Ethics Opinion 361
Lawyer’s Acceptance of Compensation From Non–Lawyer Entity for Referring Client to Such Entity; Opinion 245 Overruled in Part
A lawyer who refers a client to a non-lawyer service provider such as a financial services firm may accept compensation from the provider for the referral so long as the criteria of Rule 1.7(c) and, if applicable, Rules 1.8(a) and 5.7 are satisfied. Those criteria are exacting, however, and the arrangement may be beyond the lawyer’s malpractice coverage even if permitted by the Rules.
Applicable Rules
- Rule 1.7 (Conflict of Interest: General)
- Rule 1.8(a) (Conflict of Interest: Specific Rules)
- Rule 5.7 (Responsibilities Regarding Law-Related Services)
Inquiry
The committee has been asked whether a lawyer who refers her client to a non-lawyer service provider1 may accept compensation from the provider or potential partner for such a referral. Although this issue can arise in various contexts, the particular scenario presented is whether a lawyer may refer her client to a financial services firm in exchange for a referral fee. The inquirer advises that the referral arrangement would be disclosed to the client in writing and is permissible under the federal securities laws.2
Discussion
The foregoing scenario offers one of the many contexts in which fee-for-referral situations can arise. Variables include whether the transaction with the other entity will involve “law-related services” (e.g., title insurance for a real estate purchase versus the purchase of an automobile), whether the lawyer’s representation of the client is related to the client’s transaction with the other entity, whether the lawyer represents the other entity in unrelated matters, and whether the lawyer owns or controls the other entity.
For the reasons set out below, we believe that the D.C. Rules of Professional Conduct (“Rules” or “D.C. Rules”) permit such arrangements if certain criteria are satisfied. We caution, however, that the prerequisites for such an arrangement are exacting and that even when permitted by the Rules, the arrangement may fall outside the coverage of the lawyer’s professional malpractice insurance.
Rules 1.7 and 1.8, which govern conflicts of interest, and Rule 5.7, which deals with the provision of law-related services, are relevant to this inquiry. No reported decision of the District of Columbia Court of Appeals or the District of Columbia Superior Court appears to have addressed this issue since the D.C. Rules of Professional Conduct took effect in January 1991.3 This committee addressed the issue in a 1993 opinion (Opinion No. 245) but an intervening change in the Rules makes reconsideration in order.
The 1993 inquiry was whether a company offering services as a registered agent for corporations could pay commissions to lawyers who referred their clients to the company. Following a brief discussion that cited Rule 1.7(b)(4) of the D.C. Rules and several ethics opinions from this and other jurisdictions, the opinion concluded that—
a lawyer may not retain a referral fee or commission from a third party for referring legal clients. Any payment offered to the lawyer for referral of a client’s business must be disclosed to the client. The client must consent to the payment, and the payment must be turned over to the client directly or as a credit to the bill for legal services. A lawyer’s judgment in referring a client for services from third parties must be based on assessment of the quality of the third party’s services and fairness of the price, not on a potential financial benefit to the lawyer.
Legal Ethics Op. 245 (1993) (“Opinion 245”). Most of the precepts set forth in the above quotation—notably, those respecting disclosure, consent, and impairment of the lawyer’s independent professional judgment—apply with equal force today. Under the current D.C. Rules, however, such a fee need not be turned over to the client if—
- the client—following full disclosure as contemplated in Rule 1.7(c)(1)— gives his informed consent (as contemplated in Rules 1.7(c)(1) and 1.0(e)) to retention of the fee by the lawyer; and
- notwithstanding the lawyer’s personal conflict under Rule 1.7(b)(4), “the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to [the] client,” as required by Rule 1.7(c)(2); and
- the requisites of Rule 1.8(a), which governs business transactions between lawyer and client, are satisfied; and
- if Rule 5.7, which addresses the provision of “law-related services,” applies, the requisites of that rule are satisfied.
Rule 1.7. Rule 1.7 is the general rule relating to conflicts of interest and waivers of such conflicts. One type of conflict arises when “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 interests.” D.C. Rule 1.7(b)(4).
