OF SECURITIES IN A CLIENT COMPANY IN EXCHANGE FOR LEGAL SERVICES TO
TOPIC: Acceptance of securities
in a client in exchange for legal services to be performed; business
transactions with clients; conflicts of interest; charging or collection
of an excessive fee.
DIGEST: Attorney may, in
certain circumstances, ethically accept securities in a client company
in exchange for legal services to be performed; an attorney may have
to meet the requirements of DR 5-104(A) if the client expects the lawyer
to exercise independent professional judgment for the protection of
the client; attorney should be mindful that, in some situations, there
may be non-consentable conflicts of interest which preclude such an
arrangement; in other situations, the attorney may be required to disclose
potential conflicts of interest, advise client of right to seek independent
counsel with respect to the fee arrangement and obtain written consent
of client; attorney should evaluate, at the time the fee arrangement
is agreed to, whether the acceptance of securities as compensation for
legal services to be rendered would constitute an excessive fee.
CODE: DR 2-106; DR 5-101;
DR 5-104; DR 5-105; EC 2-20; EC 2-24; EC 5-3; EC 5-15
May an attorney accept securities in a corporate
client for legal services to be rendered, and, if so, what ethical concerns
are presented by an agreement by an attorney to accept securities in
a client company instead of a cash fee?
As high technology and
internet companies have continued to spawn throughout the country from
Silicon Valley, California to Silicon Alley, New York, the legal
profession has been prompted to examine and adopt alternatives to the
conventional hourly billing rate arrangement that has been traditionally
applied to more mature companies. In response to the attitudes
and concerns of the "new age" entrepreneurs who are often
strapped for cash, normally risk-averse attorneys increasingly are accepting
securities, including options or equity stakes, in startup companies,
instead of their customary cash retainers and monthly payments for legal
These relatively new and novel, business-driven fee arrangements, which
provide the attorney with an additional interest in the business success
of the client, raise important questions of professional and ethical
concern to attorneys in private practice and have generated a new arena
for critical review and analysis.
Among the ethical issues
raised by a lawyer's acceptance of securities in a corporate client
in exchange for legal services to be rendered are those relating to
the reasonableness of the fee charged to the client, the potential conflicts
of interest with the client and the effect on the attorney's independence
and judgment. Given the increasing frequency with which lawyers
are accepting securities and the widespread interest by members of
the Bar in the ethical propriety of these arrangements, we take this
opportunity to examine and address the ethical issues raised by acceptance
of securities in exchange for legal services to be rendered.
In Part A, we examine the application of ethics rules governing an attorney's
business transactions with a client to arrangements between a lawyer
and a client for fees to be paid in securities of a client company.
In Part B, we analyze potential conflicts of interest that may arise
as a result of accepting securities in exchange for legal services to
be rendered. In Part C, we address the issues to be considered
in determining whether a payment in the form of securities in the client
company is "excessive."
Before turning to these
specific ethical concerns, for the sake of clarity, we state here our
conclusion that there is no per se ethical prohibition on the
acceptance of shares or other securities, including options, as compensation
for legal services to be rendered. We hasten to add, however,
our caution that such arrangements can present thorny ethical and other
issues that must be resolved prior to entering into an arrangement in
which a lawyer is to be compensated in client company securities.
A. Entering into a Business Transaction
with a Client
As a threshold matter,
whenever an attorney is considering accepting securities in a client
company as a fee for services to be rendered, DR 5-104(A) may be implicated.
This rule outlines the parameters under which it is ethically permissible
for an attorney to enter into a business transaction with her client.
DR 5-104 provides:
(A) A lawyer shall not enter into a business
transaction with a client if they have differing interests therein and
if the client expects the lawyer to exercise professional judgment therein
for the protection of the client, unless:
(1) The transaction and terms on which the
lawyer acquires the interest are fair and reasonable to the client and
are fully disclosed and transmitted in writing to the client in a manner
that can be reasonably understood by the client;
(2) The lawyer advises the client to seek
the advice of independent counsel in the transaction; and
(3) The client consents in writing, after
full disclosure, to the terms of the transaction and to the lawyer's
inherent conflict of interest in the transaction.
