Attorneys in the United States are under increasing pressure to change and adopt practices commonly found in the world of finance and business. Over the past thirty years, the bar and legal academics have debated what to do; the focus of this debate has been over whether to change Model Rule of Professional Conduct 5.4 to allow partnerships between attorneys and nonlawyers or partnerships owned by nonlawyer shareholders.
One of the reasons attorneys are debating changes to Rule 5.4 is that the practice of law depends on capital, and the old methods for raising capital are no longer sufficient. Rather than raise capital from nonlawyers by partnering with them or selling equity to them, this Article recommends that attorneys look to their own fees as a source of capital.
This Article argues that there is confusion among state bar ethics committees and some ethics commentators about whether the sale of future, or unmatured, fees is unethical. The argument that lawyers may not sell unmatured fees is based on the claim that it would be fee-splitting. This Article argues that those who think that the sale of unmatured fees is fee-splitting are relying on a theory of Rule 5.4 called the Direct Relation Test, which takes as its premise that it is unethical for an attorney to allow a nonlawyer to invest in her productive capacities with the aim of earning a profit. This Article argues that the Direct Relation Test is incoherent and cannot be consistently maintained in a system, like ours, that allows attorneys to factor their earned fees. This Article also argues that the Direct Relation Test is a deontological principle that lacks normative appeal.
This Article concludes that ethics committees, courts, and legal ethicists should reject the Direct Relation Test and recognize that the sale of unmatured fees is not fee-splitting.
I. Introduction
Capital lies beneath the foundations of American law. Of course, the legal profession’s foundations are its obligations to the public and loyalty to clients.1 These are quite real and are not merely a facade. But, in the United States at least, the bedrock that supports legal practice are the financial resources that pay for everything from rent, salaries, and other overhead as well as litigation expenses, if they are advanced by the attorney.2 Some of this capital comes from the public fisc, when it supports federal, state, and municipal attorneys in both civil and criminal practice.3 Some of it comes from private sector entities that employ attorneys only for their own benefit and do not engage in the practice of law generally.4 But for the very large proportion of lawyers engaged in the practice of law—in large Am Law 100 firms and small solo practices—their firm’s access to capital is ultimately the only source of funds for their practice.5
Anxiety over the negative effect that inadequate capital has on attorneys in private practice has been a constant source of concern for the bar. The 1986 report by the American Bar Association’s (“ABA”) Commission on the Profession—whose title, “A Blueprint for the Rekindling of Lawyer Professionalism,” indicated its focus—began with a description of the increasingly difficult economic environment faced by attorneys in private practice.6 The average attorney, the report noted, earned a little less than $50,000 per year, and over half practiced alone. The report cited a 1985 study by a law firm economic consulting group, which found that in “established firms . . . it costs $62,000 a year to keep the average lawyer in business before he or she takes the first dollar home,” and from this concluded that firms have to bill twice the expected average income of their attorneys, “putting a continuing squeeze on lawyer income.”7 These pressures, the report cautioned, could not excuse the decline in professionalism, but they had to be acknowledged before any effort to “rekindle” professionalism could be attempted.8
Since 1986, many things have changed—the size of the American legal market has grown faster than either the economy or the rate of inflation,9 and concern over the lack of available capital to lawyers in private practice has only increased10—but the sources of capital to attorneys have not changed.11 Since the early twentieth century, the only way that an attorney can raise capital is either by investing her own funds or borrowing. This is a result of the broad interpretation of the rule against the “sharing” of fees currently expressed as Rule 5.4 in the Model Rules of Professional Conduct (“Rule 5.4”), and it has been adopted in almost identical form in all fifty-one jurisdictions in the United States.12 As Gillian Hadfield has noted, this means that lawyers are limited to using financial tools that are primitive compared to the modern advances in finance that have occurred over the past two centuries.13
Over the past two decades, legal scholars have identified the negative consequences that flow from restricting attorneys to capital raised only from the two sources permitted under the Model Rules of Professional Conduct. The first negative consequence is that innovation is stifled, since attorneys cannot afford to invest in either research or the capital-intensive technologies that research might produce in the way entrepreneurs in Silicon Valley have done.14 A second negative consequence is the inability of attorneys to exchange equity in their practices for capital in order to plan along much longer time horizons than the current rules allow. Long-term planning could take different forms, all of them yielding different advantages. For plaintiffs firms that do contingency fee work, the ability to raise working capital means that they could spread the risk of failure or subpar performance over a group of lay investors and not just a portfolio of clients’ cases.15 For large Wall Street firms, the ability to sell equity would provide firms with a way to reward attorneys at every point in their career to avoid “short-termism,” either by finding a way to reward partners for investing in the training of younger attorneys or to find some way to compensate “rainmakers” to remain with a firm without engaging in expensive (and risky) bidding wars with other firms over salary.16
A third negative consequence has received a great deal of attention since the financial crisis of 2008. Starved of capital from any outside source other than debt, attorneys will borrow.17 Excess debt may have certain negative consequences.18 As one analyst observed, the fact that the only outside source of capital available to law firms was conventional debt put them in an especially vulnerable position during the Great Recession when business slowed and lenders lacked liquidity:
[The firms that failed] borrowed substantial amounts of money to fuel growth as well as to pay partners during periods of cash shortfalls. Many of these firms were thinly capitalized—some almost as a matter of philosophical principle—a condition that drove an increased need for debt financing. High debt levels put these firms at particular risk when external economic conditions turned against them.19
Even in periods of normalcy, debt may be an inferior method to raise capital compared to outside investment, especially for plaintiffs firms whose practice includes complex and capital-intensive contingent-fee cases.20 Contingent-fee firms “may place heavier reliance on debt financing because the timing and size of revenue streams is harder to predict. . . . But contingent fee firms have a harder time borrowing from banks precisely because their revenues are harder to predict.”21 The lack of credit may result in these firms partnering with other firms for no reason other than to raise capital, resulting in a dissipation of expected earnings.22
Finally, lenders may exercise control over attorneys depending on the covenants written into the debt agreements. This point goes beyond the risk observed above, which is that failure to comply with the specific payment requirements of bank debt may trigger loan covenants, thus putting the fate of the firm out of the attorneys’ hands.23 The control exercised by a lender can be more than just the power to exercise liens it has on property in the event of default. It could be actively exercised during the life of the loan and in order to govern decisions that are conventionally associated with the management of the practice of law by attorneys, including the deployment of manpower and other resources on behalf of current clients.24 Lenders like Citigroup, which already use covenants to force attorneys to “control[] . . . discretionary spending, cut[] bonuses, freez[e] associate salaries, postpone[e] new hires or initiatives, lay[] off professional and administrative staff, and revamp[] partner compensation schedules,” could go even further and instruct attorneys about the staffing of cases, the pricing of motions, and even whether to withdraw from representation of certain clients.25
Debate over how to solve attorneys’ concern over access to capital has gone on for probably almost as long as the concerns themselves have been expressed. Most have centered around rewriting the ethics doctrines that form Rule 5.4 and its predecessors. Although each proposal may vary in countless details, the efforts at reform can be divided into four general families.26
A. Allow Corporations to Practice Law
Allowing corporations to practice law solves the problem of capital formation for attorneys by allowing nonlawyers to contribute capital to corporations which could then be used to fund salaries, investments, and overhead. This is not actually a reform, since it was permitted in the beginning of the twentieth century.27 Before 1928, corporations formed that offered legal services.28 The corporate practice of law drew widespread criticism from certain parts of the bar and was soon prohibited by many states.29 The ABA’s 1928 Canon 35 adopted a broad rule that complemented the states’ prohibition of the corporate practice of law.30 Canon 35’s prohibition on the corporate practice of law was carried forward into the 1969 ABA Code of Professional Responsibility and Rule 5.4 in 1983.31
Before the 1983 Rules were adopted, a version of Rule 5.4 was proposed in 1981 that would have allowed for nonlawyer ownership of an entity that employed attorneys as long as the attorneys’ independent professional judgment was insulated from the nonlawyer owners of the entity.32 Technically, since the proposed 1981 version of Rule 5.4 explicitly prohibited a corporation (by definition a nonlawyer) or a nonlawyer manager from controlling an attorney-employee’s practice of law, it did not return attorneys to the pre-1928 status quo.33 It was still too radical and was never adopted.34
B. Allow Attorneys to Form Professional Partnerships with Nonlawyers (Especially Nonlawyer Professionals)
This could take two forms: (i) multidisciplinary practices (“MDPs”) that have attorney and nonlawyer owners where the nonlawyer partners provide services that are not necessarily connected to the practice of law by the attorney partners; and (ii) law firms owned in part by nonlawyers whose role is limited to helping firm lawyers provide legal services (e.g., the version of Rule 5.4 adopted by the District of Columbia).35 In 2002, the ABA debated and rejected a proposal to allow MDPs in some form.36 The ABA later tried to adopt the District of Columbia’s version of Rule 5.4, but this proposal was debated and rejected in 2012.37
C. Allow Attorneys to Sell Equity in Their Practice
While this idea has often been conflated with allowing a corporation to either employ or practice law, it need not mean anything more than allowing nonlawyers to have a beneficial interest in an attorney’s property interest in her legal practice (that is, its assets and debts). Academics have offered variations on this idea since at least 1998, spurred in part by changes in Australia and the United Kingdom that have allowed nonlawyers to have ownership interests in law firms.38 Ownership in a law practice may lead to control of the law practice, but the two do not necessarily go together.39 Control by nonlawyers can be separated from ownership through a number of mechanisms, including sale of a derivative,40 limiting the managerial control of the practice to attorneys (preferably attorneys in the firm)41, or mandating that the attorney or attorneys who sell ownership interests in their practice maintain majority ownership or control.42
D. Allow Nonlawyers to Purchase an Interest in Attorneys’ Expected
(or Unmatured) Fees
By advancing money to an attorney in advance of the attorney receiving a fee, the nonlawyer is providing capital to the attorney. This method of raising capital is more modest than the other three methods outlined above. First, since the amount of capital is linked to the expected earned fees of an attorney (or her net fees—her profits), the investment advanced by the nonlawyer would not include other forms of future equity. Second, since the only thing sold would be earnings, there is no risk that a nonlawyer could control the attorney by becoming either the owner or manager of the attorney’s practice. On the other hand, unlike debt financing, this method of raising capital avoids the problems associated with debt described above. The danger of financial collapse in the event of a slowdown in business is clearly limited, since the capital provider’s right to payment is directly linked to the attorney’s success. While it is true that a nonlawyer seeking to purchase an interest in fees might insist on inserting conditions relating to the future conduct of the attorney, it is not obvious that these conditions would necessarily be more onerous than the covenants that lenders may already impose on attorneys.43
All of the foregoing reforms have been resisted one way or another by the organized bar. The corporate practice of law was met with stiff resistance in the early twentieth century, and the arguments for its rejection helped shape Rule 5.4.44 The reasons for rejecting the Kutak Commission’s amendments to Rule 5.4 are still influential today. Critics were, and continue to be, concerned that nonlawyer investors would engage in the unauthorized practice of law, interfere with attorneys’ independent professional judgment, cause attorneys to reveal client confidences, and weaken attorneys’ professionalism.45 Those same concerns were revived to defeat new efforts to allow MDPs over the past two decades.46 As the debate moved from reforms concerning nonlawyer ownership to MDPs, the concern over the weakening of professionalism was reframed as the need to protect the “core values” of the profession.47
The last two reforms in the list above, the sale of equity in law practices and the sale of unmatured fees, have not been explicitly rejected as much as ignored. For example, when the ABA reached out to its members to discuss amendments to Rule 5.4, it recognized that nonlawyer ownership of law firms was an option that could be considered, but it decided sua sponte not to allow the membership to consider it.48 The idea of allowing the sale of unmatured fees has received even less attention from the defenders of the traditional conception of Rule 5.4 than the idea of selling equity. No explicit resistance has been necessary since there has been no concerted effort to amend or otherwise interpret Rule 5.4 to allow and encourage capital formation by the sale an interest in unmatured fees.49 The reason for this is the assumption—which this Article will challenge—that the sale of fees not yet earned is a form of fee-splitting in violation of Rule 5.4.50
The history of efforts to reform Rule 5.4 has been dominated by arguments over the corporate practice of law, nonlawyer ownership of law practices, and partnerships formed by attorneys and nonlawyers. The reasons for this are outside the scope of this Article. This Article examines an idea that has not received attention, that is, the sale of unmatured fees. It too is a way that attorneys may raise capital, and it therefore serves some of the same purposes as the more well-known topics of controversy such as MDPs and publicly traded law firms. It is also subject to attack for being a violation of Rule 5.4 for some of the same reasons that defenders of the status quo have argued that MDPs and publicly traded law firms violate Rule 5.4.51
The sale of unmatured attorneys’ fees deserves serious attention for two reasons. First, it is a way of raising capital that does not necessarily involve the sale of a property interest in an attorney’s practice or placing the attorney under the control of a firm owned by nonlawyers. Therefore, the arguments raised against MDPs and publicly traded law firms should be weaker and carry less weight than they have in the past. Second, as this Article will argue, strong arguments can be made that the sale of unmatured fees is consistent with the current Rule 5.4—assuming, of course, that the interpretation of “fee-sharing” offered in this Article is accepted by state bar ethics committees and courts. If both these conditions hold, then the sale of unmatured fees could be an important new source of capital for attorneys. It would not fully substitute for the other reforms that have been urged on the ABA since the early twentieth century, since MDPs and other forms of alternative law practice structures serve important and specific functions in addition to capital formation. To the extent that attorneys struggle to raise capital, it can be addressed by creating a market in unmatured fees. There is no reason to discourage the development of such a market, however, even if the debate and controversies over other issues related to Rule 5.4 are left open and unresolved.
The structure of the Article is as follows. Part II provides a history of the concept of fee-splitting as an interpretation of the modern legal concept of fee-splitting, characterized as the “Direct Relation Test.” Part III analyzes the practice of factoring legal fees and argues that there is no difference between “standard” factoring of legal accounts receivable and the factoring of unmatured fees or accounts. Part IV argues that the general acceptance of the sale of accounts receivable in legal fees puts courts and ethics committees on the horns of a dilemma: either they are obliged to prohibit the sale of legal accounts receivable or they must articulate a principled basis for distinguishing between “standard” factoring of legal accounts receivable and the factoring of unmatured fees. Part V argues that the “Direct Relation Test” is impossible to implement practically and has almost no normative attraction. Part VI concludes that if attorneys are not constrained under the Direct Relation Test, then there is no reason that Rule 5.4 prevents them from selling their unmatured fees to raise capital.
II. Taking Fee-Splitting Seriously
A. The Historical Roots of the Prohibition Against Fee-Splitting
Critics of the reforms debated by the ABA since the Kutak Commission have always seen a deep connection between Rule 5.4’s central purpose—“to prevent non-lawyers from influencing the practice of law”—and Rule 5.4(a)’s specific prohibition on an attorney sharing fees with a nonlawyer.52 According to some courts, ethics committees, and professional responsibility treatises, Rule 5.4(a)’s reach extends—in theory, at least—to any agreement by an attorney to pay a nonlawyer an amount of money drawn from her fee.53 As a 1925 ABA Formal Ethics Opinion put it, “[a]s the attorney cannot share his professional responsibility with a layman or lay agency, he cannot properly share his professional emoluments with them.”54 According to one commentator, the prohibition in Rule 5.4(a) is central to the regulation of law as a profession: “Virtually all professions prohibit splitting fees with lay persons . . . . Obviously, if a lawyer gives a portion of his fee to someone else, he is doing so for a reason” of concern for the profession.55
First, a note about nomenclature. While the term “fee-splitting” is commonly found in published judicial opinions,56 bar committee opinions,57 and treatises,58 it is not, in fact, a term of art or a defined term. In fact, the term “fee-splitting” does not appear in any statute or in any of the rules of professional conduct regulating lawyers.59 This is because, for centuries, it has been understood that “fee-splitting” is simply impermissible fee-sharing, and this is so obvious to courts and commentators that the terms are used interchangeably.60 When the New York legislature prohibited the “sharing” or “dividing” of fees by lawyers with nonlawyers, the courts instantly understood this to be a prohibition on fee-splitting.61 State ethics committees have understood the ABA’s prohibition on the sharing of fees with nonlawyers in Rule 5.4(a) in a similar way.62
Fee-splitting is in fact an unruly term whose meaning is informed by a variety of legal sources. Courts use it to explain why certain contracts between lawyers and other lawyers, as well as lawyers and nonlawyers, will be enforced (or not enforced) according to the law of contract. And bar committees (and occasionally courts) use it to explain why certain conduct by lawyers is subject to sanction.63 The sources of law that inform these various judgments about whether fee-splitting has occurred are not the same and are informed by different purposes.
