment. It raises a litany of issues, ranging from conflicts of interest to ethical limitations under most bar rules. However, faced with the economic realities of the modern law practice, many attorneys will confront this issue. Clients are looking for ways to pay attorneys with something other than cash. Attorneys are looking to move away from the standard billable hour toward fee arrangements that allow them to participate in the success of projects they help make happen.

As a threshold issue, bar ethics rules directly address investing in a client, whether as a stand-alone investment or as part of a fee arrangement with the client. The American Bar Association's Model Rule 1.8, "Conflict of Interest: Current Clients," permits an attorney to invest in a client, if three general requirements are satisfied:

  • The terms of the transaction are fair and reasonable and disclosed in writing.
  • The client is informed of and given the chance to seek independent counsel regarding the transaction.
  • The client provides written, informed consent.

The ABA permits such investment to take the form of a traditional investment opportunity or as a "payment" for legal services in lieu of a cash payment. ABA Formal Opinion 00-418 (July 7, 2000). California has followed the ABA's lead by adopting Rule 3-300 to the California Rules of Professional Conduct. Rule 3-300 has the same three general requirements as the ABA Model Rule. As a result, attorneys and law practices considering an investment in a client should start with these three requirements.

Are the transaction's terms fair and reasonable?

One significant limitation for attorneys investing in clients is whether the transaction is fair and reasonable—from the perspective of the client. Courts are especially sensitive to whether an attorney is unfairly trading off of the attorney's knowledge of client confidences or secrets or otherwise leveraging the relationship to gain an unfair advantage.

When that happens, the attorney is presumed to place her or his own interests above the interests of the client. Obviously, this would be an impermissible conflict between the client's interest and the attorney's interest.

As a result, investments in clients, even when just a means to payment of a fee, should be objectively commercially reasonable. In practical terms, it means employing those terms that an ordinary person would consider fair and reasonable.

The better practice is to ask a different, objective attorney to assess the reasonableness of the investment terms. Attorneys evaluating their own investments are often presumed to be biased in assessing the fairness and reasonableness of the terms of the investment. The safer course is to take that issue off the table with an independent review.

Have the transaction's terms been reduced to writing?

Written confirmation of the terms of the investment protects the attorney as much as the client. The written confirmation reduces the risk of a misunderstanding between the attorney and the client regarding the exact terms of the arrangement. For transactions that go as planned, there is less risk of a misunderstanding. For transactions that go unexpectedly—either better or worse than expected—the risk increases dramatically.

Having a written agreement with the client, detailing the terms of the arrangement, also makes it more enforceable. Of course, the most obvious reason for disclosing the terms in writing is because the ethics rules require it.

Inform the client of and give the chance to seek independent counsel regarding the transaction. One fail-safe protecting clients from unreasonable terms is the opportunity to consult with independent counsel. Independent counsel operating with no interest in the transaction allows the client to benefit from professional judgment free from conflict.

This step actually involves multiple obligations. First, the attorney must inform the client of the right to seek independent counsel regarding the transaction. Second, the attorney must give the client the chance to actually seek independent counsel. Third, should the client decide to exercise the right to seek independent counsel and receive advice, the attorney must defer to that advice over any advice the attorney might otherwise believe or give.

To be effective, attorneys should confirm the right and opportunity of the client to seek and consult with independent counsel in writing. If it is not in writing, there can be a question of whether it ever happened. So the best course is put it in writing.

Does the client have sufficient information to give informed consent?

Like all conflicts of interest, informed consent to an investment by an attorney in a client involves more than just reporting that a conflict might exist. Effective consent depends on the attorney providing sufficient information for the client to understand the risks associated with the consent. Often this involves informing the client of the alternatives to the proposed transaction. Obtaining informed consent also depends on the disclosure of the advantages and disadvantages of the transaction.

One important disclosure involves the degree to which the relationship between the attorney and the client might be affected by the proposed arrangement. For example, an investment by an attorney creates other relationships that could impair the attorney-client relationship, such as if the attorney becomes a shareholder, limited partner or partner of the client.

In those situations, attorneys should explain how conflicts between the differing relationships will get resolved. If such conflicts cannot get resolved, then attorneys should consider whether the arrangement is even proper.

Has informed consent been provided in writing?

This involves two different components. First, the writing should document the specific information provided to the client. It is not enough to simply state that the client has been informed. The actual information should be detailed so that, if a question ever arises, a third party can see that the client was reasonably informed prior to providing consent.

Second, the writing should document the client's actual consent. In practical terms, this means the client signs the disclosure with a sentence added that states the client: (1) has been afforded the opportunity to consult independent counsel; (2) has been informed of the risks, advantages, disadvantages, alternatives and information necessary to assess the transaction; and (3) affirmatively and expressly consents to the transaction.

As an additional precaution, have a witness to the client's signature. The most important goal is to eliminate any dispute regarding the client's consent to the transaction.

Do the attorney's internal documents reflect the transaction's impact?

Some investments can change the nature of the relationship of the attorney and the client to the law practice. Depending on the investment, attorneys may become a client of the firm, in addition to their other role with the practice.

Such changes implicate myriad issues, including the evaluation of potential conflicts of interest for both existing and prospective clients. In order to detect and resolve these potential issues, changing a law practice's client intake procedures is vital. Be sure to include any information now relevant because of the transaction.

As published by The Recorder