Should your firm take equity in its clients? | Practical Law

Should your firm take equity in its clients? | Practical Law

Law firms are increasingly faced with a dilemma. Should they take equity in their clients or are the ethical and business pitfalls too dangerous to ignore? With some US West Coast lawyers now earning more that their Wall Street Rivals, the temptation may be hard to resist. We investigate the pros and cons.

Should your firm take equity in its clients?

Practical Law UK Articles 4-101-1048 (Approx. 10 pages)

Should your firm take equity in its clients?

by Scott Appleton, Josephine Carr and Priyanka Koul, European Counsel
Published on 17 Jan 2000International
Law firms are increasingly faced with a dilemma. Should they take equity in their clients or are the ethical and business pitfalls too dangerous to ignore? With some US West Coast lawyers now earning more that their Wall Street Rivals, the temptation may be hard to resist. We investigate the pros and cons.
On the West Coast of America, the birthplace of the burgeoningnumber of Internet start-up companies, a large number of firms,from niche boutiques to the biggest practices, regularly investin their clients. Some have been doing so for 20 years.
The trend first spread across the US, partly following therise of high-tech centres around Washington and Boston, and isnow starting to take a hold in the European market. Late lastyear, UK firm Linklaters & Alliance announced its intentionto join a growing band of UK law firms prepared to accept sharesin lieu of fees from Internet start-up clients. One of theworld's largest firms, Clifford Chance, is also activelyinvestigating the advantages and disadvantages, as isFreshfields.
The temptations are obvious. At the very least, a firm couldmake a lot of money as dot-com company stock rockets in value. Inthe US the market is alive with stories of overnightmillionaires. Silicon Valley firm Wilson Sonsini Goodrich &Rosati, a pioneer in this area, hit the headlines in January whenthe pricing of its shares in a computer hardware company, VALinux Systems, soared from US$30 (EUR30) to US$239.25 (EUR237)per share, valuing its holding at US$25.66 million (EUR25.4million). For many of the US firms investing in their clients,1999 has been very lucrative, with many making their biggestgains to date. And the firms are investing more and more. In 1998Brobeck Phleger & Harrison invested in 40 companies. In 1999that number rose to in excess of 70. The average investment inindividual companies was US$25-50,000 (EUR25-50,000). Six havealready gone public, increasing in value between 50 to 150 timesthe amount invested. None have so far failed.

Sharing in the success

Today the technology industry is a major force in the USmarket as many high-tech companies, not least Cisco Systems andYahoo, have quickly evolved into substantial internationalcompanies. The law firms that helped them on their way arereaping two major dividends: a loyal international client basewith names that rival those of any Wall Street firm and equityinvestment funds that are sometimes worth 10's of millions.
Although investing in clients can be risky, the potentialrewards can be hard to resist. "Over the years, I doubt thefailure rate has changed but if they do make it, it can be huge",says Wilson Sonsini's Don Bradley. Client demand is a key impetussays Neal Millard, a partner in the Los Angeles office of White& Case, a firm that has just started down this route becauseit received so many enquiries from clients. "Giving up stock isnot as painful from a client's perspective", he says. Clientsfeel they are getting a more committed service from theirlawyers. It is also the only way that most of them can ever hopeto launch themselves.
The approach to taking equity has become very sophisticated.Many firms start out by allowing ad hoc investments thatbecome assets of the firm. The majority soon establish separateinvestment funds to hold the assets. Millard says his firm talkedto a number of other firms with experience before it gave theconcept the go ahead. In most cases White & Case takes acombination of shares and fees in cash, "In some cases we agreeup front to take a fixed 1% in shares. In other cases we pick avalue that enables the client to maximise its cash receipts".