The common law’s prohibition against fee-splitting can be traced to a 1729 English Act of Parliament barring an attorney from allowing any nonattorney to use the attorney’s name for profit.64 In 1819, an English court invalidated an agreement by an attorney to pay one-third of his profits to his nonlawyer clerk in lieu of salary on the grounds that it permitted a nonlawyer to use the attorney’s name for profit.65 In 1879, the United States Supreme Court observed in Meguire v. Corwine that, in the United States, fee-sharing agreements with nonlawyers were “forbidden by a statute or condemned by public policy” and were “clearly illegal.”66 In late-nineteenth-century New York, contracts between lawyers and nonlawyers to share contingent recoveries were held to be unenforceable and could result in both the disbarment and criminal prosecution of the attorney under New York Code, Civil Procedure sections 73–75.67
In 1908, the ABA added to the body of rules that limited fee-splitting with the promulgation of the Canons of Professional Ethics. Canon 28 prohibited lawyers from paying nonlawyers for referrals, but the Canons did not otherwise prohibit fee-sharing with nonlawyers.68 The Canons left open the possibility that lawyers could ethically remit their fees to a nonlawyer, such as a corporation, as part of an employment contract.69 The ABA’s 1928 Canons adopted a broad rule that complemented the prohibition of the corporate practice of law discussed in Part I.70 Canon 34 directly prohibited fee-sharing with nonlawyers by providing that “[n]o division of fees for legal services is proper, except with another lawyer, based upon a division of service or responsibility.”71 Canon 34’s injunction against fee-splitting has been carried forward in each of the ABA’s subsequent major revisions to its model codes in 196972 and 1983.73
B. Fee-Splitting Today
1. The Many Faces of Fee-Splitting
The range of financial arrangements with nonlawyers deemed fee-splitting is broad. It includes cases involving impermissible forms of payment to law office employees and independent contractors working for the attorney.74 It includes cases involving the payment of referral fees to nonlawyers, which is no different from the practice of hiring “runners” to bring cases to lawyers.75 It includes cases involving the payment of a portion of a law firm’s fees to a “professional employer organization” (which provides “back-office” personnel support to law firms) in exchange for the vendor taking over all of the payroll and benefits management for the firm, since the vendor is a nonlawyer.76 It has been extended to bar lawyers from New York who practice in New York from working for London law firms if their fees would be distributed to English firms that had nonlawyer equity partners.77
In most of these decisions, the prohibition on fee-splitting can be seen as serving certain policy goals that have been traditionally identified as part of the “core values” served by the modern regime of legal ethics.78 The prohibition of fee-splitting with nonlawyer employees and agents serves the goal of preventing the unauthorized practice of law (“UPL”), which has certainly been a core concern of both public law and the bar associations regulating the profession.79 The public must be protected against UPL for multiple reasons.80 Obviously, insuring competent representation is one. Another relates to the fear that financial incentives affect nonlawyers differently than lawyers, or, to put it differently, since nonlawyers lack the ethical muscles developed by lawyers, they are more likely to pursue their own self-interest, all things being equal, than lawyers.81 Ethics opinions barring fee-splitting with nonlawyer agents emphasize that there is an ineliminable risk that, when an agent’s earnings are contingent on the outcome of a case on which he works, he may act against the client’s interests by directing (or otherwise causing) the attorney to invest time and other resources among multiple clients based on which case promises the greatest reward.82
The prohibition of fee-splitting to prevent referrals from nonlawyers reflects a deeply entrenched set of concerns, this time felt especially by the bar itself.83 One justification for preventing lawyers from paying for referrals from nonlawyers is client protection.84 An additional argument has to do with the dignity of the profession. The 1908 Canon was a product of “the lawyers who made up the membership of the ABA [who] looked with disdain on the scrambling, ungraceful efforts to gain business engaged in by some newcomers to the bar,” including the use of runners and paid referrals.85 Even today, the Restatement, after listing various client-protection concerns about fee-splitting and referrals, adds: “beyond that, the prohibition reflects a general hostility to commercial methods of obtaining clients.”86
The prohibition of fee-splitting within partnerships that contain nonlawyer owners has also been justified by reference to the core value of the professional independence of the attorney, which is seen as imperiled by the ends necessarily pursued by nonlawyers.87 It is not clear whether professional independence is valued because it maximizes the likelihood that a client will get the most competent and efficacious advice, given her ends, or because it maximizes the likelihood that the client will receive advice filtered through special, noninstrumental values that lawyers employ which are inaccessible to laypersons.88 Sometimes, defenders of the prohibition on fee-splitting with nonlawyer partners suggest the former,89 and sometimes the latter.90
Given the heterodox origins of the prohibition on fee-splitting, there is no point trying to discern the “original intent” of any single legislator behind the rule, regardless of whether that legislator was the ABA in 1908 or New York in the mid-nineteenth century. The ABA and the states, when they adopted limitations on fee-sharing, left it to the courts and to the ethics committees to implement those limitations using the concept of “fee-splitting” as a legal term whose meaning would be developed through interpretation. Currently, the leading interpretation is something that this Article calls the “Direct Relation Test” (“DRT”).
2. The Direct Relation Test
The DRT has been stated in a leading treatise in the following way: “[T]he phrase ‘shall not share legal fees’ [in Rule 5.4(a)] is intended to bar any financial arrangement in which a nonlawyer’s profit or loss is directly related to the successfulness of a lawyer’s legal business.”91
As will be argued below, the DRT is flawed in two ways—it is almost impossible to implement in a principled fashion and it is normatively unattractive—but the purpose of this Section is to demonstrate that it is the best interpretation of what courts and ethics committees say that they are doing when they implement the prohibition against fee-splitting.
In addition to the scenarios described above involving payments to employees and agents, referral fees, and partnerships with nonlawyers, the prohibition on fee-splitting has been applied to bar many proposed financing agreements between lawyers and nonlawyers. For example, Hazard, Hodes, and Jarvis’s treatise (which, at this point, may be as influential with courts and ethics committees as the Restatement) contains a “black letter” illustration that contrasts three lawyers, A, B, and C, each of whom is planning to construct a law office and each of whom needs $50,000.92 A borrows $50,000 on a line of credit with a bank; B “borrows” $50,000 from a wealthy friend in exchange for 10% of his net legal fees; and C takes a $50,000 fee earned from a client and uses it to pay for the construction costs.93 Hazard, Hodes, and Jarvis observed that although the transactions are “substantially similar” from an economic point of view, “Lawyer B has certainly violated Rule 5.4(a).”94
In the example above, all Lawyer B has done is seek capital and, in exchange, promise to give a contingent sum of money to a nonlawyer upon the occurrence of certain future events in exchange for that capital. Unlike in the cases of solicitation by “runners” or the coordination of services with private investigators discussed above, there is no explicit obligation or expectation that the nonlawyer do anything other than advance capital.95 Therefore, the DRT’s reach is not limited to cases where the nonlawyer performs a service for the attorney or enhances the conditions under which the attorney practices law.96 The transaction sought by Lawyer B involves the funder in the attorney’s practice no more than the loan transaction sought by Lawyer A, as Hazard, Hodes, and Jarvis noted.97 The friend has simply advanced capital to Lawyer B, nothing more; although, since the advance is nonrecourse, it is technically not a loan.98
3. Applying the DRT to Capital Advances
Transactions involving capital advances like the one sought by Lawyer B are not the subject of many court opinions or ethics decisions, but they have been challenged; and when they are, the DRT has been applied with varying degrees of strictness. The DRT has been applied by state bar ethics committees to capital advances that fall in to two rough categories: those that offer a fixed return and those that offer a return that is contingent upon the size of the attorney’s fee.
a. Fixed-Return Contingent Advances
A handful of ethics committees have held that a nonrecourse loan priced through a fixed interest rate is fee-splitting. Under this interpretation of the DRT, an attorney may not promise to a nonlawyer “lender” to repay any capital she receives, plus interest, contingent on her earning a fee. Although called a nonrecourse loan, this transaction is really a fixed-return contingent advance.99 Ethics opinions in Maine, Missouri, and Nevada have prohibited fixed-return contingent advances.100 Not all ethics committees agree: a Philadelphia bar ethics committee, for example, observed that since a fixed-return contingent advance is “no different than when an attorney negotiates a loan from a bank,” it is not fee-splitting.101
b. Percentage-Return Contingent Advances
The committees that deemed fixed-return contingent advances to be fee-splitting must have assumed that, under the DRT, any nonrecourse advance between an attorney and a nonlawyer is fee-splitting. One need not make this assumption; it is conceivable, at least, to hold that nonrecourse advances that cost the attorney a fixed interest rate are not fee-splitting, while nonrecourse advances that cost the attorney a percentage of her fee are fee-splitting. The latter type of advance is a percentage-return contingent advance. A North Carolina bar ethics committee drew exactly this contrast between a fixed-return contingent advance and a percentage-return contingent advance.102 An attorney asked if he or she could accept a fixed-return contingent advance from a nonlawyer, and the committee gave its permission but cautioned that were the attorney to go further and promise the nonlawyer “a percentage of the attorney’s fee in a given case,” the transaction would cross the line into fee-splitting.103
Although it has been silent on whether fixed-return contingent advances are fee-splitting, Texas has rejected the percentage-return contingent advance as fee-splitting in three different ethics opinions. In Texas Op. 558, an attorney asked whether he or she could, in addition to paying a fixed interest rate to a funder who lent money for case expenses, agree to pay the funder a percentage of the attorney’s contingency fee.104 The committee held that this would be fee-splitting.105 In Texas Op. 576, an attorney asked whether he or she could enter an agreement with a nonlawyer identical to the arrangement proposed in Texas Op. 558, except that the attorney’s nonrecourse obligation to the nonlawyer for the funds advanced would be a contingent sum calculated as a percentage of the attorney’s fee, capped at a multiple of the funds advanced.106 The Texas ethics committee said that this would be fee-splitting.107 In an interesting twist on the more conventional forms for capital formation, in Texas Op. 467, an attorney asked whether he or she could “enter into a lease of office space with a non-lawyer landlord under the terms of which rent equals the greater of a specified minimum rental or a percentage of the law firm’s gross receipts.”108 The Texas ethics committee said this would be fee-splitting.109
Analytically, the only difference between a fixed-return contingent advance and a percentage-return contingent advance is the way that the price of the advance is determined. From the perspective of the attorney, the chief advantage of the fixed-return contingent advance is that if she receives no fee, she does not have to repay the advance. The fact that the price of taking that chance is a fixed interest rate as opposed to a percentage of her fee should matter much less than the fact that any payment to the nonlawyer is contingent on the case generating proceeds.110 And the converse is true for the nonlawyer providing the advance—for him, the big risk is that he will receive nothing due to the contingent nature of the transaction. The size of his recovery, if there is a recovery, is of secondary importance.111
For this reason, the treatment of contingent advances by the state bar ethics committees should not turn on the difference between fixed and percentage returns. This is borne out by a review of the opinions, where the committees raise concerns about self-dealing referrals and nonlawyer interference with independent professional judgment.112 These policy concerns, as was shown above, have been part of the historical rationale for the rule against fee-splitting. These functional concerns cannot in themselves explain why the committees decide to treat some (but not all) contingent advances as violations within the reach of the rule against fee-splitting (and not others) or why loans are excluded entirely.113
The explanation of how the committees identify which advances fall under the rule against fee-splitting is found in the way that they identify a certain feature or characteristic of the transactions. For example, the Maine ethics committee held that a fixed-return contingent advance was fee-splitting because the interest paid to the nonlawyer was evidence that he was “sharing in the prospects of success or failure of the particular litigation.”114 Similarly, one of the Texas bar committees explained that the reason a percentage-return contingent advance was fee-splitting was because “[b]y tying the proposed funding fee to a percentage of the recovery, the lending company would be directly benefiting from the lawyer’s knowledge, skill, experience and time expended to the detriment of the lawyer . . . .”115 The feature or characteristic of the advances that define them as fee-splitting is that they are made by the nonlawyer with the expectation that the attorney’s efforts will create new proceeds that will be paid to the nonlawyer. The DRT is designed to prevent this beneficial relationship between attorney and nonlawyer, and the prevention of this beneficial relationship is why these committees have held that all forms of contingent advances are fee-splitting.
III. The Problem with Factoring
A. Factoring
This Section has two goals. First, it draws attention to the fact that one form of factoring by lawyers—when law firms sell their accounts receivable of fees billed to the client, but not yet paid—does not run afoul of the DRT. This is a somewhat banal claim. Second, it argues that a factoring contract between an attorney and a nonlawyer for fees that will be billed to clients once they are earned is the same, from the point of view of commercial law, as a factoring contract for earned fees that have been billed to the client but not yet paid. This second claim has been endorsed by various state courts, but one state bar ethics committee has held that the sale of unearned or “unmatured” fees violates the DRT.116
B. Standard Factoring
This Section introduces the concept of factoring of accounts receivable and applies it to earned legal fees. Factoring is a practice that is deeply woven into the fabric of commercial law in England and the United States.117 As one practice treatise puts it:
Factoring in modern commercial practice is understood to refer to the purchase of accounts receivable from a business by a “factor” who thereby assumes the risk of loss in return for some agreed discount. . . . Factoring of accounts receivable is a process by which a seller who acquires accounts receivable from the sale of goods or services, instead of retaining these accounts receivable until paid by the purchaser, obtains cash for them by selling or assigning them to a factor or by borrowing against them from a factor.118
When law firms sell their accounts receivable of fees billed to a client but not yet paid, they are engaged in factoring. The following example illustrates standard factoring:119
Standard Factoring of Hourly Fees. At T1, L is retained on an hourly rate contract. At T2, L works three hours at $100 per hour. At T3, L bills C for $300. C has 30 days to pay L $300. At T4, B buys L’s accounts receivables for $290. At T30, B tenders demand for $300 to C, which C pays.
This example is drawn from Santander Bank, N.A. v. Durham Commercial Capital Corp.120 A law firm, Connolly, Geaney, Ablitt & Willard, PC (“CGAW”), earned hourly fees by doing work for a client, Santander Bank.121 CGAW then sold its accounts receivable in those fees to a factor, Durham.122 Santander and CGAW disagreed over certain billing statements, and Santander did not pay the disputed bills.123 Eventually, CGAW went bankrupt.124 Durham sued Santander for payment of the accounts receivable it had purchased from CGAW.125 Santander sought a declaratory judgment that Durham had no standing to seek the fees for the work that CGAW allegedly earned.126 The court rejected Santander’s arguments and noted that the transaction at issue was not unusual.127 It rejected Santander’s argument that earned fees cannot be treated as “accounts receivables” under Massachusetts law because doing so would violate public policy, either by allowing lawyers to violate their duty of confidentiality to their clients or because it would be fee-splitting.128
Additional variations on the Santander case of standard factoring can be illustrated. For example:
Standard Factoring of Fixed Fees. At T1, L is retained on a fixed-fee basis of $300. At T2, L performs the legal work promised. At T3, L bills C for $300. C has 30 days to pay L $300. At T4, B buys L’s accounts receivable for $290. At T30, B tenders demand for $300 to C, which C pays.
There is no difference between “Standard Factoring of Hourly Fees” and “Standard Factoring of Fixed Fees” except that in the latter, the fee earned and assigned is based on a fixed fee, not an hourly fee.
Yet one more variation on the Santander case of standard factoring can be described:
Standard Factoring of Contingent Fees. At T1, L is retained on a contingent-fee contract of 30%. At T2, L performs the legal work promised. At T3, D and C settle for $1,000, and the court approves the settlement. D has 30 days to pay C $1,000. At T4, B buys L’s accounts receivable for $290. At T30, B tenders demand for $300 to C, which C pays.129
There is no difference between “Standard Factoring of Hourly Fees” and “Standard Factoring of Contingent Fees” except that in the latter, the fee earned and assigned is based on a contingent fee, not an hourly fee.
Given the thin cash flow of many plaintiffs’ firms, the decision by the attorney in the last example to engage in standard factoring is unremarkable. Standard factoring of contingent fees is typically the sale of a fee post-settlement. In fact, a large industry exists to provide this service.130
Despite the ubiquity of post-settlement purchases of accounts receivable, and the apparent willingness of courts to enforce the purchases, one state, Ohio, has indicated that it is a violation of that state’s rules of professional responsibility for an attorney to “sell or assign” his or her legal fee even after settlement.131 The bar ethics committee was asked whether an attorney, “upon reaching a settlement,” could “sell or assign his or her legal fee to a funding company in exchange for immediate cash at a small discount to the full value of the legal fee.”132 The committee did not distinguish between a settlement that still required court approval and a settlement that already had been approved by a court (or did not require court approval).133 The committee’s reasoning would apply, therefore, with equal force to settlements pre- and post-court approval.134 The committee observed that an attorney’s duty to his or her client did not end until the money in a settlement had been disbursed to the client, since the risk of failed disbursement exists post-judgment as well.135 The committee did not explain why the attorney’s loyalty or incentive to represent his or her client would be impaired after a settlement, either pre- or post-court approval, and at least one Ohio court has suggested that the committee’s reasoning was flawed and that the opinion should be treated as merely advisory.136
C. Factoring Unmatured Fees
This Section introduces the concept of factoring accounts receivable of fees yet to be earned (“unmatured” fees). The following example illustrates how an unmatured fixed fee could be sold by an attorney:
Factoring Unmatured Fixed Fees. At T1, L is retained on a fixed-fee basis of $300. At T2, L performs some of the work required on the C v. D matter. At T3, B buys “all the accounts receivable in the C v. D matter” for $280. At T4, L performs the remainder of legal work required on the C v. D matter. At T5, L bills C for $300. C has 30 days to pay L $300. At T30, B tenders demand for $300 to C, which C pays.
There is no difference between “Standard Factoring of Fixed Fees” and “Factoring Unmatured Fixed Fees” except that in the latter, the fee is fully earned after L assigns the accounts receivable to B. Commercial law recognizes that accounts receivable in a fee not yet earned may be assigned, pledged, or sold, just like accounts receivable in fees earned.137 Although courts and commentators may differ about the exact portion of the Uniform Commercial Code (“U.C.C.”) under which unmatured fees fall when they are pledged in loans, as opposed to when they are assigned or sold, there appears to be a consensus that an unmatured legal fee, when it is factored, is an “account” under U.C.C. section 9-102.138 The PNC Bank court explained that, because an attorney who grants a security interest or assigns an unmatured fee is not fee-splitting, a lien held by a nonlawyer on unmatured fees is not unenforceable because it violated public policy.139
In theory, accounts receivable arising from any kind of legal fee, including hourly fees, may be sold in their unmatured form. For example:
Factoring Unearned Defined Hourly Fees. At T1, L is retained on an hourly rate contract of $100/hour. At T2, B buys the accounts receivable of “the first three hours earned by L for work performed for C” for $280. At T3, L works three hours for C and earns $300. At T4, L bills C for $300. C has 30 days to pay L $300. At T30, B tenders demand for $300 to C, which C pays.
There is no difference between “Factoring Unearned Defined Hourly Fees” and “Factoring Unmatured Fixed Fees.” In both, B assumes the risk that L may not earn the full amount of the anticipated fee, since there is always the possibility that, because of some unanticipated circumstance, L will not perform enough work to earn the fixed fee or to bill three full hours, and C will only owe L quantum meruit.140 But on a practical level, this is a remote risk.
The previous example illustrates that in every case where unmatured fees are factored, the capital provider assumes a risk inherent to the fact that the attorney has not yet earned the fee, but expects to; this expectation can be reduced to a greater or lesser probability. For example, consider this variation of the previous example:
Factoring Unearned Undefined Hourly Fees. At T1, L is retained on an hourly rate contract of $100/hour. At T2, B buys from L “all the accounts receivables payable in the C v. D matter” for $250. At T3, L works for three hours. At T3, L bills C for $300. C has 30 days to pay L $300. At T30, B tenders demand for $300 to C, which C pays.
