Introduction: The Expansion of ABS
Alternative business structures (ABS) is a generic term used in the legal ethics arena to refer to any form of business model for provision of legal services that is different from traditional law practice models (sole proprietorship and various types of partnerships). ABS can include the possibility of equity ownership by non-lawyers, including even publicly traded law firms (as has been seen in Australia, where ABS is known as “incorporated legal practices”) and business or consulting entities with non-lawyer equity owners that provide both legal and non-legal services.
Besides Australia, ABS has been permitted for many years in England and Wales (since the Legal Services Act of 2007) and, here in the United States, in the District of Columbia.[1] The D.C. liberalization of its Rules of Professional Conduct did not yield a significant amount of law-firm affiliated ABS. Part of this may have been due to uncertainty about whether D.C.-licensed lawyers, many of whom are also licensed in one or more other U.S. jurisdictions (e.g., Maryland, Virginia), would run afoul of the rules of professional conduct in the other jurisdictions, which did not permit ABS.[2] More recently, however, Arizona and Utah have modified their respective versions of Model Rule 5.4[3] to permit business structures that allow nonlawyer ownership of law firms and the sharing of legal fees with nonlawyers.
Model Rule 5.4
Under ABA Model Rule 5.4, which has been adopted essentially unchanged in nearly all other U.S. jurisdictions, lawyers are prohibited from sharing legal fees[4] with a nonlawyer or practicing in a law firm in which a nonlawyer owns any interest or serves as an officer or director. The original purpose of this prohibition, which a number of lawyers deem anachronistic, was to preserve the professional independence of lawyers.
Starting in the latter part of the twentieth century, however, it became clear that lawyers no longer had—assuming they ever had—a monopoly on the provision of legal and law-related services. Accountants and other tax professionals had for many years offered tax-related services to the general public in a manner that frequently blurred any distinction between legal and non-legal services. Other providers made available document discovery and a broad array of low-cost, high-volume legal-related services to both businesses and individuals.
The success of many of these initiatives attests to the societal problem posed by the high cost of lawyers’ services. The author has frequently remarked (only partially in jest) that, were he in need of a lawyer, he couldn’t afford himself. The issue does not call for levity, however. In a nation that widely regards itself as a leading exponent of the rule of law, the World Justice Project 2020 Rule of Law Index ranked the United States as only twenty-first out of a total of 128 countries, but—more tellingly in terms of peer group analysis—fifteenth out of twenty-four on a regional basis and twenty-first out of thirty-seven based on population income level.
Affordability of legal services is a large component of arguments advanced in support of repeal or revision of Model Rule 5.4. The revisions in Utah and Arizona in 2020 and 2021, respectively, have already been mentioned. In February 2020, the ABA recognized that “more than 80% of people below the poverty line and the many middle-income Americans who lack meaningful access to effective civil legal services.”[5] Accordingly, the House of Delegates passed Resolution 115 calling for “regulatory innovations that have the potential to improve the accessibility, affordability, and quality of civil legal services.”
In an era in which lawyers and law firms routinely practice on a multistate basis, piecemeal adoption of such changes raises an obvious question: May a lawyer practicing in a jurisdiction that adheres to the current text of Model Rule 5.4 invest in an ABS in a jurisdiction that allows it, and if so, what ethical limitations (if any) apply to that investment?
Formal Opinion 499
In September 2021, the Standing Committee on Ethics and Professional Responsibility (the “Ethics Committee”) addressed that question in Formal Opinion 499. It interpreted Model Rule 5.4 to allow a lawyer “passively [to] invest in a law firm that includes nonlawyer owners . . . operating in a jurisdiction that permits ABS entities, even if the lawyer is admitted to practice law in a jurisdiction that does not authorize nonlawyer ownership of law firms.” “Passive” investment,[6] for this purpose, means investment in an ABS with the sole aim of receiving a return on capital based on the efforts its employees, without any personal participation by the investor in the ABS’s work or management—in short, wholly unrelated to the investor’s law practice.
As a corollary, the opinion further refined its definition of “passive investment” as negating access by the investing lawyer to confidential information protected by Model Rule 1.6 without the informed consent of the ABS’s client. This sounds fairly straightforward, but it is actually somewhat complex, because, as the Ethics Committee acknowledges, it may often be difficult to anticipate what kinds of information about the ABS a potential investor might reasonably request, and therefore “it is unrealistic to assume that there will be no investor requests for information about the ABS operations or revenue. The issue of disclosure of confidential information by an ABS is a developing area of the law and beyond the scope of this opinion.” No extraordinarily useful guidance there, to be sure, but until this area is fleshed out further, conservative ethics advice (which the Ethics Committee, to its credit, offers) is this: If considering investment in an ABS, a lawyer “should exercise due care to avoid exposure to confidential client information held by the ABS or other associations that could result in a determination that the . . . [investing] lawyer is part of the ABS ‘firm.’”
