As published by The Daily Report
Independent counsel operating with no interest in the transaction allows the client to benefit from professional judgment free from conflict—and adds to the likelihood that the agreement will pass muster in the future.
Long-term attorneys of corporate entities are sometimes like family. Although attorneys’ expertise typically manifests in providing legal advice and guidance to their corporate clients, that legal advice may be used by the clients to help them meet their business and economic goals. Over time, an attorney may begin to celebrate the nonlegal success of her or his clients.
To that end, it is becoming more and more common for attorneys to invest financially in their clients, whether in their clients’ overall success or for specific projects or tasks. Some clients view this as a favorable opportunity not only to identify creative ways to pay their attorneys but also as a potential reward for attorneys who help facilitate their clients’ success.
As a threshold issue, Model Rule of Professional Conduct 1.8(a) generally permits attorneys to invest in their clients or enter into such business transactions if three general requirements are met:
- The terms of the transaction are fair and reasonable to the client 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 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).
The ABA has noted that the Model Rules of Professional Conduct do not prohibit a lawyer from acquiring an ownership interest in a claim, whether as a traditional investment opportunity or in lieu of a cash payment for legal services. (ABA Formal Opinion 00-418, July 7, 2000). Indeed, the ABA has recognized that this sort of arrangement may even be preferable for attorneys who work for startup businesses.
By starting with the requirements of Rule 1.8, attorneys can take steps to ensure that their nontraditional financial arrangements with or investments in their clients are above board.
Are the Transaction’s Terms Fair and Reasonable to the Client?
Whether the transaction’s terms are fair and reasonable to the client’s interests will often be viewed from the perspective of the client. Courts and bars reviewing such an arrangement may be particularly focused on whether there is any suggestion that the attorney is financially trading off of the client’s confidences and secrets or otherwise taking advantage of their knowledge of the client’s confidential information. That is because there can be an appearance in such a situation that the attorney is placing her or his financial interests above the interests of the client, potentially creating a conflict.
Many attorneys in this situation will consider asking an outside, objective attorney to assess the reasonableness of the investment terms. This can help avoid the appearance of bias by the attorney obtaining the financial interest in the client.
Disclosing in Writing and Recommending Independent Counsel
In addition to being in compliance with the rules, obtaining 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 and also helps makes it more enforceable.
Separately, the attorney can and should, in compliance with Rule 1.8, advise the client that they can consult with independent counsel regarding the fairness of the proposed terms.
Independent counsel operating with no interest in the transaction allows the client to benefit from professional judgment free from conflict—and additionally adds to the likelihood that the agreement will pass muster in the future.
Like all conflicts of interest, obtaining a client’s informed consent to an investment by an attorney typically involves more than just reporting that a conflict might exist. In this scenario, most attorneys will take additional steps to ensure that any consent given by the client is effective, including by providing sufficient information for the client to understand the risks associated with the consent.
This may involve informing the client of the alternatives to the proposed transaction. Depending on the circumstances, it may involve disclosing to the client the objective advantages and disadvantages of the proposed transaction.
One important disclosure to consider is 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 could change the relationship between the parties and impact the attorney-client relationship, such as if the attorney becomes a shareholder, limited partner or partner of the client.
To obtain the client’s informed consent to the potential risks associated with the proposed investment, many attorneys will prepare a writing that documents the specific information provided to the client. Typically, this is more involved than just stating that the client has been informed. Instead, the writing is detailed enough so that, if a question ever arises, a third party can see that the client was reasonably informed prior to providing consent.
Second, many attorneys will ensure that the client’s actual consent is disclosed in writing. In practical terms, this may mean that the client signs the disclosure with a sentence added that states the client:
- Has been afforded the opportunity to consult independent counsel,
- Has been informed of the risks, advantages, disadvantages, alternatives and information necessary to assess the transaction; and
- Affirmatively and expressly consents to the transaction.
One additional precaution that some will take is the addition of a witness to the client’s signature. The most important goal is to eliminate any dispute regarding the client’s consent to the transaction.
Change Internal Documents to Reflect the Transaction’s Impact
Some investments can change the nature of the relationship of the attorney and the client to law practice. Depending on the investment, attorneys may become a client of the firm, in addition to their other roles with the practice.
As a result, in order to detect and resolve these potential issues, attorneys can consider whether these financial relationships need to be documented within their law firms’ official systems.