This type of conflict can be waived if (A) the client “provides informed consent” “after full disclosure of the existence and nature of the possible conflict and the possible adverse consequences of such representation” and (B) “the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to [the] client.” Rule 1.7(c).
Opinion 245 was issued in 1993. In 1995, the Court of Appeals promulgated rules revisions that included a new comment to Rule 1.7:4
[36] Lawyers, either alone or through firms, may have interests in enterprises that do not practice law but that, in some or all of their work, become involved with lawyers or their clients either by assisting the lawyer in providing legal services or by providing related services to the client. Examples of such enterprises are accounting firms, consultants, real estate brokerages, and the like. The existence of such interests raises several questions under [Rule 1.7]. First, a lawyer’s recommendation, as part of legal advice, that the client obtain the services of an enterprise in which the lawyer has an interest implicates paragraph 1.7(b)(4). The lawyer should not make a recommendation unless able to conclude that the lawyer’s professional judgment on behalf of the client will not be adversely affected. Even then, the lawyer should not make such a recommendation without full disclosure to the client so that the client can make a fully informed choice. Such disclosure should include the nature and substance of the lawyer’s or the firm’s interest in the related enterprise, alternative sources for the non-legal services in question, and sufficient information so that the client understands that the related enterprise’s services are not legal services and that the client’s relationship to the related enterprise will not be that of a client to attorney. * * * Third, the lawyer should be aware that the relationship of a related enterprise to its own customer may create a significant interest in the lawyer in the continuation of that relationship. The substantiality of such an interest may be enough to require the lawyer to decline a proffered client representation that would conflict with that interest; at least Rule 1.7(b)(4) and (c) may require the prospective client to be informed and to give informed consent before the representation could be undertaken. Fourth, a lawyer’s interest in a related enterprise that may also serve the lawyer’s clients creates a situation in which the lawyer must take unusual care to fashion the relationship among lawyer, client, and related enterprise to assure that the [client’s] confidences and secrets are properly preserved pursuant to Rule 1.6 to the maximum extent possible.
D.C. Rule 1.7, cmt. [36]. Comment [36] makes clear that a lawyer’s profit-motivated financial or managerial involvement with another entity to which she refers clients is not per se prohibited but is subject to the waiver provisions of Rule 1.7(c).
We view the instant inquiry—in which the other entity pays a commission to the referring lawyer—as an example of the type of lawyer interest described in comment [36] and hence as not per se prohibited by the Rules. Instead, an arrangement for such a referral fee or commission is subject to the waiver provisions of Rule 1.7(c). To exemplify, we do not believe the Court of Appeals intended to permit waiver for a referral to an accounting firm owned by the referring lawyer but to forbid waiver, even with full disclosure to and informed consent by the client, for a referring lawyer’s receipt of a $100 gift card from a court reporting service.
Accordingly, Opinion 245 is overruled insofar as it erects a per se bar to the receipt of compensation by a lawyer for referring her client to a non-lawyer entity. We emphasize, though, that the requirements of “[d]isclosure and consent are not mere formalities,” D.C. Rule 1.7 cmt. [27], that “the lawyer bears the burden of proof that informed consent was secured,” id. cmt. [28], and that a waiver is ineffective unless “the lawyer reasonably believes”—i.e., the test is objective—“that he or she will be able to provide competent and diligent representation” despite the conflict, id. cmt. [30]; accord D.C. Rule 1.7(c)(2). The disclosure should include the fact that the lawyer stands to benefit from the referral, the amount and manner5 of the benefit, that other providers of the services might do so more capably, at a lower cost or both, and that the fact of the benefit conceivably could affect the lawyer’s independent professional judgment. See Ariz. Ethics Op. 05-01 (2005) (requiring disclosure of amount and manner of benefit); Calif. Formal Op. 1995-140 (1995) (requiring disclosure that better and less costly services may be available elsewhere). Moreover, “the form of disclosure sufficient for more sophisticated business clients may not be sufficient to permit less sophisticated clients to provide informed consent.” D.C. Rule 1.7, cmt. [28]; accord Phila. Bar Ass’n, Joint Ethics Op. 2000-100 (2000). Finally, the quantum of the benefit to the lawyer is a factor in whether the lawyer reasonably can conclude that the arrangement will not affect adversely the lawyer’s ability to provide competent and diligent representation. See D.C. Rule 1.7, cmt. [30] (noting that “it is doubtful that a lawyer could [so conclude] where the lawyer’s individual interests make it likely that the lawyer will be adversely situated to the client with respect to the subject matter of the legal representation”); Phila. Bar Ass’n, Joint Ethics Op. 2000-100 (2000); Utah Ethics Advisory Op. 99-07 (1999) (noting difficulty, under Rule 1.8, of satisfying requirement that lawyer’s judgment not be affected); Wisc. Ethics Op. E-00-04 (2000) (stating that disclosure requirements of Rule 1.8 can be satisfied only if benefit to lawyer not unduly substantial).
