Financial and similar arrangements with nonlawyers (Rule 5.4)

PROPOSED RULES OF PROFESSIONAL CONDUCT

The state of California’s Second Commission for the Revision of the California Rules of Professional Conduct recently completed a major overhaul of the current rules. The proposed rules, which were adopted by the State Bar Board of Trustees, will replace the current rules if approved by the California Supreme Court. The purpose of the overhaul is to bring California in line with the American Bar Association model rules and the rules of other states, as uniformity is becoming increasingly important due to the growing number of multi-jurisdictional lawsuits.

Proposed Rule 5.4 consolidates three current rules: Rule 1-310 (Forming a Partnership With a Non-lawyer), Rule 1-320 (Financial Arrangements With Non-Lawyers) and Rule 1-600 (Legal Service Programs). The proposed rule retains most of the content of the current rules, but expands protection for consumers against the unauthorized practice of law and promotes collaboration between attorneys and nonprofit organizations that do not practice law. The need for clear and strong safeguards against third-party interference with legal representation and attorney-client relationships cannot be overstated. The proposed rule addresses these concerns.

Like the current rules, the proposed rule prohibits third party interference with attorney-client relationships and independent attorney judgment in rendering legal services to his or her clients. A lawyer cannot practice law in a business or nonprofit organization where a nonlawyer can direct the lawyer or interfere with the lawyer’s professional judgment. Business arrangements in which a nonlawyer owns an interest, or is a director or in a similar leadership position, violate the proposed rule and the current rules.

The proposed rule also retains the long-standing ban on sharing legal fees with nonlawyers. Paragraph A articulates five exceptions to this general rule. The exceptions — allowing lawyers to share fees with deceased lawyers’ estates, allowing lawyers to share income with nonlawyer employees through compensation and retirement plans, and to pay fees to accredited referral services — have not changed.

However, paragraph A of proposed Rule 5.4 allows lawyers to share court-awarded legal fees with a nonprofit organization that employed, retained, or recommended them in the matter. This is a departure from the current scheme which totally prohibits lawyers from sharing fees, either directly or indirectly, with nonlawyers. Currently, there are no express exceptions for nonprofits.

Paragraph B of the proposed rule expands on Rule 1-310. While Rule 1-310 prohibits the formation of partnerships with nonlawyers, the proposed rule goes a step further. It prohibits not only the formation of partnerships, but also of any “other organization” that engages in the practice of law. Thus, the rule expands protection for consumers against the unlicensed practice of law. The general prohibition against paying nonlawyers for client referrals is still in place. Lawyers may compensate referring nonlawyers in only two situations. As previously discussed, lawyers may share court-awarded fees with referring nonprofit agencies. Additionally, the proposed rule allows lawyers to pay fees to an established referral service that is operated in accordance with the Minimum Standards for Lawyer Referral Services. Referral services must be certified by the State Bar. Among other requirements, certified referral services cannot charge fees that increase the client’s cost beyond that normally charged and must serve the community by working to improve the quality and affordability of legal services. The proposed rule also expressly prohibits lawyers from accepting referrals from services that do not comply with the standards.

The authors of this article recently defended a litigation matter that emphasized the importance of setting clear and strict rules for sharing fees with nonlawyers. The case was initiated by a nonlawyer, a “finder,” who identifies potential plaintiffs for personal injury and securities-based lawsuits and refers them to a lawyer who shares a percentage of the proceeds in exchange for referrals. The referring nonlawyer party had a personal financial interest in the case, but owed no similar ethical duties to the plaintiffs as did their legal representative. The referring “finder” seemingly interfered with and delayed the litigation, and informal and formal (e.g., in private mediation) settlement negotiations, to the plaintiffs’ disadvantage. If the “finder” had not been involved in the matter, there would have been less competing, divergent interests in the progression and outcome of the case as the “finder” in this instance did not seem to have unified objectives and was not subject to the same governing ethical rules. Proposed Rule 5.4 expands and strengthens protection for consumers against this type of scenario and the potential for unethical legal practice.