More helpful, by way of guidance, is the rejection by Formal Op. 499 of any notion that this kind of investment could create a conflict of interest per se. “A passive investment does not create an ‘of counsel’ relationship where conflicts are imputed to other lawyers. Nothing about a passive investment necessarily creates the ‘close, regular and personal relationship’ characteristic of ‘of counsel’ arrangements.” To make appearance double sure, however, the opinion insists that investing lawyer make sure that the ABS does not in any way imply that the investor is a lawyer for the ABS or is otherwise associated with the ABS. Furthermore, the mere fact of a lawyer’s passive investment in an ABS in a Model Rule 5.4 jurisdiction does not require imputation of conflicts under Model Rule 1.10 between the investing lawyer (or that lawyer’s firm) and the ABS.
While conflicts at the time of investment are rare, they are not impossible, however. Formal Op. 499 cautions that if the investor when making the investment also represented a client with interests adverse to a client of the ABS, a concurrent conflict under Model Rule l.7(a)(2) might exist. Such a conflict could arise equally where the investor is an advocate for a client adverse to one of the ABS’s clients or a business lawyer representing a client involved in a transaction with one of the ABS’s clients. This is so, the opinion concludes, because the investing lawyer’s interest in the ABS could “create a significant risk” that the investor’s representation of the client would be “materially limited” by the investment in the ABS.
The attentive reader will have noted that the Ethics Committee’s conflict of interest analysis applies only at the point of investment. The opinion subsequently underscores this point: “The fact that a conflict might arise in the future between the . . . [investing lawyer’s] practice and the ABS firm’s work for its clients does not mean that the . . . [investor] cannot make a passive investment in the ABS.”
The Ethics Committee considered the conflict of law issue that arises when (as often will be the case, at least at present) the investor is admitted to practice in a jurisdiction that retains Model Rule 5.4. That issue is addressed by Model Rule 8.5(b)(2). Formal Op. 499 concluded that the law of the jurisdiction in which the ABS is authorized to operate should apply “because under Rule 8.5(b)(2), the predominant effect of . . . [the] passive investment in an ABS would be in the jurisdiction(s) where the ABS would be permitted.”
To recapitulate, then, the gist of Formal Op. 499, a lawyer admitted to practice in a jurisdiction that has adopted (or substantially adopted) Model Rule 5.4 may invest in an ABS entity with nonlawyer equity owners that is permissible under the ethics rules of another jurisdiction if:
- the investment is solely for obtaining a return on capital;
- the investing lawyer does not practice law with the ABS;
- the investing lawyer ensures that the ABS does not in any manner hold out the investing lawyer as practicing at or working at the ABS;
- the investing lawyer, prior to making the investment in an ABS, ascertains that none of his or her existing clients are adverse (within the meaning of Model Rule 1.7(a)(2)) to any of the ABS’s clients;
- the investing lawyer does not enjoy access to confidential information protected by Model Rule 1.6 absent
- the informed consent of affected clients; or
- compliance with an applicable exception in the ABS jurisdiction’s version of Rule 1.6.
Beyond Formal Opinion 499
There are, however, some important ethics principles related to lawyer investment in ABS that are not addressed in detail by Formal Op. 499 and that may pose potential snares for unwary lawyer investors. First, the opinion observes, “[T]he mere fact of a passive investment by a Model Rules Lawyer in an ABS does not require imputation of conflicts under Model Rule 1.10 between the . . . [investing] Lawyer (or that lawyer’s firm) and the ABS.” This is correct but could benefit from further elaboration. Where the ABS is itself a client of the investing lawyer or where the investing lawyer asks a client also to invest in the ABS, Model Rule 1.8(a) imposes several requirements before a lawyer may enter into a business transaction with a client.[7] Under that rule, a lawyer cannot enter into a transaction with the client unless (i) the transaction and its terms are fair and reasonable and fully disclosed in writing to the client in a manner that the client can reasonably understand; (ii) the client is notified and given a reasonable opportunity to seek an independent lawyer’s advice; and (iii) the client gives informed consent, in a writing signed by the client, both to the essential terms of the transaction and to the lawyer’s role therein (including whether the lawyer is representing the client in the transaction). While discipline for transgressing this rule can be severe,[8] unlike other conflict of interest limitations in the Model Rules, these are not imputed to affiliated lawyers under Model Rule 1.10(a)[9] (though they may be under the Restatement’s approach).[10]
Furthermore, the mere fact that there is no per se conflict at the time the investing lawyer makes the investment in the ABS does not mean that conflicts will not arise in the future. Therefore, the investing lawyer’s continuous monitoring is required for concurrent conflicts, such as where the lawyer is engaged to represent a client whose interests are adverse to a client of the ABS. In that scenario, the investing lawyer’s representation of the client could be “materially limited” by the investment interest (assuming it is not de minimis) in the ABS; other lawyers in the investing lawyer’s firm might, however, be able to take on that representation.