The disclosures mandated in connection with a request to waive a lawyer’s conflict under Rule 1.7 are not required to be in writing. The same is true for the client’s informed consent. D.C. Rule 1.7(c) & cmt. [28]. The comments note, however, that “[i]t is ordinarily prudent for the lawyer to provide at least a written summary of the considerations disclosed and to request and receive a written informed consent.” D.C. Rule 1.7, cmt. [28].
Rule 1.8. The D.C. Rules impose special waiver requirements when a lawyer enters into a business transaction with a client. The transaction must be “fair and reasonable to the client” and must be fully disclosed in writing “in a manner which can be reasonably understood by the client.” D.C. Rule 1.8(a). The disclosure should, “[w]hen necessary, [include] the material risks of the transaction, including any risk presented by the lawyer’s involvement, and the existence of reasonably available alternatives and, where appropriate, should explain that the client may wish to seek the advice of independent counsel. D.C. Rule 1.8, cmt. [2]. Also, the client must be accorded a reasonable chance to obtain independent legal advice and the client must give informed written consent to the transaction. D.C. Rule 1.8(a). A lawyer-client transaction is subject to this rule even if unrelated to the legal representation but—
the risk to a client is greatest when the client expects the lawyer to represent the client in the transaction itself or when the lawyer’s financial interest otherwise poses a significant risk that the lawyer’s representation of the client will be adversely affected by the lawyer’s financial interest in the transaction.
D.C. Rule 1.8, cmts. [1], [3]; accord N.J. Ethics Op. 688 (2000). Moreover, “[t]he rule applies to lawyers engaged in the sale of goods or services related to the practice of law, for example, the sale of title insurance or investment services to the existing clients of the lawyer’s legal practice.” Id. cmt. [1].
The D.C. Rules provide expressly that Rule 1.8(a) applies if the other entity is controlled by the lawyer—a criterion that includes the lawyer’s ability to direct the entity’s operation. D.C. Rule 5.7, cmts. [4], [5]; see In re Brown, 930 A.2d 249 (D.C. 2007) (applying Rule 1.8(a) where real estate brokerage handling sale of decedent’s property was wholly owned by lawyer for personal representative).
No published opinion of the D.C. Court of Appeals, nor the D.C. Rules, nor any of our previous opinions (including Opinion 245) addresses whether Rule 1.8(a) (or its predecessor under the D.C. Code of Professional Responsibility, Disciplinary Rule 5-104(A)) applies where the lawyer does not control or have an ownership interest in the other entity but, as here, stands to profit directly from the referral. Most other jurisdictions that have addressed the question, though, have concluded that Rule 1.8(a) does apply in such circumstances. See, e.g., Ariz. Ethics Op. 05-01 (2005) (rule applies; noting “heavy burden” of demonstrating compliance); Calif. Formal Op. 1995-140 (1995) (rule applies); Conn. Ethics Op. 94-25 (1994) (same); Ill. State Bar Ass’n Op. 97-04 (1998) (same); Ky. Ethics Op. E-390 (1996) (rule applies but difficult to satisfy informed consent requirement); Mich. Op. RI-317 (2000) (rule applies); N.J. Ethics Op. 688 (2000) (same); Ohio Op. 2000-1 (2000) (rule applies); Phila. Bar Ass’n, Joint Ethics Op. 2000-100 (2000) (rule applies); Va. Legal Ethics Op. 1564 (rev. 1995) (same); Utah Ethics Advisory Op. 99-07 (1999) (same; noting difficulty of satisfying requirement that lawyer’s judgment not be affected); Wisc. Ethics Op. E-00-04 (2000) (rule applies but can be satisfied only if benefit not unduly substantial); see also Mo. Informal Advisory Op. 960124 (n.d.) (disapproving arrangement without referring to rule on business transactions with clients); N.Y. State Bar Ass’n Op. 682 (1996) (same); Vt. Advisory Ethics Op. 1998-08 (1998) (same).
