The Evolving Ethics of Selling a Law Practice
By Dennis A. Rendleman
Rendleman is ethics counsel, ABA Center for Professional Responsibility, and formerly general counsel, Illinois State Bar Association, and assistant professor of legal studies, University of Illinois at Springfield. The opinions expressed herein are the author’s alone and not those of the American Bar Association.
Before the 1990 ABA Model Rules of Professional Conduct, there was no statutory provision governing the sale of a lawyer’s law practice. However, in 1945, the ABA Committee on Professional Ethics and Grievances issued Opinion 266, which stated:
The purchase of the practice and good will of a deceased lawyer by another lawyer not his partner and the payment therefor [sic] to his estate measured by a percentage of the fees, gross or net, subsequently paid by his former clients, violates Canon 34, and may violate Canons 37 and 27.
As summarized by the dean of ethics, Henry Drinker, “A lawyer’s practice and good will may not be offered for sale” (Legal Ethics 161, 1953).
But, as Sportin’ Life tells us in Porgy and Bess, “it ain’t necessarily so!”
Early methods of selling a practice
In fact, the sale of a lawyer’s practice happened regularly. First, it has always been the normal course of business for lawyers in a firm to buy out a partner, shareholder or any of the other myriad ownership interests used by law firms. And through mergers and acquisitions, law firms managed to “sell” themselves to each other.
Sole practitioners, of course, had to be more creative. The physical fixtures and furnishings of the lawyer’s office could be sold outright. Any amount paid beyond a reasonable fair market value for those items was subject to question as being improper. For example, in 1976, the California appellate court ruled in an action between two California lawyers disputing the default in payment under a 1970 contract for sale of a law office’s physical assets, files and work in progress (Geffen v. Moss, 53 Cal. App. 3d 215, 125 Cal. Rptr. 687 (2d Dist. 1976)). The selling lawyer agreed to sublet office space to the purchasing lawyer and to cooperate in sending appropriate ethical announcements. Moreover, the selling lawyer agreed not to practice within 10 miles of the office or within six years. The selling lawyer also expressed his intention to encourage present and former clients to use the legal services of the office in the future. The court held that:
Although the contract … is so drawn as to omit any reference to “goodwill,” precludes any payment to the plaintiff [selling lawyer] based on pending or future business, and although the evidence establishes that the plaintiff at no time did or would break down the total sales price as to the value assigned to any particular item, and although the contract provision … providing $15,000 instead of $13,750 as attributable to the fair value of physical assets was prompted by way of modification at defendant’s request, it is clearly apparent to this court … that each party considered the expectation of future business from present clients and former clients as a principal motivating factor in this transaction. (53 Cal. App. 3d at 222)
It is interesting to note a portion of the text of the letter sent by the selling lawyer to his clients that was quoted by the court:
All of my files and records remain intact at the above Norwalk address. In order to provide continuity in the handling of the legal affairs of the clients of my office, I was fortunate in being able to arrange for an experienced and competent attorney, Russell J. Moss, to take over at my location.
Mr. Moss, who has practiced in the Inglewood-Hawthorne area for the past 16 years, has agreed to complete all legal matters in the office, subject to the approval of the clients involved. He has custody of all files and records of the office, including original wills, which may have been drawn for you by this office.
If you have any questions or problems regarding your legal affairs, Mr. Moss will be pleased to assist you just as I would if I were available. (Id.)
In sum, the court concluded that the parties intended the expectation of future patronage of former and current clients to be a prime motivating element of the contract:
The attempted sale of the expectation of future patronage by former and current clients of a law office coupled with an agreement to encourage said clients to continue to patronize the purchaser of the physical assets of the office, under the facts of this case, may well be said to constitute an attempt to buy and sell the good will of a law practice as a going business, contrary to public policy, and that the portion of the agreement purporting to so do is invalid and unenforceable. (Id. at 226)
This, however, was the way sole practitioners “sold” law firms for many years before the adoption in 1990 of ABA Model Rule 1.17 — they just didn’t put it in writing or seek court enforcement of that writing.
Taking a partner
More subtle is the traditional junior partner transition. It is standard operating procedure for law firms: Associates are hired and after several years rise to partner at the same time that long-serving partners retire with some form of pension. For the sole practitioner, as the lawyer discovers that retirement is looming, negotiations ensue with a younger lawyer interested in “taking over” the practice. The young lawyer buys into and joins the sole practitioner in a new firm named “Old Practitioner and Successor.” For a period of time, the two may practice together, allowing the clients to get to know the successor. Thereafter, Old Practitioner might become “of counsel” or withdraw from practice entirely, while the name remains a part of the firm and a continuing financial benefit flows to Old Practitioner.
