In the typical attorney-client relationship, attorneys may provide legal advice that is used to help clients achieve and maintain their business goals. Sometimes, based on their work together, attorneys and clients become friends and have social relationships independent of the attorney-client relationship or may look for other ways to work together. Imagine a client approaching their attorneys to describe a new business venture: Perhaps the attorney would consider forgoing a traditional fee arrangement to provide legal services for the venture in exchange for an ownership interest in the venture. What are the rules?

It is becoming more common for attorneys to invest financially in their clients, but there can be restrictions. As an initial matter, ABA Model Rule of Professional Conduct 1.8 (a) provides guidance to attorneys considering whether to invest in their clients or enter into such business transactions. Rule 1.8 (a) provides that a lawyer shall neither enter into a business transaction with a client, nor shall the lawyer knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless:

1. The terms of the transaction are fair and reasonable to the client and disclosed in writing.
2. The client is informed of and given the chance to seek independent counsel regarding the transaction.
3. 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 American Bar Association has recognized that this sort of arrangement may even be preferable for attorneys who work for start-up businesses, which may be short on cash to pay lawyers but high on potential. The ABA has noted that the Model Rules of Professional Conduct do not prohibit a lawyer from acquiring an ownership interest, whether as a traditional investment opportunity or in lieu of a cash payment for legal services.  See ABA Formal Opinion 00-418 (July 7, 2000).

While there is nothing inherently unethical about these non-traditional financial arrangements or investments, an initial consideration of the requirements of Rule 1.8 can ensure that attorneys implement steps to ensure that such financial arrangements in their clients are proper.

Consider the Fairness and Reasonableness

In reviewing whether an investment relationship is appropriate, attorneys may consider potential conflicts of interest and the overall optics of the transaction. Whether the transaction’s terms were fair or reasonable will typically be viewed from the perspective of the client and, sometimes, after the fact. Courts and bar associations 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. This is particularly important due to the concern that attorneys could place their financial interests above the interests of their clients, thereby potentially creating a conflict.

Many attorneys in this situation will consider seeking the advice of their colleagues or objective attorneys to assess the reasonableness of the investment terms. This additional step can help avoid the appearance of bias by the attorney obtaining the financial interest in the client.

Obtain Written Informed Consent

In accordance with the professional rules, obtaining written informed consent from a client will typically require that:

1. The client has been afforded the opportunity to consult independent counsel;
2. The client has been informed of the risks, advantages, disadvantages, alternatives and information necessary to assess the transaction; and
3. The client affirmatively and expressly consents to the transaction.

To obtain the client’s informed consent to the potential risks associated with the proposed investment, consider documenting the specific information provided to the client. The document can be sufficiently detailed so that, if a question ever arises, a third party can readily determine that the client was reasonably informed prior to providing consent.

Another particularly 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 instance, 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. As an additional precaution, some attorneys will require the signature of an additional witness to the consent, but it is not required.

Following the recommended steps and guidelines may help achieve the ultimate goal to eliminate misunderstanding and prevent disputes regarding the client’s consent to the transaction.

Considering the Involvement of Independent Counsel

Having an opportunity to consult with independent counsel can help clients confirm the path forward. Pursuant to the guidelines set forth in Rule 1.8, attorneys may advise clients that they can consult with independent counsel regarding the reasonableness and fairness of the proposed terms. If the client chooses to consult with independent counsel, that can help confirm the overall reasonableness of the transaction and potentially increase the likelihood that the agreement will survive a critical inspection in the future. Nevertheless, clients may, and have the right to, decide not to consult independent counsel after being fully advised.

Tips for In-House Lawyers

Rule 1.8 is also understood to apply to in-house counsel when they are negotiating deals with their corporation clients that provide ownership interests to the counsel. As detailed by the Southern District of California in Gurvey v. Legend Films, Inc., an in-house lawyer may need to advise their client corporation to seek independent counsel and provide written consent before entering into a business transaction by which the counsel would acquire an ownership interest in the company.