TEXAS LAWYERS' INSURANCE EXCHANGE

Taking Stock in Lieu of Fees: A Rapidly Changing Landscape

The Legal Environment

American Bar Association Standing Committee on Ethics and Professional Responsibility Formal Opinion 00-418, July 7, 2000. ¹

For the first time, the Committee has addressed the ethical issues surrounding the practice of taking stock in lieu of fees. Before exploring the substance of the opinion, it is worth noting that courts cite the Committee's opinions regularly. Moreover, a lawyer's compliance, or non-compliance, with legal ethics rules can impact a malpractice case. Section 74(2) of the Restatement (Third) The Law Governing Lawyers codifies what many malpractice lawyers know: courts in many jurisdictions will allow juries to consider the ethics rules in making their decisions. The Reporters' Note to that section cites a number of such cases.

The Committee opines that taking stock in a client in lieu of fees is not an inherent violation of Model Rule 1.7. However, a lawyer who does it must consider whether she satisfies the material limitation, adverse effect, and consent provisions of Rule 1.7(b).

The most significant finding of the Committee is that taking stock in lieu of fees is subject to the requirements of Model Rule 1.8(a). Many experts have thought that was the case, and that is the Restatement's position at Comment a to §126. ABA Opinion 00-418 makes such a finding in disciplinary and malpractice cases even more likely. The requirements of the rule are tough: the terms of such an arrangement must be in writing; the terms must be "fair and reasonable to the client;" the client must consent to the arrangement in writing; and the client must be afforded an opportunity seek the advice of other counsel.

The Committee compares the "fair and reasonable" requirement of Rule 1.8(a) with the Rule 1.5(a) requirement that fees be "reasonable." A "lawyer-friendly" aspect to the opinion is the Committee's view that the fairness analysis of the arrangement should be as of the time the inception of the relationship. At inception, the riskiness of taking stock in lieu of fees is more apparent, and a finding of reasonableness is arguably more likely.

Failure to comply with Rule 1.8(a) can be devastating. In Passante v. McWilliams, 62 Cal. Rptr. 2d 298 (Cal. App. 1997), failure to comply with California's version of Rule 1.8(a), in part, cost the lawyer his ability to collect $32 million worth of stock from a client. Likewise, in DiLuglio v. Providence Auto Body, Inc., 2000 R.I. LEXIS 159 (R.I., June 30, 2000), the court held that a lawyer's failure to comply with Rule 1.8(a) in contracting with a client could entitle the client to rescind the contract. (The court denied rescission in DiLuglio, because the client waited six years to raise the issue.)

Some Recommendations for Loss Prevention

Taking stock in lieu of fees and investing in clients should not be done at the whim of individual lawyers but rather under supervision of the firm's management group or special committee set up for that purpose.

All firms should have an insider trading policy and take steps to ensure that all lawyers and staff are periodically reminded of it.

Be constantly mindful of Model Rule 1.8(a) - in particular its requirement that the client be urged to seek other counsel, and its requirement that the client's consent to the arrangement be in writing.

Ensure that these practices do not run afoul of the firm's malpractice insurance policy.

Try to ensure that each position not be a large percentage of the client's securities or a large percentage of the firm's investment portfolio.

Avoid shady clients. If the enterprise fails - and many high-tech enterprises have begun to fail - the risks of being involved in an aiding and abetting claim, or a claim that the firm was a principal violator of SEC Rule 10b-5, are substantial.

TLIE appreciates the opportunity to share this article with our readers. It originally appeared in the lpl Advisory, Vol. 4, No. 2, Fall, 2000; permission to reprint it was granted by the author, and by the publisher, the ABA Standing Committee on Lawyers' Professional Liability. William Freivogel is a consultant on legal ethics and professional liability. He publishes Freivogel on Conflicts, an online guide to conflicts of interest: http://www.freivogelonconflicts.com.

^{1 Ed. Note - A synopsis of Opinion 00-418 is available at http://www.abanet.org/cpr/ethicopinions.html. The opinion in its entirety may be obtained for a moderate fee by contacting the ABA Center for Professional Responsibility Ethics Department at 312-988-5326 or ctr-profresp@abanet.org.}