On its face, DR 5-104(A)
requires a two part inquiry. First, the attorney must determine
if the transaction is one in which the attorney and her client have
differing interests and in which the client expects the lawyer to exercise
professional judgment on the client's behalf. If these questions
are answered in the affirmative, then the attorney must demonstrate
that the terms of the transaction are fair and reasonable to the client
and have been transmitted to the client in clear written form, that
the attorney has advised the client that the client may consult independent
counsel and that the client has consented in writing after full disclosure.
In other jurisdictions,
ethics committees considering arrangements in which an attorney accepts
securities in a client instead of a cash fee consistently have concluded
such transactions may withstand ethical scrutiny provided that the obligations
to provide full disclosure, to advise the client of the client's right
to obtain independent counsel and to obtain written consent of the client
are satisfied. See, e.g., Utah 98-13 (1998) (finding that
Model Rule 1.8, which is analogous to DR 5-104, "was intended to
apply to any transaction with a client in which the lawyer acquires
an ownership interest in the client"); Mississippi 230 (1995) (opining
that "the acceptance of stock in a corporation as a fee for incorporating
the business does not create a conflict of interest per se"
but that "the lawyer's acquisition of stock in the client amounts
to the entering into a business transaction with the client");
Pennsylvania 89-158 (1989) (opining that attorney may accept securities
in client as payment for corporate work and that such a fee arrangement
constitutes a business transaction with the client within the purview
of Pennsylvania's Rule 1.8). Accord Hazard & Hodes,
The Law of Lawyering, § 1.8:202, p. 263, "Illustrative Case:
Taking an Interest in a Client's Business in Lieu of a Fee" (finding
that taking an interest in a client's business instead of a cash fee
implicates disclosure, consent and independent counsel requirements
of ABA Model Rule 1.8(a)).
Some commentators have concluded that DR 5-104(A)'s disclosure and consent
requirements do not apply to fee arrangements entered into at the outset
of the representation:
However, the text of N.Y.
DR 5-104(A) differs from that of the rules under which these opinions
were issued. Unlike these other rules, the New York rule interposes
a threshold inquiry before requiring the lawyer to undertake the disclosure
and other prescribed remedial measures. On its face, DR 5-104
applies only to business transactions where "the client expects
the lawyer to exercise professional judgment therein for the protection
of the client,"
and absent a specific requirement imposed by disciplinary rule, requirements
such as those imposed by DR 5-104(A) would not be mandated. See
Beatie v. DeLong, 164 A.D.2d 104, 561 N.Y.S.2d 448, 451 (1st
Dep't 1990) (finding "[no] authority to support defendant's contention
that attorney . . . was obliged to advise [client] of the desirability
of obtaining independent legal advice" before granting him an interest
in the proceeds of the patent as payment for legal services to be rendered);
see also N.Y. City 80-14.
A prominent exception to DR 5-104(A) is that a fee agreement, at its
inception, is not covered by the rule, even though a fee agreement is
literally "a business transaction with a client." If
fee agreements were covered by the rule, then a lawyer would have to
advise every client to obtain independent counsel before entering into
a fee agreement. If the client retained independent counsel, that
lawyer would also have to advise the client to obtain independent counsel
before entering into a fee agreement so on down the line.
To avoid this absurd result, fee agreements are considered outside the
scope of DR 5-104(A).
Simon's Code of Prof'l
Resp. Ann., DR 5-104(A), Commentary at 310 (West 2000).
Professor Simon's conclusion is consistent with a prior opinion of this
Committee. See N.Y. City 88-7 (1988) ("the mere establishment
of a lawyer's fee . . . is not normally regarded as a business transaction'
under DR 5-104(A)") (citing Wolfram § 8.11.3, at 481-82).
In Opinion 88-7, we concluded
that an attorney's acceptance of a mortgage interest in a client's home
to secure payment of a fee constituted a "business transaction
with a client" within the meaning of DR 5-104(A). In reaching
this conclusion, we stated:
A mortgage and related agreements may well contain
highly technical language raising important legal obligations readily
ascertained by the lawyer but imperceptible to the untrained eye.
