“While some law firms undoubtedly invested solely because the firm recognized a promising opportunity to make money, the majority appear to have acted out of a concern related to the preservation and nurturing of the attorney-client relationship.”

The notion of a lawyer taking his or her fee in the form of stock in a client’s company is not a new one. However, this method of compensation became much more widespread with the advent of the Silicon Valley start-up phenomenon of the 1980s and 1990s. For some lawyers, the move was a wise one leading to unforeseen riches, while for others, both the company—and the remuneration— went bust.

It didn’t take long before the American Bar Association (ABA), as well as state bar associations, ‘took stock’ of what was going on the field of stock-for-legal services agreements and decided to explore the ethics of such an arrangement. The rules have now been broadened to include not just investing in lieu of legal fees but also the issues surrounding investment in a client’s business, even outside the attorney-client context.

Entrance….and Exit

It is not uncommon for venture capital investors and initial employees of a startup to take equity in a new company because they are anticipating that by helping the company succeed, they will earn a significant reward at the time of a hoped-for short-term exit. The potential, of course, seems quite high at the beginning, especially for tech stocks, and an aggressive growth plan is a major attraction for seed money and beyond. However, if the client’s business is based on a slow growth scenario or the intention to own and operate long term, then investment by the lawyer who takes equity rather than a present-value cash fee might make less sense. There is also the hybrid scenario whereby the lawyer takes a fee part in cash and part in securities, thus hedging his or her risk. However, even an acceptance of part of a fee by way of securities in a client’s company raises the same ethical issues as if the lawyer were fully compensated in that manner.

A 2019 report on the top five startup law firms in Silicon Valley found that the average value of legal services expended by startups (excluding any litigation or significant IP issues) was $40,000. Before risking such a sum via investment in the client, the lawyer should seriously evaluate whether the motivation for taking securities over a traditional currency fee is to actually receive a fee—albeit deferred— for legal services rendered or, to simply invest in and help the client’s entrepreneurial venture get off the ground.

ABA Formal Opinion

In July 2000, the ABA weighed in on the issue of lawyers taking securities from a client’s business in lieu of a traditional fee. The ABA’s Standing Committee on Ethics and Professional Responsibility issued Formal Opinion 00-418, which concluded that receiving stock in a client’s company, either in payment of legal fees or even as an investment, did not violate the Model Rules of Professional Conduct. However, in all cases of investment in a client’s business enterprise, the lawyer must make certain that Model Rule 1.8(a) is complied with. The Rule prohibits business transactions with a client unless:

  1. the deal is fair and reasonable to the client;
  2. its terms are fully disclosed to the client in writing;
  3. the client is advised in writing to consult independent legal counsel and given a reasonable opportunity to do so; and
  4. the client gives informed consent, in writing, to the transaction and the lawyer’s role in it, including whether the lawyer is representing the client in the transaction.
  5. Notably, a lawyer who takes stock in the payment of legal fees or even invests with a client is deemed to have entered into a business relationship with that client.

    Additional ABA Rules Compliance

    In addition to the ABA’s year 2000 Rule 1.8, if the lawyer is representing the client in the business transaction, he or she must additionally comply with Model Rule 1.7 (‘Conflict of Interest—Current Clients’) governing “material limitation” conflicts. Those arise when the lawyer’s financial interest in the transaction raises a ‘significant risk’ that representation of the client will be materially limited by the lawyer’s own interests. Because of concern over real or perceived conflicts of interest, some larger firms actually prohibit their lawyers from investing in their clients’ businesses.

    Furthermore, when stock is received for legal fees, the lawyer must comply with Rule 1.5(a), which imposes its own reasonableness requirement that takes into consideration the rule’s eight enumerated factors. In discussing how Rule 1.5(a) applies, The ABA has drawn an analogy to determining the ‘reasonableness of a contingent fee’, opining that ‘only the circumstances reasonably ascertainable at the time of the transaction should be considered.’ Problematically, neither Rule 1.5(a) nor its commentary has addressed when the time of the transaction occurs, leading some observers to conclude that the reasonableness should be measured both at the outset of the representation and when the fee becomes quantifiable.

    Disclosure and Consent

    Of particular importance is the extent of the lawyer’s disclosure to the client when investing in the client’s business and the level of informed consent obtained from the client. In addition to being in compliance with the ethics rules, obtaining clear, comprehensive, written confirmation of the terms of the investment will protect the attorney as well as the client, thereby reducing the risk of any misunderstanding arising between the attorney and the client. In compliance with Rule 1.8, the attorney must advise the client—preferably in writing—of the necessity of consulting with independent counsel.

    Likewise, as in the case of all potential conflict of interest scenarios, the lawyer must obtain from the client informed consent as to the lawyer’s investment with the client.

    Risk to Reputation

    It is not just the potential for the financial risk that is at stake when a lawyer decides to take stock in lieu of a traditional fee, but what should also be considered is the possibility that if the business venture fails, the client could scrutinize the representation as to deficiencies in the legal services provided. Although a client whose business fails might make such an assertion under any circumstances where the lawyer has invested and provided advice, the lawyer’s defense to such a claim can be further complicated.

    Particularly in light of the stresses placed on businesses over the court of the COVID-19 pandemic, the present environment for taking stock in lieu of a traditional fee is, at best, an uncertain one. For all of the foregoing reasons, the lawyer considering the same should proceed with caution.

    Executive Summary

    The Issue

    What are the ethical and risk considerations in taking stock in lieu of a traditional fee for legal services?

    The Gravamen

    Although not considered unethical to do so, the lawyer must strictly comply with the various Model Rules and State Bar Rules before undertaking a stock-as-fee arrangement.

    The Path Forward

    With the burgeoning number of startups requiring representation by lawyers, opportunities abound for taking stock as remuneration; however, those opportunities must be weighed against the potential for financial as well as professional risk.

    Action Items

    Familiarity with Model Rules:

    It is essential to fully understand not only the ABA Model Rules addressing the issue of taking stock in a client’s venture but also one’s State Bar Rules, which may not necessarily converge.

    Full Disclosure:

    An attorney’s disclosure to the client should be in writing and thoroughly confirm the terms of the investment, thereby mitigating any claims of irregularity in the future.

    Client’s Informed Consent:

    The client must be encouraged, in writing, to obtain independent advice regarding the lawyer’s investment, and acknowledge the lawyer’s recommendation—in writing— as part of the client’s informed consent.

    Financial Advice:

    It is recommended that a lawyer engage the services of a financial professional in order to ascertain the value of the stock involved, thereby avoiding the possibility of an excessive fee resulting.

    Further Readings


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