Assessing Impact of Proposed DR 1-107, etc.

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By Roy Simon
[Originally published in NYPRR February 2001]


In last month’s NYPRR (Jan 2001), I discussed what you can do until the proposed amendments to DRs 106 and 107 and several related changes in the Code are actually adopted by the Appellate Divisions. The amendments were offered by the NYSBA to expand the relationships between lawyers and non-lawyers, in response to the pressure to recognize MDPs. This month, I will discuss what will change if the amendments are adopted.

Let’s start with the same hypothetical that I used last month: Your most entrepreneurial partner, M.D. Prak, wants to create a closer relationship between your law firm and a good small accounting firm. He proposes three possible plans: (a) forming a partnership with the accountants; (b) employing the accountants; or (c) entering into a mutual referral agreement with the accountants. When we looked at these options under the current ethics rules, we saw that (a) partnership with non-lawyers is flatly prohibited by DR 3-103; (b) employing the accountants is ethical but can create lots of problems (conflicts, improper solicitation, etc.); and (c) mutual referral agreements are prohibited by DR 2-103(B). Will any of this change if the Appellate Divisions adopt the proposed new rules and amendments?

Plan A — Forming a Partnership: No change here. Last June, the NYSBA House of Delegates emphasized that “[n]o change should be made to the law that now prohibits lawyers and law firms directly or indirectly from transferring ownership or control to non-lawyers.” The century-old ban on partnerships between lawyers and non-lawyers, reflected today in New York’s DR 3-103, will continue even if the proposed amendments are adopted.

The intent to enjoin partnerships is clear, but proposed DR 1-107 ought to say so explicitly — it should contain a statement like, “Nothing in this rule is intended to permit partnerships currently prohibited by DR 3-103” — but instead the proposed DR 1-107 is more oblique. It provides, in part:

A. A lawyer or law firm may enter into and maintain a contractual relationship with a non-legal professional or non-legal professional service firm for the purpose of offering to the public, on a systematic and continuing basis, legal services performed by the lawyer or law firm, as well as other professional services … provided that:

2. The lawyer or law firm neither grants to the non-legal professional or non-legal professional service firm, nor permits such person or firm to obtain, hold or exercise, directly or indirectly, any ownership or investment interest in, or managerial or supervisory right, power or position in connection with, the practice of law by the lawyer or law firm.

Since a partnership is a kind of “contractual relationship,” the new rule appears to permit partnerships between lawyers and non-legal professionals. However, because partners presumably hold or exercise a “managerial or supervisory right, power or position,” partnerships with non-legal professionals will remain prohibited under DR 1-107. The new rule should make this prohibition explicit rather than using terms like “ownership,” “investment interest,” or “managerial or supervisory right.” Otherwise, some lawyers will design partnerships with non-legal professionals that provide the non-lawyers with a share of the profits without any power over the law practice — e.g., an agreement under which the non-lawyers would have power over the accounting practice but not over the law practice. (Of course, that still would not overcome the prohibition on sharing legal fees with a non-lawyer — but DR 1-107 ought to state explicitly that the fee-sharing prohibition continues as well.)

Plan B — Employment: Law firms may ethically employ non-lawyer professionals now and will be permitted to employ them after the proposed amendments take effect. Your law firm will still be permitted to compensate these professionals with (a) a salary and (b) participation in your firm’s profit-sharing retirement plan. You can probably add (c) year-end cash bonuses based on the law firm’s overall profitability, and perhaps even (d) bonuses for outstanding assistance in particular matters (though this question is unsettled). But you still will not be permitted to share your legal fees with the accountants, even the fees of clients that they refer to your firm.

But proposed DR 1-106 may broaden a lawyer’s responsibility for a non-lawyer professional’s conduct. The Rule would divide services offered by a law firm into two categories: (1) non-legal services that are “not distinct” from the law firm’s legal services — these will always be subject to the Disciplinary Rules; and (2) non-legal services that are distinct from the law firm’s legal services — these will be subject to the Disciplinary Rules only “if the person receiving the services could reasonably believe the non-legal services are the subject of an attorney-client relationship.”

