Ethical Issues Related to Legal Fee Financing
The availability of third-party financing for legal fees is a trend sweeping the country and increases access to legal services for persons who can afford financing, but are unable to pay immediately by cash or credit card. However, a lawyer should proceed with caution and carefully consider the relevant ethical obligations when they refer their client to a third party to borrow money to pay for their legal fees.
This article is the third in a five-part series that addresses the payment of legal fees by non-traditional means. Specifically, this article addresses the American Bar Association’s approach to a lawyer’s obligations when clients use companies or brokers to finance the lawyer’s fee. Next week, the MSBA will discuss the MSBA Committee on Ethics Opinion addressing the issue.
ABA Formal Opinion 484
In 2018, the American Bar Association Standing Committee on Ethics and Professional Responsibility (ABA) issued Formal Opinion 484, which addresses third-party financing for legal fees when a lawyer refers the client to a finance company. Specifically, Formal Opinion 484 (ABA Opinion) addressed six different factual scenarios that were presented for consideration involving lawyers who assisted their clients in financing the lawyer’s fee through a bank, a loan financing company, or a broker. The ABA independently considered that a lawyer may have an ownership interest in a third party in which the lawyer refers a client for financing the lawyer’s legal fee. Approval of all scenarios was conditioned upon the lawyer complying with all ethical obligations. This article will discuss all seven factual scenarios and all ABA Model Rules of Professional Conduct that must be complied with before a lawyer may refer a client to a third party for financing their legal fees.
The ABA Opinion addressed the following scenarios between a lawyer, a client, and a third party that provides financing to the client:
- Traditional loan arrangement. The client applies for a loan directly from a financing company to cover the lawyer’s fees without the lawyer’s assistance and pays the loan back to the financing company with interest.
- The lawyer pays a fee to a financial company, and in return, the lawyer is allowed to submit loan applications from clients. If the client receives a loan, the lawyer receives the money minus a finance fee charged by the finance company. The lawyer has no financial interest in the finance company and the company makes all decisions about whether to loan funds to the client, in what amount, and on what terms.
- The lawyer gives the client information about a finance plan. If the client is approved, the lawyer will submit payment vouchers to the finance company for services rendered to the client, who must approve the vouchers. If the voucher is approved by the client, the finance company pays the lawyer the amount of the voucher minus a service charge.
- The lawyer pays a one-time registration or monthly subscription fee to a finance company. The lawyer gives the client a link to a finance company’s website or posts the link on the lawyer’s website, either of which directs clients to the finance company’s loan application forms. The finance company disburses the loan funds directly to the client but notifies the lawyer when disbursements are made to the client.
- A finance company offers a “same as cash” funding program for a lawyer’s fees or retainer in which the company provides a computer or other hardware necessary for the client to apply for financing in the lawyer’s office. If the finance company determines the client qualifies, then the lawyer provides the client with the loan documents and the finance company pays the lawyer directly, but the financial relationship remains between the lender and the client.
- A lawyer works with a financial brokerage company that helps clients obtain legal fee financing. The broker is not a lender; it locates banks willing to finance the client’s legal fees. The broker may charge the lawyer a fee to facilitate the transactions. The lending bank pays the loan amount to the client, who then pays the lawyer’s fee in accordance with their fee agreement.
The above factual scenarios are permissible only if the lawyer adheres to the following ABA Model Rules of Professional Conduct (Model Rules):
- Model Rule 1.2(c) Scope of Representation and Allocation of Authority Between Client and Lawyer. Rule 1.2(c) allows a lawyer to limit the scope of representation if the limitation is reasonable. The limitation on representation in these factual circumstances is necessary, so the client will not believe the lawyer is exercising his professional legal judgment by recommending financing, a particular financing company or has evaluated the terms of the loan on behalf of the client.
- Model Rule 1.4(b) Communications. The lawyer must communicate and explain to their client the financial arrangement to the extent reasonably necessary to permit the client to make informed decisions about the representation, including the lawyer’s relationship with the bank, financing company, or broker, how the lenders may pay the lawyer directly, the costs and benefits to the client, any payment terms the lawyer intends to impose if the finance company disburses the loan proceeds directly to the client, whether the lawyer will charge the client a service fee because of the financing, and any and all other factors.
