Ethics Opinion 253
Referral Fee Arrangement Between Law Firms and Insurance Companies
* [NOTE: See how Opinion 253 has been substantively affected by the amendments to the D.C. Rules of Professional Conduct that became effective on February 1, 2007]
A law firm that (1) pays an insurance company a referral fee for clients referred from the company, (2) subleases office space on the premises of the insurance company, and (3) maintains a line of credit from the principals of the insurance company, may satisfy Rule 7.1, which requires that the potential client be informed of payments made to intermediaries, by disclosing these facts, but still not satisfy Rule 1.7, which sets forth the more detailed disclosure required when potential conflicts of interest exist. Moreover, even if the disclosure satisfied the rigorous requirements of Rule 1.7, and even if the client provided meaningful consent to the arrangement as would be required by Rule 1.7, the law firm would not be able to provide the zealous representation required by Rule 1.3 in cases involving a direct conflict of interest between the insurance company and the referred client.
Applicable Rules
- Rule 1.3(a)-(b) (Diligence and Zeal)
- Rule 1.7(b)-(c) (Conflict of Interest: General Rule)
- Rule 5.4 (Professional Independence of a Lawyer)
- Rule 7.1 (Communications Concerning a Lawyer’s Services)
Inquiry
The inquiring lawyer represents a Law Firm that proposes to pay an Insurance Company for clients the Company referred to the Firm. Payment would be due upon settlement or judgment in the referred cases and would be based upon a fee of $300 for each of the first three hundred cases referred, $425 for each of the next hundred cases, and $500 per case thereafter. In addition, the Insurance Company offered to sublease office space on its premises to the Law Firm for use as a satellite office and to arrange for a line of credit from principals of the Company to the Law Firm.
The Insurance Company provides liability insurance to members of a specific industry in which civil claims for damages are common. The Insurance Company’s liability plan covers claims made against industry members, but does not cover claims made by industry members. Nonetheless, industry members often ask the Insurance Company to help them select a lawyer to handle cases in which they intend to assert, rather than, defend against, a claim.
As part of the contemplated referral process, the Insurance Company would advise potential Law Firm clients of (1) the advisability of consulting legal counsel, (2) their right to seek legal counsel of their own choice, and (3) the availability of counsel in the Law Firm’s satellite office on the Insurance Company’s premises. The Insurance Company would also provide such potential clients with a brochure to be produced by the Law Firm; the Law Firm would be responsible for the brochure’s compliance with Rule 7.1(a) of the District of Columbia Rules of Professional Conduct (“D.C. Rules” or “Rules”). Upon contacting the Law Firm, each referred client would receive written disclosure concerning the referral fee plan, the sublease arrangement, and the line of credit. This written notice would also include a statement that payment of the referral fee (which would be paid by the firm from its percentage contingency fee) would have no effect on the total fee charged to the client.
The inquirer framed the request as an inquiry under D.C. Rule 7.1, which governs the use of intermediaries in soliciting business for lawyers. While Rule 7.1 is relevant, it is not independent of the other Rules, and the inquiry also implicates D.C. Rule 5.4(a) dealing with the sharing of legal fees with nonlawyers; D.C. Rule 1.7 relating to conflicts of interest; and D.C. Rule 1.3 setting forth the duty of zealous representation.
Discussion
A. Rules 5.4 and 7.1
D.C. Rule 5.4 flatly prohibits lawyers from sharing legal fees with nonlawyers (except in a limited situation not applicable here). However, without any reference to Rule 5.4, Rule 7.1(b)(5) allows a lawyer to pay an intermediary to solicit clients if the lawyer takes
reasonable steps to ensure that the potential client is informed of (a) the consideration, if any, paid or to be paid by the lawyer to the intermediary, and (b) the effect, if any, of the payment to the intermediary on the total fee to be charged.
