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February 24, 2022 Top Story

ABA Approves Lawyers’ Passive Investment in Nonlawyer Owned Firms

Model Rule 5.4 does not prohibit lawyers from passively investing in law firms with nonlawyer owners

By Leslie R. Snider

The ABA Standing Committee on Ethics and Professional Responsibility has decided lawyers may now passively invest in law firms that include nonlawyer owners, also known as Alternative Business Structures (ABS). ABA Formal Opinion 499 addresses the ethical obligations of attorney investors, while considering choice-of-law conflicts with non-ABS permissive jurisdictions. ABA Litigation Section leaders advise investors to proceed with caution.

Break open your piggy banks! New rule states lawyers may now invest in law firms that include nonlawyer owners.

Break open your piggy banks! New rule states lawyers may now invest in law firms that include nonlawyer owners.

unomat | iStockphoto by Getty Images

Recent Modifications Lead to a Fresh Look at Model Rule 5.4

ABA Model Rule of Professional Conduct 5.4 generally prohibits lawyers from sharing legal fees, forming partnerships, and practicing in business structures with nonlawyers. While most jurisdictions have adopted Model Rule 5.4, Arizona, Utah, and the District of Columbia have modified the rule to allow the sharing of legal fees with nonlawyers.

Considering these modifications, Opinion 499 states that “the question raised is whether a lawyer admitted to practice law in a jurisdiction adhering to Model Rule 5.4 . . . may acquire a ‘passive’ investment interest in an ABS?” Opinion 499 answers the question affirmatively, and further addresses how attorneys in Model Rule 5.4 jurisdictions are to proceed.

Opinion Allows “Passive Investments”

According to Opinion 499, “...a ‘passive’ investment interest means that a lawyer contributes money to an ABS with the goal of receiving a monetary return on that investment.” Opinion 499 makes clear, however, that passively investing lawyers cannot practice, hold a managerial position, or participate in day-to-day operations through the ABS. Additionally, passively investing lawyers cannot have access to confidential information under ABA Model Rule 1.6 without a client’s informed consent.

Attorneys Must Avoid Conflicts

Opinion 499 clarifies that passively investing attorneys must still identify potential conflicts. Attorney investors are not precluded from investing in an ABS simply because a future conflict of interest may arise between the lawyer’s practice and the ABS. However, if the personal conflict is present at the time of investment, the attorney must refrain from investing or address the conflict under ABA Model Rule 1.7.

“A passive investment in an ABS, without more, does not mean that the Model Rule Lawyer is practicing law through the ABS.” But to avoid the appearance of practicing law, the ABS must avoid identifying or holding out the attorney investor as a lawyer associated with the ABS. And further, “[n]othing about a passive investment necessarily creates the “close, regular and personal relationship” characteristic of “of counsel” arrangements.” Accordingly, passive investments by attorneys do not obligate imputation of conflicts under ABA Model Rule 1.10 between the attorney investor, that investor’s firm, and the ABS.

Choice of Law Issues

Opinion 499 specifically provides guidance to attorneys in Model Rule 5.4 abiding jurisdictions, which do not allow an ABS (Model Rule Lawyers). When a Model Rule Lawyer becomes a passive investor in an ABS permissive jurisdiction, such as the District of Columbia, Arizona, or Utah, a choice-of-law question arises. Is the investor still compelled to abide by their jurisdiction’s Model Rule 5.4 that does not allow nonlawyer ownership in firms? According to Opinion 499, “even if the lawyer is admitted to practice law in a jurisdiction that does not authorize nonlawyer ownership of law firms,” the attorney is still allowed to passively invest in an ABS.

In that case, ABA Model Rule 8.5 applies to resolve conflicts. Under Model Rule 8.5(b)(1), when a matter is before a tribunal, the rules of that tribunal typically apply. For any other conduct, the jurisdiction where the lawyer’s conduct occurred typically applies, under Model Rule 8.5(b)(2). “In the Committee’s view, the conflict-of-law issue in the passive investment context is resolved by applying the law of the jurisdiction in which the ABS is authorized to operate....” More particularly, Opinion 499 provides that Model Rule 8.5(b)(2) applies because an attorney investor’s only relevant conduct, and meaningful effect of that conduct, occurs in the ABS permissive jurisdiction.

Impact on the Future of the Legal Profession

Litigation Section leaders agree that lawyers ought to make an informed decision and proceed with care before investing in an ABS. “While the Standing Committee’s Formal Ethics Opinions carry great weight, it is also the State Bar opinions that lawyers will want to see in evaluating whether to make the passive investment,” advises John M. Barkett, Miami, FL, cochair of the Section’s Ethics & Professionalism Committee. “There is a reason why there is a rarity of lawyers going into business with their clients in the legal profession. Passive investments change the risk calculus,” states Margaret Monihan Toohey, Cleveland, OH, Newsletter and Web Editor for the Section’s Ethics & Professionalism Committee. “How do passive investments in an ABS impact the legal profession in the eyes of the public? A primary concern is whether the passive investments with nonlawyers may undercut a lawyer’s status as professionals,” questions Toohey.

Section leaders have advice for those who want to invest on how to address and mitigate the risks of conflict. “Avoid actually practicing law in the firm. The passive investment should not create a conflict, but active or future conflicts should be addressed,” Toohey counsels. “Lawyers investing in an ABS should not have access to the ABS’s clients’ confidential information. If that does happen, the consequences could range from a grievance to a malpractice lawsuit, to privilege or work product waiver issues,” reiterates Barkett. “If a lawyer makes a referral to the ABS, I recommend the lawyer also make disclosure of their interest in the ABS. I would also recommend that the passive investing lawyer tell the client or non-client to evaluate the ABS independently and make an independent decision whether to engage the ABS,” concludes Barkett.

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Leslie R. Snider


Leslie R. Snider is a contributing editor for Litigation News.

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