- Model Rule 1.5 (a) and (b) Fees. Section (a) of Model Rule 1.5 prohibits the lawyer from collecting an unreasonable fee. Section (b) requires the lawyer to disclose the basis or rate of the fee and expenses for which the client will be responsible. In accordance with Rule 1.5, any service fee charged by the lawyer to the client because of a financing plan or transactional costs must be fully disclosed. Likewise, if a lawyer charges a higher base fee to reimburse himself for any transactional costs or subscription fees the lawyer must pay the lender, that fee must be reasonable and disclosed to the client. The ABA opined the service fees, subscription fees, and transactional costs the lawyer charges to their clients over and above their customary fee is “akin to a merchant fee that credit card companies charge.” Furthermore, the ABA stated these fees do not violate the prohibition on fee-sharing by Model Rule 5.4(a).
- Model Rule 1.6 (a) and (b) Confidentiality of Information. The lawyer may not reveal information regarding the client’s case to the bank, finance company, or broker except as permitted under Rule 1.6 (a) and (b).
- Model Rule 1.7 (a) and (b) Conflict of Interest. Current Clients. A possible conflict of interest may arise in any of the six scenarios considered. If a lawyer recommends fee financing to a client even though fee financing is not in their client’s best interests, then an obvious conflict will exist. In this instance, the ABA stated that the lawyer may avoid the conflict by not placing his own financial interests ahead of his client’s, e.g., the lawyer may not recommend financing. A conflict may also exist if the third-party financing company is also represented by or in a business relationship with the lawyer. The ABA specifically noted that a lawyer may resolve a concurrent conflict of interest in this situation if all the requirements of Rule 1.7(b) are satisfied. Rule 1.7(b) requires written informed consent by the client.
- Model Rule 1.9(a) Duties to Former Clients. Rule 1.9(a) prohibits a lawyer who has formerly represented a client in a matter from representing another person in which that person’s interests are materially adverse to the interests of the former client. There is an exception if the former client gives informed consent, confirmed in writing. Consequently, if a lawyer previously represented a bank, finance company, or broker and is now representing a current client in obtaining fee financing from the former client, the lawyer must do so in accordance with Rule 1.9(a) by obtaining written informed consent.
The ABA Opinion addressed an additional factual scenario where a lawyer might have an ownership interest in a bank, financing company, or broker. If a lawyer recommends financing to a client with a business entity in which the lawyer has an ownership or financial stake, then the lawyer must also comply with Rule 1.8(a) of the Model Rules. Rule 1.8(a) requires the lawyer to disclose the relationship, ensure fair and reasonable terms, advise the client to seek independent legal advice on the transaction, and obtain the client’s written informed consent of the transaction and the lawyer’s role.
The ABA Opinion only addressed scenarios where a client borrows funds to pay legal fees and did not address non-recourse cash advances that come directly out of any future settlement or judgment.
In sum. “Lawyers may participate in the fee financing arrangements described” in all the factual scenarios discussed in this article, “provided they comply with Model Rules 1.2(c), 1.4(b), 1.5(a), 1.6, 1.7(a)(2), and 1.9(a). They may further acquire an interest in or form a finance company or brokerage and thereafter refer clients to that entity provided that they comply with Model Rule 1.8(a).”
Join us for the next two weeks as we continue to cover in detail the payment of legal fees through non-traditional means.
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This is the third article of a five-week series that will discuss non-traditional payment of legal fees by credit card, payment apps, or third-party financing. This series is designed to assist you in becoming aware of the ethical consideration a lawyer must consider before accepting payment of legal fees through one of these methods, as well as providing guidance to mitigate risks.
The first week the MSBA addressed payment of legal fees by credit card. Last week, the MSBA discussed the ethical considerations when accepting legal fees through a payment app. Next week, the MSBA will brief the Maryland Committee on Ethics’ opinion regarding third-party financing of legal fees. In the final week, the MSBA will finish the series by summarizing all of the issues involved in accepting legal fees by credit card, through a payment app, and through third-party financing.