Although numerous, these opinions offer little in the way of reasoning. We think that a somewhat more nuanced approach is in order. Rule 1.8(a) applies where there is a “business transaction” between lawyer and client. Where the lawyer has an ownership interest or management role in the other entity, such a transaction is present and the lawyer accordingly must comply with Rule 1.8(a) as well as with Rule 1.7(c). Where the lawyer has no such interest or role in the other entity, however, there is no “business transaction” between the lawyer and her client even if the lawyer is to receive a commission or similar benefit from the other entity. In that circumstance, Rule 1.7(c) applies but Rule 1.8(a) does not.
The waiver requirements under D.C. Rule 1.8(a) are outlined above. Lawyers preparing disclosures contemplated by this rule also may wish to take note of the following opinions from other jurisdictions. The Illinois ethics opinion cited above states that full disclosure should include “informing the client . . . that the lawyer would not be involved in any way to protect the client’s interest but would continue to receive a portion of the advisor’s fee.” Ill. Advisory Op. 97-04 (1998). Michigan cautions that where the lawyer has an ongoing, as opposed to a one-time, interest in the fees paid to the advisory firm, disclosure “should include . . . that the lawyer cannot render legal advice to the client if disputes or differences arise between the advisory firm and the client.” Mich. Op, RI-317 (2000). Wisconsin advises the lawyer to disclose “such factors as relative cost; suitability to the client’s needs; and the competence, character, and reputation of the person to whom the lawyer refers the client.” Wisc. Ethics Op. E-00-04 (2000).
Rule 5.7. The D.C. Rules expressly address the responsibilities of a lawyer when “law-related services” are provided by an entity “controlled by the lawyer individually or with others” in circumstances that are distinct from the lawyer’s provision of legal services to her client. D.C. Rule 5.7(a)(2). “Law-related services” are those “that might reasonably be performed in conjunction with and in substance are related to the provision of legal services, and that are not prohibited as unauthorized practice of law when provided by a nonlawyer.” D.C. Rule 5.7(b). Examples include “providing title insurance, financial planning, accounting, trust services, real estate counseling, legislative lobbying, economic analysis, social work, psychological counseling, tax preparation, and patent, medical or environmental consulting.” Rule 5.7, cmt. [9].
The facts before us are insufficient to determine whether this rule, which was added in February 2007, applies to the instant inquiry. For example, the rule does not apply if the lawyer lacks “the ability to direct [the] operation” of the non-lawyer entity to which she refers her client, Rule 5.7, cmt. [4], nor does it apply if the services provided by the non-lawyer entity are unrelated to the provision of legal services. The inquiry does not indicate whether the lawyer has a controlling, ownership, or management interest in the non-lawyer entity, nor does it indicate the relationship, if any, between the services being provided by the lawyer and those to be provided by the non-lawyer entity. As to the latter criterion, it is one thing if the lawyer is defending the client against a reckless driving charge and the referral is to an entity that would manage the assets of the client’s business, but quite another if the lawyer represents the client in an inheritance matter and the referral is to an entity that would manage the inherited assets.
If Rule 5.7 does apply, however, the lawyer will be subject to the Rules of Professional Conduct in respect of the services provided by the non-lawyer entity unless the lawyer takes “reasonable measures to assure that [the client] knows that the services are not legal services and that the protections of the client-lawyer relationship do not exist.” Rule 5.7(a)(2). The communication should be made before the client enters into an agreement for the law-related services, Rule 5.7 cmt. [6], and the burden is on the lawyer to show compliance with the notification requirement, id. cmt. [7].
