When a lawyer and a client enter a business transaction beyond the typical fee-for-service, the risk of a claim rises dramatically. Price-sensitive clients may offer you business equity, investment returns or even patents to better afford your services. Some of these carefully arranged side deals may even be legal and ethical at the outset but can still lead you into violations or repercussions over the long term.

As a lawyer, proactively managing lawyer–client business transaction risks such as these becomes key to avoiding a dangerous and complex situation down the road.

Partnering with Your Client

Analyzing the ethics of any business transaction with a client must come first. The American Bar Association Model Rules are very clear on the issue of conflict of interest, particularly in Rule 1.8(i):

“[A] lawyer shall not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except that the lawyer may: (1) acquire a lien authorized by law to secure the lawyer’s fee or expenses; and (2) contract with a client for a reasonable contingent fee in a civil case.”

and in Rule 1.5(a):

“[A] lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses.”

But whether a particular lawyer–client business transaction involves “unreasonable” remuneration or is a “cause of action” or “subject matter of litigation” is not always as clear and likely requires further review.

Managing Ownership Interest and Investment Risks

Under the right circumstances, it may be ethical for a client to offer you a small percentage of the company in exchange for assisting with various general legal matters, provided that certain steps are followed, and appropriate terms are set.

Restatement 3d of the Law Governing Lawyers, § 36, notes that the rule prohibiting acquisition of a proprietary interest is “limited to matters in litigation.” Similarly, ABA Formal Ethics Op. 00-418 (July 7, 2000) notes:

“The Model Rules of Professional Conduct do not prohibit a lawyer from acquiring an ownership interest in a client, either in lieu of a cash fee for providing legal services or as an investment opportunity in connection with such services, as long as the lawyer complies with Rule 1.8(a) governing business transactions with clients, and, when applicable, with Rule 1.5 requiring that a fee for legal services be reasonable.”

Rule 1.8(a) prohibits entering into a lawyer–client business transaction unless certain steps are followed, including:

“(1) the transaction and terms … are fair and reasonable to the client and are fully disclosed and transmitted in writing… (2) the client is advised … and is given a reasonable opportunity to seek the advice of independent legal counsel … and (3) the client gives informed consent…”

To comply with Rule 1.5, a lawyer may opt for an independent valuation of the company or business interest to determine what percentage of equity or profits would have been equal to a reasonable fee for service.

However, per Restatement 3d of the Law Governing Lawyers, § 207, cmt e., lawyers should be mindful that it is their burden to prove the transaction was fair and reasonable under the circumstances at the time it was entered into—not in hindsight.

Managing Patent Interest Risk

For patent litigators, the risk of lawyer–client business transaction claims is even higher. It is common for these practitioners to be offered an interest in a specific patent or patent application, and such an additional exception is allowable under the United States Patent Office Rules of Professional Conduct. In 37 CFR § 11.108(i)(3), the rules state that a registered patent practitioner may:

“[i]n a patent case or a proceeding before the Office, take an interest in the patent or patent application as part or all of his or her fee.”

However, per 78 FR 20183:

“practitioners who take an interest in a patent or patent application as part of or all of their fee remain subject to the conflict of interest provisions of § 11.108.”

Due to the USPTO exception, a conflict exists between the USPTO Rules and state bar rules, which has resulted in a mix of decisions in litigation:

• In Sperry v. Florida ex rel. Florida Bar, 373 U.S. 379, 385 (1963), the Supreme Court held that “[a] State may not enforce licensing requirements which… give the State’s licensing board a virtual power of review … or which impose … additional conditions not contemplated by Congress.”
• Further decisions, such as Kroll v. Finnerty, 242 F.3d 1359 (Fed. Cir. 2001), have clarified that registered practitioners may still be subject to their state bar rules for matters related to practice before the USPTO, and likely both sets of rules apply.
• In the complex case of Buechel v. Bain, 766 N.E.2d 914 (N.Y. 2001), the New York Court of Appeals found that the USPTO’s express exception did not obviate compliance with state bar rules, noting that registered practitioners wishing to take an interest in a patent or patent applications must still comply with disclosure obligation under both state law and USPTO Rules.

Mitigating Business Transaction Risks

Beyond ownership and patent interest risks, lawyers may face other risks. A side deal which has the appearance, though not the intent, of dishonesty, fraud, deceit or misrepresentation, contrary to ABA Rule 8.4(c), may lead to an ethics violation. Even a properly executed patent business transaction may cause you problems in a lateral move or conflicts of interest check years later.

In any such business transaction, a careful analysis of the law and compliance with all applicable ethics rules is a must. Doing so can help mitigate your risk but may not fully eliminate it. To more fully protect your career and your assets, ensure that you have adequate levels of Professional Liability Insurance coverage. The right insurance can offer protection should business transaction risks turn into claims down the road.

Information provided by Lockton Affinity is not intended as legal advice.