There is therefore some considerable tension between D.C. Rule 5.4, which prohibits lawyers from sharing fees with nonlawyers, and D.C. Rule 7.1(b)(5), which recognizes that lawyers may pay intermediaries for referrals. This tension is alleviated in the Model Rules of Professional Conduct (“Model Rules”) because Model Rule 7.2(c) absolutely prohibits a lawyer from “giv[ing] anything of value to a person for recommending the lawyer’s services,” except that a lawyer may “pay the usual charges of a not-for-profit lawyer referral service or legal service organization.” In adopting the D.C. Rule 7.1, the D.C. drafters
decided not to retain the prohibition in ABA proposed Rule 7.2(c) concerning the use of paid intermediaries to contact prospective clients. ... The Board of Governors agreed that the ABA’s prohibition against paid intermediaries should not be retained, but added, in subparagraph (b)(5), certain disclosure requirements. . . . The use of paid intermediaries may assist lawyers in making their availability known to those who might not otherwise be able to secure the legal representation they desire. Proposed D.C. Rules of Professional Conduct, Comment 17 to Rule 7.1 (Nov. 19, 1986).
While commentary to the Proposed Amendments to the D.C. Rules does not specifically address how replacing Model Rule 7.2(c) with D.C. Rule 7.1(b)(5)—thereby allowing lawyers to pay referral fees to intermediaries—can be reconciled with Rule 5.4’s prohibition against sharing legal fees with nonlawyers, it is our view that D.C. Rule 7.1(b)(5) was intended to be a narrow exception to Rule 5.4. Therefore, only those lawyers who disclose to their clients the information required under Rule 7.1(b)(5) can escape Rule 5.4’s general ban against the sharing of legal fees with nonlawyers.
The Law Firm in this inquiry would satisfy all of D.C. Rule 7.1(b)(5)’s requirements by disclosing information on the referral fee, the sublease arrangement, and the line of credit, along with the statement that the payment of the referral fee would have no effect on the total fee for the client. Because the inquiry states that the Law Firm intends to make all of these required disclosures, the referral arrangement between the Insurance Company and the Law Firm would not run afoul of D.C. Rule 7.1.1 Yet the analysis does not end here. Rule 7.1 does not address the more complicated situation where the lawyer and the intermediary have a business relationship that could lead to a conflict of interest between the lawyer and the referred client. For guidance in this case, we must consider Rule 1.7 dealing with conflicts of interest.
B. Rule 1.7
Resolving the issues arising under Rules 5.4 and 7.1 does not resolve the question whether the proposed business relationship between the Insurance Company and the Law Firm would hinder independent and aggressive legal representation in situations where the referred client’s interests conflict with the Insurance Company’s interests within the meaning of D.C. Rule 1.7(b)(4). Generally, insurance companies agree to pay for a lawyer to represent the insured for claims on which the insurance company may be liable; in exchange, the insured agrees to relinquish his right to control the defense and settlement process.2 In this typical situation, the insurance company usually hires one attorney to represent both itself and the insured.
There are, however, situations where it would be inappropriate for one attorney to represent both the insurance company and the insured policyholder, including where: (1) the insurer takes the position that its policy does not cover the claim; (2) a potential conflict of interest exists between the insurer and the insured,3 or (3) the insurer represents two or more insureds with potentially adverse interests.4 The inquiry does not contemplate that the Law Firm will represent the Insurance Company on any of the latter’s matters so that these situations, which concern conflicts of interests between clients, are not directly applicable. Rule 1.7(b)(4) nonetheless forbids, except as permitted through disclosure and consent, a lawyer from representing a client when the lawyer has financial or business interests in a third party (here the Insurance Company) that “reasonably may” adversely affect the lawyer’s professional judgment on behalf of the client,5 notwithstanding the fact that the third party Insurance Company will not also be a client of the Law Firm.
The referral arrangement at issue here anticipates a mutually beneficial long-term relationship between the Law Firm and the Insurance Company: the Company does not receive maximum benefits until the 401st referred case. Moreover, the Law Firm further commits to the relationship by renting office space on the Insurance Company’s premises. Such a plan involves substantial commitments between the Insurance Company and the Law Firm, with business incentives for the Law Firm to please the Insurance Company on its handling of referred claims. A lawyer’s judgment may be adversely affected, as defined in Rule 1.7(b)(4), by conflicts between the Insurance Company and a referred policyholder, which may arise in the following ways.