The difference between “Factoring Unmatured Fixed Fees” and “Factoring Unearned Undefined Hourly Fees” is that the value of the accounts receivable L assigned to B in the latter was not a fixed dollar amount and was contingent on the number of hours L actually worked. B bears a greater risk in the example “Factoring Unearned Undefined Hourly Fees” than he does in the example “Factoring Unearned Defined Hourly Fees,” although L shares a symmetrical risk.141 As with the original example “Factoring Unearned Defined Hourly Fees,” it is not clear why the example “Factoring Unearned Undefined Hourly Fees” should be treated differently than the example “Factoring Unmatured Fixed Fees.”
Finally, consider this final variation:
Factoring Unmatured Contingent Fees. At T1, L is retained on a contingent-fee contract of 30%. At T2, L works on the C v. D case. At T3, B buys “all the accounts receivable in the C v. D case” for $200. At T4, L performs more work on the case. At T5, D and C settle for $1,000 but D has 30 days to satisfy the judgment. At T30, B tenders demand for $300 to C, which C pays.142
The only difference between “Factoring Unmatured Contingent Fees” and “Factoring Unmatured Fixed Fees” (or “Factoring Unearned Undefined Hourly Fees”) is that the accounts receivable are earned under a contingent-fee contract, not a fixed-fee contract. The fact that factoring unmatured contingent fees involves a contingent fee and not an hourly fee or a fixed fee should not affect the permissibility of the assignment of L’s account to B.143
Attorneys are factoring unmatured contingent fees today.144 Furthermore, the courts are perfectly aware of contracts in which law firms factor their unmatured contingent fees, and they have either enforced those contracts when they have been challenged or acknowledged their existence without negative comment.145 As one New York court put it, an attorney may “assign the future right to receive legal fees upon settlement or judgment, even though the fee may be uncertain, doubtful or contingent.”146 The court in PNC Bank took a somewhat blasé attitude toward the use of “unmatured contingency fees” in secured lending and observed that the objection that it was “inappropriate” for lawyers to engage in what is a boring, commonplace form of business planning was to treat lawyers worse than other business people “under the guise of ethics.”147
There are many cases where courts have noted in passing that an attorney had assigned an unmatured contingency fee, either as security for a debt or by factoring, as in the example “Factoring Unmatured Contingent Fees.”148 There are companies that rely on the assignment of unmatured contingency fees in order to secure nonrecourse debt to law firms.149 The sale of unmatured legal fees is a commercial reality in the United States today.
D. The DRT and the Factoring of Fees
To be clear, with the exception of one informal ethics opinion from Ohio (whose conclusions have been challenged by Ohio courts), there are no bar ethics committee opinions squarely addressing the factoring of accounts receivable, whether earned or unmatured.150 And, to be equally clear, where courts have held that the factoring of accounts receivable in legal fees is not fee-splitting, such as in Santander and Core Funding Group, they have done so only in the context of ascertaining the status of the transaction as a matter of contract law, not advising lawyers as to professional obligations.151 Therefore, the obvious question, which motivates this Article, is whether the factoring of legal fees is consistent with the DRT.
The question needs to be refined further: the real question is whether the factoring of unmatured fees is consistent with the DRT. It is hard to see how any plausible argument could be made that standard factoring violates the DRT. After all, the DRT prohibits a promise by an attorney to pay a capital provider a sum of money where the quantum of the sum is directly correlated to the quantum of the fee (if any) earned by the attorney. In standard factoring, the attorney promises to pay a capital provider a sum of money where the quantum of the sum is specified in advance—and therefore, by definition, it is not directly correlated to the quantum of the fee earned by the attorney.152
But does an attorney violate the DRT when she factors unmatured fees? When an attorney promises to a capital provider that, in exchange for x dollars today, the capital provider has the right to all or some of the dollars earned by the attorney in connection with a specific legal service, the attorney has, in exchange for x dollars, promised a payment to the capital provider of a sum that is directly affected by the quantum of the fee (if any) earned by the attorney.153 It is hard to see why the capital provider—a nonattorney—is not “sharing in the prospects of success or failure of the [attorney’s] particular litigation.”154
IV. The Dilemma
The argument in the Section above leaves state bar ethics committees with two options: (1) permit standard factoring of legal fees and prohibit the factoring of unmatured fees or (2) permit standard factoring of legal fees and permit the factoring of unmatured fees.155 The problem with option one is twofold: first, it would require the committees to articulate a principled basis for distinguishing between standard factoring of legal accounts receivable and the factoring of unmatured fees, which as courts have pointed out, cannot be done on the basis of any distinction found in commercial law; and second, given that many lawyers are currently factoring their unmatured fees, a market which currently exists and around which expectations have been formed would be disrupted.
The problem with option two is also twofold: first, as argued above, it seems that by factoring an unmatured fee, an attorney is doing exactly what the DRT prohibits; and second, if the DRT does not apply to the sale of accounts receivable in unmatured fees, lawyers will be able to engage in a wholesale evasion of the DRT by redrafting many of the transactions which are now prohibited under the DRT as sales of unmatured fees. As with all dilemmas, the solution is to examine the premises that lead to the dilemma, and in this case, I hope to argue that the problem is with the DRT. The following sections will demonstrate each prong of the dilemma, starting with option two.
A. Option Two: Factoring Unmatured Fees Is Not Prohibited by the DRT
It could be argued all that the bar ethics committees’ opinions reviewed in Part II teach is that securing debt with the accounts receivable in a single case is fee-splitting, not that an attorney who sells a property interest in his accounts receivable in a single case is fee-splitting. The hostility of the ethics committees to contingent advances could be nothing more than a hostility to nonrecourse loans between attorneys and nonlawyers. As mentioned above, there are some ethics opinions that categorically prohibit nonrecourse loans to lawyers on the grounds that any form of nonrecourse lending is fee-splitting.156
Option two presupposes that the reason nonrecourse debt is subject to the DRT (regardless of whether the interest rate is fixed or based on a share of the fee recovered) is that the promise to pay upon the occurrence of the named event (the settlement or judgment), from the point of view of the parties, involves a transfer of property (money) upon the event of a future contingency—the attorney earning her fee. The nonlawyer has no property until the attorney, by paying over the proceeds of the fee to the nonlawyer, causes the title to the money to pass.157 In this sense, the nonlawyer who provides a nonrecourse loan stands in the same relation to the attorney as any vendor with whom the attorney transacts, regardless of whether it is an office supply store or a landlord. Until the money owed is in the possession of the nonlawyer, all he has (like a vendor or a landlord) is a legal right that the attorney perform the debt contract, and his remedy is a lawsuit for damages. The DRT becomes interested in the content of that contract (its terms) when the payment promised is not fixed (as it would be in the sale office supplies or the signing of a lease with fixed monthly payments) but is correlated with the success of the attorney’s earned fee. That is why the DRT prohibits directly linking payments to the existence or amount of the attorney’s fee.158
On the other hand, from the point of view of the parties, the sale of accounts receivable in unmatured fees stands on a very different footing. The nonlawyer’s legal interest is not in the attorney’s performance of a contract, and the remedy available to the nonlawyer is not a lawsuit for damages. Title to the accounts receivable was transferred to the nonlawyer earlier, upon the purchase of the accounts receivable. To see why this is possible, it is important to start at the beginning—with the attorney’s original acquisition of the property she sold to the nonlawyer.
Before the attorney and the nonlawyer make their contract, the attorney already has in her possession a property interest. It may seem odd to think of an unmatured contingency fee as a species of property. Indeed, it is important not to confuse the property held by the attorney upon being retained by a client with the assignment of the client’s causes of action, in part or in whole.159 It is not an ownership interest in the client’s lawsuit.160 It is, however, a lien on the proceeds that arise from the resolution of the client’s lawsuit.161 And that lien is itself a species of property: as the New York Court of Appeals put it, “because a cause of action is a species of property, an attorney acquires a ‘vested property interest’ in the cause of action at the signing of the retainer agreement and thus a ‘title to “property and rights to property.”’”162 The court went on to emphasize that an attorney’s contract right is not “a mere claim against either property or payment,” but property in its own right.163
The history of the right to this property is tied up with the evolution of one of the rules designed to protect lawyers from faithless clients—what is today known as the “charging lien.”164 A charging lien is a property interest because it is a lien on property—the property the client has in his or her chose in action.165 Its origins are in the common law, in the form of an equitable assignment.166 For example, where the fee agreement promised the attorney half of the land at issue in the client’s suit, the common law made “the attorney the equitable owner of the undivided one-half of whatever shall result from the prosecution or compromise of the suit instituted by him to recover the land.”167 A fee agreement for a portion of a damage award was not “an obligation to pay upon the contingency named . . . . It was in effect a constructive appropriation in favor of the [lawyer] of so much of the money” that the client was awarded.168
It is because the equitable interest held by the attorney upon being retained is a species of property that it can serve as collateral or as a security interest in a loan.169 And, for the same reason, it can also be sold outright in exactly the same way that an earned fee can be sold outright in standard factoring.170 But, unlike when the attorney’s equitable interest in her client’s property is used to secure a loan, the sale of the equitable interest does not fall under the DRT because when the client’s property is reduced to a specific sum, the portion that the nonlawyer receives is not a share of the attorney’s property but the property to which the nonlawyer already has title. The reason the sale of accounts receivable looks like a loan is that the quantum of money received by the nonlawyer buyer is correlated with the attorney’s success. But unlike a loan, the source of the money received by the nonlawyer is not the attorney’s fee; it is an equitable property interest already owned by the nonlawyer, finally reduced to money. This is not unusual—it is the nature of an equitable property interest that it may take various forms, and the fact that it does not ripen fully into a form of property over which the owner can take control (e.g., money) does not change the fact that it is nonetheless property already owned.171
The idea that the attorney’s unmatured fee is an equitable property interest is a useful piece of doctrine that can help resolve the dilemma posed above. If the ethics committees that used the DRT to condemn the transactions in Part II wanted to find some basis to allow attorneys to continue to factor unmatured legal fees, they could draw the line at property: an attorney is not splitting her earned fee if she sells a portion of her property interest in it before it matures (is earned) and is reduced to a specific monetary amount. The DRT prohibits a promise by an attorney to pay a nonlawyer a sum of money where the quantum of the sum is directly correlated to the quantum of the fee (if any) earned by the attorney. If the money received by the owner of a property interest in the attorney’s fee is the owner’s own money—just converted into a form over which the owner can now take possession—then the attorney is not giving the nonlawyer a portion of her fee, and therefore the attorney cannot be splitting a fee.
This means, for example, that the ethics committees should in theory permit the factoring of unmatured fees in any form, since all unmatured fees are a property interest. This is option two. In some cases, option two would be easy for an ethics committee to adopt—where, for example, the sale of an unmatured fee looks almost like the sale of an earned fee, as in the case of the “Factoring Unearned Defined Hourly Fees” example. The only difference between standard factoring and factoring unearned defined hourly fees is that in standard factoring, B knows in advance that L has worked three hours (or at least L has represented that he has worked three hours on C’s matter), whereas when unearned defined hourly fees are factored, B anticipates that L will work three hours on C’s matter.172 It is hard to see why this makes a difference, and, as noted in PNC Bank, the U.C.C. treats both transactions as functionally equivalent.173
But how far could we expect ethics committees to go with option two, even if they were inclined to accept certain transactions involving unmatured fees that most resembled standard factoring, such as those involving defined hourly fees and fixed fees? The problem with option two is that, through clever drafting, most transactions held to violate the DRT in Part II could be presented as the sale of a contract right, or an account.174 Once that door is opened, it is possible that almost any transaction prohibited under the DRT could be restated as a property transaction that would avoid the DRT’s reach.
In fact, option two should allow any of the “nonrecourse loans” prohibited by the ethics committees in Part II if they are restated as advances in exchange for a property interest in an unmatured fee. For example:
Accounts in Unmatured Contingent Fee Sold for Nonrecourse Advance. At T1, L is retained on a contingent-fee contract of 30%. At T2, B agrees to advance $200 in exchange for ψ, where ψ equals “$200 + ⅓(L’s accounts receivable in C v. D).” At T3, L works on the case. At T4, D and C settle for $1,000 but D has 30 days to satisfy the judgment. At T30, B tenders demand for $300 to C, which C pays.175
This example achieves the economic goals of the lawyers who sought nonrecourse loans that were prohibited by the ethics committees in Part II, but it is not a loan. At T3, L already has in her possession a property interest. It is property in that it can be the subject of a lien, since the “property” is C’s obligation to pay x (the earned fee).176 The money paid by C to B belongs to B, not to L. It is hard to know what an ethics committee would make of this transaction. It is, after all, not that far from the transactions recognized by the courts in Core Funding and PNC Bank (as well as other cases). In fact, exchanging an advance for an unmatured contingent fee is functionally equivalent to factoring an unmatured undefined hourly fee.177 If an ethics committee would permit factoring of unmatured undefined hourly fees, it is hard to see on what basis it would prohibit the transaction presented in “Accounts in Unmatured Contingent Fees Sold for Nonrecourse Advance.”
Even the transaction in Tex. Op. 467, involving a landlord seeking a percentage of his attorney-tenant’s gross receipts in lieu of rent, could be redrafted to be allowed under option two.178 To see why, it is first necessary to note that the Texas ethics committee did not say specifically whether the proposed rent exchange with the landlord was a contingent fee and, under the reasoning offered in the opinion, the landlord should not have been allowed to make the same deal with a transactional or family law attorney.179 Keeping that in mind, the transaction in Texas Op. 467 could be restated so that it was not fee-splitting under option two. It would look like this:
Accounts in Unearned Undefined Hourly Fees Sold for Use of Real Property. At T1, L is retained by C on an hourly rate contract of $100/hour in the matter of C v. D. At T2 (May 1), B exchanges “all the accounts receivable payable in the C v. D matter” for “one month of occupancy in Office O in May” and occupies the office. At T3 (May 2–May 28), L works three hours for C and earns $300. At T4 (May 31), L bills C for $300. C has 7 days to pay L $300. At the end of T5 (June 7), B tenders demand for $300 to C, which C pays.
Since there is no reason to distinguish between the sale of unearned hourly fees or unmatured contingent fees, the transaction that was prohibited in Texas Op. 467 should be permissible under option two even if it were restated using exactly the same details contained in the question posed to the committee:
Accounts in Unmatured Contingent Fees Sold for Use of Real Property. At T1 (May 1), B buys “30% of L’s accounts receivables in May” in exchange for “one month of occupancy in Office O in May” and occupies the office. At T2 (May 2), L is retained on a contingent-fee contract of 33% by C. At T3 (May 3–30), L works on the C v. D case. At T4 (May 31), D and C settle for $3,000, but D has seven days to satisfy the judgment. At the end of T5 (June 7), B tenders demand for $300 to C, which C pays.180
The key move in the hypothetical examples in this Section was to take an advance that was once labeled a loan and turn it into a purchase of a property interest in a right to an undefined sum. It is possible that the committees that rejected the contingent advances described in Part II would resist this move simply because these hypothetical examples “feel” too similar to the nonrecourse loans they rejected. The problem, as argued in Part III, is that it is hard to imagine these same ethics committees breaking with clear judicial precedent and prohibiting an attorney from trading her unearned but defined hourly fees for an advance of funds.181 The ethics committees would almost certainly take the view that an attorney who traded $280 in exchange for the first three hours of her work for a client whom she will bill at $100/hour is doing something so similar to standard factoring that is a sale of property and not a scheme to allow a nonlawyer to “directly” benefit from the attorney’s future efforts.
The dilemma identified at the beginning of this section is now hard to avoid. It is possible that a bar committee would “feel” that the example “Accounts in Unearned Undefined Hourly Fees Sold for Use of Real Property” was too similar to the transaction rejected in Texas Op. 467 and deem it to be fee-splitting. It seems unlikely that the same committee would deem the following transaction to be fee-splitting:
Accounts in Unearned Defined Hourly Fees Sold for Use of Real Property. At T1, L is retained by C on an hourly rate contact of $100/hour in the matter of C v. D. At T2 (May 1), B exchanges the accounts receivable of “the first three hours earned by L for work performed in the C v. D matter” for “one month of occupancy in Office O in May” and L occupies the office. At T3 (May 2–May 28), L works three hours for C and earns $300. At T4 (May 31) L bills C for $300. C has seven days to pay L $300. At the end of T5 (June 7), B tenders demand for $300 to C, which C pays.
The foregoing example is virtually identical to the “Factoring Unearned Defined Hourly Fees” example in Part III. A key similarity is that, in both, the nonlawyer knows the value of the contingent right if it comes to pass. It must be conceded that the “definiteness” of the contingent right is a difference between the “Accounts in Unearned Defined Hourly Fees Sold for Use of Real Property” and the “Accounts in Unearned Undefined Hourly Fees Sold for Use of Real Property.” But why is this significant? There is no difference in the type of interest L is transferring. At T2 in the “Accounts in Unearned Undefined Hourly Fees Sold for Use of Real Property” example, the property interest the landlord receives from L is a property interest in “C’s obligation to pay,” and the landlord relies on the security of a lien on that “property” to guarantee that he will receive what he has bought. Furthermore, all the examples offered in this Section are more like each other than standard factoring in one very important way: the payment B hopes to receive, whether defined or undefined, may be zero, depending on contingent events that are partially the result of L’s expenditures of “skill, experience and time.”
The point of going through these variations is not to predict how the North Carolina and Texas bar ethics committees would decide these hypotheticals, which are, in essence, efforts to repackage transactions they already prohibited into formal categories they might be inclined to accept. The point is that if, as option two suggests, the line between debt and property determines whether a financial relationship is “direct” or “indirect” under the DRT, then these committees would be hard pressed to explain their decision to approve one transaction but not another. The committees would need to rely on a principle more substantive than simply one that says that a nonlawyer is “directly” benefiting when his financial gain is tied to future expenditures of an attorney’s “skill, experience and time.”182 The word “direct” is an ad hoc label applied after a committee has decided that a transaction like Accounts in Unearned Defined Hourly Fees Sold for Use of Real Property “feels” more like a property transfer than some other transaction.