Thus, if the accountants in our hypothetical are working with the law firm’s clients on tax strategies, estate plans, or other services bound up with (and therefore “not distinct from”) the firm’s legal services, then all of the work done by the accountants on those matters will be subject to the Disciplinary Rules. This means that the lawyers will be fully responsible for conduct by the accountants that would violate the Disciplinary Rules if engaged in by a lawyer.

Even if the non-legal services are “distinct from” the legal services — for example, if the accountants are doing annual personal income tax returns unrelated or unconnected with any legal work being done by the law firm — DR 1-106 still subjects the non-legal services to the Disciplinary Rules.” If the person receiving the services could reasonably believe the non-legal services are the subject of an attorney-client relationship.” However, under DR 1-106(A)(4), it will be presumed that the recipient of the non-legal services could not reasonably believe an attorney-client relationship exists “if the lawyer or law firm has advised the person receiving the services in writing that the services are not legal services and that the protection of an attorney-client relationship does not exist with respect to the non-legal services.”

But a disclaimer under DR 1-106(A)(4) provides only limited grace. The recipient of the non-legal services is free to show that the attempted disclaimer was inadequate, superseded by later events, contrary to oral representations, or otherwise invalid. Moreover, as I read the Code, even lawyers who provide a valid written disclaimer will remain on the hook under DR 1-104(D), which makes a lawyer responsible for an associated non-lawyer’s violation of the Disciplinary Rules in three situations: (i) if the lawyer orders, directs, or ratifies the specific misconduct, or (ii) if the lawyer is a partner in the firm that employs the non-lawyer, or (iii) if the lawyer has “supervisory authority” over the non-lawyer and knows (or should have known) of the non-lawyer ’s misconduct in time to take remedial action to avoid or mitigate the consequences.

Plan C — Mutual Referrals: The fallback arrangement offered by our entrepreneurial partner in last month’s hypothetical was a mutual referral agreement with the accountants. Under the existing version of DR 2-103(B), mutual referral agreements are unethical. Lawyers are not allowed to give anything of value in exchange for client referrals — and an agreement to refer matters to a non-lawyer in exchange for the non-lawyer’s referrals to the law firm constitutes something “of value.”

The proposed amendment to DR 2-103(B) changes this. It provides: “A lawyer or law firm may refer clients to a non-legal professional or non-legal professional service firm pursuant to an agreement or other contractual relationship with such non-legal professional or non-legal professional service firm to provide legal and other professional services on a systematic and continuing basis as permitted by DR 1-107.” Thus, the amendment to DR 2-103(B), in combination with new DR 1-107, will permit lawyers to enter into exclusive mutual referral agreements with non-lawyer professionals or with non-lawyer professional service firms.

However, the right to enter into mutual referral agreements is not unlimited. First, the agreement must be with a non-lawyer “professional” (or a non-lawyer “professional” service firm). The proposed amendment to DR 2-103(B) will still prohibit mutual referral agreements with anyone who is not a “professional.” But when an agreement is limited to “reciprocal referrals,” some of the restrictions ordinarily imposed by proposed DR 1-107 will be lifted. Ordinarily, DR 1-107(A)(1) permits contractual relationships with non-legal professionals only if their profession is “listed by the Office of Court Administration pursuant to DR 1-107(B).” This limitation to professionals who are on the OCA’s list of professions may pose severe obstacles to most contractual relationships with non-lawyers, for two reasons.

First, the OCA has not yet developed any list of professions, and there is no telling when it may do so. (Indeed, it may never happen — remember New York’s experience with specialization?) Second, DR 1-107(B)(3) limits eligibility to professionals who are “required under penalty of suspension or revocation of license to adhere to a code of ethical conduct that is reasonably comparable to that of the legal profession.” Given the breadth and stringency of the New York Lawyer’s Code of Professional Responsibility, especially with respect to conflicts of interest and confidentiality, it is far from clear which professions have a code of ethics “reasonably comparable” to ours.