Malpractice coverage. Although we do not opine on legal questions arising other than under the Rules of Professional Conduct, we offer a final caveat: Compliance with the D.C. Rules aside, a “business enterprise exclusion” is a standard feature of lawyers’ professional liability insurance policies, American Guarantee & Liab. Ins. Co. v. Timothy S. Keiter, P.A., 360 F.3d 13, 16 (1st Cir. 2004), and courts have interpreted this exclusion broadly, e.g., Minnesota Lawyers Mut. Ins. Co. v. Antonelli, Terry, Stout & Kraus, LLP, 2010 U.S. Dist. LEXIS 122836, *28 (E.D. Va. Nov. 18, 2010) (Civil No. 1:08-CV-1020) (holding that exclusion extends not only to claims “arising from” lawyer’s other business but also claims “relating to” such business). One purpose of the exclusion is “to avoid the circumstance where an insured so intermingles his business relationships with his law practice that an insurance carrier incurs additional risk of having to cover the insured for legal malpractice claims relating to the conduct of business, rather than solely out of the professional practice.” Id. at 17 (quoting Jeffer v Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 703 A.2d 316, 322 (N.J. Super. 1997).) One application of the exclusion is where a lawyer has an interest in a business that becomes involved in the services the lawyer is providing to her client. E.g., Darwin Nat’l Assurance Co. v. Hellyer, 2011 U.S. Dist. LEXIS 60592 (N.D. Ill. June 7, 2011) (No. 10 C 50224). “[T]he [insurance] policy makes it clear that it will not extend coverage to an insured sued for professional malpractice outside of legal matters conducted between the firm and its clients.” Jeffer, 703 A.2d at 322. The upshot is that even where the D.C. Rules permit a lawyer to accept a commission from the non-lawyer entity to which she refers a client, the lawyer’s malpractice insurance might not cover a claim that relates to the referral or to the services rendered by the other entity, particularly where the lawyer has a financial interest involving the other entity. Ill. Advisory Op. 97-04 (1998).6
Conclusion
If the criteria of Rule 1.7(c) and, if applicable, Rules 1.8(a) and 5.7 are satisfied, a lawyer who refers a client to a non-lawyer service provider such as a financial services firm7 may accept compensation from the provider for such a referral. The prerequisites for such an arrangement are exacting, however, and the arrangement may be outside the coverage of the lawyer’s professional malpractice insurance even if permitted by the Rules.
Published: November 2011
1. This opinion does not address compensation for referrals between lawyers, which is governed by Rule 1.5(e), or payments to non-lawyers for referring potential clients to lawyers, which are governed by Rules 5.4 and 7.1.
2. This committee does not opine on compliance with legal requirements, such as those under the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-1 through 80b-21 (2006), and its District of Columbia analog, the Securities Act of 2000, D.C. Code §§ 31-5601.1 through 5608.04 (2001), aside from those imposed by the D.C. Rules of Professional Conduct.
3. A 2007 Court of Appeals decision stated that a lawyer referring a client to a non-lawyer entity owned by the lawyer must comply with the requirements of Rule 1.8(a), which governs business trans- actions between lawyer and client. In re Brown, 930 A.2d 249 (D.C. 2007), aff ’g 2006 D.C. Super. LEXIS 5 (D.C. Super. Ct. Feb. 22, 2006) (Adm. No. 1374-03). Perforce the Rules permit a lawyer to refer a client to a non-lawyer entity in which the lawyer has less than a complete ownership interest.
4. The comment originally was promulgated as comment [25] but currently is comment [36].
5. By “manner,” we include whether the fee is a one-time or recurring payment. See, e.g., Phila, Bar Ass’n, Joint Ethics Op. 2000-100 (2000) (requiring that the client be advised of this fact).
6. We do not mean to suggest that the simple act of referring a client to a non-lawyer service provider, where the lawyer receives no economic benefit from the referral, is beyond the scope of standard legal malpractice coverage.
7. As noted above, this opinion does not address compensation for referrals between lawyers, which is governed by Rule 1.5(e), or payments to nonlawyers for referring potential clients to lawyers, which are governed by Rules 5.4 and 7.1.
