By Andrew A. Servais
California Rule of Professional Conduct and ABA Model Rule of Professional Conduct 5.4 feature a number of prohibitions designed to preserve the professional independence of lawyers, including prohibiting the sharing of legal fees with a nonlawyer, forming a partnership with a nonlawyer (if any of the activities of the partnership consist of the practice of law), and practicing in a business structure in which a nonlawyer owns any interest in the business or serves as a corporate director or officer.
Arizona, the District of Columbia, and Utah have modified their jurisdiction’s Rule 5.4 to permit business structures that allow nonlawyer ownership of law firms and the sharing of legal fees with nonlawyers. For instance, in 2021, Arizona eliminated Rule 5.4 altogether, substituting a system in which Arizona law firms that include nonlawyer owners or investors may be certified by the Arizona Supreme Court as “alternative business structures” (ABS).
Because these jurisdictions allow nonlawyer ownership, the question arises whether a lawyer practicing in a jurisdiction that adheres to a version of Rule 5.4 (a “Model Rule Lawyer”) may invest in an alternative business structure in another jurisdiction.
ABA Formal Opinion 499 was recently released stating that a “lawyer may passively invest in a law firm that includes nonlawyer owners (‘Alternative Business Structures’ or ‘ABS’) operating in a jurisdiction that permits ABS entities, even if the lawyer is admitted to practice law in a jurisdiction that does not authorize nonlawyer ownership of law firms.,” ABA Comm. on Ethics & Prof’l Responsibility, Formal Op. 499 (September 8, 2021).
In other words, a lawyer generally may invest passively in a law firm that includes nonlawyer owners in jurisdictions that permit such alternative business structures, according to the new ABA ethics opinion. The lawyer may passively invest, even though the lawyer practices law in a jurisdiction that does not permit such nonlawyer owners.
“In the Committee’s view, the conflict-of-law issue in the passive investment context is resolved by applying the law of the jurisdiction in which the ABS is authorized to operate because under Rule 8.S(b)(2), the predominant effect of a Model Rule Lawyer’s passive investment in an ABS would be in the jurisdiction(s) where the ABS would be permitted.” Formal Op. 499 at p. 3.B.
In this regard, the Committee noted that “A passive investment does not create an ‘of counsel’ relationship where conflicts are imputed to other lawyers. Nothing about a passive investment necessarily creates the ‘close, regular and personal relationship’ characteristic of ‘of counsel’ arrangements,” Formal Op. 499 at pp. 4-5 citing ABA Comm. on Ethics & Prof’l Responsibility, Formal Ops. 90-357 & 94-388.
To “avoid any appearance of practicing law through the ABS, the investing Model Rule Lawyer must ensure that the ABS does not identify the Model Rule Lawyer as a lawyer, or hold out the Model Rule Lawyer as a lawyer associated wit he ABS.” Formal Op. 499 at p.4.C.
Should the Model Rule Lawyer be held out as counsel related to the ABS or otherwise become active in the ABS, such may trigger conflict of interest issues.
Thus, the Committee warned that, for example, “a Model Rule l.7(a)(2) concurrent conflict of interest based on the Model Rule Lawyer’s personal interest in the investment in the ABS would likely exist if, when the Model Rule Lawyer made the investment the Model Rule Lawyer also represented a client whose interests were adverse to a client of the ABS.” Id.
Under this scenario, a conflict would exist if the “Model Rule Lawyer were to act as an advocate against a client of the ABS or represent a business in a transactional matter requiring negotiation with a client of the ABS” because the Lawyer’s “investment interest in the ABS could ‘create a significant risk’ that the Model Rule Lawyers representation of the client would be ‘materially limited’ by the lawyer’s investment in the ABS.” Formal Op. 499 at pp. 4-5, fn. 10 citing ABA Comm. on Ethics & Prof’I Responsibility, Formal Op. R. 1.7, cmt. [10] (a “lawyer’s own interests should not be permitted to have an adverse effect on representation of a client.”)
This is obviously an area subject to continued developments regarding attorneys’ ethical duties related to “passive investments” in certain jurisdictions. However, practitioners can take away that “passive investment” requires the lawyer to act passively, and not as an attorney for the ABS, to avoid potential conflict issues which are sure to expand over time.