People whose situation requires the assistance of counsel may be particularly
In certain circumstances,
these concerns may also apply to the fee arrangements considered here.
Principals in startup companies typically entering into "securities
for fees" arrangements may be legally unsophisticated and may be
relying on the attorney with respect to the transaction.
In our opinion, the application
of DR 5-104(A) can, and should, be resolved by the text of the rule,
which extends its mandates to all those situations in which the client
expects the lawyer to exercise independent judgment for the protection
of the client. Consistent with Opinion 88-7, we conclude that
DR5-104(A) does not exclude from its ambit fee agreements between lawyers
and clients. To be sure, garden variety fee arrangements generally
can be expected to fall outside the scope of DR 5-104(A) because the
client will rarely be relying on the lawyer to provide "independent
advice" in connection with such an arrangement. As a result,
the endless chain of independent lawyers envisioned by Professor Simon
will not occur. In any event, there is nothing in the text of
DR 5-104(A) that automatically precludes its application to all fee
This same textual analysis
also leads the Committee to the ineluctable conclusion that New York's
DR 5-104(A) does not automatically impose any consent or disclosure
requirements on all transactions in which an attorney accepts securities
in a client company for legal services to be rendered, at least where
such an agreement is reached at the outset of the representation.
This is not to say that DR 5-104(A) will never apply to such a fee arrangement.
Whether the rule applies in specific circumstances will necessarily
turn on whether the lawyer is expected to provide independent advice
in the specific transaction by which the securities for services exchange
is made. If the lawyer is expected to play any role in advising
the client, especially if a client lacks sophistication, the mandates
of DR 5-104(A) must be followed. See N.Y. City 88-7.
In performing this analysis, we note, however, that there is a crucial
difference between bargaining with the client, a function that puts
the lawyer squarely on the other side of the table, and providing advice
to the client relating to a transaction, including a transaction involving
fees, where the client expects to rely on the attorney's judgment.
Although DR 5-104(A) does
not always apply, the Committee notes that the New York Court of Appeals
has cautioned that transactions between attorneys and their clients
are "not advisable." Greene v. Greene, 56 N.Y.2d
86, 92, 436 N.E.2d 496, 499, 451 N.Y.S.2d 46 (1982); see also Mary
C. Daly, "The Perils in Business Transactions with Clients,"
The New York Professional Responsibility Report, at 2 (March
2000); Hazard & Hodes, The Law of Lawyering, § 1.8:200 at 262 ("there
are no transactions that courts will scrutinize with more jealousy than
dealings between an attorney and his clients"). Indeed, if
the attorney-client relationship were to dissolve and litigation over
the fee arrangement were to ensue, the terms of the agreement would
be construed most favorably to the client. Schlanger v. Flaton,
218 A.D.2d 597, 631 N.Y.S.2d 293, 295 (2d Dep't 1995). Absent
the attorney's ability to demonstrate "that the client was fully
aware of the consequences and that there was no exploitation of the
client's confidence in the attorney," the client may be able to
rescind the agreement. Greene, 56 N.Y.2d at 92.
If the attorney makes complete disclosure, obtains client consent and
informs the client that the client should seek independent advice with
respect to the fee arrangement, even where such measures are not required
by DR 5-104, the lawyer may reduce the likelihood of such an adverse
Thus, although it is not ethically mandated in all cases by DR 5-104(A),
we believe that the more prudent course for an attorney exchanging legal
services for securities in the client company would be to follow the
disclosure and written consent requirements of the rule.
B. Conflicts of Interest
An attorney's inquiry into
her potential ethical obligations arising out of a transaction in which
the attorney accepts securities for fees does not end with DR 5-104.
Unique issues of potential conflicts of interest also may arise as a
result of such arrangements.