The problem with option two, therefore, is that it does not offer a principled interpretation of the DRT. Whatever was motivating the ethics committees that decided the examples in Part II, it was not a concern that the contracts that promised the nonlawyer payment in exchange for the advance of funds had to be based on the sales of some species of property. The discussion of the hypothetical examples in this Section supports the conclusion in Part II that the “something else” that drove the committees to make their decisions was an expression of the principle that an attorney cannot pay a nonlawyer for an advance of capital with a promise that the nonlawyer will benefit “directly” from the attorney’s exercise of her legal skills.183 Option two does not capture this principle. This leads inevitably to the other prong of the dilemma, option one.
B. Option One: Permit Standard Factoring of Legal Fees and Prohibit the Factoring of Unmatured Fees
Upon being confronted with the confusion engendered by option two above, it is easy to see why ethics committees might choose to draw the line at the factoring of earned fees and choose option one. In addition to avoiding the problems described in option two, a rule that permitted lawyers to factor fees only after they have been “earned” would seem to have the advantage of simplicity.
Still, option one brings with it two new problems that make it as unattractive as option two. First, as noted in Part III, the practice of factoring unmatured fees has grown over the past few years, and the practical effect of a categorical prohibition on the factoring of unmatured fees would be huge given the large number of contingent-fee firms that rely upon these transactions.184 Second, it is not clear that drawing the line at earned fees gives the ethics committees anything more than the advantage of simplicity: the policy goals that are purportedly served by the DRT are not clearly served by drawing the line at factoring earned fees. This Section will focus on the second problem.
The argument for drawing the line at earned fees must be something like this: Since the DRT prohibits nonlawyers from directly benefiting from the efforts of lawyers in the practice of law, nonlawyers may only receive from lawyers funds that are not connected to a client’s case, and an earned fee is no longer connected to a client’s case since it is like cash in the attorney’s bank account (not the client’s bank account). But this statement is a nonsequitur since accounts receivable are always earned in connection with a specific matter, and they are not reduced to money “in the bank” (that is, in the possession of the attorney) until someone (usually the client but sometimes the defendant) pays over an amount of money corresponding to the earned fee in a specific matter. Were the DRT to be taken at face value, it should not permit even standard factoring. Some ethics committees have drawn this conclusion. Recall that, in an informal opinion, Ohio held that lawyers could not factor earned fees.185 The committee offered this reasoning:
A lawyer’s legal representation of the client does not end upon reaching a settlement agreement, but continues from settlement agreement through the time of receiving and disbursing the settlement money. A lot can happen in that interval. . . . Until the money agreed upon in the settlement is paid and disbursed, the attorney has not completed his or her legal representation of the client.186
In a series of opinions that represent a clear break from the mainstream application of the DRT, ethics committees in Utah have prohibited all financing arrangements where an attorney grants a security interest in the attorney’s fee to a nonlawyer as a condition for an advance or a loan.187 For example, a committee prohibited a nonrecourse loan where the attorney promised to repay to the nonlawyer the principal advanced and a fixed interest payment (not a share of the fee) if the nonlawyer took a security interest in the attorney’s unmatured contingent fee.188 But, in a later ethics opinion, a committee upheld a nonrecourse loan (which would “be repaid” by giving the lender a share of the contingent fee) as long as the attorney did not give the nonlawyer a security interest in the fee.189 In other words, a promise to pay a nonlawyer a share of an unmatured fee is not fee-splitting in Utah as long as the nonlawyer does not have a lien on the attorney’s fee. According to the Utah ethics committee:
Once a security interest in the recovery of contingent fees from a particular case is granted, Rule 5.4 is implicated. Upon that grant, Lender has an interest in the attorney’s contingent-fee award, which Lender has the right to attach upon a default in payment on the loan. That particularized interest in the contingent fees of a case could compromise the lawyer’s judgment in a number of ways.190
The committee’s focus was on the rights that a security interest granted the nonlawyer: the right of priority with regard to other creditors and the right to pursue payment directly against the client, if necessary.191 These are the conventional hallmarks of holding a property interest, as Core Funding illustrates. But they are not limited to just the property interest that exists in unmatured contingent fees. The same rights vis–à–vis other creditors and the client are held by the nonlawyer when a security interest in unearned hourly fees is assigned (see PNC Bank), and the same rights vis–à–vis other creditors and the client are held by the nonlawyer when a security interest in earned hourly fees is assigned (see Santander). The same rights vis–à–vis other creditors and the client are held by the nonlawyer when a security interest in fees earned by an attorney who has secured a default judgment is assigned, even though the proceeds (and fee) may not be paid over for a long time.192 According to Utah’s reasoning, if the DRT prohibits nonlawyers from having a property interest in an attorney’s fee that is linked to a specific case or legal matter, then the transaction enforced by the court in Santander is void. And if the transaction in Santander is void, then attorneys cannot engage in standard factoring.
The Utah ethics opinions, like the Ohio opinion, give extremely restrictive answers to the question of where to draw the line between direct and indirect interests in an attorney’s fee. The view taken by Utah and Ohio is that the incident of property that matters most to legal ethics when it comes to financial relations between lawyers and nonlawyers is the right to exclusive control over any portion of the interest the attorney has in her fee. As long as the property interest held by the nonlawyer affords him unilateral control over a portion of the attorney’s fee, fee-splitting occurs, and this possibility is present even in cases of standard factoring. A nonlawyer who owns a portion of an attorney’s earned fees can do more than just sue a client for the funds after the legal matter in which the fees were earned is completed. As the Ohio committee observed, the nonlawyer may have an interest in collecting on the earned fee after a settlement, which could lead it to pursue the defendant directly, to the detriment of other long-term interests of the client and the attorney who sold the fees after settlement.193 The Utah committees may have had some of these concerns in mind as well. Even where there is no property upon which to attach a lien—as is often the case of the sale of an earned hourly fee—the nonlawyer can interfere with the attorney’s ability to make judgments in the best interest of the client.194 The Ohio and Utah committees take the DRT to its logical conclusion—and, if they are right, reveal just how high a price the DRT demands from legal practice.
There is one escape route left for an ethics committee that wanted to maintain the line between standard factoring and the factoring of unmatured fees and therefore save option one. One could concede that, as a formal matter, since all factoring involves the transfer of a property interest, all factoring is in theory the sharing of fees between an attorney and nonlawyer, but a retreat from the formal application of the rule against fee-splitting, and insist that Rule 5.4(a) has to be read functionally, not formally. Under this account, the reason that the line is drawn between standard factoring and the factoring of unmatured fees is that the former transaction does not implicate the various policy concerns described in Part II, while the latter does.
Some bar ethics committees have tried to take this route. In Virginia Op. 1783, which was about fee-splitting but did not concern contingent advances, the committee emphasized that the “application of Rule 5.4(a) must move beyond a literal application of language of the provision to include also consideration of the foundational purpose for that provision.”195 The functional approach adopted in Virginia Op. 1783 could be applied to the decision to draw a line between earned and unmatured fees.
As noted in Part II, one of the concerns addressed by the prohibition on fee-splitting, which the DRT (in theory) addresses, is the avoidance of improper interference by third parties with the conduct of the litigation.196 As the Virginia ethics committee noted, it had repeatedly emphasized that “[t]he primary purpose of Rule 5.4 is to prohibit nonlawyer interference with an lawyer’s professional judgment and ensure lawyer independence.”197 The functional approach would counsel that the DRT adopt an ad hoc distinction between transactions where nonlawyers have a property interest in the results produced by attorneys where the fee has already been earned, as opposed to a property interest in those same results where the fee has not yet been earned. The argument for this would be that, as a practical matter, nonlawyers who factor earned fees simply cannot do very much to interfere with the independent professional judgment of attorneys and cannot therefore do very much to harm their clients, compared to factors who purchase unmatured fees of any sort. If this were the question, one might conclude that most of the time, nonlawyers’ ownership of earned fees does not pose a threat to an attorney’s independence—since all the owner of the fee can do is enforce a lien against the attorney’s client, and that threat, even if carried out, is unlikely to yield much leverage over either the attorney or the client.
The problem with this functional argument is that it does not look at the whole picture. The question is not, “Does the sale of earned fees differentially increase the likelihood of the nonlawyer interfering with the attorney’s exercise of independent professional judgment only through the nonlawyer’s efforts to enforce their lien?” It is, “Does the sale of earned fees differentially increase the likelihood of the nonlawyer interfering with the attorney’s exercise of independent professional judgment any more than the sale of unmatured fees?” A functional analysis must take all the possible effects of a practice into account, and it has to be comparative. If we look at the effects of allowing the purchase of earned fees from the widest possible perspective, it is not obvious that nonlawyers are significantly less likely to interfere with an attorney’s professional judgment in a world where they are only buying earned fees. The comparison should be analyzed along two dimensions.
First, the risk of interference by nonlawyers in cases of standard factoring extends beyond just the risk that the nonlawyer will begin a collection action for the earned fee. The nonlawyer’s interest in the fee earned by the attorney might lead the nonlawyer to influence the attorney before the fee is earned, or to influence the attorney’s behavior to the extent that it affects the client’s decision to pay before a collection action is initiated. In the case of standard factoring of earned hourly fees, the nonlawyer might be tempted to interfere with the attorney’s relationship with the client since the period of time between the attorney earning a fee and the client paying that fee could be quite long, and many things could happen in the meantime.198 Since the attorney might act in a way that might lead the client to refuse any payment (especially if the client intends to sue for malpractice), or the attorney might act in a way that might cause the client to lose the assets with which the fee was to be paid (especially if the hours were earned in “bet the company” litigation), the nonlawyer might try to preempt or mitigate the conditions which affect these risks. The nonlawyer might try to use whatever influence he has with the attorney to preserve the attorney-client relationship (even if that is not in the attorney’s best interest) or to encourage the attorney to take a conservative approach to litigation that guarantees the nonlawyer’s property interest at the expense of the attorney’s independent professional judgment.199
Second, it may be the case that the incentive for nonlawyers to interfere with lawyers in cases of factoring of unmatured fees is overstated. It is important to recall that the distinction between cases of standard factoring and cases of factoring unmatured fees is blurred in practice. The reason, in Santander, that the factor bought the law firm’s accounts receivable at a discount is that it assumed the risk that those accounts would not be collectable.200 That is the same reason, in Core Funding, that the funder initially bought $124,000 of the plaintiff attorney’s unmatured contingent fee for $100,000.201 The plaintiff’s attorney, Diana MacDonald, had co-counseled with a major plaintiff’s firm in an airline crash, and after litigating the case for a while, she felt confident that the case would generate proceeds and wanted to sell those proceeds in advance of the case settling.202 There is no reason to assume that the type of risk faced by the buyers in Santander was any different in kind (as opposed to degree) from the risk faced by the buyer in the Core Funding case, even though in Santander the fees were fully earned when the accounts receivable were purchased, while in Core Funding they were unmatured and contingent.203 This is true even if we restrict the analysis only to the market for the fees from plaintiffs’ attorneys who can only factor their contingent fees. As a functional matter, it is not clear that in most cases where factors have purchased unmatured fees, they actually face a risk of nonpayment due to a litigation contingency that is any greater than the risks of nonpayment faced by a factor who purchased a matured fee post-settlement.204
In terms of providing a practical barrier against interference with the independent professional judgment of attorneys, there is no reason to draw a distinction between earned and unmatured fees. There is no reason based on how law is actually practiced in the United States to believe that the risk of interference, to the extent that it exists (which is itself an empirical question for which little or no evidence has been produced), can be predicted based on whether the nonlawyer factor is purchasing an earned fee or an unmatured fee. A functional interpretation of the DRT is no more likely to provide guidance to ethics committees than the formalist version of option one introduced at the beginning of this section.
V. The Direct Relation Test Revisited
A. The DRT as a Deontological Principle
At the end of Part IV, I argued that the DRT cannot provide a functional basis for drawing a distinction between the factoring of earned fees and unmatured fees. The reason for this failure is that the DRT, as currently expressed by ethics committee opinions and commentators over the last few decades, is not based on functional concerns—in other words, the norm it instantiates is not consequentialist but deontological.205 Of course, deontology is a respected ethical tradition and there may be parts of legal ethics that cannot be explained except by reference to deontological principles.206 But to the extent that professional responsibility is governed by norms that should be applied without regard to their consequences, those norms must be instantly recognizable as widely shared. Perhaps the norm behind Rule 1.6—that confidences belong to the client, not the attorney (even if silence harms others)—is one such norm, but the noninstrumentalist norm identified at the heart of the DRT is neither instantly recognizable nor widely shared. 207 In fact, the norm that undergirds the many applications of the DRT reviewed in this Article does not make much sense once it is isolated and analyzed.
The DRT’s deontological injunction is that nonlawyers may not benefit from gains generated by legal resources that were enabled by the nonlawyer for the use of an attorney on behalf of her client. This injunction can be seen, for example, in the explanation offered by the Texas ethics committee that rejected the nonrecourse loans described in Part II. The committee argued that the problem with such arrangements was that the nonlawyer’s gain “would be tied directly to the amount of the recovery in the underlying litigation.”208 In a New York case, the court said much the same thing: the “prohibition against fee-splitting with nonlawyers is ‘intended to bar any financial arrangement in which a nonlawyer’s profit or loss is directly related to the success of an attorney’s legal business.’”209 This interpretation of the DRT focuses on the “productive” or “generative” relation between nonlawyer’s contribution and the attorney’s fee in which the nonlawyer hopes to share. As the ethics committee put it in Texas Op. 576:
The amount of the recovery in a lawsuit is largely determined by the lawyer’s knowledge, skill, experience and time expended. . . . By tying the proposed funding fee to a percentage of the recovery, the lending company would be directly benefiting from the lawyer’s knowledge, skill, experience and time expended . . . .210
The statement from Texas Op. 576 has two parts. The first assertion, that “the amount of the recovery in a lawsuit is largely determined by the attorney’s knowledge, skill, experience and time expended,” simply states that outcomes in civil litigation are the product of the application of the attorney’s legal skills and that the resources available to the attorney can help her maximize the effect of those skills.211 The second assertion is the key move for our purposes. It is that a nonlawyer may not “directly” benefit from the increase of efficacy that his contribution of capital might produce. Two implications follow from this second assertion: first, only the client may directly benefit from the attorney’s “knowledge, skill, experience and time expended,” and second, if anyone else benefits from the attorney’s “knowledge, skill, experience and time expended,” they may do so only indirectly. The second assertion is not, as we saw above, based on any well-grounded policy argument. It is presented as a claim about the improper nature of the gain sought by the nonlawyer. The assumption is that only certain persons should directly benefit from the application of resources (such as money) to the practice of law—attorneys and clients—but not nonlawyers.
As a deontological norm, the DRT has to be interpreted in ways that make sense of it as an action-guiding norm.212 “Directly benefit” must mean more than simply a historical correlation between the resources put into a legal matter by the relevant parties (the client, the attorney, and the nonlawyer) and the outcome of the legal work performed on behalf of the client. It must refer to the subjective intent of the parties when the resources were added to the legal matter. In other words, the DRT prohibits a nonlawyer from providing an attorney who has a client matter additional resources with the intent that the client’s legal results would thereby be improved and that some of the gains produced as a result of the improvement in the client’s legal matter would be returned to the nonlawyer. This principle is not based on a consequentialist concern over the effects of the addition of resources on the client—it is based on a nonconsequentialist concern with the nonlawyer’s reasons for action. The DRT is a deontological principle that prohibits any act helping the client if it arises from a nonlawyer funder’s self-interested motive to profit from the attorney’s exercise of her resources on behalf of her client. The DRT is deontological because its reach is not conditioned on a concern for the effects of the prohibition on the client’s ends; it is conditioned on a belief that certain ends should simply be unavailable to nonlawyers in connection with legal resources. That is, nonlawyers who are not clients cannot act with the intention that they will enjoy the fruits of the productive capacities of lawyers working on behalf of their clients.
B. Some Questions About the Deontological Foundations of the DRT
The argument for abandoning the DRT is not just pragmatic, although the pragmatic consequences of halting the practice of factoring unmatured accounts should not be minimized.213 The argument for abandoning the DRT is that it relies upon a distinction that is an empty formalism: it is an incoherent and counter-intuitive deontological norm.
The DRT is based on the assumption that positive gains in the actual value of the client’s legal matter cannot be given to a nonlawyer if he “directly” enhanced the attorney’s legal capabilities by the act of providing some additional resource.214 This begs the following question: assuming that it is possible to identify “directly caused” enhancements of legal capabilities—which would be a prerequisite if the DRT were to operate as a conduct-guiding norm—why bar nonlawyers from enjoying gains that are the result of direct enhancement, but allow them to enjoy gains resulting from indirect enhancements?
For purposes of this Article, let us assume that the line between direct and indirect support by the nonlawyer can be drawn along some simple version of the but-for test for causation.215 So, for example, if there is an advantage (such as an extra $10,000 in the final settlement) that would not have come about but for some additional quantum of legal practice made possible by the nonlawyer’s contribution to the resources at the attorney’s disposal, then, according to the DRT, the nonlawyer was the “direct” cause of the resulting advantage. Under this approach, the gains secured by the nonlawyer in standard factoring are indirect because the attorney’s legal judgment or practice cannot be affected by the buyer’s contribution of resources to the attorney since the buyer’s advance arrives on the scene after the legal resources have been expended. The effect of the exercise of the legal resources on the client’s matter is already in the past and, therefore, the nonlawyer’s additional funds are not able to affect the matter through the resources that the nonlawyer is ostensibly buying (the hours already expended or the fee already earned).
Ignoring, for the moment, the artificiality of the but-for test as it is applied in cases of standard factoring,216 what possible ethical reason could be offered for distinguishing between resources that are but-for causes of the exercise of legal resources and those that are not? The “but-for test” for directness has the virtue of clarity, but it lacks any normative content. To see why this is so, assume that the deontological claim at the root of the DRT concerns the permissibility of nonlawyers (the capital provider) gaining a benefit in a certain way: through the enhancement of an attorney’s capabilities. Why should this matter from the perspective of legal ethics? It cannot be because the benefits that are gained by means the DRT deems direct reflect a reason for action on the part of the nonlawyer that is shameful or unseemly. The motive seems no more or less praiseworthy than the motive behind a nonlawyer who engages in standard factoring (or lending, for that matter), where the nonlawyer only indirectly benefits from the enhancement of an attorney’s capabilities.