According to the inquiry, the Insurance Company intends to refer to the Law Firm for legal consultation current policyholders who belong to a specific industry in which civil claims for damages are common.6 It is likely that such a policyholder would ask for referrals from the Insurance Company regarding disputes arising out of the policyholder’s business, which might include matters for which the policy issued by the Insurance Company arguably should provide coverage or legal representation. This might lead to a direct conflict by requiring the Law Firm to decide whether the policy requires the Insurance Company to provide coverage and/or legal representation and to press those claims against the Insurance Company should they prove meritorious. For instance, counsel for a policyholder in a case involving denial of coverage by the Insurance Company would have to confront the Insurance Company on the issue of whether the policy properly covered the policyholder’s claim.
Moreover, where the Insurance Company insures two or more policyholders with adverse interests, counsel for a referred policyholder might be obliged to press the claim that the Insurance Company should pay for independent legal representation on behalf of the policyholder.
In addition, many such referrals from the Insurance Company likely touch upon the policyholder’s business, for which the Insurance Company provides liability insurance. They thus present the threat of a counterclaim alleging liability on the part of the client that might trigger the Insurance Company’s duty to defend and provide coverage under the policy and possibly necessitate a third-party action against the referring Insurance Company. For instance, a policyholder might seek a referral in order to press a claim, for which the liability policy issued by Insurance Company would not provide coverage. If the policyholder’s claim arises out of its business activities, however, the threat exists that the defendant may file a counterclaim triggering coverage under the policy. These kinds of cases would necessarily involve a direct conflict of interest that could tempt the attorney to balance the client’s interest in receiving coverage and being the beneficiary of the company’s duty to defend against those of the Insurance Company in denying coverage and/or a duty to defend.
There may be situations when client referrals from the Insurance Company to the Law Firm would involve no direct conflicts of interest. For instance, an art insurance company that insures only rare paintings could refer one of its customers to a law firm with which it had entered into the proposed referral arrangement to pursue a medical malpractice claim. Because the subject of the proposed representation would bear no relationship to any coverage provided by the insurer, there is no possibility that the suit would involve claims, counterclaims or third-party claims that might trigger coverage provided by the insurance company. We suspect, however, that these kinds of referrals would be very uncommon because insurance companies would not generally have the expertise to select lawyers for claims completely unconnected to matters for which the insurers provide coverage.7
If the conflict is direct, 1.7(c)(1) nonetheless permits a lawyer to represent a client if that client consents after “full disclosure of the existence and nature of the possible conflict and the possible adverse consequences of such representation.”8 This “full disclosure” goes far beyond the cursory disclosure requirements of Rule 7.1(b)(5). Full disclosure requires “a detailed explanation of the risks and disadvantages to the client.” In re James, 452 A.2d 163, 167 (D.C. App. 1982), cert. denied, 460 U.S. 1038 (1983).
The Law Firm in this inquiry would not meet the strict disclosure requirements of Rule 1.7. To understand the nature and extent of a possible conflict, a referred client must know whether the firm receives a substantial amount of business pursuant to a referral agreement with an adversary or potential adversary, such as the Insurance Company. That information should at the very least include the percentage of the Law Firm’s total income derived through referrals from the Insurance Company. The Law Firm does not propose to reveal to the referred client this or other relevant information concerning the referral arrangement.
Furthermore, after full and meaningful disclosure, Rule 1.7(c)(1) requires the client to consent to representation from the lawyer despite the potential conflict of interest. See, e.g., In re James, 452 A.2d at 167; see also D.C. Bar Op. 210 (1990). Consent “must not be coerced either by the lawyer or by any other person.” D.C. Rule 1.7, Comment [14]. Even if a referred client provided meaningful consent to representation after the Law Firm’s full detailed disclosure of the potential conflict of interest, the Law Firm would still have to “comply with all other applicable rules with respect to such representation” of the referred client. Rule 1.7(c)(2). As explained in Comment [15] to Rule 1.7:
[D]isclosure and consent to representation do not diminish a lawyer’s obligations to comply with the other Rules of Professional Conduct. For example, even if a client provides informed and uncoerced consent, a lawyer may not undertake or continue a representation if the lawyer is unable to comply with the obligations regarding diligence . . . provided in Rule[] 1.3.