At the outset of the representation,
the acceptance of securities in a client corporation as part of the
consideration for legal services to be rendered may implicate the standard
of independent professional judgment that is embodied in DR 5-101(A):
A lawyer shall not accept or continue employment
if the exercise of professional judgment on behalf of the client will
be or reasonably may be affected by the lawyer's own financial, business,
property, or personal interests, unless a disinterested lawyer would
believe that the representation of the client will not be adversely
affected thereby and the client consents to the representation after
full disclosure of the implications of the lawyer's interest.
Under this rule, if the
lawyer accepts securities from a client in exchange for legal services
to be rendered, as a threshold matter, she must determine whether this
ownership interest in the client would, or reasonably may, affect the
exercise of her independent professional judgment on behalf of the client.
If the answer is affirmative, the lawyer must then determine whether
a "disinterested lawyer" would believe that the effect on
the lawyer's exercise of professional judgment will be adversely
affected because the lawyer stands to be paid in securities of her client.
If the effect is determined to be adverse, then the conflict is non-consentable
and the representation on those terms must be declined. On the
other hand, if a reasonable determination is made that the effect on
the representation would not be adverse, then the arrangement can proceed
if the client consents to the representation after the implications
of the lawyer's interest are fully disclosed.
The New York State Bar
Association's Committee on Professional Ethics has observed that "when
there is no more than a fanciful, theoretical or de minimus risk
that the lawyer's judgment will be affected adversely by a potentially
relevant set of interests, DR 5-101(A) imposes no restriction. . . .
At the other extreme, DR5-101(A) has long been understood to foreclose
the lawyer from undertaking a representation, even with the client's
consent after full disclosure, if there is a reasonable probability
(viewed objectively) that the lawyer's interests will affect adversely
the advice to be given or the services to be rendered to the client."
N.Y. State 712 (1999) (citations omitted). See also NYSBA
It is this Committee's
opinion that an arrangement by which a lawyer accepts securities in
a client corporation as compensation for legal services to be rendered
reasonably may affect the professional judgment of the lawyer on behalf
of her client. By way of example, when a lawyer has agreed to
accept securities in a client corporation as a fee for negotiating and
documenting an equity investment, or for representing it in connection
with an initial public offering, there is a risk that the lawyer's
judgment will be skewed in favor of the transaction to such an extent
that the lawyer may fail to exercise independent professional judgment.
It is possible that the lawyer's interest in the securities may
create economic pressure to "get the deal done," which pressure
in turn may impact the lawyer's independent judgment on disclosure
issues. In this respect, the risk is not significantly different
than that presented when the lawyer's cash fee depends (in whole or
in part) on a business transaction's successfully closing. In
both cases, the lawyer is "invested" in the transaction.
The contingent fee arrangement has long been accepted as ethical if
the fee is appropriate and reasonable and the client has been fully
informed as to alternative billing arrangements. ABA 389 (1994).
We see no ethical distinction between the transactional contingent fee
and agreeing to take client securities instead of cash fees.
Although such an arrangement
may affect the lawyer's independent professional judgment, it still
can pass muster under the "disinterested lawyer" test of DR
5-101(A). DR 5-101(A) would preclude any arrangement if there
exists a reasonable probability (viewed objectively) that the lawyer's
interests will affect adversely the advice to be given or the specific
services to be rendered to the client. See N.Y. State 712
(1999). See also Utah 98-13 (1998) (if a lawyer agrees
to accept stock in a client company in return for performing services
for that company, a possible conflict does not preclude the representation;
the critical questions are the likelihood that a conflict will arise
and whether it will materially interfere with the lawyer's professional
judgment in considering alternatives or foreclosing courses of action).
This Committee believes that, standing alone, acceptance by a lawyer
of a "stake in the action," is not sufficient to warrant the
conclusion in every case that a lawyer's exercise of professional judgment
on behalf of his client will be adversely affected by accepting securities
in her client's company for legal services to be performed. See
Mississippi 230 (1995) (there is no inherent conflict of interest in
lawyer accepting stock for fees to incorporate a corporation and provide
legal advice); Virginia 1593 (1994) (not per se improper for
lawyer to be compensated in stock for his legal services).
