Ethics: Three Folks Walk Into a Lawyer’s Office…

One time-worn variety of joke begins, “Three guys walk into a bar …” Then the joke-teller describes the professions, religions or other characteristics of the guys. For us ethics lawyers, one time-honored variety of ethics question begins: Three business people walk into a lawyer’s office. One has money, one has an idea and one can sell anything. They want the lawyer to help them form a new business, including setting up an entity to own and run the business. They all want to own a piece of the business. 

As with so many ethics questions, there’s really no punchline. But the question is, Who’s the lawyer’s client? Or maybe, who should be the lawyer’s client? 

It’s no joke. There are better and worse answers. And the difference can mean conflicts of interest and less-than-happy clients— and nonclients. Or even a malpractice claim.

Pick a Client (Or Clients)

The first thing the lawyer should remember is that a lawyer-client relationship can generally be formed two ways—either by mutual agreement of lawyer and client or by implication, where the lawyer fails to clearly disclaim an attorney-client relationship with someone who reasonably believes the lawyer is their lawyer. We sometimes call the client in the second situation an “accidental client,” as the lawyer-client relationship implied by law is often not one the lawyer intended to form.

The law in pretty much every jurisdiction is that we can become someone’s lawyer essentially by implication if we deal with someone seeking legal advice or services and if we let them reasonably believe that we are their lawyers. (For the law on this, see the American Law Institute’s Restatement of the Law Governing Lawyers, Section 14.) Hence, the amazing utility of the “I’m-not-your-lawyer” letter—it can defeat any claim of reasonable belief that a lawyer-client relationship existed.

(A bar bet question: Which ethics rule governs when and how a lawyer-client relationship is formed? Answer: None of them. It’s purely a question of common law.) So the first rule for the lawyer is to decide who the lawyer wants to be her client. There are several solutions.

Pick One

The lawyer can simply agree to represent just one of the three businesspeople, often the one bringing money. This may be the simplest option—no conflicts, only one person to answer to and only one person responsible for paying the bill.

In this scenario, the lawyer should clearly tell the other businesspeople that she is not representing them in the matter and that they might want to get their own lawyers. The lawyer might even offer the nonclients lawyer recommendations—offering several is sometimes prudent. And the lawyer would be well-advised to confirm this in writing—even a short email is invaluable protection.

Can a lawyer representing only one of the three businesspeople perform services that benefit all three, like incorporating the business? Yes, she can. That fact alone does not create an attorney-client relationship.

The Multiple-Client Solution

Can the lawyer represent more than one of the three? Yes, but all the usual concerns of joint representation then kick in. They do matter in this situation, and they often argue against joint representation.

The potential for conflicts of interest abounds. The money client, the idea client and the sales client may have very different expectations about capital contributions, ownership interest, governance and operations. The lawyer should try picturing herself representing only one of the clients, and think through the advice she would give to just that client on these important subjects, and then compare it to the advice she’d give each of the others individually. Complexities quickly appear.

If the idea is an invention, who owns the patent, and if not the entity, what license terms will govern? Will any of the three clients be employees and, if so, on what terms and at what compensation rate? What about noncompetes?

One lawyer can certainly represent all three in some situations, but she cannot then negotiate these issues between them or advise any of the three adverse to the others. Will these three businesspeople be able to adequately sort all these issues out among themselves without the lawyer’s help? Remember, one key measure of whether joint representation is even permissible is whether the lawyer can provide competent representation to all the clients. Some clients, maybe especially less sophisticated clients, should not be left without a lawyer to advise them individually on these kinds of issues, and joint representation may have that effect.

Most lawyers understand that joint representation in these circumstances is tricky. Any lawyer attempting it should certainly document the arrangement and the three clients’ informed consent to joint representation in a clear engagement letter.

(For more on these issues, see my article, “The Ethics of Joint Representation,” published in the ABA Litigation Section’s Litigation, vol. 40, no. 1, Fall 2013, available at americanbar.org/groups/litigation/publications/litigation_journal/2013-14/fall/the_ethics_joint_representation.)

Old Ties

Another relevant consideration is whether the lawyer has any current or former ties with any of the three, including another attorney-client relationship. Any such ties can create a “material limitation” conflict of interest that can complicate a joint representation. Disclosure of such a relationship to the other clients will likely be required. As a practical matter, other relationships outside the current deal may counsel that the lawyer stick with representing only their existing client in this new deal.

But Wait, There’s Another Option

Whenever I discuss this scenario, some savvy business lawyer raises her hand and says, “Well, I generally represent the entity, not the individuals.” In other words, this lawyer only takes on the representation of the business organization that she is forming for the three businesspeople and does not represent any of them individually.

Crafty. One client. No conflicts (unless the lawyer also rep­resents one of the three on other matters, which may raise issues requiring caution or consent). And an attorney-client relation­ship with a new business with great prospects.

Can you do that? Can you represent some entity that doesn’t yet exist? Well, yes, you probably can. There are a handful of authorities out there that support this “relation-back” theory of representation, and no authority I have ever found rejects it.

Of course, the lawyer does need to very carefully lay out this approach in their engagement letter, including telling all three businesspeople that none of them are clients. Prudence suggests that all three businesspeople should sign the engagement letter, even though they are not the clients. They can speak as organiz­ers, and they can confirm clearly that they know they are not the lawyer’s clients.

Of course, the three will all need to agree on the business terms of their relationship—capital contributions, ownership shares, employment terms, identification of any assets and the like—without the kind of advice that any of them would have if they had their own personal lawyer.

There is the possibility of complication if the entity doesn’t get formed for some reason, such as failure of the parties to agree on some critical terms. This might argue for the lawyer to provide for payment of fees by personal obligation by one or more of the three nonclients. (Of course, nonclients can agree to pay a lawyer’s fees.)

The (Ethics) Punchline?

What have we learned?

Choose and identify your client—or clients here—consciously and intentionally. Discuss this thoroughly with all three businesspeople. Confirm who you are representing and, critically, who you are not representing, in writing to all three businesspeople. If any joint representation is involved, carefully obtain each of the client’s informed consent to joint representation after disclosing the risks and benefits, preferably in writing.

After The Creation

And one more thing, the job’s not done until the lawyer cleans up the worksite.

If the lawyer and the businesspeople choose a solution other than representing the new business, and if the lawyer does take on representation of the business after it is formed, the lawyer should send a clean and fresh new engagement letter to the new business after formation.

As important, the lawyer should also send clear disengagement letters to the client or clients represented in the formation. Good representation hygiene is tremendous protection from numerous issues down the road.