C. Rule 1.3
D.C. Rule 1.3(a) states: “A lawyer shall represent a client zealously and diligently within the bounds of the law.”9
It is well-settled that this duty of zealous representation cannot be compromised, even with the 9 consent of the client. Indeed, this Committee has concluded several times that the representation of a party—even with consent—would be improper where “the lawyer himself [] conclude[s] that his ability zealously to represent th[at] [] party (as required by Rule 1.3) would be compromised” by a conflict of interest. D.C. Bar Op. 226 (1992). See also D.C. Bar Op. 210 (1990) (“The Committee has previously recognized that the obvious ability to provide adequate representation, which pursuant to DR 7-101 [the predecessor to Rule 1.3] must be zealous, is an independent requirement which must be met even though consent is provided.”); D.C. Bar Op. 163 (1986) (same); D.C. Bar Op. 49 (1978) (same).
In cases involving a direct conflict, the Law Firm’s proposed arrangement with the Insurance Company necessarily raises a serious obstacle to the zealous representation of referred clients. Use of the referral scheme in such situations raises the same concerns as in a case where an insurance company appoints counsel to represent a policyholder to avoid a potential conflict between the insurance company and the policyholder. In such cases, “[a]lthough [some] courts seem to trust the insurer and attorney to act in the best interests of the insured, the more common view is that the longstanding ties that defense counsel has with the insurer will inevitably influence his conduct of the case.” Berg, Losing Control of the Defense—The Insured’s Right to Select His Own Counsel, 26 For the Defense 10, 15 (July 1984).10
In short, the Law Firm would always be tempted to sacrifice the client’s interests due to the Firm’s long-term financial relationship with the Insurance Company in any matter involving a direct conflict between a potential client and the Insurance Company. We therefore conclude that when the referred client’s interests in the matter for which representation is sought involves conflicts with the interests of the Insurance Company, the Law Firm cannot provide the zealous representation required by Rule 1.3.11
Conclusion
Although the Law Firm in this inquiry would satisfy the disclosure requirements of D.C. Rule 7.1, it would fall short of the more demanding disclosure required by Rule 1.7 in cases of direct conflict. Moreover, even if the client provided meaningful consent under Rule 1.7, this would not cure the Law Firm’s inability to provide the zealous representation required by Rule 1.3 in cases of direct conflict. The Committee believes that, when referrals will be on behalf of policyholders whose business activities are covered by the Insurance Company’s liability insurance, the Law Firm’s ability to accept such referrals would be limited by D.C. Rule 1.7 and D.C. Rule 1.3.
Inquiry No. 91-5-18
Adopted: November 15, 1994
1. Of course, if the consideration paid by the lawyer to the intermediary who referred the client has any effect on the total fee that the lawyer charges to the client, then the referral fee would have to be “reasonable” pursuant to D.C. Rule 1.5. This is not a concern in the present inquiry because we are assuming that the Law Firm would pay the Insurance Company from its percentage of the contingency fee, so the referral fee would have no effect on the total attorney’s fee charged to the client and that the Law Firm bases its contingency fee on well-established standards within the profession.
2. “Liability insurance policies typically provide that the insurer (the company) will pay any judgment for damages entered against the insured and will bear the cost of providing a defense against a claim for damages, including the cost of hiring a lawyer to present the interests of the insured. In return for those protections, the company typically retains the right to control the defense of the action and the decision whether to settle any claims.” Charles W. Wolfram, Modern Legal Ethics 428 (1986).
3. See D.C. Bar Op. 173 (1986) (“[T]he lawyer cannot continue to represent the insured where the insurer has a different interest and the lawyer’s performance for the insured will be affected adversely by that different interest, unless each client consents after full disclosure and it is ‘obvious’ the attorney adequately can perform.”) (citation omitted).
The following list describes other situations where the interests of the insurer and insured interests may be adverse:
1. Complaint alleges claims against the insured which may or may not potentially fall within the insurance policy;
2. Potential damages exceed insurance policy limitations;
3. The insurer has provided inadequate representation for the insured;
4. A conflict of interest arises between the insured and the insurer in settlement negotiations.
Annotation, Duty of Insurer to Pay for Independent Counsel When Conflict of Interest Exists Between Insured and Insurer, 50 A.L.R. 4th 932, 941-954 (1986).
4. In such circumstances, some jurisdictions require the insurance company to pay for independent counsel. See, e.g., Illinois Mun. League Risk Mgt. v. Siebert, 585 N.E.2d 1130, 1136 (Ill. App. 4th Dist. 1992). See generally Annotation, Duty of Insurer to Pay for Independent Counsel When Conflict of Interest Exists Between Insured and Insurer, supra note 3. The D.C. courts have not ruled on whether the insurance company must reimburse insureds who are entitled to and do obtain independent counsel. With the law ambiguous, D.C. insurance companies may require the policyholder to pay for independent counsel. The Committee takes no position on this practice at this time.