Go West, young man

On the West Coast, it has got to the point where somepartners, and associates, refuse to work for a client unless theyget equity, on top of their fees. The market allows them todemand both as there is an acute shortage of lawyers in privatepractice with experience in the field. This is partly because somany associates are tempted to have a go at launching a start-upand are often headhunted by clients. It seems that everyone knowssomeone who has become an overnight multi-millionaire, and theyoung lawyers know that their firms will welcome them back withopen arms if the venture fails.
Tower Snow Jr, managing partner of Brobeck Phleger &Harrison, tells the story of one of his firm's associates who gota job offer from a start-up dot-com company. The lawyer signedthe package, including the stock options, and was working out hisnotice at the firm when the dot-com was sold. His stock optionsaccelerated and he made around US$52 million (EUR51.5 million)without ever having worked a day for the company. "The reactionin the firm was interesting" says Snow, with half of his lawyerssaying well done and trying to work out how they could do it,while the other half were left writhing in jealousy.
To try and make sure that the younger lawyers feel that theyare participating in the dot-com gold rush, without having torisk joining a start-up, many of the firms now let theirassociates share in the success of their clients. At WilsonSonsini a trust holds funds for its associates, and, saysBradley, "They have made a great deal of money in a shorttime".
Brobeck Phleger has partner, associate and staff funds. Itinvests US$2,500 (EUR2479) into the fund for each associate, forexample, which is then invested in clients. The fund vests 20%each year, and becomes fully vested in five years.