In both types of transactions (direct and indirect), the economic rationale behind the price at which the buyer purchases the attorney’s accounts receivable is the same: his greater ability to bear the attorney’s risk that earned fees will not be paid. If this is the case, it is hard to see how any feature of the nonlawyer’s reasons provides a deontological reason to distinguish between the two transactions.
Perhaps the ground for the deontological distinction does not have to do with the nonlawyer who seeks a benefit drawn from the enhancement of the attorney’s legal capabilities, but with the reasons of the attorney who seeks out the enhancement of her capabilities. Perhaps the insight behind the DRT is that an attorney ought not to receive resources or capital for the “wrong” reasons. This argument, of course, depends on being able to articulate why the attorney who accepts enhancement of his or her legal capabilities from a nonlawyer investor is acting in a way that is wrong, when he or she would not be acting wrongfully if those enhancements came from the client or from the attorney’s own capital.
It is true that, as between factoring earned fees and factoring unmatured fees, the attorney’s reasons for wanting to sell the property interest she has may not be the same. But is this difference morally significant? It must be conceded that an attorney’s rationale for accepting resources from the nonlawyer may differ depending on whether the attorney receives the resource before or after the fee is earned. When an attorney factors an unmatured contingent fee, the attorney could use the money she receives to invest further in the case upon which she is working, or she may use it for a purpose entirely independent of that case (and even independent of the practice of law). While the attorney will always be interested in these particulars, the buyer can afford to be indifferent to them; all the buyer cares about is that at the end of the day he receives the proceeds from the case that he purchased.
But why should the bar committees that prohibited the transactions reviewed in Part II care about what the attorney intends to do with the resources advanced to her when she sells her accounts receivable to the nonlawyer? Assuming that we have already excluded the functional concerns about interference with independent professional judgment, there may be one remaining possibility: the concern that, by allowing nonlawyers to act with the subjective intent to enhance an attorney’s practice of law, the nonlawyer is himself violating the prohibition on the UPL.217
UPL is a poor justification for a categorical prohibition on lawyers accepting resources in circumstances where the resources might enhance their legal capabilities. According to this reasoning, all ex ante support of an attorney’s practice of legal skill and judgment is the practice of law. This is a conceptual argument that cannot possibly be defended. The refutation is easy to demonstrate. Let us assume, for the sake of argument, that a “direct” relation between a capital advance and the attorney’s fee exists when the capital affects the attorney’s exercise knowledge, skill, experience, and time expended by making her more effective or efficient. But the enhancement of a professional’s exercise of professional knowledge, skill, experience, and time expended is not necessarily itself the exercise of professional skills. When nonlawyer staff enhance an attorney’s exercise of professional skills, no one says that the nonlawyer staff is necessarily practicing law.218 When a bank, through a conventional recourse loan secured by assets unrelated to any specific case, enhances an attorney’s exercise of professional skills, no one says that bank is practicing law (although in reality, the bank may impose covenants that may do just that).219
There is no plausible argument for adopting a deontological norm against nonlawyers benefitting from directly enhancing lawyers’ legal capabilities. The argument lacks any intuitive appeal, and to the extent that it is justified as a necessary prophylactic to protect against the unauthorized practice of law, it is very unlikely that the “necessity” upon which this argument relies can be demonstrated.
VI. Conclusion
This Article began with a description of the anxiety over capital expressed by attorneys over the past thirty years.220 The other half of the story, which is equally important and perhaps better known, is the anxiety that the bar has felt over the pressures imposed on it to become more like a business.221 This latter anxiety is based on the reasonable fear that, as a general matter, efforts to allow nonlawyers to engage in profit-making activities with attorneys will erode the legal profession’s core values and independence.222 Still, it is important to recognize that not every move to allow nonlawyers to pursue profit-making activities with attorneys will result in a descent down a slippery slope toward turning law into a “swashbuckling” market in which legal ethics plays no role, and attorneys no longer are expected to “have special responsibilities and special roles to play in our society.”223 As this Article has argued, there are at least four different ways that nonlawyers could invest in modern American legal practice.224 Debate over the formation of professional partnerships with nonlawyers and the sale of equity in an attorney’s practice have dominated the bar’s attention. This Article tries to lower the temperature of the debate and address the anxieties on both sides by asking everyone to turn their attention to a different reform—passive investment in legal practice by allowing attorneys to sell their unmatured fees.
The advantages of the reform proposed in this Article are threefold. First, unlike the reform most frequently debated, the formation of professional partnerships between attorneys and nonlawyers, the sale of unmatured fees does not formally allow nonlawyers to become involved with an attorney’s practice. The concerns raised by critics of MDPs over UPL, interference with attorney’s independent professional judgment, and violation of client confidences are thereby reduced if all the nonlawyer is doing is advancing capital.225 The genuine concern raised by critics of the Australian or United Kingdom reforms that would allow law firms to sell equity in their practice (either controlling or noncontrolling shares)—that the firms would be driven to “practice to the share price”—would not be reproduced if all that the nonlawyer could purchase was an interest in a future, contingent fee.226 Since the nonlawyer buying the unearned fee can only profit if the attorney earns her fee, the attorney’s original interest in her client’s recovery and the nonlawyer’s interest when he bought the fee are aligned.227
Second, the advantages to attorneys and society of allowing the purchase of unmatured fees, while hard to quantify, are potentially significant. As shown in Part I, the size of the legal market in the United States is large, and the need for capital is demonstrable. Finally, as documented in Part II, attorneys and financiers are willing to engage in factoring transactions involving unmatured fees.228 It is not the intention of this Article to oversell the advantages of allowing the purchase of unmatured fees—they are not designed to provide clients with the additional efficiencies that MDPs and ALPS might provide.229 In 2011, the ABA’s 20/20 Commission received unsolicited comments about passive investment from two very different perspectives, and the contrast between them is revealing.230 One comment, which came from Consumers for a Responsive Legal System, urged the ABA to consider reforms of Rule 5.4 that would include passive investment.231 The other comments, which came from the United States Chamber of Commerce, objected to any “loosening of Model Rule 5.4’s restrictions on non-attorney investments in law firms.”232 America’s law firms, it argued, complain “about their ability to raise money [but] there is no evidence that U.S. law firms lack sufficient capital.”233 To the extent that one accepts that these comments demonstrate the interests that would be served if attorneys were allowed to sell unmatured fees, there is reason to believe that consumers would benefit from this reform.
Third, the adoption of the reform proposed in this Article would not require changing Rule 5.4. As argued in Part IV, the current state of the law with respect to contingent advances is in a state of confusion. The state bar ethics committee opinions which prohibit fixed-return contingent advances and percentage-return contingent advances are based on a principle, the DRT, that either excludes too many or too few transactions. This Article views these ethics committee opinions as too unreliable to provide guidance in the future and argues that their reasoning should be ignored. This is not to say that all of the opinions arrived at the wrong conclusion. It is to say, however, that the principle produced by these opinions, the DRT, is not a valid interpretation of Rule 5.4. This Article recommends that bar ethics committees and courts begin with the assumption that the sale of unmatured fees is not fee-splitting and prohibit transactions that involve such sales only if it can be shown that the transactions would lead to any of the concerns which have led committees to prohibit fee-splitting in the past: namely the UPL, interference with an attorney’s independent professional judgment, and violation of client confidences. Rule 5.4 should not be read as requiring a per se prohibition of a market in unmatured fees. This Article, therefore, calls for reform in how the profession thinks about allowing attorneys to raise capital by selling their fees to nonlawyers, and not in Rule 5.4 itself.
1. The central premise of the regulation of attorneys in the United States since the Founding has been that law is a profession and not a business. See, e.g., Rayman L. Solomon, Five Crises or One: The Concept of Legal Professionalism, 1925–1960, in Lawyers’ Ideals/Lawyers’ Practices: Transformations in the American Legal Profession 147 (Robert L. Nelson et al. eds., 1992) (arguing that “the interests of the client and the public are to take precedence over the lawyer’s economic self-interest”); Russell G. Pearce, The Professionalism Paradigm Shift: Why Discarding Professional Ideology Will Improve the Conduct and Reputation of the Bar, 70 N.Y.U. L. Rev. 1229, 1231 (1995) (describing the self-conception of American law as a profession in contrast to business). As a profession, law is characterized by an assumption that “the practitioner’s self-interest is overbalanced by devotion to serving both the client’s interest and the public good.” ABA Comm’n on Professionalism, In the Spirit of Public Service: A Blueprint for the Rekindling of Lawyer Professionalism 10 (1986).
2. There are various efforts to measure the size of the American legal market. According to one measure, total expenditures on legal services in the United States grew from approximately $100 billion to approximately $210 billion between 1997 and 2013. See Ben Barton, A Comparison Between the American Markets for Medical and Legal Services, 67 Hastings L.J. 1331, 1335–36 (2016) (citing Gross–Domestic–Product–(GDP)–by–Industry Data, Bureau Econ. Analysis, https://www.bea.gov/industry/gdpbyind_data.htm (last visited Apr. 22, 2018)). According to legal publisher Thomson Reuters, the American legal market represented $437 billion in spending in 2016. See The Size of the US Legal Market: Shrinking Piece of a Bigger Pie – an LEI Graphic, Thomson Reuters Legal Exec. Inst. (Jan. 11, 2016), http://legalexecutiveinstitute.com/the-size-of-the-us-legal-market-shrinking-piece-of-a-bigger-pie-an-lei-graphic/ [hereinafter The Size of the US Legal Market].
3. See, e.g., Lynn Bauer & Steven D. Owens, Justice Expenditure and Employment in the United States, 2001, Bureau Just. Stat. Bull. (U.S. DOJ), May 2004, at 4 (total expenditures by federal, state, and municipal governments on salaries for the justice system was approximately $38 billion in 2001). Note that this figure includes salaries and overhead for judges and other employees of the judicial branch, which is not included in the Bureau of Economic Analysis figures cited supra note 2. See NAPCS Product List for NAICS 5411: Legal Services, US Census Bureau, https://www.census.gov/eos/www/napcs/finalized/web_5411_final_reformatted_edited_US082208.pdf (last visited on Apr. 22, 2018).
4. See, e.g., Frank Strong, BTI Consulting: US Legal Market Exceeds $100 Billion, LexisNexis: Bus. L. Blog (Jan. 16, 2014), http://businessoflawblog.com/2014/01/bti-consulting-us-legal-market-exceeds-100-billion/.
5. Thomson Reuters estimated in 2016 that large firms (more than 175 lawyers) have 35% of the available market for legal services; while mid-sized firms (30–174 lawyers) have 26% of the market, and small firms (1–29 lawyers) have 39% of the market. See The Size of the US Legal Market, supra note 2.
6. See ABA Comm’n on Professionalism, supra note 1, at 8 (“Any realistic understanding of the pressures faced by lawyers today must take account of certain economic realities.”).
7. Id. at 9; see also Edward S. Adams & John H. Matheson, Law Firms on the Big Board?: A Proposal for Nonlawyer Investment in Law Firms, 86 Calif. L. Rev. 1, 24 (1998) (“[F]rom 1975 to 1985, when overhead increased by 161%, gross per-attorney receipts rose only 123%, and average partner compensation went up only 90%.”) (citing Susan Raridon, The Practice of Law: The Next 50 Years, Legal Econ., Apr. 1989, at 31).
8. ABA Comm’n on Professionalism, supra note 1, at 9.
9. There is some evidence that the growth of the legal market, which exceeded the growth of the economy in the 1980s and 1990s, has tracked the growth of the United States’ GDP since 2006. See Barton, supra note 2, at 1336. There is also some evidence that the inflation rate for the cost of legal services has exceeded the inflation rate for consumer prices between 2001–2012. See America’s Lawyers: Guilty as Charged, Economist
(Feb. 2, 2013), http://www.economist.com/news/leaders/21571141-cheaper-legal-education-and-more-liberal-rules-would-benefit-americas-lawyersand-their.
10. See Adams & Matheson, supra note 7, at 23–24 (between 1988–1998, “per-lawyer overhead increased more than 81%, while per-lawyer revenues increased only 73%.”) (citing Ward Bower, Economic Trends in the Legal Profession: Planning Implications for Law Firm, Ariz. Att’y, May 1996, at 16, 17).
11. See Jack A. Guttenberg, Practicing Law in the Twenty–First Century in a Twentieth (Nineteenth) Century Straightjacket: Something Has to Give, 2012 Mich. St. L. Rev. 415, 481 (“The traditional law firm practice model requires that firms are either self-funded—the partners contribute to the capital needs of the firm by devoting a portion of each partners share to the capital needs of the firm—or the firm must borrow from outside sources, usually banks.”).
12. Rule 5.4 is titled “Professional Independence of a Lawyer” and it has four parts. Section (a) prohibits an attorney from sharing legal fees with a nonlawyer except under certain limited conditions. Section (b) prohibits the formation of a partnership for the practice of law with a nonlawyer. Section (c) prohibits nonlawyer interference with an attorney’s independent professional judgment. Section (d) prohibits an attorney from working in a corporation or association that is owned (to any degree) or controlled by a nonlawyer (absent certain narrow exceptions). Model Rules of Prof’l Conduct r. 5.4 (Am. Bar Ass’n 1983).
13. See Gillian Hadfield, Legal Barriers to Innovation: The Growing Economic Cost of Professional Control over Corporate Legal Markets, 60 Stan. L. Rev. 1689, 1726–27 (2008).
[Attorneys are] restricted to the plowed-back profits and owner-manager mechanisms that financed companies in the late-nineteenth century before the advent of the modern corporation, which brought with it the separation of ownership and control and the explosion of stock markets and financial institutions that prompted significant economic growth in the first part of the twentieth century.
Id.
14. See id. at 1714 (“A ‘start-up,’ even one dreamt up by a lawyer, cannot seek angel investors or tap into venture capital networks to build the business.”); see also Adams & Matheson, supra note 7, at 32 (comparing law firms to stock brokerages that needed outside capital to invest in new technologies in the 1960s).
15. See Adams & Matheson, supra note 7, at 34–35 (arguing that contingent-fee attorneys could pursue more cases and take on more risky cases if they were able to raise capital from lay investors); Thomas Markle, Comment, A Call to Partner with Outside Capital: The Non–Lawyer Investment Approach Must Be Updated, 45 Ariz. St. L.J. 1251, 1263–64 (2013) (same); see also John C. Coffee, Jr., Understanding the Plaintiff’s Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 Colum. L. Rev. 669, 706 n.103 (1986) (“Plaintiff’s firms lack access to the equity markets because legal ethics preclude any division of fees with a nonlawyer or the formation of a partnership with a nonlawyer.”).
16. See, e.g., Jonathan T. Molot, What’s Wrong with Law Firms? A Corporate Finance Solution to Law Firm Short–Termism, 88 S. Cal. L. Rev. 1, 5 (2014) (“Due to law firms’ lack of permanent equity, they are ill-equipped to make long-term investment decisions and have a decidedly short-term bias—a bias that harms both clients and lawyers.”).
17. According to Citi Private Bank, law firm debt was 19.8% of net income in 2000, and that declined to 14.1% in 2006 (and this was before the 2007 crisis). Leigh Jones, Firms Ask Partners to Pony Up; as Credit Tightens, the Cost of Being a Partner Is Rising, Nat’l L.J., July 7, 2008. As a result of tightening credit, personal borrowing by individual partners increased in order to make up the difference in new demands on attorney equity contributions. Id.; see also Matthew W. Bish, Note, Revising Model Rule 5.4: Adopting a Regulatory Scheme That Permits Nonlawyer Ownership and Management of Law Firms, 48 Washburn L.J. 669, 687 (2009) (“Due to Model Rule 5.4, law firms in the United States which are in need of capital rely primarily on borrowing.”).
18. See Heather A. Miller, Note, Don’t Just Check “Yes” or “No”: The Need for Broader Consideration of Outside Investment in the Law, 2010 U. Ill. L. Rev. Online 311, 319 (“For example . . . Brobeck, Phleger & Harrison had close to $90 million in debt when it collapsed in late 2002. When Heller Ehrman dissolved in September 2008, it had close to $30 million of debt.”).
19. Erin J. Cox, Comment, An Economic Crisis Is a Terrible Thing to Waste: Reforming the Business of Law for a Sustainable and Competitive Future, 57 UCLA L. Rev. 511, 522 (2009).
20. See Molot, supra note 16, at 41 (describing drawbacks of bank lending for contingent-fee firms); Markle, supra note 15, at 1263 (same).
21. Molot, supra note 16, at 41.
22. Id.
23. See Larry E. Ribstein, The Death of Big Law, 2010 Wis. L. Rev. 749, 774; Bernard Sharfman, Note, Modifying Model Rule 5.4 to Allow for Minority Ownership of Law Firms by Nonlawyers, 13 Geo. J. Legal Ethics 477, 486 (2000) (“Overdependence on bank borrowings may put a severe financial strain on a law firm and its lawyers, putting pressure on their independence of judgment about what is best for the client.”).
24. See Cox, supra note 19, at 522 (describing how, for nearly a year, lenders controlled the law firm Thelen’s expenditures).
25. Id. at 524 (quoting Susan A. Berson, Loans and Moans: Past Firm Failures Mean Tougher Credit Rules, A.B.A. J. (Sept. 2009), http://www.abajournal.com/magazine/article/loans_and_moans); see also Larry E. Ribstein, Ethical Rules, Law Firm Structure and Choice of Law, 69 U. Cin. L. Rev. 1161, 1173 (2001) (noting the creation of law firm McKee Nelson Ernst & Young tied it into an accounting firm through its name, non-recourse loan financing, support services, and referrals of accounting work, which lead to uncertainty whether the lender had so much control that the agreement violated the ethics rules in all fifty states).
26. But see Ted Schneyer, “Professionalism” as Pathology: The ABA’s Latest Policy Debate on Nonlawyer Ownership of Law Practice Entities, 40 Fordham Urb. L.J. 75, 109 n.121 (2012) (listing five different categories of reforms).
27. See Adams & Matheson, supra note 7, at 4.
28. See Roy D. Simon, Jr., Fee Sharing Between Lawyers and Public Interest Groups, 98 Yale L.J. 1069, 1076–78 (1989).
[The Associated Lawyers’ Company] employed an astonishing six thousand lawyers nationwide . . . [and] offered one-stop shopping for collection work and litigation. . . . Another pioneer law corporation was the Co-operative Law Company. Through its legal staff, Cooperative transacted “a general law business, including the prosecution and defense of suits; incorporation of business enterprises; drawing of contracts, leases and agreements, drawing and probating of wills, management of estates, etc.”
