ABA Issues Ethics Guidance on Passive Investment in Nonlawyer Owned Law Firms

What happens when a Pennsylvania lawyer desires to invest in a law firm in D.C. where some of the owners are not lawyers? Under the Pennsylvania Rules of Professional Conduct, the lawyer is not permitted to make that investment, but the D.C. Rules would allow it for a D.C. lawyer.

ABA Formal Opinion 499 resolves this question and provides guidance on key considerations for lawyers in states, like Pennsylvania, whose rules do not permit non-lawyer ownership in law firms. Lawyers 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 ownership.

Most jurisdictions (including Pennsylvania) follow Model Rule 5.4 of the ABA Model Rules of Professional Conduct, which prohibits nonlawyer ownership of law firms. The rule also prohibits lawyers from sharing fees or forming partnerships with nonlawyers.

However, a few jurisdictions have modified Rule 5.4 to permit nonlawyer ownership of firms and the sharing of legal fees. These jurisdictions include Arizona, the District of Columbia and Utah. Arizona earlier this year eliminated Rule 5.4 and allowed nonlawyer owners or investors in law firms to be certified as alternative business structures.

Florida has under consideration a recommendation to authorize minority nonlawyer ownership of law firms, and other states will no doubt follow suit.

Because some 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.

Formal Opinion 499, released on September 8, 2021, permits such investment, with the caveat that the lawyer must be cognizant of possible conflict of interests that could arise.

An ABA press release is here.

The opinion discusses choice-of-law issues and determines that the law of the jurisdiction that permits the alternative business structures would control. The opinion also addresses conflict of interest risks, noting that “A passive investment in an ABS, without more, does not mean that the Model Rule Lawyer is practicing law through the ABS.” Further, a passive investment does not create an “of counsel” relationship.

A lawyer in a “Model Rule” state seeking to make a passive investment in an alternative business structure must consider the possibility of “concurrent conflicts of interest that could arise from the Model Rule Lawyer’s representation of clients in the Model Rule jurisdiction.”

For example, the lawyer could have a conflict of interest under Model Rule 1.7(a)(2) if the lawyer invests in an alternative business structure and also has a client with an interest adverse to the alternative business structure.

Similarly, if the lawyer advocated against a client of the alternative business structure or represented a business in a transactional matter requiring negotiation with a client of the alternative business structure, there could be a “significant risk” that the lawyer would be materially limited in their representation of the client because of their role with the alternative business structure.

The opinion further explains that in such a scenario, the investing “Model Rule Lawyer” cannot represent the client, but that personal interest conflict would not be imputed to the lawyer’s law firm. The opinion states that, “if, however, the Model Rule Lawyer’s investment in an ABS will create a conflict of interest at the time of the investment, the Model Rule Lawyer would need to refrain from the investment unless the conflict can be resolved appropriately under Model Rule 1.7(b).”

The opinion did not reach “the issue of disclosure of confidential information by an ABS,” noting that the question is beyond the scope of this opinion.

While this new ABA ethics guidance most directly impacts the several jurisdictions in the vanguard on nonlawyer ownership of law firms and the sharing of fees with nonlawyers, the trend is picking up steam and similar initiatives are bound to be adopted on at least an interim basis elsewhere. The attractiveness of passive investment opportunities in ABS vehicles will vary, and careful due diligence will be key to positive outcomes. The adequacy of the due diligence will depend in part on whether the ABS clients will give informed consent to the disclosure of otherwise confidential client information.

Lawyers considering making a passive investment in a law firm that includes nonlawyer owners in jurisdictions that permit such investments must also be wary of conflicts of interest with their existing practices. This is a potentially important development and an opportunity for lawyers interested in making a passive investment in an ABS, so long as the lawyer investor follows the several key cautions in the ethics opinion.  The usefulness of Formal Opinion 499 in advancing regulation of the delivery of legal services into the modern era remains to be seen because of the limited number of jurisdictions permitting ABS and the limitations on lawyers seeking to invest. The traditional restrictions embodied in Model Rule 5.4 remain in place in the overwhelming majority of states and act as barriers to entry for firms seeking to revolutionize delivery of legal services by partnering with technology providers or seeking growth through capital investment rather than debt financing.

There is still much work to be done to address the access to justice gap and aligning law firm practice with the pace of technology, but Formal Opinion may mark the beginning of a national conversation on this topic. 

The September 8, 2021 ABA Standing Committee on Ethics Formal Opinion 499: Passive Investment in Alternative Business Structures is here: https://www.americanbar.org/content/dam/aba/administrative/professional_responsibility/aba-formal-opinion-499.pdf

*Thomas G. Wilkinson (twilkinson@cozen.com) is a member of the Legal Profession Services Practice Group of Cozen O’Connor.  He is a past chair of the Pennsylvania Bar Association Legal Ethics and Professional Responsibility Committee, and has served on the ABA Standing Committee on Professionalism. He is the co-editor of the Pennsylvania Ethics Handbook (5th Ed. 2017).

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Last modified: November 4, 2021

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