Fools gold

However, before a firm gets a severe case of gold fever, thereare several major drawbacks it needs to address.
First, according to Bradley, it is important to remember thatthe company may never make it out of the bedroom or garage. Inhis firm's experience, out of every 10 investments, one willprobably be successful and maybe two or three will return theinvestment.
Second, there are the ethical concerns. They includeeverything from maintaining independence and potentialmalpractice suits all the way to a temptation to indulge ininsider trading. These ethical stumbling blocks are the reasonsmost often advanced by firms for their reluctance to invest inclients. There is a thin line between being an objective legaladviser protecting your client's interests and being a biasedlegal adviser with a stake in the success of the client, whichmight blinker otherwise dispassionate advice and lead to a desireto encourage short term gain rather than long term growth.
Stephen Bent at Washington firm Foley Lardner says this ismore than an academic concern, "I encounter situations all thetime where I am aware that somebody I'm dealing with is somehowacting in a way that suggests their objectivity is beingcompromised". However, Bent's firm has accepted equity, althoughstrictly, he says, as a last resort, for example where a clientinsists that it will not get venture capital if it does not havethe firm's backing. Bent says his firm prefers to make otheraccommodations such as deferring or discounting fees with a bonusif the company achieves a certain milestone, "The ethicalconcerns are too significant and there are other things you cando which are virtually as good for the company and allows them todo what they have to do".
Paul Hastings Janofsky & Walker's Eric Joss says his firmis looking at the issue, but it is, "Concerned whether it isappropriate for the firm and it clients". In his view the issuesinclude professional responsibility, independent judgement andinsider trading. "We are aware of troubles and malpracticeissues", he adds. Skadden Arps Slate Meagher & Flom's JeromeCoben, based in the firm's Los Angeles office says "We have beenin the situation where clients offer equity but we prefer to helpin different ways". Whether or not to take equity is a continuingdebate within the firm, "The reality and perception is thatjudgement is impaired and investing in equity is not what lawyersare about. I have seen situations where the founders havescratched their heads and asked, 'Why is this happening'". JohnHartigan at Morgan Lewis & Bockius also queries whether theSecurities Exchange Commission will be happy accepting opinionsfrom stockholding firms.
Continental Europe. But if you move to theEuropean continent, the ethical concerns are proving to be amajor stumbling block to firms seeking to take this approach.While the Law Societies in England and Scotland accept that firmscan take equity in clients, the practice has yet to catch onacross the continent where the bar rules are much stricter.Although in some jurisdictions it is simply unclear what the barposition is.
In Sweden the bar raised the issue as a matter for debateafter two firms, Vinge and Delphi & Co, both publiclyannounced their intention to buy into their clients' businesses.A significant proportion of the bar membership said they thoughttaking equity in lieu of fees was against the rules. Vinge andDelphi & Co have been asked to comment on these findings. Inaddition the bar has set up a special committee to investigatethe issue further. In the meantime Vinge is reflecting on whatthe decision means for it and has publicly put a hold on itsplans to take equity. However, the firm is frustrated by thedelay, says Vinge partner Björn Gustavsson, "We need to be apart of the new economy and safeguard our competitiveness. Thedriving force behind this more than anything else is theclient".
In Germany, the bar rules do not appear to prohibit thepractice but very few firms have taken the plunge. Andreas Klein,the director of the German Bar's International Department, sayshe has not heard this issue being raised, "There is nothing likethis in Germany so far. It is not known to the public or to thebar, which doesn't mean it doesn't go on".
Hans-Jürgen Hellwig, Vice President of the German Bar,confirms that the practice is not barred and that the German Barwould probably take a pragmatic view, based on the size of theinvestment.
There are indications that it will soon become an issue.Heuking Kühn Lüer Heussen Wojtek has not taken fees inlieu of equity as yet, but has plans to do so in the future.Peter Brautigam at Nörr Stiefenhofer & Lutz also doesnot rule it out as a future possibility, "There is quite a bigmarket for venture capitalists and start-ups in Germany andclients are suggesting this to us all the time". According toAndré Turiaux at Heuking Kühn, taking equity is lessproblematic for smaller firms, "It is easier for them becausewhere one or two partners own the firm, the shares can be moreeasily attributed to the partners. In a bigger firm with 100partners sharing the equity it can be problematic from anorganisational point of view".
In Finland it seems that firms are precluded from takingequity. Rainer Hilli at Roschier Holmberg & Waselius says,"This is an issue the firm has recently had to give someconsideration to, following some client demand. The same isprobably true for most Finnish firms. The Bar rules are veryclear: an attorney cannot engage in any form of business otherthan that of an attorney".
In The Netherlands Frederik Hemskerk, general secretary of theDutch Bar, says, "Lawyers are not entitled to indulge in anycommitments which may jeopardise their independence". A firmbuying into one of its own clients could be interpreted asjeopardising this independence. He is not aware of this practicegoing on in The Netherlands.
Philippe Jadoul, a partner in the recently mergedDutch/Belgian firm Huysmans Trenité Van Doorne has discussedthe possibility with some of his clients but is not entirely surewhether the bar rules would permit it in Belgium, where firms areprohibited from accepting fees in kind. When approached by European Counsel, the Belgian bar was outraged at anysuggestion that a lawyer would take equity in lieu of fees. TheParis bar reacted in a similar way, although some lawyers havedipped a toe into this area. One lawyer in a small Paris firmsays, "The main issue is the way the share purchase isstructured. It can be illegal if not done in a certain way". Itis important that the lawyer taking equity is seen to be buyingthe shares rather than accepting them in lieu of regular fees. Hehas taken equity on two occasions. In one case he was approachedby an individual who wanted to set up a company but could notafford the legal fees to protect his intellectual property rightsagainst another's claims. The lawyer accepted one share aspayment. Five years later it is valued at US$80,000(EUR79,000).
Wilson Sonsini's Bradley, however, believes the ethical issueshave been overblown. He says, "Our investing in clients is donethrough a partnership which is a separate entity composed of allthe partners of the firm". He also claims that the investmentsare so small that they do not create situations where lawyersmight be tempted to compromise their objectivity. A lawyer at aUK firm which takes equity adds, "There must be nothing betweenus and the client. We take the equity and we put it into aprofessionally managed fund. That takes it off the table. Thepartners don't see it and we get the same deal as everybodyelse".
Jim McCulley from the Virginia Bar's ethics committee says hisbar, along with most state bars, has debated this point anddecided that lawyers may take stock/equity in lieu of fees, aslong as the client consents after full disclosure and thetransaction "is not unconscionable, unfair or inequitable whenmade".
The California Bar and The Law Society of England and Waleshave also issued guidance notes on this issue. Guidance thatCooley Godward follows. Managing partner Lee Benton says hisfirm, "Gets a waiver from the client and points them to othercounsel to set the terms on which the firm takes stock". Whileclients often do not get independent advice, it is important torecord in writing that they were encouraged to do so. AlistairMorris of Pagan Osborne in Scotland agrees that it is vital toget a clear agreement, and ensure that the firm gets the sharesat value, which may mean paying a higher price than thedirectors. (For further details of the California Bar and TheLaw Society of England and Wales guidance see"European Counsel extra materials".)
But some lawyers are not convinced of the effectiveness ofthese safeguards. Even if the investment is small, the potentialvalue to the firm is huge and whether or not the fund isseparated from the firm is seen as irrelevant. Says one, "Theissue here is that if you're rendering counsel in matters thatwill affect the value of a company, your self interest willappear to be paramount even if it is not".
In addition, some firms are finding that start-up companiesare now reluctant to give them shares. Some companies believe itcould be a very expensive way for them to get legal advice. Acompany could be giving away 1% of its shares, which grow to beworth several millions, in return for US$20,000 of legaladvice.

