HIGHLIGHTS

• Arizona and Utah recently began allowing nonlawyers to establish or become part owners of law firms, raising the question of whether lawyers admitted in jurisdictions that do not permit nonlawyers to have an ownership interest in a law firm could passively invest in law firms with nonlawyer owners in the states that permit such an alternative business structure (ABS).
• In Formal Ethics Opinion 499, the American Bar Association (ABA) has answered that question in the affirmative, albeit with caveats to address issues of confidentiality and conflicts.
• This alert looks at the current landscape of law firm ownership, provides an overview of ABA Formal Opinion 499 and gives several considerations for lawyers who may be looking to diversify their portfolios with such an investment.

The ABA’s Formal Ethics Opinion 499 (Sept. 8. 2021) moved closer to approving alternative business structures (ABS) in the practice of law. Recently, Arizona and Utah began allowing nonlawyers to establish or become part owners of law firms. That raised the question of whether lawyers admitted in jurisdictions that do not permit nonlawyers to have an ownership interest in a law firm could passively invest in law firms with nonlawyer owners in the states that permit it. The ABA has answered that question in the affirmative, albeit with caveats to address issues of confidentiality and conflicts.

The Current Law Firm Ownership Landscape

Under ABA Model Rule 5.4, which has been adopted in nearly all U.S. jurisdictions, lawyers are prohibited from sharing legal fees with a nonlawyer or practicing in a law firm in which a nonlawyer owns any interest or serves as an officer or director. The prohibition, which some see as outdated, was designed to preserve the professional independence of lawyers. Arizona and Utah each modified their version of Rule 5.4 to permit an ABS and the sharing of legal fees with nonlawyers.¹ In 2020, the Utah Supreme Court launched a pilot program under which court-approved entities could include nonlawyer owners in law firms. And in 2021, Arizona nixed its Rule 5.4 in favor of a system in which an ABS with nonlawyer owners or investors may be certified by the Arizona Supreme Court.

Arizona and Utah’s regulatory changes prompted the ABA to ask “whether a lawyer admitted to practice law in a jurisdiction adhering to Model Rule 5.4 (i.e., a jurisdiction that strictly prohibits nonlawyer ownership of law firms) … may acquire a ‘passive’ investment interest in an ABS?”

The Impact of ABA Formal Opinion 499

Opinion 499 defined “passive investment” as follows:

For purposes of this opinion, a “passive” investment interest means that a lawyer contributes money to an ABS with the goal of receiving a monetary return on that investment. Passive investment does not include scenarios in which the investing lawyer practices law through the ABS, manages or holds a position of corporate or managerial authority in the ABS, or is otherwise involved in the daily operations of the ABS.

Further, passive investment, as used in this Opinion, means that the investing lawyer does not have access to information protected by Model Rule 1.6 without the ABS client’s informed consent.

Under that definition, Opinion 499 concludes that a lawyer in a jurisdiction adhering to Model Rule 5.4 may make a passive investment in an ABS located in a jurisdiction that has approved the ABS structure without violating Rule 5.4.

The Opinion considered at length conflicts of interest that may arise based on a lawyer’s passive investment in an ABS owned in whole or in part by nonlawyers, as follows:

• Current client conflicts: Before investing in an ABS, the lawyer must analyze whether any of his or her current clients are adverse for purposes of Model Rule 1.7(a)(2) to the ABS’ clients at the time of the investment. If such a conflict arises, the lawyer must either refrain from the investment or appropriately address it pursuant to Model Rule 1.7(b).
• Potential or future conflicts in general: A potential or future conflict, however, does not prohibit a passive investment any more than a lawyer is prevented from investing in a publicly traded company under such a circumstance.
• Doing business with a client: Lawyers who ask a client to invest in an ABS, or who invest in an ABS that is a client, should consider whether they need to comply with Model Rule 1.8(a).
• Imputation: Passive investment alone, which by definition does not give the investing lawyer “access to information protected by Model Rule 1.6 without the ABS client’s informed consent,” does not create the sort of relationship with the ABS that requires the imputation of conflicts under Model Rule 1.10 between the lawyer and the ABS. As Opinion 499 explains, “personal interest conflicts are generally not imputed to other lawyers in the same firm unless those interests create a significant risk of materially limiting the representation of a client by the remaining lawyers in the Model Rule Lawyer’s firm.” See Model Rule 1.10(a)(1). Traditional imputation analyses would be required outside of the context of a personal interest conflict.
• Continuous monitoring for conflicts: Lawyers should, however, monitor for concurrent conflicts that could arise based on, for instance, the lawyer’s representation of a client whose interests are adverse to a client of the ABS. In such a situation, the lawyer’s representation of the client would be “materially limited” by the lawyer’s investment interest in the ABS, but other lawyers in the firm could likely represent that client.

The committee also considered the conflict of law issue raised by investment in an ABS by a lawyer admitted in a Model Rule jurisdiction, and concluded that the law of the jurisdiction in which the ABS is authorized to operate should apply “because under Rule 8.5(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.”

Finally, the Opinion cautions that lawyers considering investing in an ABS “should exercise due care to avoid exposure to confidential client information held by the ABS or other associations that could result in a determination that the Model Rule Lawyer is part of the ABS ‘firm.’ ”

Conclusion

Under ABA Formal Opinion 499, lawyers looking to diversify their investment portfolios may consider making a passive investment in an ABS, or in the words of ABA Formal Opinion 499, an investment in which the “lawyer does not have access to information protected by Model Rule 1.6 without the ABS client’s informed consent.”

Notes

¹ The District of Columbia permits, in certain circumstances, individual nonlawyers to be partners in law firms, as long as such nonlawyers are not providing legal advice but are, instead, providing professional services that assist the firm in delivering legal services. The District of Columbia does not, however, permit passive investment in law firms.

This article summarizes aspects of the law and does not constitute legal advice. For legal advice for your situation, you should contact an attorney.