Id. at 1038, n.38 (citing In re Co–operative Law Co., 92 N.E. 15, 15 (N.Y. 1910)).
29. Id. at 1079 (“By 1935, nearly half the states had passed laws prohibiting corporations from furnishing lawyers for profit.”). “The lives of Associated and Co-operative were glorious but short. After New York passed a statute forbidding corporations from practicing law, neither corporation was able to renew its corporate charter.” Id. at 1038 n.38 (citations omitted).
30. Canon 35 stated, “[t]he professional services of a lawyer should not be controlled or exploited by any lay agency, personal or corporate, which intervenes between client and lawyer.” Report of the Fifty–First Annual Meeting of the American Bar Association, 51 Ann. Rep. A.B.A. 779 (1928). The 1928 Canons codified various bar association disciplinary committee opinions that expressed the organized bar’s hostility to nonlawyers’ involvement in the practice of law. See Bruce A. Green, The Disciplinary Restrictions on Multidisciplinary Practice: Their Derivation, Their Development, and Some Implications for the Core Values Debate, 84 Minn. L. Rev. 1115, 1134–41 (2000).
31. See Adams & Matheson, supra note 7, at 6–10.
32. This was known as the Kutak Commission proposal. Id. at 11.
33. The Kutak Commission proposal was to permit attorneys to participate in an ALPS (“Alternative Law Practice Structure”): “for-profit entities in which lawyers practice law but which, unlike traditional law firms, are owned at least in part by nonlawyers.” Schneyer, supra note 26, at 78.
34. The Kutak Commission proposal was rejected by the ABA’s House of Delegates for a variety of reasons, including, most infamously, the so-called “Fear of Sears.” See Susan Gilbert & Larry Lempert, The Nonlawyer Partner: Moderate Proposals Deserve a Chance, 2 Geo. J. Legal Ethics 383, 392–400 (1988) (noting that debate about reform to Rule 5.4 during a February 1983 ABA meeting was essentially shut down on the affirmation by Prof. Geoffrey Hazard that it would allow Sears to own and operate a law firm).
35. See Schneyer, supra note 26, at 79–81.
36. See id. at 105–09 (describing the proposal forwarded by the Commission on Multidisciplinary Practice that “Rule 5.4 be amended to permit lawyers to share legal fees with non-lawyers in an MDP” and its rejection by the House of Delegates).
37. See id. at 81–83 (describing the proposal forwarded by the ABA Commission on Ethics 20/20 Working Group on ALPS to allow attorneys to practice in firms with nonlawyer partners who assisted in the firm’s practice of law, and the rejection of the proposal by the Commission).
38. See, e.g., Edward S. Adams, Rethinking the Law Firm Organizational Form and Capitalization Structure, 78 Mo. L. Rev. 777, 818 (2013) [hereinafter Adams, Rethinking]; Adams & Matheson, supra note 7, at 40; Thomas R. Andrews, Nonlawyers in the Business of Law: Does the One Who Has the Gold Really Make the Rules?, 40 Hastings L.J. 577, 629 (1989); Cox, supra note 19, at 533; Hadfield, supra note 13, at 1731; Bruce MacEwen et al., Law Firms, Ethics, and Equity Capital, 21 Geo. J. Legal Ethics 61, 69 (2008); Molot, supra note 16, at 42; Milton C. Regan, Jr., Lawyers, Symbols, and Money: Outside Investment in Law Firms, 27 Penn St. Int’l L. Rev. 407 (2008); Sharfman, supra note 23, at 498. For a review of Australia’s Legal Profession Act 2004 (which allows law firms to adopt the corporate form) and the United Kingdom’s Legal Services Act 2007 (which allows nonlawyer investment in firms), see Adams, Rethinking, supra, at 802–03.
39. Compare Nonlawyer Investment, supra note 7, at 38–40 (assuming that lawyers would be the managers and would control shareholders), with Andrews, supra note 38, at 629 (assuming that shareholders would install nonlawyer professional managers who would “control” the attorneys but not interfere with their independent professional judgment).
40. See MacEwen et al., supra note 38, at 69.
41. See Adams, Rethinking, supra note 38, at 787.
42. See Cox, supra note 19, at 528, 547–48; Sharfman, supra note 23, at 494; Tyler Cobb, Note, Have Your Cake and Eat It Too! Appropriately Harnessing the Advantages of Nonlawyer Ownership, 54 Ariz. L. Rev. 765, 796 (2012).
43. See Regan, supra note 38, at 427 (explaining control by passive investors is no different than “the case now with lenders who provide funds to firms”); see also L. Harold Levinson, Independent Law Firms That Practice Law Only: Society’s Need, the Legal Profession’s Responsibility, 51 Ohio St. L.J. 229, 248 (1990) (recognizing that bank debt may be just as threatening to a firm’s independence as passive nonlawyer investment).
44. See supra notes 28–31 and accompanying text.
45. See Gilbert & Lempert, supra note 34, at 390; John H. Matheson & Edward S. Adams, Not “If” but “How”: Reflecting on the ABA Commission’s Recommendations on Multidisciplinary Practice, 84 Minn. L. Rev. 1269, 1281–82 (2000).
46. See Paul R. Koppel, Under Siege from Within and Without: Why Model Rule 5.4 Is Vital to the Continued Existence of the American Legal Profession, 14 Geo. J. Legal Ethics 687, 692 (2001).
47. John S. Dzienkowski & Robert J. Peroni, Multidisciplinary Practice and the American Legal Profession: A Market Approach to Regulating the Delivery of Legal Services in the Twenty–First Century, 69 Fordham L. Rev. 83, 137 (2000) (defining the core values as (1) independence of judgment, (2) confidentiality, (3) loyalty and (4) competence); Markle, supra note 15, at 1260 (explaining the rejection of 2000 amendments to Rule 5.4, although similar to rejection of the Kutak Commission proposal, now included a concern for “core values”).
48. See ABA Comm’n on Ethics 20/20, Discussion Draft for Comment, Alternative Law Practice Structures (2011) (explaining that passive outside investment or ownership in law firms would “depart sharply from U.S. traditions, and raised significant ethical concerns”).
49. The large litigation finance firms do not purchase unmatured fees in individual cases. See Ben Hancock, Ethics Rule Has Lit Funders Treading Carefully in Class Actions, Recorder (Feb. 15, 2017, 3:25 PM), http://www.americanlawyer.com/id=1202779263898?keywords=Hancock. At least one post-settlement legal finance firm has purchased unmatured fees in a large products liability case. See RD Legal Capital, L.L.C., Securities Act Release No. 10111 (July 14, 2016), https://www.sec.gov/litigation/admin/2016/33-10111.pdf (detailing purchase of approximately $6 million unmatured legal fees arising from multiple lawsuits against various manufacturers of bisphosphonates). Published opinions in multiple state and federal cases reveal that legal finance firms have purchased unmatured attorneys’ fees with some frequency over the past decade. See infra notes 74–90 and accompanying text.
50. See infra Part IV.
51. See infra notes 74–90 and accompanying text.
52. See Koppel, supra note 46, at 701. Rule 5.4(a) provides that:
(a) A lawyer or law firm shall not share legal fees with a nonlawyer, except that:
(1) an agreement by a lawyer with the lawyer’s firm, partner, or associate may provide for the payment of money, over a reasonable period of time after the lawyer’s death, to the lawyer’s estate or to one or more specified persons;
(2) a lawyer who purchases the practice of a deceased, disabled, or disappeared lawyer may, pursuant to the provisions of Rule 1.17, pay to the estate or other representative of that lawyer the agreed-upon purchase price;
(3) a lawyer or law firm may include nonlawyer employees in a compensation or retirement plan, even though the plan is based in whole or in part on a profit-sharing arrangement; and
(4) a lawyer may share court-awarded legal fees with a nonprofit organization that employed, retained or recommended employment of the lawyer in the matter.
Model Rules of Prof’l Conduct r. 5.4(a) (Am. Bar Ass’n 1983).
53. See Koppel, supra note 46, at 701–02 (reviewing case law and ethics opinions); Geoffrey C. Hazard, Jr. et al., The Law of Lawyering (4th ed. 2014) § 45.04 [hereinafter Law of Lawyering] (reviewing Rule 5.4(a)).
54. ABA Comm’n on Prof’l Ethics & Grievances, Formal Op. 8 (1925).
55. Cindy Alberts Carson, Under New Mismanagement: The Problem of Non–Lawyer Equity Partnership in Law Firms, 7 Geo. J. Legal Ethics 593, 625 (1994).
56. See, e.g., Rich v. Simoni, No. 1:12CV12, 2014 U.S. Dist. LEXIS 138352 (N.D. W. Va. Sept. 30, 2014) (stating that a university professor who attended law school but did not pass the bar could not “split fees” with an attorney with whom he worked on an asbestos case).
57. See, e.g., N.Y. State Op. 1068 (2015) (“Aiding Unauthorized Practice of Law; Referrals from Nonlawyers; Fee-Splitting”).
58. See Law of Lawyering, supra note 53, § 45.04 (“fee-splitting” is a synonym for “fee-sharing with a non-lawyer prohibited by law”).
59. This is true even where the title of the law or rule uses the expression. See N.M. Stat. Ann. § 36-2-31 (2018) (although titled “Fee splitting prohibited; division of fees by attorneys excepted,” the text of the statute does not refer to fee “splitting” but instead refers to fee “sharing”); Cal. St. Bar Rules of Procedure, Standard 2.8 (although titled, “Fee-Splitting with Non-Lawyers,” the text refers to a lawyer who “shares” fees illegally, not one who “splits” fees).
60. This is not because legislators and the drafters of the professional responsibility codes do not know how to directly regulate fee-splitting. In other professions, such as medicine, “fee-splitting” is frequently the subject of state law. See, e.g., Wis. Stat. Ann. § 448.08 (West 2016) (defining and prohibiting “fee-splitting” by physicians).
61. See, e.g., Heer v. N. Moore St. Developers, L.L.C., 36 N.Y.S.3d 93 (N.Y. App. Div. 2016) (discussing NY CLS Jud. L. § 491).
62. See, e.g., State Bar of Georgia, Formal Advisory Op. No. 05-9 (2005). It appears that the ABA is the last hold-out: it never refers to prohibited forms of fee-sharing as “fee-splitting” in its formal opinions.
63. Simon, supra note 28, at 1072.
64. Id. at 1076 (citing Regulation of Attorneys and Solicitors Act, 2 Geo. 2, ch. 23 (1729)).
65. Id. at 1077 (citing Tench v. Roberts, 56 Eng. Rep. 1047 (1819)).
66. 101 U.S. 108, 111–12 (1879).
67. See, e.g., In re Clark, 95 N.Y.S. 388 (N.Y. App. Div. 1905); Hirshbach v. Ketchum, 5 A.D. 324 (N.Y. App. Div. 1896).
68. Canon 28 said it was “disreputable” for a lawyer “to pay or reward, directly or indirectly, those who bring or influence the bringing of such cases to his office.” ABA Canons of Prof’l Ethics Canon 28 (Am. Bar Ass’n 1908).
69. Simon, supra note 28, at 1079.
70. See supra note 30 and accompanying text.
71. ABA Canons of Prof’l Ethics Canon 34 (Am. Bar Ass’n 1928).
72. Disciplinary Rule 3-102(A) provided: “A lawyer or law firm shall not share fees with a non-lawyer.” Model Code of Prof’l Responsibility DR 3–102 (Am. Bar Ass’n 1969).
73. As a result of the defeat of the Kutak Commission proposal, the current Rule 5.4(a) was adopted. See Gilbert & Lempert, supra note 34, at 392–400.
74. See, e.g., Patterson v. Law Office of Lauri J. Goldstein, P.A., 980 So. 2d 1234 (Fla. Dist. Ct. App. 2008) (fee-splitting agreement between lawyer and her paralegal, while valid, “might subject [attorney] to professional discipline”); Atkins v. Tinning, 865 S.W.2d 533 (Tex. App. 1993) (stating that lawyer’s promise to pay investigator one third of his contingent legal fee was unethical because it was fee-splitting).
75. See Trotter v. Nelson, 684 N.E.2d 1150, 1154 (Ind. 1997) (holding that a lawyer may not pay a clerk 5% of fee earned as referral fee); Vidrine v. Abshire, 558 So. 2d 288, 292 (La. Ct. App. 1990) (holding against a “runner” who sought 10% of the cases he brought to the attorney); Plumlee v. Paddock, 832 S.W.2d 757, 759 (Tex. Ct. App. 1992) (attorney may not pay an ambulance company a fee including a portion of the attorney’s fee earned for steering cases to the attorney).
76. See N.Y.C. Bar Ass’n, Formal Op. 2015-1 (“Use by a Law Firm of a Professional Employer Organization”); North Carolina State Bar, Formal Op. 6 (2003) (“Contracting with Professional Employer Organization to Handle Human Resources, Payroll, and Other Functions for Law Firms”). New York State Bar ethics opinions permit the payment of fees to nonlegal service providers, so long as they are not calculated based on legal fees. Compare N.Y. State Bar Ass’n Comm’n on Prof’l Ethics, Formal Op. 565 (1984) (attorney may not pay marketing company a commission based on fees earned from clients introduced by the marketing company) (emphasis added), with N.Y. State Bar Ass’n Comm’n on Prof’l Ethics, Formal Op. 917 (2012) (attorney may pay bonus to marketer for advertising services if bonus is not based on fees paid by clients).
77. See N.Y. State Bar Ass’n Comm’n on Prof’l Ethics, Formal Op. 911 (2012); see also N.Y. State Bar Ass’n Comm’n on Prof’l Ethics, Formal Op. 1038 (2014) (applying the same conclusion to a D.C. firm, which has amended Rule 5.4 to allow nonlawyers to form professional partnerships that engage in law-related activities).
78. See Green, supra note 30, at 1145–46 (describing the five premises upon which the “core values rationale” relies).
79. See O’Hara v. Ahlgren, Blumenfeld & Kempster, 537 N.E.2d 730, 734 (Ill. 1989) (fee-splitting arrangements facilitate the UPL).
80. Andrews, supra note 38, at 579 (“Prohibitions against nonlawyers practicing law have been common in this country for at least a hundred years.”).
81. See Hildebrand v. State Bar of Cal., 225 P.2d 508, 520 (Cal. 1950) (“[L]ay [persons] who solicit cases and then sell them to attorneys are apt to seek out, not the most competent attorney, but the one who will pay the most for a case.”).
82. See Texas Disciplinary Rules of Prof’l Conduct r. 5.04 cmt. 1 (amended 2016); D.C. Bar, Op. 322 (2004).
83. See Joseph M. Perillo, The Law of Lawyers’ Contracts Is Different, 67 Fordham L. Rev. 443, 460 (1998).
84. Id. (“The rationale usually given for the prohibition of fee splitting with non-lawyers is that ‘[a] person entitled to share a lawyer’s fees is likely to attempt to influence the lawyer’s activities so as to maximize those fees. That could lead to inadequate legal services.’”) (quoting Restatement (Third) of the Law Governing Lawyers §11 cmt. b).
85. In re Krasner, 204 N.E.2d 10, 14 (Ill. 1965) (splitting fees with nonlawyers who solicit clients invites “derision [for] and disrespect” of the profession); Susan D. Carle, Lawyers’ Duty to Do Justice: A New Look at the History of the 1908 Canons, 24 Law & Soc. Inquiry 1, 8 (1999).
86. Restatement (Third) of the Law Governing Lawyers § 47 cmt. b. It may be that the prohibition on fee-splitting is one of the many tools used by the bar and the state in “protecting the legal profession’s image and reputation.” See Alexander v. Cahill, 598 F.3d 79, 91 (2d Cir. 2010) (recognizing state’s interest in preserving lawyers’ reputations).
87. See, e.g., Lawrence J. Fox, Accountants, the Hawks of the Professional World: They Foul Our Nest and Theirs Too, Plus Other Ruminations on the Issue of MDPs, 84 Minn. L. Rev. 1097, 1106 (2000) (arguing that Rule 5.4 guards against “interference by non-law trained masters who wish us to take short cuts to maximize profits”).
88. The latter option is distinguished from the former in two ways. First, an attorney’s reasons for action cannot be simply a mirror of her client’s reasons, and second, an attorney’s reasons for action are informed by a role morality that other third parties (such as financially interested nonlawyers) do not share. The content of that role morality can vary greatly, as is illustrated by the different conceptions of the role morality of lawyers presented by David Luban and W. Bradley Wendel. See, e.g., David Luban, Legal Ethics And Human Dignity (Gerald Postema ed. 2007); W. Bradley Wendel, Lawyers And Fidelity To Law (2010).
89. See, e.g., Anthony J. Sebok, What Do We Talk About When We Talk About Control?, 82 Fordham L. Rev. 2939, 2950 (2014) (“Critics of nonlawyer investment have argued that loyalty to clients will be compromised by demands of investors to cut expenses or divert resources to cases on the basis of their potential return to the law firm and not based on the needs of the firm’s clients.”).
90. See, e.g., Green, supra note 30, at 1146.
Even if the legal services were rendered exclusively by lawyers in the multidisciplinary firm, lawyers could not be counted on to serve skillfully and in accordance with the legal profession’s ethics rules . . . . The clients should not be allowed to contract to accept service under a different set of norms from those governing the attorney-client relationship . . . .
Id. (emphasis added).
91. Law of Lawyering, supra note 53, § 48.04 (emphasis added); see also Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (nonlawyer cannot “directly” benefit from the attorney’s legal skills).
92. Law of Lawyering, supra note 53, § 48.05.
93. Id.
94. Id.
95. See supra note 75 and accompanying text.
96. The nonlawyer is not, for example, providing an activity that is not related to law, like managing the attorney’s office or providing accounting advice to the attorney’s clients.
97. Law of Lawyering, supra note 53, § 48.05.
98. See, e.g., Odell v. Legal Bucks, LLC, 665 S.E.2d 767, 776–77 (N.C. Ct. App. 2008) (explaining that the nonrecourse purchase of litigation proceeds is not a loan, although it is an advance); Prof’l Merch. Advance Capital, LLC v. Your Trading Room, LLC, No. 17469-2012, 2012 N.Y. Misc. LEXIS 6757, at *5 (N.Y. Sup. Ct. Nov. 28, 2012) (“Unless a principal sum advanced is repayable absolutely, the transaction is not a loan.”).