The determination of whether
a reasonable probability of such an adverse effect exists is factually
driven and demands an analysis of the nature and relationship of the
particular interest and the specific legal services to be rendered.
Some salient factors to be considered may be the size of the investment
in proportion to the holdings of other investors, the potential value
of the investment in relation to the law firm's earnings or assets,
the possible impact on the lawyer of levels of risk involved, and whether
the investment is active or passive. See Barrie, "Investing
in Your Client's Business," Wash. State Bar News (Mar. 2000).
The Committee can envision situations in which there exists a likelihood,
when viewed objectively, that the lawyer's interest in "getting
the deal done" will adversely affect the lawyer's independent professional
judgment. The risk of such an adverse effect would be especially
high, for example, in the case of a potentially very large fee paid
in client securities which represents both a significant portion of
the law firm's revenues and a substantial stake in the client's business.
In these circumstances, it is conceivable that the desire to obtain
such a fee might diminish the willingness of the attorney, albeit unconsciously,
to advise the client company to disclose negative information or increase
the lawyer's willingness to issue a questionable legal opinion required
to close the deal. In such situations, the conflict would be non-consentable
and the fee arrangement ethically prohibited.
If, however, a determination
is made under the "disinterested lawyer" test that the lawyer's
representation of the client will not be adversely affected by an agreement
to accept client securities as payment for legal services to be rendered,
DR 5-101(A) allows the representation, but only if full disclosure is
made to the client and the client's consent is obtained. Although
not required under the Disciplinary Rule, the Committee recommends that
the disclosure and consent be in writing for the same reasons we believe
it is prudent under DR 5-104(A). See NYSBA EC 5-3.
Disclosure should include,
among other things: (1) the risks inherent in representation by
a lawyer with a financial, business, property, or personal interest
in the company, including the possible effects upon the lawyer's actions
and recommendations to the client; (2) the possible conflicts that
might arise between lawyer/shareholder and client or its management
and the range of possible consequences stemming from them; and (3) any
potential impact on the attorney/client privilege and confidentiality
rules, particularly in communications between the client and the attorney
in his role as investor rather than as counsel.
See Barrie, "Investing in Your Client's Business,"
Wash. State Bar News (Mar. 2000).
A lawyer must also consider
whether accepting securities in a client as payment for legal services
to be rendered constitutes the charging or collection of an excessive
fee in violation of DR 2-106.
An agreement to accept
securities in satisfaction of legal fees is not prohibited by DR 2-106(A).
However, DR 2-106(A) prohibits a lawyer from agreeing to charge
an excessive fee for his or her legal services as well as collecting
such a fee. An arrangement by which an attorney is to be paid
wholly or partly in securities must satisfy this requirement.
DR 2-106(B) provides a
test for determining whether a fee is "excessive" by asking
whether it would be the "definite and firm conviction" of
"a lawyer of ordinary prudence" that "the fee is in excess
of a reasonable fee." This test (eliminated from comparable
Rule 1.5(a) of the ABA's Model Rules of Professional Conduct) is intended
to be an objective one.
The rule also provides eight "factors" to assist in determining
whether a legal fee is excessive. Those eight factors are:
(1)The time and labor required, the novelty and
difficulty of the questions involved and the skill requisite to perform
the legal service properly.
(2)The likelihood, if apparent, or made known to
the client, that the acceptance of the particular employment will preclude
other employment by the lawyer.
(3)The fee customarily charged in the locality
for similar legal services.
(4)The amount involved and the results obtained.
(5)The time limitations imposed by the client or
by the circumstances.
(6)The nature and length of the professional relationship
with the client.
(7)The experience, reputation and ability of the
lawyer or lawyers performing those services.
(8)Whether the fee is fixed or contingent.
(See Simon's New
York Code of Professional Responsibility Annotated, 2000 edition, at
148, 149 for discussion of these factors).
The foregoing factors are not meant to be all-inclusive.
Determination of what is excessive is a fact-specific exercise.
