ABA Opinion 499 Green Lights Lawyers’ Passive Investment in Firms with NonLawyer Ownership

Despite ABA Green Light, States May Not Embrace Passive Investment in Alternative Business Structures

An Alternative Business Structure (“ABS”) that permits lawyers and nonlawyers to collaborate and share revenue has become a hot, revolutionary topic in the rapidly evolving practice of law.  In fact, Arizona has deleted Rule 5.4, which prohibits lawyers from being in business or sharing fees with nonlawyers. Utah has established a regulatory sandbox that provides a safe harbor for lawyers to collaborate with nonlawyers without the restrictions of Rule 5.4.

Other states are contemplating similar experiments. For example, The Florida Bar’s Special Committee to Improve the Delivery of Legal Services recently recommended changes to Rule 4-5.4 in its Final Report, which included eliminating the prohibition on fee sharing with nonlawyers and establishing a Law Practice Innovation Laboratory Program or “Lab” similar to Utah’s sandbox.

So, it comes as no surprise that the American Bar Association’s Standing Committee of Ethics and Professional Responsibility (“ABA”)has provided guidance for lawyers who want to passively invest in alternative business structures (“ABS”) in Formal Opinion 499. The opinion defines a “passive” investment interest as a situation in which “a lawyer contributes money to an ABS with the goal of receiving a monetary return on that investment.” In other words, even if your state doesn’t permit an ABS, maybe you can invest in one in another state.

Model Rule 5.4, which prohibits lawyers’ involvement in an ABS, serves as the model for most states’ 5.4 rules. Model Rule 5.4 aims to preserve the professional independence of lawyers by prohibiting lawyers or law firms from sharing legal fees with nonlawyers, owning law firms with nonlawyers, and practicing “in a business structure in which a nonlawyer owns any interest in the business or serves as a corporate director or officer.”

For discussion purposes, Opinion 499 designates a lawyer admitted to practice law in a jurisdiction that follows a state version of Model Rule 5.4 as a “Model Rule Lawyer.” The Opinion notes that Utah and Arizona recently diverged from this standard.

In fact, in August 2020, Utah introduced its “regulatory sandbox” to test new business structures dedicated to the practice of law. Shortly after, the Arizona Supreme Court eliminated Rule 5.4 and allowed fee-sharing between lawyers and nonlawyers via an ABS. Approved entities in Utah can be found here, while approved entities in Arizona can be found here.

The relatively narrow question addressed by the ABA Opinion is whether Model Rule Lawyers should be permitted to acquire a passive investment interest in an ABS. Although the Opinion answered in the affirmative and specifically stated that “[a] lawyer admitted to practice law in a Model Rule jurisdiction may make a passive investment in a law firm that includes nonlawyer owners operating in a jurisdiction that permits such investments,” it delineated important limitations. The Model Rule Lawyer cannot:

• practice law through the ABS,
• be held out as a lawyer associated with the ABS, or
• have access to information protected by Model Rule 1.6 without the ABS clients’ consent or compliance with an applicable exception to the rule in the jurisdiction.

The Opinion provides guidance on resolving choice of law issues concerning the issues arising in connection with the passive investment, and concludes that, in accordance with Model Rule 8.5(b)(2), an investing lawyer would be subject to the law of the jurisdiction in which the ABS is authorized to operate. The analysis stems from the fact that a lawyer’s passive investment would be relevant conduct with a meaningful effect in the ABS jurisdiction.

In terms of conflicts, the opinion stated that the mere potential for a conflict “does not prohibit a Model Rule Lawyer form making the passive investment, but it does require the Model Rule Lawyer to address a conflict that later materializes.” However, if there is a conflict at the time of the investment, then the “Model Rule Lawyer must refrain from the investment or appropriately address the conflict pursuant to Model Rule 1.7(b).”

Furthermore, the Committee noted that a passive investment does not create an “of counsel” relationship where conflicts would be imputed to other lawyers. Thus, the passive investment in an ABS “does not require imputation of conflicts under Model Rule 1.10 between the Model Rule Lawyer (or that lawyer’s firm) and the ABS.”

Although confidentiality was beyond the scope of the opinion, the committee stated that the Model Rule Lawyer “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 investing lawyer is part of the ABS ‘firm.’”

The ABA opinion provides detailed guidance but is not binding on any of the state bars, so it will be interesting to see if states embrace the guidance and what changes, if any, Opinion 499 will bring.