The ABA Formal Opinion 499 and What You Should Know

Published: 29 September 2021

                    business partners shaking hands

Featured in the Legal Ethics & Malpractice Reporter, Vol. 2, No. 9

Edited by Professor Mike Hoeflich

On September 8, 2021, the American Bar Association Standing Committee on Ethics and Professional Responsibility issued Formal Opinion 499 on lawyer investments in what have come to be called “Alternate Business Structures”—entities in which lawyers and non-lawyers share fees and profits as owners or investors in a firm that provides legal services. This opinion marks a somewhat radical departure from existing beliefs about such investments and opens up significant new financial and investment possibilities for lawyers.

Traditionally, there have been few restrictions on lawyer investments. Lawyers who want to invest in client businesses are required to comply with the requirements of Rule 1.8(a) as adopted in Kansas and Missouri, which reads:

A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless:

  1. The transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client; and
  1. The client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and
  1. The client gives informed consent in writing, signed by the client, to the essential terms of the transaction and the lawyer’s role in the transaction, including whether the lawyer is representing the client in the transaction.

KRPC 1.8(a); MRPC 4-1.8(a).

In some cases a lawyer’s investments may also require compliance with Rule 5.7, regarding the provision of “law related services.” Kansas Rule of Professional Conduct 5.7 provides:

A lawyer shall be subject to the Rules of Professional Conduct with respect to the provision of law-related services, as defined in paragraph (b), if the law-related services are provided:

  1. By the lawyer in circumstances that are not distinct from the lawyer’s provision of legal services to clients; or
  2. In other circumstances by 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.
  3. The term “law-related services” denotes 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.

Missouri Rule 4-5.7 tracks the Kansas rule.

Until the issuance of Formal Opinion 499, most lawyers could not, however, invest or participate in a business that provided legal services if a non-lawyer was entitled to share in fees or profits from the business. The Kansas and Missouri rules provide:

(a) A lawyer or law firm shall not share legal fees with a nonlawyer, except that:

  1. An agreement by a lawyer with the lawyer’s firm, partner, or associate may provide for the payment of money, 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 who undertakes to complete unfinished legal business of a deceased lawyer may pay to the estate of the deceased lawyer that proportion of the total compensation which fairly represents the services rendered by the deceased lawyer;
  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; and
  4. A lawyer may share court-awarded legal fees with a nonprofit organization that employed, retained or recommended employment of the lawyer in the matter.

(b) A lawyer shall not form a partnership with a nonlawyer if any of the activities of the partnership 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 professional judgment in rendering such legal services.

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

  1. A nonlawyer owns any interest therein, except that a fiduciary representative of the estate of a lawyer may hold the stock or interest of the lawyer for a reasonable time during administration;
  2. A nonlawyer is a corporate director or officer thereof or occupies the position of similar responsibility in any form of association other than a corporation; or
  3. A nonlawyer has the right to direct or control the professional judgment of a lawyer.

KRPC 5.4; MRPC 4-5.4.

In most cases, Rule 5.4 has made it ethically impermissible for a lawyer to become involved in a business that provides legal services when a non-lawyer shares in the business profits. Although Rule 5.4 remains in force in most United States jurisdictions (including Kansas and Missouri), a few jurisdictions have either modified or eliminated Rule 5.4 to permit lawyers to be involved in legal businesses with non-lawyers. These business are characterized as “alternate business structures” for law practice. Such structures are now permitted to varying degrees in Arizona, Utah, and the District of Columbia.

The fact that these jurisdictions have made this change and the possibility that more may do so in the future raises the question: May a lawyer licensed in a state that follows the traditional form of Rule 5.4 make a passive investment in an ABS firm in state where such a firm is ethically permitted? Formal Opinion 499 provides the answer: Yes, subject to a few qualifications.