Posthumous sale
This model, mirroring in its way the practice in larger law firms, does not work when the sole practitioner dies. In O’Hara v. Ahlgren, Blumenfeld and Kempster et al. (171 Ill. 2d 333, 537 N.E.2d 730 (1989)), the Illinois Supreme Court took the same position as had California in Geffen v. Moss. In this case, the widow of a sole practitioner contracted with a law firm to pay her a percentage of income that the law firm would receive over the following five years attributable to gross receipts from her late lawyer husband’s practice. The widow subsequently signed a letter that was sent to all her husband’s clients advising them of his death and that the purchasing law firm had assumed possession of all files and pending matters. From March 1979 through January 1983, the law firm partially compensated the widow under the terms of the agreement. But in 1982 the widow filed suit alleging the law firm had failed to perform its full obligation. The law firm not only denied this but also affirmatively claimed that the widow lacked the capacity to transfer any goodwill from her late husband’s law practice. Thus, the contract was not supported by legal consideration.
A key component of the widow’s argument to the Illinois Supreme Court was the discriminatory effect of what was then Illinois Rules of Professional Conduct Rule 3-102, which was virtually identical to ABA Model Code of Professional Conduct Rule 3-102 (now ABA Model Rules of Professional Conduct Rule 5.4(a)(1) ). The court’s interpretation of the rule as written at the time permitted a law firm to make payments to the estate of a deceased partner based on earnings accrued after the partner’s death. The widow argued that the same should apply in her situation even though her husband had not been a member of the firm that was to be paying (127 Ill. 2d at 345-6).
The court declined to read the existing rule so broadly. It found that someone in the widow’s position would have an incentive to recommend the successor’s services that did not exist in the law firm situation because the heirs of a deceased partner receive the benefits of the firm’s future receipts irrespective of whether that partner’s clients retain the firm’s services (Id. at 346).
Second, the court speculated that a purchasing firm would have an incentive to reduce the services provided to the clients whose cases would require a payment to the widow or heirs as the fee would not fully inure to the lawyer taking over the practice. Such incentive does not exist when the law firm is making payments to the estate of a pre-existing partner’s estate (Id. at 347).
Although these arguments may be difficult to accept, they were the basis for determining that the widow’s agreement with the law firm was improper fee sharing and was, thus, a violation of public policy and unenforceable (Id. at 347-8; see also, Crosby v. Gullstrand, 909 F.2d 1486, 1990 WL 107833 (7th Cir. 1990)). The implications of this ruling were significant beyond this single fact situation. Subsequently, a very prominent Chicago lawyer who was sole owner of his practice died suddenly with no succession plan. The widow and her counsel saw no option but to close the firm, dismiss the 50 employees, including approximately two dozen lawyers, and refer all the cases to other firms.
The Michigan Court of Appeals took a different approach in 1980 because the estate of the deceased lawyer and the purchasing lawyer, the trial judge, and the appellate court and bar counsel were attentive to terminology (Detroit Bank & Trust Co. v. Coopes, 93 Mich. App. 459, 287 N.W.2d 266 (1980)). Before entering into the contract for sale, counsel for the State Bar Grievance Board was consulted. As a result, the agreement was changed such that it provided for the purchasing lawyer to pay the estate based upon “retainers on the books” instead of the word “clients.” The lawyer was not purchasing “clients” but was, instead, compensating the estate from the funds connected to the “work performed” by the deceased as allowed by the Michigan rule (Id.).
Model Rule 1.17: Parity for solos
Critical mass to address the discriminatory contradiction between sole practitioners and members of a firm in the transfer of ownership interest or goodwill was consolidating during the late 1980s. In 1988, the state of California introduced a resolution to the ABA House of Delegates to amend the Model Rules of Professional Responsibility to authorize the sale of an individual law practice based on a rule adopted by the California Supreme Court that same year. After review and revision by the ABA Standing Committee on Ethics and Professional Responsibility, Model Rule 1.17, Sale of Law Practice, was adopted by the ABA House of Delegates in February 1990.
