Dewey Really Want to Say That Crowdfunding Is Unethical Fee Splitting? The Biglaw/SmallLaw Double Standard

Back in May 2013, Findlaw blogger William Peacock posted about Upstart, a  crowd funding site where “backers” provide money to new graduates, who pledge to repay the funds through a percentage of future income for a term of five or ten years. Upstart and similar crowd funding platforms might potentially offer an innovative solution to debt-saddled law graduates want to start a practice — particularly in underserved communities where demand is high. Seems like a win-win situation right? So it’s not surprising then that archaic ethics rules threaten to put the kibosh on these types of arrangements.

As Peacock suggests, Model Rule 5.4’s bar against fee-splitting with non-lawyers arguably prohibits an arrangement where backers (who are non-lawyers) fund a law firm and get a cut of the firm’s income that derives from client fees. Initially, I thought that Peacock was overreacting – after all, many jurisdictions permit percentage-based arrangements in other contexts.  For example, attorneys may retain collection agents to recover unpaid client fees and take their payment as a percentage of the proceeds. Ethics boards reason that once the fee is already earned, the possibility that the lawyer’s judgment might be impaired during representation (which is the raison d’etre  for the fee-splitting bar) is eliminated.  [See NYSBA Op. 608 (summarizing state opinions on contingency-based fee collection arrangements). On the other hand, this law review comment (at 145) suggests otherwise, concluding (albeit critically) that an arrangement whereby a lawyer borrows from a wealthy friend, and agrees to repay the loan through a 10 percent share of net receipts, would run afoul of Model Rule 5.4. In addition, it’s also possible that other crowdsourcing scenarios, depending upon their structure could be construed as giving “investors” an ownership interest in a law firm which also runs afoul of Model Rule 5.4.

Ethics committees haven’t yet weighed in on crowd funding (at least so far as I could find), but should they or the ABA decide to provide guidance, they should conclude that crowd funding does not violate Model Rule 5.4.  Crowd-funding presents an entirely different scenario than investment by a rich uncle or a few wealthy friends. For starters, many crowd funding sources don’t evaluate a firm’s business plan or revenues at all so they’re less likely to interfere in a way that lawyers choose to handle their cases and serve clients. [NOTE: Some Lending clubs — another type of crowd funding service that provides loans and credit to small business may check financials – but here, the loans are repaid in the same manner as conventional bank loans rather than as a percentage of client fees].  More importantly, the beauty of crowd funding is that it spreads risks over a large pool of investors.  As a result, crowd-funding lawyers are less beholden to the demands of a single, overreaching investors and therefore, less likely to compromise their professional independent judgment to appease a financial backer. 

To the extent that policy and fairness play a role in legal ethics (wishful thinking?), a ban on crowd funding creates a double standard with big law. As I mentioned before, our profession tolerates other forms of fee splitting: collection agencies can take a cut of unpaid fees that they recover for lawyers and firms may include non-lawyer employees in compensation or retirement plans based on profit-sharing. So it’s unclear why there’s any principled reason to treat crowd funding differently.   If bars are concerned that crowd funding will lead to non-lawyer equity ownership (which really wasn’t an option before the JOBS Act, they could clarify that any participation in crowd funding platforms must still comply with rules banning non-lawyers from owning equity interests in firms.

In addition, if the bars are concerned about undue influence to lawyers’ professional judgment, why don’t they crack down on big law borrowing practices? Take a look at the recent events involving Dewey LeBouef, where the firm was so heavily reliant on nearly-depleted lines of credit that it resorted to deceptive (and allegedly fraudulent) accounting practices to keep the cash flowing. Dewey even dragged its clients into the mess, encouraging them to backdate checks to boost the the previous year’s revenues.

If Dewey’s addiction to its bank loans didn’t result in a compromise of its independent judgment, it’s not clear what would. Yet, the bars would never consider imposing restrictions on law firms’ borrowing practices. So why restrict access to sources of funds likely to be tapped by solos and smalls, based merely on hypothetical speculation of potential harm?

A final caveat:  just because I believe that crowd funding is ethical inasmuch as it doesn’t violate Model Rule 5.4 doesn’t mean that it’s a sound business practice. Publicly broadcasting your law firm’s need for funding assistance online isn’t likely to inspire client confidence – nor is it likely to generate much in the way of donations except perhaps from friends and family (but note – crowd funded “lenders’ club” options would not raise this confer because they are handled privately through an application process rather than web campaign). Crowd funding for a particular case is also tricky as it can implicate client confidentiality rules by revealing information about the case, so you’d need client consent. Plus, because money collected through the crowd-funding source for a particular case could be construed as advance payment for the benefit of the client – so the fees would arguably need to be deposited into a trust account (the reason why I’m equivocating is because even though the funds are unearned, technically speaking, the money isn’t the client’s property, though it’s not really the lawyer’s either. I need to think that through).

Still, there are situations where I crowd funding could make sense for lawyers. For new lawyers or existing solos who want to represent traditionally underserved clients or found a non-profit or open a law practice incubator (that’s my own personal fantasy) or launch an ancillary service, crowdfunding could provide a source of cash to get the venture off the ground. Likewise, lawyers can also use crowd funding to raise money for cause-based pro bono matters or individual clients – as in the case of George Zimmerman (though crowdfunding for individual cases doesn’t implicate raise the same ethics concerns related to fee sharing or potential ownership interests as raising funds for a law firm).

Ultimately, crowd-funding could unlock opportunities for so many sectors that currently lack options – from new grads with limited options to solos and smalls seeking to grow. But we’ll never know the outcome if we kill the possibility for crowd funding legal before we give it a chance. So please, ethics boards – provide guidance on crowdfunding for law firms if you feel compelled to chime in, but don’t prohibit it. And lawyers considering the crowdfunding option – consult your professional responsibility rules to ensure that you can carry out crowdfunding ethically, but don’t assume that it’s presumptively unethical.

NOTE: This post is the third in an on-going series on 21st century ethics for solos and smalls.