Unlike a corporation, a U.S. law firm may not have non-lawyer investors or shareholders. That is probably not a problem for a law firm with steady cash flows or one that can secure commercial loans. But it can sometimes pose a problem, particularly for law firms representing plaintiffs on a contingent-fee basis or otherwise financing their clients’ litigation.
The impediment to outside investors is Rule 5.4 of the ABA Model Rules of Professional Conduct and state ethics rules based on it. Aiming to protect lawyers’ professional independence, Rule 5.4 forbids lawyers from giving non-lawyers an ownership interest in their law firms and from sharing legal fees with non-lawyers. The rule originated in a 1909 New York law, adopted at the urging of New York lawyers, forbidding corporations from practicing law. Over the next two decades, other states passed similar laws, and the ABA and other bar associations concluded that it is unethical for lawyers to offer legal services to the public in partnership with, or as employees of, non-lawyers. In 1928, the ABA amended its Canons of Professional Ethics to include the proscriptions on which the current Rule 5.4 was based.
The U.S. bar never successfully excluded non-lawyers from law practice, however. In 1931, a preeminent corporate law professor, Fordham’s Maurice Wormser, observed that companies such as title, insurance, trust, indemnity, and collection corporations were performing around 60 percent of the corporate legal work in the country. While lawyers suffered, Wormser suggested, businessmen had reason to seek legal help from corporations rather than law firms, among other reasons, because corporations used modern business methods and standardized legal work. Eighty years later, as lawyers have vastly expanded the kind of services they offer, corporations still employ lawyers to serve the public.
To some extent, the bar has come to accept that non-lawyers may profit from lawyers’ work. In 1994, following intense debate over whether lawyers may participate in “multi-disciplinary practices,” the ABA adopted a new rule allowing lawyers to form entities with non-lawyer partners to provide “law-related services” as distinguished from “legal services.” While corporations may not send their employed lawyers to court on behalf of clients, they can employ lawyers to give business advice; lobby; and provide other law-related assistance that firms customarily provide, including investigative and litigation-support services connected with lawsuits. But the professional conduct rules still forbid lawyers from bringing non-lawyer investors into their law practices, and only Washington, D.C., allows law firms to have non-lawyer partners.
Litigation funders have begun making inroads, however, into the traditional idea that non-lawyers should not be allowed to invest in lawyers’ legal services. Funders apparently have begun financing plaintiffs’ lawyers in exchange for a share in their legal fees from individual lawsuits or groups of lawsuits. For example, an investment manager wrote in 2017 that “funders can provide funding to law firms on a ‘portfolio’ basis [in which] the funder invests a fixed dollar amount into a law firm, and the funder’s return is secured by a portfolio of cases being handled by the firm on a contingency or partial contingency (a blended or hybrid) basis.”
This is a very recent U.S. development. A 2010 study by the Rand Institute found that alternative litigation funders in the United States were generally lending to plaintiffs, not to their lawyers. Likewise, a 2014 article discussing litigation funding in the United States and Canada discounted concerns that litigation funders would improperly influence lawyers, because “[l]itigation funding involves a contract between just two parties: the claimholder and the funder” and “[t]he claimholder’s lawyer is not part of the transaction.” To date, most of the writings about the ethics issues raised by third-party funding of litigation—including the recent ABA Formal Opinion 484 (Nov. 27, 2018)—assume that the funder’s arrangement is directly with a plaintiff who agrees to provide a percentage of the recovery if the lawsuit is successful.
The New York City Bar’s ethics committee (which I chair) is among the first to examine funders’ investments in law practices. Last summer, its Opinion 2018-5 concluded that New York’s version of Rule 5.4 forbids funders from taking a stake in lawyers’ fees. It cited prior opinions barring “business arrangements in which lawyers agree to make payments [for goods and services] based on the receipt of legal fees or the amount of legal fees in particular matters,” and found “no meaningful difference between payments for financing, on the one hand, and payments for goods and services, on the other.” The opinion further concluded that “Rule 5.4 is equally applicable when the lawyer’s payment to the funder is based on the recovery of legal fees in multiple matters (e.g., a portfolio of lawsuits against the same defendant or involving the same subject matter) as opposed to a single matter.” It distinguished “the traditional ‘recourse’ loan agreement . . . in which a lawyer’s payments are not contingent on the receipt or amount of legal fees in particular matters.”
While concluding that “[n]othing in the language, history or prior interpretations of Rule 5.4(a) supports an interpretation carving out litigation funding arrangements,” the ethics committee acknowledged that it may be time to reexamine the rule. The New York City Bar recently agreed, establishing a Litigation Funding Working Group (of which I am a member) whose charge includes examining the ethics rules and framework applicable to litigation funding and exploring whether to recommend revisions to the applicable ethics rules.
Needless to say, the New York City Bar’s opinion attracted ample criticism, especially from litigation funders and lawyers who work with them. Critics maintain that lawyers’ professional independence is adequately secured because funders’ contracts forbid them from controlling litigation. Critics also argue that, practically speaking, there is no meaningful difference between litigation funders’ investment in lawyers’ fees and permissible recourse lending.
It is altogether fitting that the New York City Bar take up this controversy, given that New York lawyers were responsible for the 1909 statute that led us down this road. But why is the ABA, which has the preeminent national role in developing our profession’s norms, staying on the sidelines?
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