Heading East

In the UK the hi-tech sector has seen tremendous growth andLondon is home to a number of leading IT focused law firms whichhave, again, led the way in this area. Field Fisher Waterhousewas one of the first to accept equity. Partner Michael Chissicksays his firm quickly realised it needed to change the way itworked in order to stay ahead of the field, "We picked up on thefact that everyone works with share options in the e-commercefield. Everyone is incentivised by them, the employees, thedirectors, the partners".
Field Fisher took its cue from the US model, "We started totalk to the US law firms and then put our own package together".He says that a flexible approach is the key in this market,"We'll look at deferred payments, fixed fees, equity stakes,basically it's an open approach". Start-ups can benefit from aspecifically tailored package called "Incubator" which provides abundle of services relevant to getting a company of the ground ata fixed fee, often working with experienced non-partner lawyersat rates that work within their tight budgets. Equity is taken invery modest amounts, with 1% being the norm, "We're notfinanciers, we're not here to fund businesses, we're here todevelop partnerships with our clients".
Other UK firms that offer services to start-ups in return forstakes in the business include Tarlo Lyons, Taylor JoynsonGarrett, Osbome Clark, Bird & Bird and Mishcon de Reya. TarloLyons recently invested in its client Netcentric Systems and aspokesman for the client company was keen to express howimportant that investment is for his type of company, "Equityparticipation ensures that fledgling companies are nurturedduring their early growth phase when cash and resources are at apremium".
Rupert Pearce, the head of the Internet and e-commerce groupat Linklaters & Alliance, says that competitive forces aredriving firms in the UK to change the way they work. He says, "Wereally believe that we must invest in the clients of tomorroweven if we have a tremendously vibrant practice today". AtLinklaters a start-up can expect to receive a package of advicethat will get it up and running and through its first round offinancing free of charge. Any other fees will be deferred for aperiod up to one year. In return the firm will buy into theclient's business. "That's a very significant investment by us inthem. The goal is to build long-term relationships that aremutually productive", says Pearce.
Clifford Chance is taking a cautious approach and MichaelMathews, a senior partner at the firm, has been given the task ofidentifying the financial and ethical pitfalls to produce a paperfor the firm's management. He says if the firm decides it wantsto take equity it will probably be in, "Circumstances in which ifwe didn't take stakes, we wouldn't be retained at all".
The practice is also starting to take root in Scotland. PaganOsborne's Morris was convenor for the Scottish Law Society'sprofessional practice committee that reviewed whether lawyersshould be allowed to take shares in lieu a few years ago. Itdecided that so long as the level of shareholding was small, itwould not influence the lawyer or the firm, and as such it shouldbe allowed. Morris's own firm takes equity in lieu, "It keepscosts down, keeps a good adviser for the client and helps ourfirm cement its relationship with that client".

The way ahead

Brobeck Phegler's Snow concludes that, when all the dust hassettled, "It's a simple cultural issue. On the West Coast it's anon-issue. On the East Coast it is seen as inappropriate". Thelatter is a view that extends across the Atlantic, but seems tobe by-passing the UK market. However, as Snow argues, in reality,"Only half a dozen firms in the US have the client base to do it.Those with venture funds are those doing the work".
If you are one of those firms, he says, "Its stupid not to doit. We prefer to be paid our normal fees, but if the companylooks to be a good investment we will also ask to invest".Concludes Jim McCulley from the Virginia Bar, "What's wrong inhaving an interest in a company and wanting that company to dowell?"

