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October 20, 2017 Top Story

Challenge Fails Seeking to Ban Nonlawyer Investment in Law Firms

Federal court finds either state bar advisory opinion or state court action “preferable”

Candice A. Garcia-Rodrigo

iStockphoto by Getty Images

Following prior decisions rejecting challenges to state rules of professional conduct prohibiting nonlawyers from investing in law firms, the U.S. District Court for the District of Connecticut dismissed challenges to Connecticut's rule. Some ABA Section of Litigation leaders find the plaintiff's argument against the rule to be unpersuasive to override the rule's ethical rationale.

State's Overriding Interest to Regulate Attorney Conduct

The contested state bar rule restricts lawyers from sharing fees or creating partnerships with nonlawyers. The rule makes no exception even if only a part of the business includes the practice of law. The plaintiff objected to rule, which is in line with all states' rule, because it prevents the firm from raising capital.

Such a limit "unconstitutionally restricts the law firm's ability to practice law and deprives clients of cost-effective, technologically-advanced access to the legal system." As a result, the plaintiff sought a declaration the rule violated the United States Constitution and an injunction barring its enforcement.

The plaintiff had filed similar federal actions in New Jersey and New York. The District of New Jersey ruled New Jersey's highest court should first decide the issues involved when it abstained. The District Court for the Southern District of New York initially abstained. But, it ultimately rejected the plaintiff's same argument, finding it was "entirely without merit."

In dismissing the plaintiff's case, the New York court found that "the challenged laws serve New York State's well-established interest in regulating attorney conduct." Regulating lawyers in this way supports "ethical behavior and independence among the members of the legal profession."

The Connecticut federal court granted defendants' rule 12 motion following the rationale of the New York court. The court dismissed to "avoid unnecessary friction in federal-state relations, interference with important state functions, tentative decisions on questions of state law, and premature constitutional adjudication."

To preserve the case, the plaintiff urged the court find the state law "void for vagueness." The plaintiff argued that law firms may borrow from banks through loans or credit lines. Under this rule, however, firms may not have nonlawyer investors, making application of the rule vague. The district court did not entertain that argument. The court directed the plaintiff to seek clarification from the state bar association or state court through declaratory judgment.

The Rule Ensures Lawyer's Independence

Section leaders agree that the primary rationale for the rule prohibiting nonlawyer investors in law firms is to maintain the lawyer's independence. The "objective of the rule is to avoid diluting a lawyer's exercise of independent professional judgment on behalf of clients," states Thomas G. Wilkinson, Jr., Philadelphia, PA, Section's liaison to the Center for Professional Responsibility and Section Officers Conference Professional Responsibility Committee and member of the Section of Litigation's Ethics and Professionalism Committee. "Sometimes as lawyers, the judgment exercised may not generate the most revenue the firm," says Wilkinson.

"A nonlawyer might prefer to settle a case and generate a contingent fee recovery rather than run the risk of trying the case, which may be what the client directs the lawyer to do," he continues. "That could impair the lawyer's judgment, because the investor is urging settlement contrary to the client's wishes," states Wilkinson. With the court's pronouncement that this case is "entirely without merit," litigation funding firms are unlikely to see rule changes that permit nonlawyer investing, adds Wilkinson.

The plaintiff's argument is not persuasive, opines Scott E. Reiser, Roseland, NJ, cochair of the Section's Ethics and Professionalism Committee. "An investor in a company has an ownership interest, which is different than simply loaning money. As an owner, the investor may want a say in how the business is run," he reasons.

The nonlawyer may interfere with the attorney's judgment "to make cases as profitable as possible," continues Reiser. "For example, the lawyer may want to take on a controversial pro bono case, but the nonlawyer may not want to," which fails to achieve increased access to justice, theorizes Reiser.  

Client's Interest Will Always Prevail in Lawyer-Run Law Firms

Section leaders also noted the conflicts between the lawyer's ethical requirements, such as maintaining independent judgment to advance a client's interest, and the interests of nonlawyer investors. "Nonlawyers are not obligated to put the client's interests ahead of their own," explains Wilkinson. They do not have the same fiduciary duties, such as confidentiality and loyalty, he states.

"Most law firms run with an eye on the bottom line, but the client's best interests are always at the forefront," declares Reiser. In another example of the conflict, a client may have an interest in maintaining attorney-client privilege. If the nonlawyer wants status updates on cases, then the privilege could be lost, argues Reiser. It may be possible to prevent loss of the privilege, but the ethical issue remains of putting the nonlawyer's interests ahead of the interests of client or law firm, he continues.

"The argument that allowing nonlawyer investment will somehow improve access to justice needs to be fleshed out in a more persuasive manner to gain traction," Wilkinson contends. "While it is important to make money, our profession's goal should be to ensure the rule of law and access to justice," concludes Reiser. For now, the rule barring nonlawyer investment significantly advances the bedrock principles of the practice of law, leaders agree.

Candice A. Garcia-Rodrigo is a contributing editor for Litigation News.

Keywords: ethics, fee-splitting, nonlawyer investor, attorney fees, litigation funding, litigation

Hashtag: #ethics, #attorneyfee, #litigationcosts, #accesstojustice, #litigationfunding, #litigation

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