First, the investment must be passive; the lawyer may only act as an investor, not as a legal practitioner for the firm. And, because of this, both the investor and the ABS must be careful to not create any impression that the lawyer-investor is practicing law for the ABS:

A passive investment in an ABS, without more, does not mean that the Model Rule Lawyer is practicing law through the ABS. To avoid any appearance of practicing law through the ABS, the investing Model Rule Lawyer must ensure that the ABS does not identify the Model Rule Lawyer as a lawyer or hold out the Model Rule Lawyer as a lawyer associated with the ABS.

The opinion also notes that 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.”

Second, a lawyer investing in an ABS firm must comply with Rule 1.7 regarding conflicts of interest related to current clients. If a conflict is present before investing, then the lawyer must either not invest or follow the rules and ensure that she complies with them. If a conflict arises after the investment is made, then the lawyer must, again, fully comply with Rule 1.7. However, “the 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 Model Rule Lawyer (or that lawyer’s firm) and the ABS.”

The other critical issue for a lawyer contemplating an ABS investment is the applicability of Rule 1.6 on confidentiality. But the Opinion is not quite as helpful on this issue as one might have hoped. The Standing Committee offered:

While it is hard to assess what information might be requested by investors or potential ABS investors, 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; when investing in an ABS, the Model Rule 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 Model Rule Lawyer is part of the ABS “firm.”

It is important to remember that the Committee considered the question of cross-jurisdiction ABS investment to be as a conflicts of law issue and, therefore, subject to Model Rule 8.5:

(a) A lawyer admitted to practice in this jurisdiction is subject to the disciplinary authority of this jurisdiction regardless of where the lawyer’s conduct occurs. A lawyer not admitted in this jurisdiction is also subject to the disciplinary authority of this jurisdiction if the lawyer provides or offers to provide any legal services in this jurisdiction. A lawyer may be subject to the disciplinary authority of both this jurisdiction and other jurisdictions for the same conduct.(b) In any exercise of the disciplinary authority of this jurisdiction, the rules of professional conduct to be applied shall be as follows.

  1. For conduct in connection with a matter pending before a tribunal, the rules of the jurisdiction in which the tribunal sits, unless the rules of the tribunal provide otherwise; and
  1. For any other conduct, the rules of the jurisdiction in which the lawyer’s conduct occurred or, if the predominant effect of the conduct is in a different jurisdiction, the rules of that jurisdiction.

A lawyer shall not be subject to discipline if the lawyer’s conduct conforms to the rules of a jurisdiction in which the lawyer reasonably believes the predominant effect of the lawyer’s conduct will occur.

Because Missouri Rule of Professional Conduct 4-8.5 tracks this language, Missouri lawyers may feel fairly comfortable following the guidance offered by Formal Opinion 499.

A Kansas lawyer contemplating an investment in an out-of-state ABS should be more cautious. The Kansas rule is different from the model rule and quite brief:

A lawyer admitted to practice in this jurisdiction is subject to the disciplinary authority of this jurisdiction although engaged in practice elsewhere.

KRPC 8.5.

The comments state:

In modern practice lawyers frequently act outside the territorial limits of the jurisdiction in which they are licensed to practice, either in another state or outside the United States. In doing so, they remain subject to the governing authority of the jurisdiction in which they are licensed to practice. If their activity in another jurisdiction is substantial and continuous, it may constitute practice of law in that jurisdiction. See Rule 5.5.If the rules of professional conduct in the two jurisdictions differ, principles of conflict of laws may apply. Similar problems can arise when a lawyer is licensed to practice in more than one jurisdiction.

Where the lawyer is licensed to practice law in two jurisdictions which impose conflicting obligations, applicable rules of choice of law may govern the situation. A related problem arises with respect to practice before a federal tribunal, where the general authority of the states to regulate the practice of law must be reconciled with such authority as federal tribunals may have to regulate practice before them.

KRPC 8.5.

The differences between Model Rule 8.5 and Kansas Rule 8.5 require additional consideration. An argument could be made that Kansas should adopt the reasoning of Formal Opinion 499. But the substantial differences in the language of the Model Rule and the Kansas Rule may warrant a discussion with the Kansas Disciplinary Administrator’s Office. Perhaps even seeking a Kansas advisory opinion might be prudent.

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