Avoiding the pitfalls

Jealousy and division

Divisions can arise over who should participate when aninvestment pays dividends.
The key issue is who owns the fund. It is generally seen asbad (from both the ethical and commercial perspective) to allowindividual lawyers to own shares in any client company, althoughsome firms do permit it. Long term, a fund may become reallyvaluable. Many firms therefore establish annual funds, whichclose off each year and only those partners who were in the firmduring that year participate. O'Melveny & Myers, for example,takes this approach. Managing partner C Douglas Kranwinkle sayshis firm's fund is, "Held by trustees in a blind trust. No onecan sell their share as the partnership holds the assets. Oncethe company goes public, it releases details to the partners andit moves to personal ownership on flotation".
Neal Millard at White & Case says at his firm the sharesare put into a trust for all the partners at the time the dealcame in. When it is liquidated, the distribution is based onpartnership shares, "We can vote in favour of a bonus for thepartner that brought the client in". He says the firm takes theattitude that, "You are risking firm money and the firm isbankrolling the client so any arrangement must be fair topartners not involved in the deal".
The other option is to allow your partners to invest in aseparate fund, which is then invested in clients. PillsburyMadison & Sutro's Marina Park, based in the firm's SiliconValley office, says her firm, "Has an investment fund but we donot take equity in lieu of fees. Partners can participate and itis divided according to the amount they put in. It depends ontheir stake. We are a partnership that practices law. It is notfor us to say to our partners that in lieu of fees we will makethis investment for you. These days most dot-com companies wouldrather pay you on financing". Orrick Herrington & Sutcliffehas established a fund where partners participate according totheir share. Says Leslie Jay, "We pay cash for stock as opposedto getting equity in lieu". The firm usually invests US$25,000(EUR25,000) and can allow the individual partners who brought inthe client to take upto 10%.

Keeping a distance

For some firms, the possibility of having to say no to aclient who believes that it has a great idea, but desperatelyneeds legal advice to get it off the ground, is enough to putthem off. John Hartigan at Morgan Lewis & Bockius says hisfirm does not take equity, "What is the client relationship ifyou say no? You are effectively saying you do not have confidencein the management".
The key for other firms is to distance both the partner andthe client from the decision. O'Melveny's Kranwinkle says hisfirm uses a committee to decide whether to make the investment,"Which looks for potential success, and does not just take apartner's word for it".
At Scottish firm Pagan Osborne, any proposal to accept sharesin lieu of fees is assessed by the firm's finance committee, inexactly the same way as any new client account. Says AlistairMorris, "They look at it and decide whether we can afford it atthis time, and then at whether it is a good investment".

Financial risk

By taking equity in lieu of fees, the firm is effectivelybetting some of its assets. This has a direct impact on thepartners eventual income in any one year. Says Rob Townsend ofMorrison & Foerster, this approach can affect the firm if theinvestments get to such a size that the firm becomes more aventure capital company than law firm. One way to deal with thisis to limit the investment, an approach taken by almost all thefirms on the West Coast. Says Cooley Godward's managing partnerLee Benton, "Make sure the investment is small in two differentways: in relation to the assets of the firm and in relation tothe equity of the client. That avoids it becoming an issue to thepartner and thus affecting his judgement".
The firms also seek to spread the risk, as not all theinvestments will pay off. One lawyer advises keeping a close eyeon what the venture capital companies do. If they invest it givesconfidence, as they will only take on one in 10 on average. Thenormal investment is US$25-50,000 (EUR25-50,000) or 1-2% of theequity. Pagan Osborne's Morris indicates that in Scotland thereis no hard and fast rule, but his firm would never take over 5%of the issued share capital.

