Would your law firm like to offer its employees better employment benefits while reducing the firm’s Human Resources (HR) administrative burdens? If so, you may want to consider contracting with a professional employer organization (PEO). When a business—not just law firms—contracts with a PEO, the business and the PEO share the employee as a “co-employee.” The business provides the substantive work, while the PEO provides employee benefits and HR administration. Such an arrangement may sound a bit unusual, but every ethics authority that has considered whether law firms may use PEOs has allowed the practice as long as proper safeguards are maintained.
What Is a PEO?
A PEO is a company that provides HR solutions for small to medium-sized businesses. A business chooses the services it wants the PEO to provide to the business’s employees—for example, training, payroll services, employee benefits (such as insurance and retirement benefits), HR, tax administration and regulatory compliance. The business enters a contract with the PEO, typically called a client services agreement, and pays for the PEO to provide these services to the business’s employees, who typically become “co-employees” of the business and the PEO.
The PEO, meanwhile, uses its larger scale to locate and negotiate better deals for employment benefits, qualify for certain types of benefits (such as retirement benefits) that may not be available to small to medium-sized businesses and provide more efficient and cost-effective HR functions.
Because the PEO must exercise some control over employees to qualify as a co-employer, ordinarily employer authority and responsibility are shared between the business and PEO. The business contracting with the PEO—often called the PEO’s “client”—directs and controls the employment worksite and matters such as production and delivery of products and services. The PEO, meanwhile, retains some right to hire, reassign and terminate the co-employed employees.
PEOs are quite common. According to the National Association of Professional Employer Organizations' (NAPEO) website, an industry group, more than 900 PEOs provide employment services to 175,000 small and medium-sized businesses in the U.S., co-employing approximately 3.7 million people. NAPEO’s website also estimates that approximately 15 percent of employers with 10 to 99 employees partner with a PEO to address their HR and employment benefits needs.
What the Legal Ethics Authorities Think
Legal ethics authorities are sometimes criticized for being conservative and impeding law firm innovation. Nevertheless, perhaps because of the general acceptance PEOs have received in American business, legal ethics authorities have generally been accepting of law firms contracting with PEOs as long as appropriate safeguards are maintained.
In 2015 the Association of the Bar of the City of New York issued the lead ethics opinion on law firms contracting with PEOs in its Formal Opinion 2015-1 (NYC Formal Op. 2015-1). That opinion discusses and draws upon two earlier ethics opinions discussing law firms’ use of PEOs, Connecticut Bar Association Informal Opinion 2002-08 and District of Columbia Bar Ethics Opinion 304 (2001), and identifies five ethical issues that must be considered:
- A lawyer’s duty to maintain professional independence under Rules of Professional Conduct 1.8, 2.1 and 5.4.
- A lawyer’s duty to supervise lawyers and nonlawyers at the firm under Rules 5.1 through 5.3.
- A lawyer’s duty to preserve confidential information under Rules 1.6 and 1.9.
- A lawyer’s obligation to avoid conflicts of interest under Rules 1.7, 1.9 and 1.10.
- A lawyer’s obligation to not share legal fees with nonlawyers under Rule 5.4.
Examining these five ethics issues and earlier ethics guidance, NYC Formal Op. 2015-1 concludes that a law firm may contract with a PEO for co-employment of the law firm’s employees as long as four requirements are met.
First, the law firm must not allow the PEO to interfere with the lawyers’ ethical obligations to exercise independent professional judgment or to supervise other lawyers and nonlawyers. Per NYC Formal Op. 2015-1, the PEO must not “be allowed to influence decisions that would impact the lawyer’s ability to provide independent professional judgment to his or her clients.” Also, “in connection with any aspect of the practice of law,” the PEO may not possess contractual or statutory authority to hire, terminate, discipline or otherwise control law firm employees.
Second, the law firm must not allow the PEO to access confidential information relating to the firm’s clients. To ensure confidential client information receives the protections required by Rules 1.6 and 1.9(c), NYC Formal Op. 2015-1 advises law firms to adopt safeguards that reasonably prevent confidential client information from being shared with the PEO. These protections would include language in the law firm-PEO client services agreement that the PEO has no right of access to client information. The law firm also needs to instruct all co-employees that they should not share confidential client information with the PEO co-employer.
Third, the law firm must be aware of obligations to avoid conflicts of interest. NYC Formal Op. 2015-1 recognizes that it would be foreseeable that a single PEO might contract and have co-employment relationships with multiple law firms whose clients could very well be adverse. The use of a PEO “does not alter the law firm’s duty to ensure that its legal personnel are free of disqualifying conflicts,” NYC Formal Op. 2015-1 warns. Law firms should therefore check for conflict when new employees join the firms, including when those new employees will be co-employees of PEOs.
NYC Formal Op. 2015-1 stops short of requiring the PEO to conduct conflict checks, however, because—as noted earlier—the PEO should not be gaining access to confidential client information or interfering with the lawyers’ representation of their clients.
Fourth, and finally, the law firm must not compensate the PEO in a manner that violates prohibitions against sharing fees with nonlawyers. A law firm generally may not share fees with a nonlawyer, including a PEO co-employer. NYC Formal Op. 2015-1 advises that a law firm’s payment arrangement with a PEO may not compensate a PEO based upon how much the law firm charges clients or receives on client matters. This restriction should not impose a heavy burden, however, because PEOs generally charge flat fees per employee or service, or fees based upon a percentage of total payroll. NYC Formal Op. 2015-1 advises that these fee structures are permitted, again as long as they do not effectively create an improper fee-sharing relationship.
In determining that firms must satisfy these four requirements, NYC Formal Op. 2015-1 draws not only upon the Connecticut and District of Columbia bar opinions mentioned earlier that specifically address issues relating to law firm-PEO relations but also other ethics opinions that provide guidance on law firms’ use of temporary and contract lawyers. Thus, if you are trying to evaluate how your jurisdiction might view contracting with a PEO, ethics opinions on the use of temporary or contract lawyers may provide useful guidance. NYC Formal Op. 2015-1 notes that the analogy between a PEO co-employed lawyer and a temporary lawyer is not perfect, however, because the legal benefits of the co-employment relationship require that the PEO-law firm co-employment relationship not be temporary.
Finally, lawyers evaluating whether to contract with a PEO might appreciate the outcome of Johnson v. Texas Workforce Commission, 2017 Tex. App. LEXIS 861 (Tex. App. Dallas Jan. 31, 2017). In Johnson a co-employed secretary sued the law firm and PEO for unemployment benefits. The plaintiff’s claim against the law firm was dismissed because the plaintiff had not asserted a separate claim against the law firm. The PEO prevailed because, the appellate court held, substantial evidence supported the Commission’s determination that the employee had been terminated due to her insubordinate attitude and refusal to cooperate with paralegals at the firm. Johnson mentions the law firm-PEO co-employment relationship without criticism and supports that using a PEO may help reduce HR headaches such as involvement in unemployment compensation proceedings.