Key components of the new rule included the allowance of the sale of goodwill; the obligation of the selling attorney to end private legal practice in a specified jurisdiction; the sale of the practice in its entirety; that detailed notice be provided to and actual or implied consent be received from clients; and that fees not be increased because of the sale. The Comments to Model Rule 1.17 make clear that the rule also “applies to the sale of a law practice by representative of a deceased, disabled or disappeared lawyer.” (The Illinois Rules of Professional Conduct, Rule 1.17, specifically includes this language in the text of the rule.)
As the states adopted Model Rule 1.17 and variations thereof, new refinements emerged and were considered by the ABA Ethics 2000 Commission. First, the requirement that the practice be sold to a single buyer was revised such that a sale could be made to more than one purchaser. Second, no longer was it required that the entire practice be sold, thereby allowing a lawyer to sell a specific, discrete area of the practice. Third, the requirement that the selling attorney completely leave the practice of law was revised such that the selling lawyer was only required to depart from that practice area that the lawyer was selling. Fourth, the changes eliminated the buyer’s right to refuse to represent a seller’s client unless the client agreed to pay an increased fee. (For the complete text of the current Model Rule 1.17, see below, or go to http://tinyurl.com/cgo57gm .)
As much or more than any other rule (advertising rules excluded, but that’s another article), individual states have adopted variations of Model Rule 1.17. It is important to check the applicable state rule when planning to sell one’s law firm. (For specific states’ rule variations, see http://tinyurl.com/ctfw725 .)
There are a few additional aspects worth noting. First, in a sale of a practice or part of a practice, the buyer and seller may include a noncompetition agreement. Under Model Rule 5.6(a) , a lawyer is prohibited from entering an agreement restricting the right of a lawyer to practice. However, Comment [3] specifies that “[t]his Rule does not apply to prohibit restrictions that may be included in the terms of the sale of a law practice pursuant to Rule 1.17.”
Second, a great deal of preparation is needed for a successful and ethical sale of a law practice. Model Rule 1.17 is merely the tip of the iceberg; the process is “titanic.” One must consider not just service to the current clients, but also closed client files, potential professional liability and disciplinary responsibility and substitution of counsel in pending cases. The ABA’s ETHICSearch service provides a great overview of many of these issues and can answer specific questions.
Planning beyond the sale
Finally, regarding a topic related to the sale of a law practice, in August 2007, the ABA House of Delegates approved Resolution 107 presented by the Senior Lawyers Division urging adoption of programs and procedures to encourage lawyers to plan for law practice contingencies by advance designation of another lawyer to assist in the transfer of client matters and papers/files in event of a lawyer’s impairment or other disability to practice. Although few states, particularly Florida, New York and Indiana, have specific rules on this matter, it would be advisable for all lawyers to prepare for such contingencies. Preparation such as regular review of closed files for timely disposal, timely maintenance of client and conflict lists, strict compliance with and attention to all trust account rules and accounting standards, etc., will prepare the law practice for emergencies as well as the sale of a law practice. (For more, see the article “How My Emergency Plan Saved My Practice.” )
How to succeed in the sale of a practice
Model Rule 1.17 now allows the sale of a law practice, but one must always remember that a law practice is not a physical entity. Just as songwriter Frank Loesser reminded us that “A Secretary Is Not a Toy,” so, too, does the Committee on Professional Ethics of the New York County Lawyers’ Association Opinion 109 (1943) (cited in ABA Formal Opinion 266) remind us: “Clients are not merchandise.”
Rule 1.17: Sale of law practice
A lawyer or a law firm may sell or purchase a law practice, or an area of law practice, including good will, if the following conditions are satisfied:
(a) The seller ceases to engage in the private practice of law, or in the area of practice that has been sold, [in the geographic area] [in the jurisdiction] (a jurisdiction may elect either version) in which the practice has been conducted;
(b) The entire practice, or the entire area of practice, is sold to one or more lawyers or law firms;
(c) The seller gives written notice to each of the seller’s clients regarding: the proposed sale; the client’s right to retain other counsel or to take possession of the file; and the fact that the client’s consent to the transfer of the client’s files will be presumed if the client does not take any action or does not otherwise object within ninety (90) days of receipt of the notice.
If a client cannot be given notice, the representation of that client may be transferred to the purchaser only upon entry of an order so authorizing by a court having jurisdiction. The seller may disclose to the court in camera information relating to the representation only to the extent necessary to obtain an order authorizing the transfer of a file.
(d) The fees charged clients shall not be increased by reason of the sale.
This article originally appeared in the July/August issue of the GP Solo Magazine that featured several articles on various topics related to buying, selling or closing a law practice. The entire issue of the magazine is available on the GP Solo website here.