A LAWYER'S DUTY OF CLIENT DUE DILIGENCE

How well do you have to know your client and the client's intentions regarding the possible use of your services for improper purposes? Are you able to wait until there are signs that the client seeks to use your services in a transaction to commit a crime or fraud; or should you be required to conduct an affirmative risk-based assessment of the facts and circumstances to determine whether to accept or continue a representation? Consider the following:

Prospective client asks lawyer to provide legal services for the acquisition of property in a rural area of California. Prospective client tells lawyer that client has made a lot of money in hedge funds and now wants to diversify his investments by purchasing various properties. Client states he wants to keep a low profile and does not want his identity known as the purchaser. He wants to wire money over time to the lawyer's trust account for the purchases. He asks lawyer to create a series of LLCs for the acquisitions. (Adapted from ABA Formal Opinion 20-491, which in turn was drawn from the ABA Voluntary Good Practices Guidance for Lawyers to Detect and Combat Money Laundering and Terrorist Financing (2010).)

A lawyer shall not counsel a client to engage, or assist a client, in conduct the lawyer knows is criminal or fraudulent. California Rule 1.2.1. "Knows" means actual knowledge, although knowledge may be inferred from circumstances. Rule 1.0.1(f). If a lawyer comes to know, or reasonably should know, that a client expects assistance not permitted by the rules, the lawyer must advise the client regarding the limitations on the lawyer's conduct. Rule 1.2.1, Comment [5], Rule 1.4(a)(4). Lawyers are usually entitled to believe their clients and assume that the client will use the lawyer's services for proper purposes absent circumstances indicating otherwise. Restatement Third The Law Governing Lawyers §94, Comment g.

There are occasions when a lawyer is obligated to inquire further to avoid violating Rule 1.2.1 and the lawyer's other ethical duties. For instance, a lawyer's deliberate ignorance or willful blindness may be equivalent to actual knowledge and expose the lawyer to discipline. See, e.g., In re Bloom, (1987) 44 Cal. 3d 128. In the civil context, a duty to investigate whether a client is engaged in fraudulent conduct could arise depending on the circumstances. See, e.g., FDIC v. O'Melveny & Myers(9th Cir. 1992) 969 F.2d 744 (corporate securities offering); and see California Rule 1.13(b).

Although the duty of client due diligence is currently not a blanket obligation and the rules do not mandate that lawyers play a "gatekeeper" role, there are increasing concerns that more needs to be done to combat money laundering and to counter financing terrorism. The ABA provided guidance to detect and combat money laundering and terrorist financing in 2010 and issued ABA Formal Opinion 463 in 2013 to reinforce a lawyer's duty to investigate in appropriate circumstances.

In response to continued concerns regarding lawyer's due diligence obligations, the ABA issued Formal Opinion 491 in 2020 that stated the knowledge standard under Model Rule 1.2(d) is triggered when a lawyer has knowledge of facts that "create a high probability" that the client is seeking the lawyer's services in a transaction to commit a crime or fraud. As long as the lawyer conducts a reasonable inquiry, it is proper to credit an otherwise trustworthy client even if some doubt remains. A lawyer's reasonable judgment under the facts known or reasonably available at the time would not subject the lawyer to discipline if the decisions turn out to be wrong in hindsight.

Despite the ABA's guidance, ethics opinions and current rules, government agencies and domestic and foreign entities continue to urge the ABA to create an enforceable client due diligence obligation in the Model Rules. Concern has been expressed that the failure of the legal profession to act will result in increased federal legislation and regulatory action. To address these concerns the ABA Standing Committees on Professional Regulation and Ethics and Professional Responsibility proposed amendments to the Model Rules that in essence impose a requirement that a lawyer make a reasonable inquiry into the facts and decline or terminate the representation when the lawyer has reason to believe the client seeks the lawyer's services in criminal or fraudulent activity. In January 2023, the Committees released a different discussion draft that would require lawyers to engage in a risk-based analysis under Rule 1.16 [Declining or Terminating Representation] by assessing the facts and circumstances of each representation to determine whether the lawyer may accept or continue the representation. Proposed comments to the rule make clear that the duty continues throughout the representation and that the level of assessment required varies depending on the nature of the risk posed in each situation. The rule as amended would also provide that a lawyer may not represent a client, and must withdraw, if the client or prospective client insists on using the lawyer's services to commit or further a crime or fraud.

Whether a lawyer's duty of client due diligence should be triggered when there are signs that would oblige a reasonable lawyer to conduct a further inquiry, or whether the duty requires a risk-based assessment in every case is currently being debated at the national level. Regardless of which approach is adopted, a prudent lawyer presented with the proposed engagement described above would be expected to conduct a further inquiry about the client and the circumstances before accepting representation, especially before agreeing to hold any funds in a lawyer trust account.

Mark L. Tuft is a partner and certified Legal Malpractice Specialist at Womble Bond Dickinson (US) LLP.