Ethics Question of the Month - April 2019

Scenario 1: Lawyer A represents a long-time client, Client B, in various real estate transactions.  After several years, Lawyer A asks to invest in an upcoming real estate development project for which Client B needs investors.  Lawyer A also perceives that her interests are aligned with the client’s interests because both want the project to succeed.  Client B welcomes Lawyer A’s investment.  They agree that Lawyer A will invest $50,000, and contribute her legal services, in exchange for a 10% equity share in the development. As part of her contribution of legal services, the lawyer prepares the paperwork documenting the investment agreement.

Scenario 2:  A few months later, Client B decides to start a company to create and sell real estate development software.  Client B has enough investors and capital to start the company, but is concerned about managing the start-up’s legal costs and other expenses.  Client B offers the lawyer shares of stock in the new company in exchange for legal services.  Client B proposes a formula that awards two shares of stock for every hour of services spent by Lawyer A.  Lawyer A’s hourly rate is $250.  There is a risk that the start-up may fail and Lawyer A’s stock will be worthless; there is also the possibility that the start-up could be successful and that Lawyer A’s shares could be worth significantly more than the value of her legal services at her usual hourly rate.

Which statement most accurately addresses whether these Scenarios are acceptable?

A.    Both Scenarios 1 and 2 are acceptable, and are commonplace.
B.    Scenario 2 is acceptable, but Scenario 1 is not.
C.    Scenario 1 is acceptable, but Scenario 2 is not.
D.    Both Scenarios are per se unacceptable.
E.    We don’t have sufficient facts to know whether either Scenario is acceptable.

ANSWER: E

DISCUSSION

Rule 1.08(a), Texas Disciplinary Rules of Professional Conduct, applies to both scenarios:

(a)    “A lawyer shall not enter into a business transaction with a client unless:

  • (1)    the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed in a manner which can be reasonably understood by the client;
  • (2)    the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and
  • (3)    the client consents in writing thereto.

The official Comments to Rule 1.08(a) provide some further guidance:

1.    This rule deals with certain transactions that per se involve unacceptable conflicts of interest.

2.    As a general principle, all transactions between client and lawyer should be fair and reasonable to the client.  In such transactions, a review by independent counsel on behalf of the client is often advisable.  Paragraph (a) does not, however, apply to standard commercial transactions between the lawyer and the client for products or services that the client generally markets to others, such as banking or brokerage services, medical services, products manufactured or distributed by the client, and utilities services.  In such transactions, the lawyer has no advantage in dealing with the client, and the restrictions in paragraph (a) are unnecessary and impracticable.

Lawyers are not broadly prohibited from engaging in business opportunities with clients, or even from becoming partners or shareholders in those client businesses. However, to be an acceptable transaction, Rule 1.08(a) requires that: 

(1) the terms of the transactions be fair and reasonable to the client — regardless of whether the terms are fair and reasonable to the lawyer; 
(2)  the client have a reasonable opportunity to consult with independent counsel regarding the wisdom of doing a deal with the lawyer, which often means the lawyer must alert the client of this opportunity and its implications; and 
(3)  the client consent in writing to the conflict of interest, which is not the same as the client signing the transactional documents for the deal itself, unless the conflicts disclosure is included in the transactional document.  

Neither scenario provides sufficient information to determine whether these requirements of Rule 1.08(a) were satisfied. We don’t know if Client B was given a “reasonable opportunity” to consult with independent counsel, and we don’t know if an independent counsel determined that these transactions were, in fact, “fair and reasonable to the client.”  Without knowing these facts, one cannot determine if the requirements of Rule 1.08 were met.   

While it is not uncommon for lawyers to enter into business transactions with their clients, it is common for lawyers to be unaware that special ethical considerations apply to those transactions.  Rule 1.08(a) provides a checklist for ensuring that those ethical considerations are at least procedurally protected. Lawyers who do not comply with Rule 1.08(a) risk both a disciplinary rule violation and a breach of fiduciary duty claim.
 

Posted: 3/28/2019 12:00:00 AM by TCLE Editor | with 0 comments

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About Ethics Question of the Month

Ethics Question of the Month is a regular feature of the Texas Bar Journal created and sponsored by the Texas Center for Legal Ethics.

DISCLAIMER: The information contained in Ethics Question of the Month is intended to illustrate an ethics issue of general interest in the Texas legal community; it is not intended to provide ethics advice that applies regardless of particular facts.  For specific legal ethics advice, readers are urged to consult the Texas Disciplinary Rules of Professional Conduct (including their official comments) and other authorities and/or a qualified legal ethics advisor.

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