Another lurking issue is presented where the investing lawyer’s interest in an ABS, either individually or in concert with others, is a controlling interest. This may implicate the rarely invoked Model Rule 5.7, which applies the strictures of the Model Rules in connection with the provision of “law-related services.” This term is defined in Model Rule 5.7(b) in such a way as to be quite relevant to an ABS: “services that might reasonably be performed in conjunction with and in substance are related to the provision of legal services, and that are not prohibited as unauthorized practice of law when provided by a nonlawyer.” The rule applies to:
- the lawyer in circumstances that are not distinct from the lawyer’s provision of legal services to clients; or
- in other circumstances an entity controlled by the lawyer individually or with others if the lawyer fails to take reasonable measures to assure that a person obtaining the law-related services knows that the services are not legal services and that the protections of the client-lawyer relationship do not exist. (Emphasis added).
Unfortunately, the key term “control”—a concept familiar to business lawyers in a variety of statutory contexts—is defined neither by the rule nor by the Terminology section of the Model Rules. The only guidance offered is somewhat vague and is found in Comment 4 to Model Rule 5.7:
[4] Law-related services also may be provided through an entity that is distinct from that through which the lawyer provides legal services. If the lawyer individually or with others has control of such an entity’s operations, the Rule requires the lawyer to take reasonable measures to assure that each person using the services of the entity knows that the services provided by the entity are not legal services and that the Rules of Professional Conduct that relate to the client-lawyer relationship do not apply. A lawyer’s control of an entity extends to the ability to direct its operation. Whether a lawyer has such control will depend upon the circumstances of the particular case.
Short of actually exercising dominion over the quotidian business operations of the ABS, what constitutes control for this purpose remains murky. The best way for a lawyer investing in an ABS to be sure of not running afoul of this provision would seem to be contenting oneself with a modest, minority investment and avoiding any possibility of being viewed as acting in concert with other investors who, in the aggregate, might be deemed to exercise control.
Conclusion
Formal Opinion 499 raises the curtain on a sensible approach to ABS as innovation in the provision of legal services and related services becomes more widespread. As is evident from the opinion, this is an area in which further refinement of lawyers’ ethical responsibilities can be anticipated. For now, passivity is the watchword: Make passive investments, act passively and not as a lawyer for the ABS, and be on the lookout for lurking conflicts issues.
[1] D.C. Rule 5.4(b) permits individual nonlawyers, in certain circumstances, to be partners in law firms, as long as they do not provide legal advice but provide different professional services that assist the firm in delivering legal services. The firm must have as its sole purpose providing legal services to clients. The District does not, however, permit passive investment in law firms.
[2] That is precisely the issue that is considered in the recent ABA ethics opinion discussed in this article.
[3] In Arizona, the provisions are now a part of ER 5.3.
[4] Note, the Model Rules of Professional Conduct nowhere define the term “fees.” That potentially gives rise to an argument about the source of law firm revenues that could, even under the Model Rule, be shared with nonlawyers, but this article will not consider that issue.
[5] ABA, Res. 115, Revised Resolution and Report at 1 (Feb. 2020)
[6] Formal Op. 499 is limited to passive investment in an ABS and does not address issues implicated by a lawyer practicing in an ABS.
[7] It is possible, albeit unlikely, that the factual settings alluded to here might constitute the investing lawyer “acquir[ing] an ownership, possessory, security or other pecuniary interest adverse to a client.” If that acquisition is “knowing,” that is another basis upon which Model Rule 1.8(a) would come into play.
[8] See, e.g., In re Davis, 740 N.E.2d 855 (Ind. 2001) (suspending lawyer for 18 months); State ex rel. Oklahoma Bar Ass’n v. Perry, 936 P.2d 897 (Okla. 1997) (disbarment for this and other rules violations).
[9] Standing alone, passive investment does not give the investing lawyer “access to information protected by Model Rule 1.6 without the ABS client’s informed consent” and does not create the sort of relationship with the ABS that would normally require imputation of conflicts.
[10] Under the RESTATEMENT (THIRD) OF THE LAW GOVERNING LAWYERS § 126, the rules governing a lawyer’s business transactions with clients are imputed to affiliated lawyers under § 123. See id. § 126, cmt. A.