5. D.C. Rule 1.7(b)(4) reads:
(b) Except as permitted by paragraph (c) below, a lawyer shall not represent a client with respect to a matter if:
(4) The lawyer’s professional judgment on behalf of the client will be or reasonably may be adversely affected by the lawyer’s responsibilities to or interests in a third party or the lawyer’s own financial, business, property, or personal interest.
6. The inquiry does not specify the precise nature of the cases that the Insurance Company would refer to the Law Firm, but because the facts indicate that the Insurance Company intends to refer clients in the specific industry who are also policyholders, we discuss only situations involving clients referred to the Law Firm who are also policyholders.
7. Cases where a referred client’s action falls completely outside of the Insurance Company’s field of coverage could still involve “positional” conflicts of interest. Positional conflicts arise where a lawyer’s clients hold different views on what the law or public policy ought to be, even though the clients’ interests and positions do not clash in a particular matter. For instance, in our example involving rare paintings and medical malpractice, the referring art insurance company might favor an interpretation of the law on punitive damages that would conflict with the position beneficial to the referred medical malpractice claimant. For sources discussing positional conflicts at greater length, see, e.g., Model Rule 1.7; ABA Formal Op. 93-377 (Dec. 9, 1993).
8. D.C. Rule 1.7(c) reads:
(c) A lawyer may represent a client with respect to a matter in the circumstances described in paragraph (b) above, if:
(1) Each potentially affected client provides consent to such representation after full disclosure of the existence and nature of the possible conflict and the possible adverse consequences of such representation; and
(2) The lawyer is able to comply with all other applicable rules with respect to such representation.
9. Rule 1.3 states more fully:
(a) A lawyer shall represent a client zealously and diligently within the bounds of the law.
(b) A lawyer shall not intentionally:
(1) fail to seek the lawful objectives of a client through reasonably available means permitted by law and the disciplinary rules; or
(2) prejudice or damage a client through the course of the professional relationship.
10. See, e.g., Bohna v. Hughes, Thorsness, Gantz, Powell & Brundin, 828 P.2d 745 749-50 (Alaska 1992) (appointed counsel proposed to put insured through bankruptcy in order to reduce insurer’s liability to plaintiff); San Diego Navy Fed. Credit Union v. Cumis Ins. Soc’y, Inc., 208 Cal. Rptr. 494, 498 (1984) (“A[n] [appointed] lawyer who does not look out for the carrier’s best interest may soon find himself out of work.”). See also Brown and Romaker, Cumis, Conflicts and the Civil Code; Section 2860 Changes Little, 25 Cal. W.L. Rev. 45, 54 (1988) (“The attorney wishing to maintain the insurer’s business does not want to aggravate the company.”); Saxon, Conflicts of Interest: Insurer’s Expanding Duty to Defend and the Impact of “Cumis” Counsel, 23 Idaho L. Rev. 351, 353 (1987) (Insurance counsel’s “relationship with the insurer is contractual, usually ongoing, supported by strong financial interests and often strengthened by sincere friendships.”); Berch and Berch, Will the Real Counsel of the Insured Please Rise?, 19 Ariz. St. L. J. 27, 29-30 (1987) (“[T]he attorney’s economic interests weigh heavily in favor of the insurer, which after all, may retain his services in other cases; yet the rules of professional responsibility tip the scales toward the insured.”).
11. The Committee is aware that the D.C. Court of Appeals is considering a proposal to amend the D.C. Rules. See Proposed Amendments to the D.C. Rules of Professional Conduct, D.C. Rules of Professional Conduct Review Committee, F. Whitten Peters, Chair (Dec. 8, 1993). The proposed amendments would delete Rule 1.7(c)(2) and would add commentary to Rule 1.3 stating that “Rule 1.3 is not meant to govern conflicts of interest.” Under these Proposed Amendments, a Law Firm that obtains the consent required by Rule 1.7 would not be barred in advance from representing referred clients on matters involving a conflict between the clients and the Insurance Company. This proposed change would not diminish Rule 1.3’s duty of zealous representation.