Rule 5.4 Financial and Similar Arrangements with Nonlawyers

(a) A lawyer or law firm* shall not share legal fees directly or indirectly with a nonlawyer or with an organization that is not authorized to practice law, except that:

(1) an agreement by a lawyer with the lawyer’s firm,* partner,* or associate may provide for the payment of money or other consideration over a reasonable* period of time after the lawyer’s death, to the lawyer’s estate or to one or more specified persons;

(2) a lawyer purchasing the practice of a deceased, disabled or disappeared lawyer may pay the agreed-upon purchase price, pursuant to rule 1.17, to the lawyer’s estate or other representative;

(3) a lawyer or law firm* may include nonlawyer employees in a compensation or retirement plan, even though the plan is based in whole or in part on a profit-sharing arrangement, provided the plan does not otherwise violate these rules or the State Bar Act;

(4) a lawyer or law firm* may pay a prescribed registration, referral, or other fee to a lawyer referral service established, sponsored and operated in accordance with the State Bar of California’s Minimum Standards for Lawyer Referral Services; or

(5) a lawyer or law firm* may share with or pay a court-awarded legal fee to a nonprofit organization that employed, retained or recommended employment of the lawyer or law firm* in the matter.

(b) A lawyer shall not form a partnership or other organization with a nonlawyer if any of the activities of the partnership or other organization consist of the practice of law.

(c) A lawyer shall not permit a person* who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s independent professional judgment or interfere with the lawyer-client relationship in rendering legal services.

(d) A lawyer shall not practice with or in the form of a professional corporation or other organization authorized to practice law for a profit if:

(1) a nonlawyer owns any interest in it, except that a fiduciary representative of a lawyer’s estate may hold the lawyer’s stock or other interest for a reasonable* time during administration;

(2) a nonlawyer is a director or officer of the corporation or occupies a position of similar responsibility in any other form of organization; or

(3) a nonlawyer has the right or authority to direct or control the lawyer’s independent professional judgment.

(e) The Board of Trustees of the State Bar shall formulate and adopt Minimum Standards for Lawyer Referral Services, which, as from time to time amended, shall be binding on lawyers. A lawyer shall not accept a referral from, or otherwise participate in, a lawyer referral service unless it complies with such Minimum Standards for Lawyer Referral Services.

(f) A lawyer shall not practice with or in the form of a nonprofit legal aid, mutual benefit or advocacy group if the nonprofit organization allows any third person* or organization to interfere with the lawyer’s independent professional judgment, or with the lawyerclient relationship, or allows or aids any person,* organization or group to practice law in violation of these rules or the State Bar Act.

Comment

[1] Paragraph (a) does not prohibit a lawyer or law firm* from paying a bonus to or otherwise compensating a nonlawyer employee from general revenues received for legal services, provided the arrangement does not interfere with the independent professional judgment of the lawyer or lawyers in the firm* and does not violate these rules or the State Bar Act. However, a nonlawyer employee’s bonus or other form of compensation may not be based on a percentage or share of fees in specific cases or legal matters.

[2] Paragraph (a) also does not prohibit payment to a nonlawyer third-party for goods and services provided to a lawyer or law firm;* however, the compensation to a nonlawyer third-party may not be determined as a percentage or share of the lawyer’s or law firm’s overall revenues or tied to fees in particular cases or legal matters. A lawyer may pay to a nonlawyer third-party, such as a collection agency, a percentage of past due or delinquent fees in concluded matters that the third-party collects on the lawyer’s behalf.

[3] Paragraph (a)(5) permits a lawyer to share with or pay court-awarded legal fees to nonprofit legal aid, mutual benefit, and advocacy groups that are not engaged in the unauthorized practice of law. (See Frye v. Tenderloin Housing Clinic, Inc. (2006) 38 Cal.4th 23 [40 Cal.Rptr.3d 221]. See also rule 6.3.) Regarding a lawyer’s contribution of legal fees to a legal services organization, see rule 1.0, Comment [5] on financial support for programs providing pro bono legal services.

[4] This rule is not intended to affect case law regarding the relationship between insurers and lawyers providing legal services to insureds. (See, e.g., Gafcon, Inc. v. Ponsor Associates (2002) 98 Cal.App.4th 1388 [120 Cal.Rptr.2d 392].)