Should Lawyers Ever Invest in a Client's Business?
You just finished a new client's estate plan and were blown away by how much wealth she's amassed from her dog washing on demand app startup -- and she's looking for investors in her next project. Or maybe a prospective client comes to you for help incorporating a new business. He's got a great business plan, a lot of experience, but not enough cash to cover legal fees.
Should you invest in that Uber for pet grooming? Can you help out your incorporation client by exchanging legal services for an ownership stake?
Financial Considerations
If you're simply investing in a clients business, you should research the investment as you would any other. If you're accepting an interest in the company in exchange for representation, things become a bit more complicated. First, you'll be forgoing hourly billing for a long-term investment. You'll need to make sure that you can afford to get by without that billable time. If your firm needs every client minute to keep the lights on, then investing in exchange for representation is probably a bad idea.
Similarly, you'll want to consider your relationship with the client, not as an attorney but as an investor. Does the client seem like someone you'd be willing to work with, instead of just working for? If you sell your interest in the clients business, would you expect them to walk away from your firm?
Then there's the risk. Though many BigLaw firms have made money by taking a stake in their clients' businesses, they don't walk into those relationships blindly. Those firms usually have specialized committees with significant investment expertise, writes malpractice attorney Joseph Hartley in the ABA's GPSolo magazine. Small firms often lack those resources, so experience with the industry and a clear understanding of the risks is essential.
Ethical Considerations
Of course, there are plenty of ethical considerations lawyers must address as well. Model Rule 1.8 and its state analogues are the clearest place to start. That rule requires "fair and reasonable" terms for attorney investments. "Fair and reasonable" terms should be read in light of Rule 1.5's factors for determining reasonable fees. Those include things like the time and labor required, the likelihood of later conflicts, and the going rates in the locality. Rule 1.8 also requires full disclosure, essentially requiring you to go through any potential conflicts, difficulties, and possible disasters that could come from representation.
But of course, that's not the end of it. Investments must also comply with substantive corporate law and state rules. Some states, Hartley explains, "don't consider a promise for future services to be adequate consideration for shares in a corporation."
So, if you're considering investing in a client's business, know that it's not an easy process, but it's not an impossible one either.
Related Resources:
- Should You Be Allowed to Invest in a Lawsuit? (The New York Times)
- Think Twice Before Using Crowdfunding and Litigation Investments (FindLaw's Strategist)
- Don't Be a Partner in Shelter Tax Crime (FindLaw's Strategist)
- Small Firm Startup: Cheap Malpractice Insurance is a Must (FindLaw's Strategist)