See ABA, Annotated Model Rules of Professional Conduct, 4th
ed., at 48 (discussing Model Rule 1.5(a) of the Model Code of Professional
Responsibility which identifies the same eight factors as assisting
in the determination of whether a fee is excessive).
A determination of whether
a fee is excessive is not always easily made. In the case of an
arrangement in which securities are received for legal services, the
decision is more complex, and there are additional factors which should
be considered, especially where the securities to be received are those
of a "start up" business, or are part of or in connection
with a public offering of the securities. Examples of additional
such "factors" are:
. . . (1) The likelihood the transaction
in question will or will not close and whether there are any contingent
plans for payment of legal fees; (2) the estimated current and
future value of the equity [i.e. securities] interest considering all
the normal risks of a start-up business and any specific risks to the
business or its assets; (3) the liquidity of the interest, including
whether it is now or may in the future be publicly traded; (4) any
restrictions on transfer of the interest, whether by agreement with
the client . . . or by law; (5) the percentage amount
of the interest, and what, if any, degree of control it provides the
lawyer over the business; and (6) what restrictions, if any, are
placed on the money used to pay for the equity interest for example
that it must be used to pay future legal bills.
Many of these factors,
especially in the case of securities in a startup company, obviously
cannot be determined with any degree of assurance, at least until the
transaction or matter is completed. As such, a crucial question
in determining whether a fee in the form of securities is "excessive"
is the time at which the value is measured. An equity stake in
a corporation that turns out to be successful might seem excessive in
relation to the services rendered if the value is determined only after
the success is achieved. But to make this evaluation at that end
point and with the wisdom of hindsight would not value
the fee that the client agreed to pay or the lawyer accepted, because
it would eliminate the risk that the lawyer undertook that the venture
would fail and the securities, i.e. the fee, would have little
or no value. Accordingly, we conclude that a determination of
whether a fee accepted in the form of securities is excessive requires
a determination of value be made at the time the agreement is reached.
To be sure, this test may allow attorneys to receive fees that turn
out to be spectacular windfalls in relation to the compensation
that would normally be received on a cash basis. But as long as
the reward stems from the investment risk accepted, not from an excessive
fee, the result will equate to a lawyer's investing cash, not services,
in the venture. We hasten to add that not all payments in the
form of client securities will pass muster under this test. In
cases where the risks are minimal and the amount of securities received
by the lawyer is excessive in relation to the services to be rendered,
the fee would not cease to be "excessive" merely because the
venture was not a sure thing.
The importance of estimating
the value of the arrangement whereby payment is made in the form of
client securities instead of cash is not limited to issues of professional
responsibility. In addition to being subject to professional discipline
under DR 2-106(A) if a fee were found to be excessive, a lawyer might
also face possible civil liability or a justified refusal on the part
of the client to make payment of the agreed-upon fee. The problem
is compounded by the rule that an attorney, as a fiduciary, bears the
burden of proving that the transaction entered into with a client is
reasonable and not the fruit of undue influence. See Mallen
& Smith, Legal Malpractice, 3rd ed. 1989, Section
A lawyer accepting payment
in the form of client securities should seriously consider engaging
an investment professional to advise as to the value of the securities
so given. The attorney and client can then make their own advised
decisions as to the reasonableness of the transaction.
In considering the lawyer's
obligations under DR 2-106, attention must also be given to whether
the taking of client securities as payment instead of a cash fee constitutes
the making of a contingent fee arrangement. We have seen above
that there is difficulty in estimating the value of the securities or
the size of the fee until the success or failure of the matter or transaction
has been established. There are obvious elements of contingency
in such an arrangement. At least one committee on ethics of a
sister state has concluded that a contingent fee is created where securities
are given as an attorney's fee in payment for legal services furnished
in a public offering. See Kansas Bar Association, Ethics
Opinion 98-6 (September 25, 1998). The rationale for such a conclusion
is that the failure of the offering will likely lead to no securities
being given, or whatever is given being worthless.