99. See, e.g., Kelly, Grossman & Flanagan, LLP v. Quick Cash, Inc., No. 04283-2011, 2012 N.Y. Misc. LEXIS 1460, at *13 (N.Y. Sup. Ct. Mar. 29, 2012) (asserting that an attorney who received an advance was never at risk of recourse, as “such circumstances simply cannot be stated to constitute a ‘loan’”).
100. See Maine Prof’l Ethics Comm’n, Formal Op. 193 (2007) (prohibiting a fixed interest loan where the “attorney must repay . . . only if the attorney is successful and recovers a fee”); Missouri Bar, Informal Op. 2003-0022 (2003) (“[I]t is not permissible for the repayment of the loan [to a lawyer] to be based on the outcome of the lawsuit.”); Nevada Standing Comm. on Ethics & Prof’l Responsibility, Formal Op. No. 36 (2007) (rejecting all nonrecourse lending by third parties to lawyers). As this Article was about to go into press, the Association of the Bar of the City of New York endorsed the position taken by bar committees in Maine, Missouri and Nevada. See N.Y.C. Bar Ass’n, Formal Op. 2018-5 (“Litigation Funders’ Contingent Interest in Legal Fees”). Given the timing of the opinion, my comments on the position adopted by the Association of the Bar of the City of New York are, by necessity, brief. The New York opinion acknowledges that nonrecourse, fixed-interest-rate lending has been recognized by the New York courts. Id. at 6 n.12. The New York opinion does not discuss the holdings of courts, discussed in this Article, that the assignment of contract rights in unearned fees is not fee-splitting. The New York opinion’s reasoning is formalist and vulnerable to the charge, made in this Article, that the status quo’s approach to Rule 5.4 is not just bad policy; it is incoherent.
101. Philadelphia Bar Ass’n, Op. No. 2003-15 (2003). Utah Ethics Advisory Opinion No. 97-11 prohibited a fixed return contingent advance where “a non-recourse promissory note is secured by the attorney’s interest in [his/her] contingent fee.” The ethics opinion left open the possibility that a fixed-return contingent advance that gave the nonlawyer an unsecured interest or a security interest in other property owned by the attorney would not be fee-splitting, a position that seems to be supported by a later opinion that allowed a nonlawyer to advance capital to an attorney in exchange for a percentage-return contingent advance as long as the nonlawyer did not hold a security interest in the attorney’s contingent fee. Utah State Bar, Ethics Advisory Op. 06-03 (2006); see infra, notes 178–82 and accompanying text.
102. See North Carolina Formal Ethics Op. 2006-12 (2006).
103. Id.
104. Prof’l Ethics Comm. for the State Bar of Texas, Op. 558 (2005).
105. “It is a violation of Rule 5.04(a) of the Texas Disciplinary Rules of Professional Conduct [Texas’ version of Rule 5.4(a)] for a lawyer to agree to pay a percentage of the lawyer’s contingency fee . . . in connection with obtaining a loan.” Id. Even if the fixed interest fee on the loan were recourse (which is not clear from the decision) the additional payment was clearly nonrecourse and determined by the quantum of the attorney’s fee.
106. Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006).
107. Id. (“The funding fee . . . would be tied directly to the amount of recovery in the underlying litigation . . . . This is tantamount to fee-splitting.”).
108. Prof’l Ethics Comm. for the State Bar of Texas, Op. 467 (1990).
109. Id.
110. This assumes that, for every advance, its price could be expressed as a fixed interest rate or a percentage of the attorney’s fee, and that the difference between them, while important to the parties, would not be dramatic. (For example, if a fixed-return contingent advance involves periodic payments to the nonlawyer before the resolution of the underlying litigation, the interest rate in the fixed-return contingent advance would have to be unusually high for it to be more attractive to the attorney than a percentage-return contingent advance.) These details have never been explored in any of the bar ethics opinions that have discussed contingent advances.
111. See supra note 101 and accompanying text.
112. See, e.g., Me. Prof’l Ethics Comm’n, Formal Op. 193 (2007) (“[T]he underlying rationale for the rule [against fee-splitting] is that any fee sharing arrangement creates an unacceptable risk that the professional independence of the lawyer will be influenced by the non-lawyer who has an interest in the attorney’s fee.”); Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006) (asserting that the policy basis for prohibiting fee-splitting in this case is to prevent referrals by a nonlawyer with an interest in an attorney’s fee).
113. Recall that conventional recourse lenders may have the same incentives and abilities to interfere with attorney independence as so-called nonrecourse lenders. See supra notes 23–25 and accompanying text.
114. Me. Prof’l Ethics Comm’n, Formal Op. 193 (2007) (emphasis added).
115. Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006) (emphasis added).
116. Three courts have either held or stated in dicta that the sale of unmatured accounts receivable by an attorney is not fee-splitting. See PNC Bank v. Berg, No. 94C-09-208-WTQ, 1997 WL 527978, at *10 n.5 (Del. Super. Ct. 1997); Lawsuit Funding, LLC v. Lessoff, No. 650757/2012, 2013 WL 6409971, at *5 (NY Sup. Ct. 2013); Counsel Fin. Servs., L.L.C. v. Leibowitz, No. 13-12-00103-CV, 2013 Tex. App. LEXIS 9252, at *26 (July 25, 2013), mandamus granted sub nom. In re Counsel Fin. Servs., No. 13-12-00151-CV, 2013 Tex. App. LEXIS 9255 (July 25, 2013), appeal denied sub nom. Leibowitz v. Counsel Fin. Servs., LLC, No. 13-0902, 2014 Tex. LEXIS 888 (2014). One state bar ethics committee has held that a lawyer cannot sell unearned fees to a factor. See Sup. Ct. of Ohio, Bd. of Comm’rs on Grievances and Discipline, Op. 2004-2 (2004).
117. See Grant Gilmore, Security Interests in Personal Property § 8.1, at 250–53 (1965) (detailing the development of accounts receivable financing); Dan T. Coenen, Priorities in Accounts: The Crazy Quilt of Current Law and a Proposal for Reform, 45 Vand. L. Rev. 1061, 1066–67 (1992).
The emergence of factoring as a form of commercial activity illustrates the recognition of a new variety of value-maximizing exchange. The account-purchasing factor made money on the spread between the face value of the receivable and the discounted cash price the factor paid for it. In turn, the cash paid for the account provided the account seller with capital needed to fund current business operations.
Coenen, supra.
118. 24A Fla. Jur. 2d Factors and Commission Merchants § 3 (2015).
119. Standard factoring of earned hourly fees is a common practice today. See Nell Gluckman, As Collections Loom, Firms Seek Investors to Spread the Risk, Legal Intelligencer (Nov. 29, 2016, 6:43 PM), https://www.law.com/thelegalintelligencer/almID/1202773425043/as-collections-loom-firms-seek-investors-to-spread-the-risk/ (describing how a litigation finance firm would, before the end of the calendar year, “pay $45 for a right to the first $50 that a firm collects” from clients who have been billed but may not pay until after the calendar year has passed).
120. See, e.g., Santander Bank, N.A. v. Durham Commercial Capital Corp., Civil Action No. 14-13133-FDS, 2016 U.S. Dist. LEXIS 5430 (D. Mass. Jan. 15, 2016).
121. Id. at *3.
122. Id. at *5.
123. Id. at *9–10.
124. Id. at *10.
125. Id.
126. Id. at *12.
127. Id. at *2 n.1 (“Factoring is a process by which a business sells to another business, at a small discount, its right to collect money before the money is paid.”) (quoting Houston Lighting & Power Co. v. Wharton, 101 S.W.3d 633, 636 (Tex. App. 2003)).
128. Id. at *17, *18 n.5 (“[A]ssignments of law-firm accounts receivable do not constitute ‘fee-sharing.’”); see Durham Commercial Capital Corp. v. Select Portfolio Servicing, Inc., No. 3:14-cv-877-J-34PDB, 2016 U.S. Dist. LEXIS 143229, at *32–33 (M.D. Fla. Oct. 17, 2016).
129. It is possible that L holds the proceeds in escrow and releases $300 to B. It is even possible (however unlikely) that B receives the $300 directly from D.
130. See Radek Goral, Justice Dealers: The Ecosystem of American Litigation Finance, 21 Stan. J.L. Bus. & Fin. 98, 107–08 (2015); see also Carmen Germaine, SEC Sues NJ Atty, Litigation Fund over Misleading Investors, Law360 (July 14, 2016, 4:49 PM), https://www.law360.com/articles/817528/sec-sues-nj-atty-litigation-fund-over misleading-investors (RD Legal Capital LLC, a hedge fund, invested millions of dollars to “purchase discounted legal receivables, such as attorneys’ fees, from law firms in settled proceedings.”).
131. See Sup. Ct. of Ohio, Bd. of Comm’rs on Grievances and Discipline, Informal Op. 2004-2 (2004).
132. Id.
133. Id.
134. The reasoning in Ohio Ethics Op. 2004-2 does not apply only to contingent-fee cases. The same reasoning applies to the assignment of fully earned legal fees based on an hourly rate or a fixed fee as long as the last duty the attorney has is to ensure the disbursement of funds to the client.
135. “Until the money agreed upon in the settlement is paid and disbursed, the attorney has not completed his or her legal representation of the client.” Sup. Ct. of Ohio, Bd. of Comm’rs on Grievances and Discipline, Op. 2004-2 (2004).
136. Core Funding Grp., L.L.C. v. McDonald, No. L-05-1291, 2006 Ohio App. LEXIS 1523, at *31–33 (2006).
137. See PNC Bank v. Berg, No. 94C-09-208-WTQ, 1997 WL 527978, at *27 (Del. Super. Ct. 1997) (“[B]oth the hourly billing and the contingency fee contracts meet the definition of ‘contract rights,’ and therefore ‘accounts,’ within the meaning of the Uniform Commercial Code.”); see also Peter F. Coogan et al., 1 Secured Transactions Under The UCC § 19.02 (2016) (“Rights of lawyers under contingent fee contracts are ‘contract rights’ or possibly ‘accounts’ in which an Article 9 security interest may be created.”).
138. See U.S. Claims, Inc. v. Flomenhaft, 519 F. Supp. 2d 532, 535 (E.D. Pa. 2007); U.S. Claims, Inc. v. Flomenhaft & Cannata, LLC, 519 F. Supp. 2d 515, 515 (E.D. Pa. 2006); Core Funding, 2006 Ohio App. LEXIS 1523, at *26; PNC Bank, 1997 WL 527978, at *27.
139. PNC Bank, 1997 WL 527978, at *28 n.5.
Parenthetically, the Court will note that there is no suggestion that it is inappropriate for a lender to have a security interest in an attorney’s accounts receivable. It is, in fact, a common practice. Yet there is no real “ethical” difference whether the security interest is in contract rights (fees not yet earned) or accounts receivable (fees earned) in so far as Rule of Professional Conduct 5.4, the rule prohibiting the sharing of legal fees with a nonlawyer, is concerned.
Id.; see Core Funding, 2006 Ohio App. LEXIS 1523, at *32 (citing PNC Bank, 1997 WL 527978).
140. See Model Rules of Prof’l Conduct r. 1.5(a) (Am. Bar Ass’n 2002) (“A lawyer shall not . . . charge . . . an unreasonable fee.”).
141. If, in this example, L works for two hours on C v. D, and then the matter is unexpectedly resolved, B receives only $200 from C, and L is better off than expected. If L works four hours on C v. D because the matter is unexpectedly complex, B receives $400, and L is worse off than expected.
142. It is possible that L holds the proceeds in escrow and releases $300 to B. It is even possible (however unlikely) that B receives the $300 directly from D.
143. In fact, the lawyers in PNC Bank pledged two types of accounts: unmatured hourly fees and unmatured contingent fees. The court held that they were indistinguishable from the perspective of the U.C.C.:
In the Court’s opinion, both the hourly billing and the contingency fee contracts meet the definition of “contract rights,” and therefore “accounts,” within the meaning of the Uniform Commercial Code. The hourly billing contract is an “existing contract” creating a “right to payment,” the hourly fee, that is “to be earned by future performance,” future work by an attorney on that case. In a contingency fee case the “right to payment” is more speculative, since the amount of payment to be earned by future performance depends upon whether the case results in a verdict or other recovery in favor of the client. This seems, however, to be a distinction without a difference.
PNC Bank, 1997 WL 529978, at *27.
144. For example, the gravamen of the SEC’s complaint against the hedge fund RD Legal Capital was not that it did anything wrong by purchasing unmatured legal fees. It was that it misled investors by representing that it was purchasing matured fees (accounts receivable) when it was in fact buying unmatured fees. (The unmatured fees purchased by RD Legal Capital included millions of dollars in pre-settlement contingent fees in a mass tort and millions of dollars of contingent fees in a $2 billion case against the Republic of Iran where there was a default judgment but, as of sale, no proceeds had yet been secured for the attorneys’ clients.) See RD Legal Capital, supra note 49, at 2. RD Legal Capital did not deny that it purchased the unmatured fees; it denied that it misrepresented to investors that it had purchased the unmatured fees. See Germaine, supra note 130 (asserting that an attorney for RD Capital said that “RD Capital has ‘always been completely transparent with investors’ . . . .”).
145. See, e.g., Lawsuit Funding, LLC v. Lessoff, No. 650757/2012, 2013 WL 6409971 (N.Y. Sup. Ct. 2013); Core Funding Grp., L.L.C. v. McDonald, No. L-05-1291, 2006 Ohio App. LEXIS 1523 (Ohio Ct. App. 2006); Counsel Fin. Servs., L.L.C. v. Leibowitz, No. 13-12-00103-CV, 2013 Tex. App. LEXIS 9252, at *26 (July 25, 2013), mandamus granted sub nom. In re Counsel Fin. Servs., No. 13-12-00151-CV, 2013 Tex. App. LEXIS 9255 (July 25, 2013), appeal denied sub nom. Leibowitz v. Counsel Fin. Servs., LLC, No. 13-0902, 2014 Tex. LEXIS 888 (2014).
146. Brandes v. N. Shore Univ. Hosp., 2008 N.Y. Misc. LEXIS 20, at *8 (N.Y. App. Div. 2005).
147. PNC Bank, 1997 WL 529978, at *28 n.5.
148. They include: Hamilton Capital VII, LLC v. Khorrami, LLP, 22 N.Y.S.3d 137 (N.Y. Sup. Ct. 2015); Kelly, Grossman & Flanagan, LLP v. Quick Cash, Inc., 950 N.Y.S.2d 723 (N.Y. Sup. Ct. 2012); RDLF Fin. Servs., LLC v. Esquire Capital Corp., 950 N.Y.S.2d 610 (N.Y. Sup. Ct. 2012); Cousins v. Pereira (In re Cousins), No. 09 Civ. 1190, 2010 U.S. Dist. LEXIS 136139 (S.D.N.Y. Dec. 22, 2010); U.S. Claims, Inc. v. Yehuda Smolar, PC, 602 F. Supp. 2d 590 (E.D. Pa. 2009); U.S. Claims, Inc. v. Flomenhaft, 519 F. Supp. 2d 532 (E.D. Pa. 2007); U.S. Claims, Inc. v. Flomenhaft & Cannata, LLC, 519 F. Supp. 2d 515 (E.D. Pa. 2006); Douglas v. Benton, 166 N.Y.S.2d 808, 809 (Sup. Ct. 1957), aff’d 180 N.Y.S.2d 245 (App. Div. 1958).
149. See Nora Freeman Engstrom, Lawyer Lending: Costs and Consequences, 63 DePaul L. Rev. 377, 394–95 (2014) (discussing “specialized nonrecourse funding lenders” such as Augusta Capital and Excalibur Funding Programs).
150 The Association of the Bar of the City of New York’s 2018 opinion states that any nonrecourse advance in which payment to the capital provider is contingent on an attorney’s receipt of a fee violates Rule 5.4. See N.Y.C. Bar Ass’n, Formal Op. 2018-5, at 5. The opinion takes care to note that it “does not address legal fees that have been earned and that are subject to collection but that have not yet paid.” Id. at 5 n.10. The reasoning reflected in Formal Op. 2018-5 entails that an attorney may engage in standard factoring but is prohibited from factoring unmatured fees. Id. at 4–5. This is option one of the “Dilemma” discussed in Section IV, infra.
151. See Santander Bank, N.A. v. Durham Commercial Capital Corp., Civil Action No. 14-13133-FDS, 2016 U.S. Dist. LEXIS 5430, at *17 n.5 (D. Mass. Jan. 15, 2016); Core Funding, 2006 Ohio App. LEXIS 1523, at *32.
152. This is probably what the court was trying to say in Santander when it explained its rejection of the argument that standard factoring violated Rule 5.4(a). It stated that “[t]here is a significant difference between sharing legal fees with a non-lawyer and paying a debt with legal fees.” See Santander Bank, 2016 U.S. Dist. LEXIS 5430, at *17 n.5 (quoting Counsel Fin. Servs, 2013 Tex. App. LEXIS 9252, at *7–8).
153. As noted above, the capital provider may enter a transaction involving unmatured fees with different expectations about the likelihood of his future gains corresponding to an anticipated amount, depending on various features of the specific deal. A capital provider who advances money in exchange for “the accounts receivable in the first three hours of fees earned” in a case where hundreds of hours of work are anticipated is probably highly confident that they will receive exactly what they anticipated, whereas a capital provider who advances money in exchange for accounts receivable in a percentage of a contingent fee may have little or no confidence that they will receive anything at all, and if they do, that it will correspond to a specific anticipated amount. See supra note 140 and accompanying text.
154. Me. Prof’l Ethics Comm’n, Formal Op. 193 (2007).
155. As a logical matter, there is an option three: prohibit standard factoring and prohibit the factoring of unmatured legal fees (the “Ohio Option”). The Ohio Option would appear to be impractical, given that standard factoring has become a fixture of the legal market. It has even been rejected by courts applying Ohio law. See Core Funding, 2006 Ohio App. LEXIS 1523, at *32. Therefore, it is not discussed in this Article.