The Venture Law Group guide to taking equity

Among the Silicon Valley law firms, Menlo Park based VentureLaw Group (VLG) is seen as having formulated a distinctivehands-on approach to its clients, which includes investing thefirm's own money into their development. "We're at the raggedbloody edge of the Silicon Valley schemes", admits corporatepartner Joshua Green.
Founded less than a decade ago by senior lawyers from three ofCalifornia's leading high tech law firms, VLG concentrates almostentirely on helping technology companies get started, findfinancing and develop their business potential. The firm emblemis an acorn and a number of clients, with VLG's assistance, havefound themselves turned dramatically into mighty oaks. Whilefirst and foremost legal advisors, the firm is keen to promoteitself also as a source of investment and business advice and akey tenet of its success is the strong links it maintains to theValley's venture capital community. The firm as a rule providesinitial advice free to start-ups and it is this apparent opendoor policy combined with its pedigree, business acumen anddedication to the sector that has helped propel it among the toptier of the firms active in the technology market.
VLG's relatively small size, around 22 partners, ensures thatit services only a limited pool of clients. Green reckons theircapacity is around 500 at any one time. The partners aretherefore able to offer a very hands-on approach, although heacknowledges that this style is not suited to everybody. Theyprefer to choose the clients they represent rather than let theclients choose them. From the outset lawyers take a key role inclient development, which often involves taking a seat on theboard or, at the very least, attending all board meetings.
The firm is therefore well placed to assess the businesspotential of the clients it represents and typically takes anownership stake in all those on its books. "There is no clientthe firm has that we would not invest in, we're not choosy", saysGreen. The commercial worth of a client is assessed from theoutset, "When a client is taken on, an investment in terms oftime and manpower, itself a precious resource, is already beingmade". It is only a relatively small step further to take a moreconcrete, financial, interest in their well-being. Cashinvestment and encouragement, two essentials start-up companiescannot have enough of. The financial injections are made eitherby offsetting fees, the purchase of company shares or acombination of the two.

Investment funds

The firm operates two pooled investment funds, VLGi forpartners and VLGa for associates, renewed annually with returnscalculated on a four-yearly basis. If a partner leaves after fouryears they will receive only 50% of the fund's final return. Noneof the investments have a set realisation period. Typicallyclients are steered towards an acquisition by a larger player oran IPO before returns are realised.
The firm invests in preferred stock, as any other investormight, along with taking common stock in client companies.Although loath to talk figures, Green states that the firminvests a "significant amount of after tax cash income" into theinvestment funds and that the per partner amount is "a figuremost lawyers would blanch at". Suffice to say VLG's initialinvestments in 1998-9 were treble that of the previous year anddouble again in the year 1999-2000. This year the figure islikely to be double this amount again.
VLG regards itself as having a relatively egalitarianremuneration structure with a "compressed compensation scheme",there is only a small disparity between the incomes of both themost senior and junior partners allowing the income derived fromthe firm's investments to be spread evenly. The partner VLGi fundaccounts for around 80% of the firm's total investments, theassociate fund VLGa the remaining 20%. The returns made aresignificant. Green states that VLG sees the investment process,and the sums realised through it as providing the lion's share ofthe firm's income, while fee receipts take a back seat. Wheremost firms see equity as the icing on the cake, to VLG equity isthe cake.

Waiver agreement

Green agrees that the issue of conflict is a thorny one, butone which VLG does its utmost to avoid, "The stock the firm takesis usually such a trivial amount, and the pecuniary interest thefirm holds in its clients (usually less that 1%) is such aninsignificant percentage of the total net worth, that the issuedoes not arise" he says. As a matter of course and in accordancewith the California State Bar's recommendation (Rule 3-300) allclients sign a conflict waiver agreement and are encouraged bothverbally and in writing to seek a third party opinion before anyagreement is entered in to. Clients then sign an acknowledgementthat such an option was extended to them. Green states however,that in practice this is not an issue and clients are more thanhappy with VLG's open attitude.
The amount of financial input, time and energy VLG invests inits clients is not typical of the firms active in Silicon Valley,although it is a successful model and one which attracts interestfrom other firms both in the US and Europe, including mostrecently UK firm Freshfields. VLG's tight industryspecialisation, organisational structure and ethos allow it theflexibility to operate in such a manner, nurturing the start-upclients it has, while maintaining an income stream derived fromoutside the traditional fee stream. An option not many firmswithout pre-existing alternative income sources are in a positionto adopt.