Determination of whether
a fee paid in whole or in part in securities should be characterized
as a "contingent fee" is of importance in determining whether
the lawyer is required by DR 2-106(D) to "provide the client with
a written statement at the outset of the engagement stating the method
by which the fee is to be determined" as well as a statement "at
the conclusion of the contingent fee matter," providing "the
client with a written statement stating the outcome of the matter. . . ."
Although the foregoing disciplinary rule would seem to have been drafted
with litigated actions in mind, there is no exception made in the provision
for transactional matters
Moreover, we note that New York State Bar Association Ethical
Consideration 2-20, which is not a binding ethical rule but is aspirational
in nature, states that a lawyer "generally should decline to accept
employment on a contingent fee basis by one who is able to pay a reasonable
fixed fee." Thus, to the extent a "securities for fees"
transaction includes a "contingent" element, such an arrangement
is disfavored where the client could pay a reasonable cash fee.
However, given the fact that many, if not most, of the clients seeking
to exchange their securities for legal services to be performed are
start-up companies that are strapped for cash, we view such arrangements
to be consistent with EC 2-20. In addition, the Committee notes
that Ethical Consideration 2-24 states that "even a person of means
may be unable to pay a reasonable fee, which is large because of the
complexity, novelty, or difficulty of the problem or similar factors."
As most of the matters in which client securities provide the currency
for paying a lawyer's bill are complex corporate transactions, even
well-established commercial clients may not readily be in a position
to be "able to" pay a cash fee for the legal services they
Finally, a lawyer who accepts
securities in whole or in part as a substitute for cash fees is bound
in the event of his or her premature discharge or withdrawal to receive
no more in value than the work to the date of discharge or withdrawal
justifies. To the extent the work has not been completed, it is
clear that receipt of the entire fee contemplated to be charged at the
outset would be excessive and must be credited or refunded to the client.
N.Y. State 599 (1988). See In re Cooperman, 83 N.Y.2d
465, 633 N.E.2d 1069, 611 N.Y.S.2d 465 (1994). That principle is
equally applicable to an arrangement whereby securities are given by the
client in payment for legal services to be rendered.
See, e.g., "Who Wants to Be a Millionaire?",
ABA Journal, February 2000; Cravath's $35 Million Fee Wager,
New York Law Journal, January 20, 2000; D.C. Firms: It's Time
to Take Stock, Legal Times, April 3, 2000.
See, e.g., Report: Business and Ethics Implications
of Alternative Billing Arrangements, American Bar Association, Committee
on Lawyer Business Ethics, published in Business Lawyer, November
It is beyond our scope, and, therefore, we do not address significant
potential legal issues that may impact a lawyer's determination to accept
securities for legal services, including the possible heightened exposure
to lawsuits and the impact on the lawyer's insurance coverage for malpractice.
See also Arizona 94-15 (1994) (finding that lawyer could
ethically accept interest in client's patent instead of cash fee, provided
lawyer complied with requirements of Arizona Rule 1.8(a)).
Compare N.Y. DR 5-104(A) with Miss. RPC Rule 1.8
(1999); Pa. St. RPC Rule 1.8(a) (1999); Utah Code Jud. Admin. R. 1.8(a)
(2000); D.C. Bar Appx. A, Rule 1.8 (2000). Under the analogous
rule in Virginia, which is similar to New York's rule in this respect,
the ethics committee of the Virginia Bar concluded that "an attorney
may, under DR 5-104(A), provide legal services to a corporation in consideration
of the stock issued so long as he feels his independent professional
judgment will not be affected by his status as a stockholder, the client
consents after full disclosure by the lawyer of the potential conflicts
of interest, and provided that the transaction is not unconscionable,
unfair or inequitable when made." Va. No. 1593 (1994).
However, it has been suggested that modifications to a fee agreement
after the representation is under way are subject to the strictures
of DR 5-104(A). Simon's Code of Prof'l Resp. Ann., DR 5-104(A),
Commentary at 310 ("material changes in fee arrangements made after
the attorney-client relationship has begun generally do constitute
business relationships between lawyers and clients and are governed
by DR 5-104(A)") (emphasis in original).
