Third-Party Payment of Legal Fees: Ethical and Practical Considerations

A client lacks funds to pay legal fees but has a third party—usually a parent or other relative—who is willing to help. Perhaps there simply are not sufficient assets in the marital estate to pay the fees. Perhaps the marital estate is illiquid. Perhaps the client’s spouse controls the money, so the client cannot access it. For these clients, a white knight willing to assist in paying their legal fees is a blessing. And, the financial support is often but one element of broader support, including emotional support and trusted advice, that the payor has provided to the client before she ever reaches your office, and will continue to provide throughout the case. But despite the obvious advantages to the client—and there are obvious advantages—the third-party payor arrangement is inherently triangular and presents a number of ethical, practical, and strategic issues that family lawyers must navigate.

ABA Model Rule of Professional Conduct 1.8

The core principles governing the third-party payment of legal fees are expressed in Rule 1.8 of the ABA Model Rules of Professional Conduct. Rule 1.8 has been adopted, with modifications, in every state except California, and California’s rule is similar. Rule 1.8(f) provides that a lawyer shall not accept compensation from a third-party payor unless (1) the client gives informed consent; (2) there is no interference with the lawyer’s independent professional judgment or with the client-lawyer relationship; and (3) information relating to representation of a client is protected as required by Rule 1.6. Each of these three conditions must be satisfied for a lawyer to accept compensation from a third-party.

Informed Consent

“Informed consent” is defined in Model Rule 1.0(e). In this context, it requires that the client’s consent to the third-party payor arrangement be made with an awareness of the risks of, and reasonable alternatives to, the third-party payor arrangement. Most states do not require that the lawyer’s explanation of the risks and alternatives be in writing.

What are the risks to a client when someone else pays his or her legal fees? They are situational and will vary from case-to-case. Common risks include

• the risk that the repeat payment of legal fees by a third-party could be considered regularly recurring gifts and therefore a form of income for purposes of calculating financial awards;
• the risk that the payor will seek to exert the power of the purse to control litigation decisions;
• the risk that otherwise privileged communications between the lawyer and the client may lose their privileged status as a result of disclosure to the payor; and
• the financial risks associated with the cost of litigating these issues.

The lawyer should explain not only the nature of the risks, but also the lawyer’s strategy for mitigating them and the extent to which they reasonably can be mitigated.

What are the reasonable alternatives to the third-party payment of the client’s legal fees? As with the risks, they depend on the client and the case. Reasonable alternatives may include

• liquidating marital assets;
• seeking payment of legal fees from the client’s spouse (by request or a motion for counsel fees);
• seeking a different third-party funding source; and
• the lawyer’s agreement to defer receipt of payment.

Lack of Interference with the Lawyer’s Professional Judgment or the Client-Lawyer Relationship

Neither the lawyer’s independence, the lawyer’s professional judgment, nor the attorney-client relationship may be subject to interference by the payor. The payor may believe that funding brings a measure of control and access to information. But the payor is not the client and has none of the privileges of a client. The lawyer must not allow the payor’s wishes to affect the lawyer’s independent professional judgment.

That may be easier said than done. The payor’s interests may conflict with the client’s interests. For example, the payor may want to minimize legal fees and forego strategies that the client may wish to pursue, and which may be in the client’s best interest. The payor may instruct the lawyer, either directly or through the client, to prioritize certain objectives for the payor’s benefit, such as grandparent visitation provisions or provisions relating to a family business. The payor may insist on making decisions relating to the representation and may withhold payment if dissatisfied. The lawyer must risk the payor’s disaffection and the possible loss of fees and always exercise independent professional judgment in service of the client’s best interests.

This does not mean that when a third-party pays the fees, the lawyer must disregard the expense of pursuing a course of action and operate as though there is an unlimited litigation budget. That is not reasonable when the client is paying the bills and is no more reasonable when someone else is paying them. But the decision as to whether to pursue the strategy must be evaluated based on the client’s interests, not the payor’s interests. They may be linked. Among the factors that should be considered in thinking about the client’s interests as they relate to the legal expense of pursuing a course of action are

• the consequences to the client in the event that the payor withdraws funding;
• the consequences to the client of incurring additional debt to payor; and
• the potential damage to the relationship between the client and the payor.

Protection of Client Information

The lawyer also must protect information relating to the representation of the client as required by Model Rule 1.6. Generally, Rule 1.6 prohibits a lawyer from revealing information relating to the representation of the client unless the client provides informed consent, the disclosure is impliedly authorized in order to carry out the representation, or one or more of seven enumerated exceptions applies. The rule also requires that the lawyer make reasonable efforts to prevent the inadvertent or unauthorized disclosure of, or unauthorized access to, information relating to the representation of the client. Rule 1.6 applies not only to privileged or otherwise confidential information relating to the client, but extends to all information relating to the representation of the client.

Generally, because the payor is not the client, the lawyer’s communications with the payor are not privileged and are subject to discovery. Further, the disclosure of otherwise privileged communications between the lawyer and the client to the payor risks waiving the privileged status of the attorney-client communications. Maintaining the confidentiality of lawyer’s communications with the client can be tricky when a third-party, especially one who is a confidante of the client, is paying the bills. The payor may accompany the client to the lawyer’s office and expect to attend meetings between the lawyer and the client. Or, the payor may expect to be kept informed as to the status of the case, and the legal strategy. If the lawyer does not permit the payor to attend meetings or otherwise does not communicate with the payor about the case, the client may choose, despite the lawyer’s advice to the contrary, to disclose privileged communications to the payor offline, which risks waiving the attorney-client privilege. This risk may be greater than the risk created by the lawyer communicating with the payor about the case. When the lawyer communicates with the payor, at least the lawyer controls the message.