In the case of agreements limited to mutual referrals, however, the non-lawyer professionals need not be members of the elite professions on the OCA’s list, because DR 1-107(C) provides: “DR 1-107(A)(1) shall not apply to relationships consisting solely of reciprocal referral agreements or understandings between a lawyer or law firm and a non-legal professional or non-legal professional service firm.” In other words, the amendment to DR 2-103(B) will allow lawyers to enter into mutual referral agreements with any non-legal professionals or professional service firms, not just those on the OCA’s approved list.

However, relationships with non-OCA professionals will remain subject to three important restrictions. First, under DR 1-107(A)(2), lawyers must not give non-legal professionals, directly or indirectly, any “ownership or investment interest” in a law firm, or any “managerial or supervisory” power in connection with the law firm’s practice. This means that DR 3-103’s ban on partnerships between lawyers and non-lawyers remains fully intact.

Second, under DR 1-107(A)(3), the existence of the contractual mutual referral relationship must be “disclosed to any client of the lawyer or law firm to whom non-legal professional services are provided.” Thus, our hypothetical law firm must disclose the mutual referral arrangement to every law firm client who is referred to or from the non-legal professionals. A law firm client that is referred by the professionals is just as much a client of the law firm as a law firm client that is referred to the professionals and if “non-legal professional services are provided” to a client at any time during the existence of the mutual referral agreement, the law firm’s clients must be told about it. DR 1-107(A)(3) doesn’t say who must make the disclosure — it uses the passive form “is disclosed” — so the rule is satisfied if either the lawyers or the non-lawyers make the disclosure. But if the non-lawyers fail to make the required disclosure, or if they make an incomplete or misleading disclosure, then DR 1-104(D)(2) will put the blame on the lawyers if we assume that the non-lawyers are held to be “associated” with the law firm by virtue of the mutual referral agreement.

Third, under DR 1-107(D), the firm may not “allocate costs and expenses” with the non-lawyers unless the allocation “reasonably reflects the costs and expenses incurred or expected to be incurred by each.” If the relationship with the professionals consists “solely” of a reciprocal referral agreement, there won’t be many expenses to share. If it consists of more, then the non-lawyers must be professionals on the list of professionals maintained by the OCA pursuant to DR 1-107(A)(1). For example, if the lawyers and the non-lawyers jointly advertise, or if they share office space, that would appear to go beyond a bare reciprocal referral agreement. And if the non-lawyer ’s profession isn’t on the OCA’s list (either because the OCA hasn’t gotten around to making its list or because the profession doesn’t pass muster), then the relationship with the non-lawyers must be limited to a mutual reciprocal referral agreement.

In sum, when we assess the impact of the proposed Rules and the related amendments, we must conclude that the changes will not be dramatic. The big change is not in DR 1-107 but in proposed DR 2-103(B), which will allow mutual referral agreements with non-lawyers for the first time. Since lawyers will still be prohibited from forming partnerships with non-lawyers or from sharing fees with non-lawyers, and since lawyers are already permitted to employ non-lawyer professionals, the most visible change wrought by the amendments will be the proliferation of mutual referral agreements with non-legal professionals. Those agreements may be an important advance in offering clients the kind of one-stop shopping they apparently want, but they are hardly the revolution that proponents of MDPs would espouse.

Roy Simon is a Professor of Law at Hofstra University School of Law and the author of Simon’s New York Code of Professional Responsibility Annotated, published annually by West.

DISCLAIMER: This article provides general coverage of its subject area and is presented to the reader for informational purposes only with the understanding that the laws governing legal ethics and professional responsibility are always changing. The information in this article is not a substitute for legal advice and may not be suitable in a particular situation. Consult your attorney for legal advice. New York Legal Ethics Reporter provides this article with the understanding that neither New York Legal Ethics Reporter LLC, nor Frankfurt Kurnit Klein & Selz, nor Hofstra University, nor their representatives, nor any of the authors are engaged herein in rendering legal advice. New York Legal Ethics Reporter LLC, Frankfurt Kurnit Klein & Selz, Hofstra University, their representatives, and the authors shall not be liable for any damages resulting from any error, inaccuracy, or omission.

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