Although Professor Wolfram states that "courts have applied
the code to all business transactions, including situations in which
the lawyer does not contemporaneously perform legal work or in which
the technical lawyer-client relationship has ended," Wolfram,
Modern Legal Ethics, § 8.11.2 at 480, n.79 (West 1986), he writes
elsewhere that strict scrutiny of lawyer-client business transactions
"applies to all business dealings between lawyer and client after
the relationship of lawyer and client has been established. It
extends to fee contracts themselves if they have been entered into
or modified after the representation begins." Wolfram,
§ 8.11.3 (emphasis added).
Concerns regarding the lawyer's liability arising out of a situation
in which the client pays its fees in the form of its own securities
are compounded by the fact that an attorney's malpractice insurance
may not cover a dispute with a client relating to such a fee arrangement.
See "Who Wants to Be a Millionaire?", ABA Journal,
February 2000, at 40.
In order to assure that the disclosure requirements of DR 5-104(A)
are met, the lawyer should disclose:
(1) the nature of the transaction and each of its terms;
(2) the nature and extent of the lawyer's interest in the transaction;
(3) the ways in which the lawyer's participation in the transaction
might affect the lawyer's exercise of professional judgment in concurrent
legal work for the client, if any; (4) the desirability of the client's
seeking independent legal advice if the client is not already independently
represented; and (5) the nature of the respective risks and advantages
to each of the parties to the transaction.
Wolfram, § 8.11.4, at 484-85.
The analogous provision in the ABA Model Rules of Professional
Conduct requires the client's "consent after consultation"
if the "representation of [the] client may be materially limited
. . . by the lawyer's own interest." Model Rule 1.7(b).
In addition, Model Rule 1.8(a) requires that the client be given a reasonable
opportunity to seek independent counsel and that the client consent
in writing if a lawyer "knowingly acquire[s] an ownership, possessory,
security or other pecuniary interest adverse to a client."
The Committee notes that ethical considerations have traditionally
discouraged a "contingency" arrangement in situations where
the client can afford to pay the fee in cash. NYSBA EC 2-20.
See pp. 22 - 24 infra.
This risk of compromising the lawyer's independent judgment can
be further exacerbated in situations where a lawyer's compensation depends
directly in whole or in part on the amount of fees generated for the
firm and where the particular lawyer is also responsible for providing
the legal services involved. In extreme cases, to minimize the
possibility that the independent professional judgment of the lawyers
working on behalf of the client would be compromised, a firm might consider
taking measures such as prohibiting an attorney from working on matters
of a client that she introduced to the firm and that is paying its fees
in the form of its securities or at least placing some other partner
in charge of the matters.
For guidance on disclosures to clients entering into a business
transaction generally, see Wolfram, § 8.11.4, at 484-85.
Although it does not bear on the ethical propriety of accepting
securities in a client for legal fees, it is noteworthy that if the
securities are of significant value, they may foreclose the lawyer from
accepting engagements for other clients that are adverse to the company.
By owning securities in an entity with an interest adverse to a current
client (whether such securities were purchased independently or were
obtained from a former client in exchange for legal services), an attorney
is at risk of putting her own financial or property interests
in conflict with those of her client, plainly implicating DR 5-101(A).
The question of whether a lawyer's "exercise of professional judgment
on behalf of a client will be or reasonably may be affected by the lawyer's
own" interests resulting from securities ownership involves both
objective and subjective inquiries. See N.Y. State 712
(1998). The relevant objective factors to be considered include:
(1) the nature of the attorney's representation of the current
client; (2) the likelihood that the value of the attorney's securities
in the former client will be significantly affected by the outcome of
the current representation; and (3) the extent to which the lawyer's
judgment might be affected as a consequence. See N.Y. State
712 (1988). Although not necessarily required by the rules in
each instance, the prudent course in such situations would be to obtain
the subsequent client's consent to the potential conflict after full
See ABA, Annotated Model Rules of Professional Conduct,
4th ed. at 48; Simon's New York Code of Professional Responsibility
Annotated, 2000 edition, at 146.