At the outset of representation, the lawyer must explain to both the client and the payor that

• the lawyer’s communications with the payor are not privileged and are subject to discovery;
• the lawyer’s communications with the client are privileged; and
• if the client or the lawyer share otherwise privileged communications with the payor, the communications will lose their privilege and become discoverable.

The payor may request copies of billing statements. Billing statements are information relating to the representation of the client and subject to Rule 1.6. Therefore, the client must provide informed consent to their disclosure to the payor.

Any documents, including billing statements, provided to the payor likely will be subject to discovery. If it is necessary to provide billing statements to the payor, consider providing redacted or abstracted statements with limited detail in lieu of detailed itemized statements. Do not send the payor any documents that you would be unwilling to produce in discovery.

ABA Model Rules of Professional Conduct 1.7

If the payor is an existing client, the lawyer must also comply with the conflict of interest provisions of Rule 1.7. For example, absent a valid waiver of the conflict, the lawyer may not represent a client if the representation will be directly adverse to another client, or if there is a significant risk that the lawyer’s representation of the client will be materially limited by the lawyer’s responsibilities to another client or former client.

Loan or Gift?

Consideration should be given to whether the third-party’s payment of legal fees are gifts to the client, or instead are loans. If they are regularly recurring gifts, they may be considered income to the client for purposes of financial awards. If instead they are loans to the client, the debt likewise may be considered by the court.

Loans should be properly documented. The simplest way to do this is with a promissory note, or series of notes, the originals of which should be delivered to the payor/lender. Any loan must be genuine, and not a contrivance designed to characterize the transaction as debt rather than support for the purpose of gaining advantage in litigation. Loans that are loans in name only, with no intention of repayment by the borrower, likely violate Rule 3.3 of the ABA Model Rules of Professional Conduct, Candor Towards the Tribunal, and may also be fraudulent as to the spouse. This simply cannot be done consistent with the lawyer’s ethical and legal responsibilities.

The promissory note or other loan documentation should contain clear repayment terms. These terms should be reasonable, they should be complied with, and the client should make recurring, non-nominal payments that are clearly documented.

In short, a court called upon to determine whether a family or other insider loan for legal fees is bona fide will likely apply the duck test. If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. And vice-versa. If the payment of legal fees is a genuine loan to a client, make sure it looks like one, with proper documentation and reasonable repayment terms that are complied with.

Legal Fee Agreements and Nonrepresentation Letters

Legal Fee Agreement with the Client

Model Rule 1.5(b) provides generally that the scope of the representation and the basis or rate of the fee and expenses for which the client will be responsible shall be communicated to the client, preferably in writing. Some state adoptions of the rule require rather than recommend that the fee terms be communicated to the client in writing. Where a third-party is paying the legal fees, the legal fee agreement with the client also should state:

• that a third party will pay or advance all or a portion of the legal fees and specify (if applicable) that the client is responsible for the payment of legal fees not paid by the third-party. Note that if the client is not responsible for the payment of the legal fees, the client cannot claim the legal fees as a debt to be divided in the dissolution of marriage action, and likely will be precluded from seeking the payment of legal fees from the spouse;
• whether the third-party’s failure to pay the legal fees as agreed provides a basis for the lawyer to move to withdraw as counsel for the client; and
• who is entitled to receive any unused retainer at the conclusion of the representation. Absent a contrary agreement, any excess retainer would normally belong to the payor. However, some state ethics opinions differ. It is best to clarify this in the fee agreement.

Legal Fee and Nonrepresentation Agreement with the Third-Party Payor

Although Rule 1.5(b) requires that the scope of representation and the basis of the fee for which the client is responsible be communicated to the client, it does not require that this information be communicated to a third-party payor. However, prudence dictates that, particularly where the expectation is that the payor will continue to fund the legal fees after the payment of an initial retainer, the payor’s obligations be confirmed in writing. The agreement must be consistent with the character of the payments as they relate to the client, that is, whether the payment are gifts or loans.

The payor also should be advised of the following, preferably in writing:

• the lawyer does not represent the payor;
• the lawyer’s duty of loyalty is solely to the client, not the payor;
• the lawyer’s professional judgment will be exercised solely in favor of the client, not the payor;
• the payor may not instruct the lawyer or interfere with the lawyer’s professional judgment; and
• the lawyer may not share information relating to the representation of the client without the client’s informed consent.

Conclusion

When a family is going through divorce, funds are often limited, and financial and emotional support from a devoted family member or friend can be a life saver for a client. However, lawyers must bear in mind the ethical rules and that govern this triangular relationship; explain the risks and alternatives to the client; communicate clearly with the client and payor about the differing respective roles, obligations, and constraints of the lawyer, the client and the payor; and properly document the arrangement. Above all, the lawyer must always remember that the lawyer’s duty of loyalty and duty to exercise independent professional judgment is to the client alone.