156. See Mo. Bar, Informal Op. 2003-0022 (“[I]t is not permissible for the repayment of the loan [to a lawyer] to be based on the outcome of the lawsuit.”); Nev. Standing Comm. on Ethics & Prof’l Responsibility, Formal Op. 36 (2007) (rejecting all “non-recourse lending by third parties” to lawyers).
157. The nonlawyer might have negotiated for a security interest in some collateral, such as the attorney’s furniture, but that is not the same thing as a property interest in the fee.
158. See, e.g., Rodriguez v. City of New York, 721 F. Supp. 2d 148, 152 (E.D.N.Y. 2010).
159. In fact, as a rule, in the United States, lawyers are prohibited from acquiring a property interest in their clients’ cause of action except under the limited circumstances discussed here, where the attorney takes a lien on the property interest they have in their earned fee. See Model Rules of Prof’l Conduct r. 1.8(j) (Am. Bar Ass’n 2016).
160. See, e.g., LMWT Realty Corp. v. Davis Agency Inc., 649 N.E.2d 1183, 1186 (N.Y. 1995) (“The client’s property right in his own cause of action is only what remains after transfer to the attorney of the agreed upon share upon the signing of the retainer agreement.”); High Point Casket Co. v. Wheeler, 109 S.E. 378, 381 (N.C. 1921) (“A right of action is assignable in this state, but by assigning an aliquot [partial] part of the fund recovered, or the recovery, or judgment, as it may be denominated, the assignee [the lawyer] gets no vested right in the cause of action . . . .”).
161. See, e.g., Gostin v. State Farm Ins. Co., 36 Cal. Rptr. 596 (Ct. App. 1964) (“Under a contingency fee agreement creating an attorney’s lien, the property upon which the lien is a charge is the obligation to pay the amount recovered upon the client’s claim.”).
162. LMWT Realty Corp., 649 N.E.2d at 1186 (citations omitted).
163. Id. (emphasis added).
164. The other rule is the “retaining lien,” where “a lawyer claiming to be entitled to a fee may impound a client’s papers, money, or other property that are in the lawyer’s possession until the fee has been paid.” See John Leubsdorf, Against Lawyer Retaining Liens, 72 Fordham L. Rev. 849, 852 (2004).
165. See Fischer-Hansen v. Brooklyn Heights R.R. Co., 66 N.E. 395, 396 (N.Y. 1903). In New York, the charging lien is a product of legislation. The modern version of the relevant statute is NY Jud. Law § 475.
166. See High Point Casket Co. v. Wheeler, 109 S.E. 378, 381 (N.C. 1921).
167. Id. (emphasis added). For example, “a contingent agreement to convey a portion of the land recovered by suit to the attorney for his fee will be specifically enforced, even though the land has greatly increased in value.” Id.
168. Id. at 382 (emphasis added).
169. See PNC Bank v. Berg, No. 94C-09-208-WTQ, 1997 WL 527978, at *32.
170. This is why the court in Core Funding adopted the U.C.C. analysis in PNC Bank without even pausing to consider the fact that the transaction in the former was the sale of unmatured legal fees while in the latter the unmatured fees were pledged as a security. Core Funding Grp., L.L.C. v. McDonald, No. L-05-1291, 2006 Ohio App. LEXIS 1523 (March 31, 2006).
171. This principle has been applied to charging liens:
Moreover, the general rule is that a lien upon property attaches to whatever the property is converted into and is not destroyed by changing the nature of the subject. Thus, a lien upon timber ordinarily extends to the shingles made out of it; a lien upon domestic animals to their young subsequently born, and a lien upon a mortgage to the land into which the mortgage is converted by foreclosure. It follows its subject and cannot be shaken off by a change of form or substance. . . . So a lien upon a claim or a cause of action follows the fund created by a settlement of the claim. . . . The lien was not affected by the adjustment, but leaped from the extinguished cause of action to the amount agreed upon in settlement.
Fischer-Hansen v. Brooklyn Heights R.R. Co., 66 N.E. 395, 397–98 (N.Y. 1903).
172. In the example “Factoring Unearned Defined Hourly Fees,” B bears a risk not present in standard factoring, which is that B will receive an amount less than the equivalent of three billable hours if C’s matter does not justify billing three hours to C. See Gluckman, supra note 119.
173. See PNC Bank, 1997 WL 527978, at *9: “It was the difference between being earned and unearned that distinguished ‘account’ from ‘contract right’ under the 1962 Code . . . The 1972 amendment to the U.C.C. includes contract rights within the definition of account.” (citations omitted).
174. Id. at *8 (“The U.C.C. defines an ‘account’ as ‘(i) any right to payment for goods sold or leased or for services rendered, and (ii) any credit device account, which, in either case, whether or not it has been earned by performance.’” (citations omitted)).
175. It is possible that, as in “Standard Factoring of Contingent Fees,” L holds the proceeds in escrow and releases $300 to B. It is even possible (however unlikely) that B receives the $300 directly from D. See supra note 119.
176. See Gostin v. State Farm Ins. Co., 36 Cal. Rptr. 596, 599 (Ct. App. 1964) (“Under a contingency fee agreement creating an attorney’s lien, the property upon which the lien is a charge is the obligation to pay the amount recovered upon the client’s claim. The ‘act’ for the performance of which that ‘property’ is made security is the payment of an attorney’s fee. . . .” (emphasis added)).
177. See supra note 134 and accompanying text.
178. See Prof’l Ethics Comm. for the State Bar of Texas, Op. 467 (1990).
179. Id. The same economic goal sought by a contingent-fee attorney could have been sought by a transactional or family law attorney who worked only under an hourly fee arrangement or a fixed-fee arrangement.
180. It is possible that, as in the “Factoring Earned Contingent Fees” example, D holds the proceeds in escrow and releases $300 to B. See supra note 129 and accompanying text.
181. See “Factoring Unearned Defined Hourly Fees,” supra note 140 and accompanying text.
182. Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006).
183. See supra notes 114–16 and accompanying text.
184. See supra note 144 and accompanying text.
185. See Sup. Ct. of Ohio, Bd. of Comm’rs on Grievances and Discipline, Op. 2004-2 (2004).
186. Id. An attorney’s obligations to her client may involve extensive legal work after a settlement agreement is secured on behalf of the client. See, e.g., Cadle Co. v. Schlichtmann, 267 F.3d 14 (1st Cir. 2001) (detailing a case that was settled for $825,000 contingent on approval by the Massachusetts Department of Environmental Protection which took significant post-settlement effort by the attorneys); RDLF Fin. Servs., LLC v. Esquire Capital Corp., 950 N.Y.S.2d 610 (N.Y. Sup. Ct. 2012) (factoring purchased contingent fees that were earned by an attorney in a case settled for “the prospective sum of $607,500,” but which required significant post-settlement effort by the attorney).
187. See Utah State Bar, Ethics Advisory Op. 06-03 (2006); Utah State Bar, Ethics Advisory Op. 02-01 (2002); Utah State Bar, Ethics Advisory Op. 97-11 (1998).
188. See Utah State Bar, Ethics Advisory Op. 97-11 (1998).
189. See Utah State Bar, Ethics Advisory Op. 06-03 (2006) (endorsing a nonrecourse loan that obliged attorney to “repay” the nonlawyer the principal and “a negotiated percentage (e.g., 5%) of the net recovery (gross recovery minus litigation expenses)” as long as there was no security interest in the attorney’s fee provided to the funder). Presumably the capital advancer was free to take a security interest in the attorney’s other property, such as the attorney’s furniture or operating account. It is striking that N.Y.C. Bar Ass’n, Formal Op. 2018-5, which cited Utah State Bar, Ethics Advisory Op. 97-11 (1997) in support of a position similar to option one, failed to cite Utah State Bar, Ethics Advisory Op. 06-03 (2006), which permits a lawyer to pay a nonlawyer a sum of money based on a percentage of the lawyer’s earned fee in exchange for a nonrecourse advance as long as the lawyer did not grant a security interest in the fee. See N.Y.C. Bar Ass’n, Formal Op. 2018-5, at 4–5 & n.8.
190. Utah State Bar, Ethics Advisory Op. 97-11 (1998).
191. See Utah State Bar, Ethics Advisory Op. 06-03, n.13 (2006).
192. See Germaine, supra note 130 (discussing the sale of plaintiffs’ attorney’s fees in Peterson v. Islamic Republic of Iran, 264 F. Supp. 2d 46 (D.D.C. 2003), in which the default judgment was the subject of a turnover action that lasted until 2016).
193. For example, if B purchases “⅓ of L’s fee in case C v. Da” and L settles that case but still is litigating other cases on behalf of C v. D (e.g., C v. Db; C v. Dc, etc.), then L’s ability to delay collection of the settlement, or even reopen the settlement with the consent of C and D if necessary, will be compromised if B insists on collecting his “property” from D immediately.
194. For example, if B purchases the first three hours of L’s billable hours after they have been earned by L working on C’s legal matter, and C’s matter requires another three hours of L’s work, C may be hesitant to instruct L to do more work on the matter if B insists on his “property” and C is short of funds.
195. Virginia Standing Comm. on Legal Ethics, Formal Op. 1783 (2003) (attorney could return to client difference between amount owed by a defaulting borrower according to the loan contract’s legal fee provision and the actual cost of representing the client against the borrower).
196. See supra note 87 and accompanying text.
197. Virginia Standing Comm. on Legal Ethics, Formal Op. 1783 (citing Virginia Standing Comm. on Legal Ethics, Formal Op. 1744) (finding no violation of the fee-splitting rule in sharing a portion of court-awarded fees with a nonprofit organization).
198. Even Wall Street firms are finding the delay in payment of their fees, which are comprised of billable hours, sufficiently problematic that there is an increase in suits by these firms against clients for delinquent fees. See Christine Simmons, Elite Law Firms Increasingly Suing Clients to Collect Fees, N.Y. L.J. (Dec. 2, 2016) (“What that translates to is we can no longer wait 90 days, 120 days, a year or more to collect fees.”).
199. The advantage of restricting factoring to earned fees shrinks even more if fees earned by an attorney who has obtained a default judgment are considered “earned fees.” A nonlawyer who buys an attorney’s fees in a case that has resulted in a default judgment, but not proceeds, could use his leverage against the interests of the client by enforcing his property rights in the fees, either by demanding that the client pay the assigned fees before the client has received her proceeds, or by exercising other rights of ownership, including demanding a voice in the decision of whether to accept an offer of compromise from the judgment debtor.
200. The explanation one court gave for the reason a factor buys accounts receivable from physicians applies equally to lawyers: “In exchange for providing immediate cash to Valley Hospital, the medical finance companies received as consideration accounts receivables from Valley Hospital worth an amount sufficient to justify the risk they take that they may never actually collect.” Miller v. J-M Mfg. Co., No. CV-05-1499-ST, 2008 U.S. Dist. LEXIS 9392, at *16 (D. Or. 2008) (asserting that standard factoring of accounts receivable is very common in the medical profession).
201. Core Funding Grp., L.L.C. v. McDonald, No. L-05-1291, 2006 Ohio App. LEXIS 1523, at *3 (Mar. 31, 2006).
202. Id. at *2–3.
203. Id.
204. It should be recalled that the risk of nonpayment to a factor arising from the insolvency of a judgment debtor post-settlement or post-judgment is not insignificant. See, e.g., A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994, 996 (4th Cir. 1986) (holding that attorneys who won trial judgments against A.H. Robins could not collect for their clients once it declared bankruptcy).
205. Deontology is “the school of ethics that focuses on the inherent rightness or wrongness of actions themselves, as opposed to the correctness or incorrectness of the consequences of the actions.” Deborah Paruch, From Trusted Confidant to Witness of the Prosecution: The Case Against the Recognition of a Dangerous–Patient Exception to the Psychotherapist–Patient Privilege, 9 U. N.H. L. Rev. 327, 332 (2011) (citing Encyclopedia of Ethics 63–64 (Susan Terkel & R. Shannon Duval eds., 1999)).
206. See, e.g., Christopher Slobogin & Amy Mashburn, The Criminal Defense Lawyer’s Fiduciary Duty to Clients with Mental Disability, 68 Fordham L. Rev. 1581, 1615–16 (2000) (citing Rules 1.2, 1.6, and 1.7 as examples of rules that illustrate a “deontological approach”). Some disagree. See Anita Bernstein, Pitfalls Ahead: A Manifesto for the Training of Lawyers, 94 Cornell L. Rev. 479, 506 (2009) (“Virtually every rule of professional conduct is amenable to this [rule-utilitarian] analysis . . . .”).
207. Susan R. Martyn, In Defense of Client–Lawyer Confidentiality . . . and Its Exceptions. . ., 81 Neb. L. Rev. 1320, 1328–30 (2003) (advancing deontological justifications for confidentiality).
208. Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006).
209. Rodriguez v. City of New York, 721 F. Supp. 2d 148, 153 (E.D.N.Y. 2010) (quoting N.Y. State Bar Ass’n Comm. on Prof’l Ethics, Op. 679 (1996)).
210. Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006).
211. Id.; see also Emily S. Taylor Poppe & Jeffrey J. Rachlinski, Do Lawyers Matter? The Effect of Legal Representation in Civil Disputes, 43 Pepp. L. Rev. 881, 885 (2016) (review of studies into the efficacy of legal representation).
212. For a discussion of action-guiding norms in law, see W. Bradley Wendel, Mixed Signals: Rational–Choice Theories of Social Norms and the Pragmatics of Explanation, 77 Ind. L.J. 1, 28 (2002).
213. See supra Part I (the discussion of attorneys’ need for capital); supra notes 9–11 and accompanying text.
214. Prof’l Ethics Comm. for the State Bar of Texas, Op. 576 (2006).
215. The but-for test has a certain attraction in that it can, in theory, be applied without the employment of value judgments about the merit of the underlying distribution that its application produces. But see David Rosenberg, The Causal Connection in Mass Exposure Cases: A “Public Law” Vision of the Tort System, 97 Harv. L. Rev. 849, 855 n.27 (1984) (“Although ‘causal connection’ determinations focus on the ostensibly ‘scientific’ cause-and-effect relationship, several ambiguities in the ‘but-for’ causation test necessitate the exercise of value judgments by courts and juries.”).
216. The assumption that the money provided in standard factoring does not actually assist the attorney in her practice of law in ways that create future gains to the nonlawyer is a bit naïve, given that most factoring is not a one-off arrangement but part of an ongoing arrangement where the money paid for fees today will be used to help the attorney earn fees which will be purchased in the future. See, e.g., Santander Bank, N.A. v. Durham Commercial Capital Corp., Civil Action No. 14-13133-FDS, 2016 U.S. Dist. LEXIS 5430, at *20 (D. Mass. Jan. 15, 2016) (demonstrating factor and law firm engaged in serial transactions).
217. See Koppel, supra note 46, at 701 (“Once a close relationship develops between lawyers and non-lawyers, it is easy for non-lawyers to wittingly or unwittingly become involved in the unauthorized practice of law.”) (citing Emmons, Williams, Mires & Leech v. State Bar, 86 Cal. Rptr. 367, 372 (Cal. Ct. App. 1970)).
218. UPL by staff and paralegals has to be proven by showing that their efforts did not “merge into the attorney’s completed work product.” Unauthorized Practice of Law Advisory Opinion No. 192, 1999 Va. LEXIS 88, *7 (July 13, 1999).
219. See supra notes 23–25 and accompanying text.
220. See supra notes 9–11 and accompanying text.
221. See Lawrence J. Fox, MDPs Done Gone: The Silver Lining in the Very Black Enron Cloud, 44 Ariz. L. Rev. 547, 556 (2002).
The ABA’s Multijurisdictional Practice Commission’s proposed exception depends on the invidious notion, often advanced in the pre-Enron era by the now not-so-Big Five, that lawyers really are just another set of service providers, that there is nothing special—in the sense of special responsibility—about being lawyers, that our rules of professional conduct are not all that important, and that the sooner we lawyers got off our high falutin’ horses the better off we will be.
Id.
222. See id. at 555 (“Nor should anyone doubt that lawyer regulation by the judiciary would be one of the first casualties of lawyer MDPs . . . and these enterprises [will] be regulated just like any other for-profit enterprise.”).
223. Lawrence J. Fox, Dan’s World: A Free Enterprise Dream; An Ethics Nightmare, 55 Bus. L. 1533, 1564 (2000).
224. See supra notes 27–43 and accompanying text.
225. See, e.g., Carson, supra note 55, at 615–33 (describing risks to clients of MDPs); Joseph E. Neuhaus, Comments of the New York State Bar Association Committee on Standards of Attorney Conduct on Ethics 20/20’s Issue Paper Concerning Alternative Business Structures (June 9, 2011) (same); see also Levinson, supra note 43 (arguing that admitting nonlawyers into legal partnerships will impair the independence and decisional autonomy of lawyers and the legal profession).
226. See MacEwen et al., supra note 38, at 70.
227. This is why the state bar ethics committee in Utah Ethics Advisory Opinion No. 06-03 upheld a proposed transaction involving the purchase of an unmatured contingent fee. Where an attorney is obliged to give only a portion of every dollar that she earns to the nonlawyer, the “litigation-funding Agreement does not present the potential that the lawyer will have a financial incentive not to obtain a recovery for the client.” Utah State Bar, Ethics Advisory Op. 06-03 (2006). The committee assumed that the interests of the nonlawyer aligned with the attorney and that the interests of the attorney aligned with the client.
228. See supra notes 144–49 and accompanying text.
229. Dzienkowski & Peroni, supra note 47, at 170–71 (on “coordination” benefits to clients of MDPs).
230. Cobb, supra note 42, at 786–89 (The ABA 20/20 Commission chose not to invite public comments on passive investment).
231. Comments to the ABA Commission on Ethics 20/20 Working Group on Alternative Business Structures, Consumers for a Responsive Legal System, May 31, 2011, https://www.americanbar.org/content
/dam/aba/administrative/ethics_2020/20110627_abs_issues_paper_comments_for_posting.authcheckdam.pdf.
232. Letter from John H. Beisner, U.S. Chamber Inst. for Legal Reform, to Natalia Vera, Senior Research Paralegal, Comm’n on Ethics 20/20 (June 1, 2011), https://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20110627_abs_issues_paper_comments_for_posting.authcheckdam.pdf.
233. Id.
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