Attorneys are subject to duties in two fundamental categories: duties to the client and duties to third persons.¹ Some believe there is a third -- duties to "the Deal" itself. However, unless "the Deal" qualifies as a legal entity that can be identified as a client, there can be no real duties owed to "the Deal." That leaves duties to the client (which includes imputed client-attorney relationships arising from conduct or course of dealing between the attorney and other interested persons or entities), and duties arising as to third persons even without the existence of a client-attorney relationship. For brevity, this article will explore duties to the client.

When considering investing in a client, attorneys need to weigh the professional duties and practical risks in light of protecting the client's best interests. Is it possible to meet all the ethical duties owed to the client(s) and to third parties, and still avoid substantial risk of malpractice claims or grievance reports? Maybe.

Under the Texas Disciplinary Rules of Professional Conduct, there are several broad categories of duties owed to the client: competence and diligence; communicating with and keeping the client informed; charging a reasonable fee; confidentiality; independence of professional judgment; loyalty; candor; and integrity and honesty. ABA Ethics Opinion 00-418, issued July 7, 2000, emphasizes that when an attorney accepts an ownership interest in lieu of a fee or as an investment opportunity, the four duties most relevant to the client investment issue are: reasonable fees, independence of professional judgment, loyalty, and candor.² This discussion touches on all these aspects of the professional relationship, since they tend to overlap each other in real life.

Numerous practical risks attend the attorney-investor situation, so it pays to do your homework! It is especially important to define the scope of engagement and resolve any conflicts of interest between multiple clients and/or between client(s) and the law firm, in writing. Be alert throughout the relationship for telltale signs of trouble: does the client seem to expect you to serve as ombudsman for the deal? Rather than conducting his own "due diligence," does it appear that the client intends to rely instead on your business judgment about the enterprise (and not just your legal work)? Further, is more than one client involved? This could occur by agreement, or arguably by one's conduct and course of dealing by giving rise inadvertently to an imputed client relationship.

ABA Opinion 418 describes the client's perception of the lawyer as investor: "[T]he lawyer's willingness to invest with entrepreneurs in a start-up company frequently is viewed as a vote of confidence in the enterprise's prospects." While this can help procure the client's business, this sword has two edges: it can create liability exposure if the client's expectations of the attorney are unrealistically broad, or ambiguously defined. Since Texas Rule 1.02 allows the attorney to restrict the scope of legal services (and corresponding duties), provided the client consents, attorneys who are risk-conscious can take the opportunity to help both the client and themselves by defining in writing the extent of legal services the attorney has agreed to perform, and for whom. One good rule of thumb is to do it early, before sending the first billing statement, and again at any point appropriate to the circumstances.

The client/attorney conflict of interest issue requires full disclosure and fairness in the transaction. Model R. 1.8(a); TR 1.08(a). As a fiduciary, the lawyer-investor has the burden of proving fairness. Op. 418 at p.4, n. 10.³ Full disclosure, according to Professor Wolfram, requires explanation of the nature of the transaction and all its terms; the nature and extent of the lawyer's interest; the effect of concurrent legal work for the client on the lawyer's professional judgment; the benefits of independent legal counsel; and the risks and advantages to each party. Op. 418 at p. 7, n. 23, citing C. WOLFRAM, MODERN LEGAL ETHICS (1986) Sec. 8.11.4 at 485.

Opinion 418 offers some ways to establish a reasonable fee. One is to determine a reasonable fee as of the time of the transaction, and accept stock worth that equivalent amount. The value of the stock could be set at an amount per share that a knowledgeable cash investor would agree to pay at around that same time period. Or, if the value per share is reasonably ascertainable, one might accept an agreed percentage of stock issued (although a stock split might complicate matters). Alternatively, an agreed percentage of stock could be based on the client's perceived value that the legal services would contribute to the success of the enterprise, as judged at of the time of the transaction (rather than at the peak of its success). Id., at p. 5.

Model Rule 2.1 and Texas Rule 2.01 require lawyers to exercise independent judgment and render candid advice. Make the client aware that events occurring after the lawyer's stock acquisition could create a conflict between exercising independent professional judgment as a lawyer for the entity, and the lawyer's desire to protect the stock value. Op. 418, at p. 6. Advise the client that withdrawal might be necessary if such a conflict should arise, or at least the advice of independent counsel should be considered. Id. The lawyer may be disqualified from continued representation under Model Rule 1.7(b) (Texas Rule 1.06(b)) even with the client's consent, if the lawyer's self-interest justifies a reasonable belief of adverse effect on representation of the client (for example, if the business begins to fail). Op. 418, at pp. 6, 10.

Before investing, check your malpractice policy terms for coverage exclusions regarding your business investment and provision of non-legal investment advice. The definition of professional legal services may also impose restrictions. Some policies allow a small percentage of ownership without activating the exclusion. If so, the lawyer or firm could plan to decrease the percentage ownership to a permissible level, in the event of a stock split or redemption. Malpractice claims arising in whole or in part from the investment may not be covered if the lawyer or firm's investment exceeds the allowed percentage. In certain limited circumstances, a carrier might agree in advance to waive such an exclusion through a policy endorsement. If not, a malpractice defense would likely be subject to a reservation of rights to deny coverage if the proof supports that exclusion.

In short, check Texas Disciplinary Rules 1.02, 1.03, 1.04, 1.06, 1.07, 1.08, 2.01, and 2.02 carefully before investing in a client's business and performing legal services for the business. Conflict of interest disclosures and consent to the conflict in writing will be required.

Consider realistically how likely it is that the business will succeed or fail. Decide if you and the firm can justify the risk. Effective client screening is especially critical; for instance, consider the client's reputation for reliability and veracity. If you are as risk averse as you should be in protecting your license and your livelihood, your level of certainty of the success of the business - however subjective it might be - should be well-founded and sufficient to justify the exposure that comes with acting both as an investor and as a fiduciary to the client. Frankly speaking, the most sincere loss prevention advice TLIE can offer you about investing in a client's business is not to do it.

^{1 Of course, certain duties might be created between an attorney and a law firm under terms of compensation or ownership stated in the professional corporation or partnership documents. Although relevant to this discussion, those duties arise from an agreement between attorneys, rather than from rules or statutes imposing duties on attorneys dealings with non-attorneys.}

^{2 The Model Rule numbers cited in ABA Ethics Opinion 00-418 regarding duties owed to clients roughly correspond to the Texas Disciplinary Rules as follows (reference to the Model Rules being MR, Texas Rules being TR): Loyalty -- MR 1.8 (a) / TR 1.08 (a) and MR 1.7 (b) / TR 1.06 (b), ( c); Reasonable Fee -- MR 1.5 / TR 1.04; Counsel Independently and Candidly -- MR 2.1 / TR 2.01, and MR 2.3 & Comment 4 / TR 2.02 & Comment.}