Professional ethics guidance

England and Wales

In response to requests for guidance by solicitors who arebeing offered share options in lieu of fees, the ProfessionalEthics Division of the Law Society of England and Wales hasissued the following notes.

Contingency fees

Firms receiving a share option as part of a remunerationpackage will be agreeing to a form of contingency fee. This isbecause whether or not the solicitors get paid will depend uponthe success of the company.
The view of the Law Society's Remuneration Team is that thereis no bar on contingency fees for this type of non-contentiouswork, but that any solicitor charging on a percentage contingencybasis should do so in non-contentious business agreement. Ifthere is no agreement, the total fees are liable to taxation or aremuneration certificate. The Chief Taxing Master would,apparently, take the view that, on a taxation, he would look atthe reasonableness of the charges in relation to the work done,applying the principles of the Solicitors' Remuneration Order1994 (SRO). That can be avoided where there is a non-contentiousbusiness agreement (see section 57 of the Solicitors Act1974).
The fees could then only be challenged if the agreement itselfwas unfair or unreasonable. Whatever the client agrees to now, itis wise to assume that if it were to turn out that thesolicitor's incentive payment was much higher that the clientanticipated, the client might look to overturn the agreement.This could be avoided by not agreeing to something which iscompletely open-ended. Our view is that it would be easier todefend the "unfair" claim if it was clear that the client had inmind that the agreement could result in the firm earning "up to£X". Another option would be to agree an upper limit so thatthe client would know the maximum payable.
If the firm decided that such an arrangement wasprofessionally acceptable and practical, then the major problemcould be overcome by ensuring that the fee arrangement iscontained in a non-contentious business arrangement. Our view isthat the solicitor could be at considerable risk of challenge ontaxation or a request for a remuneration certificate if therewere no non-contentious business agreement.
Any solicitor intending to offer standard terms of businessshould have regard to the Unfair Terms in Consumer ContractsRegulations 1994. If the agreements are on a one-off basis,agreed specifically with the client, there should be no problemswith those regulations.

Conduct issues

The main issue from a conduct prospective is the possibilityof taking unfair advantage of the client (see principle 14.12of The Guide to the Professional Conduct of Solicitors 1999-8thedition). However, provided that the client can predict thefinal fee and that fee is at a reasonable rate, it is difficultto see on what basis the client could complain or feelaggrieved.
If the circumstances are that the fee is unquantifiable andcould, therefore, "go through the roof", it may be wise to ensurethat the client has independent legal advice as to the merits orotherwise of the proposal, or at the very least the solicitorshould suggest to the clients that they should consider takingindependent advice.
The solicitor should also consider how the shareholding in thecompany may affect his future professional dealings with thecompany. The shareholding may put him in a position where he hasto decline subsequent instructions, for example, a proposed saleor company take-over because he has a personal stake in thecompany, and the impartiality of his advice would be open toquestion (15.04 note 10).

Other issues for consideration

Firms involved in this area will need to consider whether theyare involved in investment business (see principles 27.07 and27.03 and annex 27A of "The Guide to the Professional Conduct ofSolicitors" 1998 - 8th edition). Annex 271 of The Guidegives detailed guidance on corporate finance activitiesgenerally.

California Bar rules

The California Bar (HYPERLINK the issue of client investment and avoiding adverseinterests as long ago as 1989. The Professional Rules of Conductrule 3-330 stipulates that:
A member shall not enter into a business transaction witha client; or knowingly acquire an ownership, possessory,security, or other pecuniary interest adverse to a client, unlesseach of the following requirements has been satisfied:
  • The transaction or acquisition and its terms are fair andreasonable to the client and are fully disclosed and transmittedin writing to the client in a manner which should reasonably havebeen understood by the client.
  • The client is advised in writing that the client may seekthe advice of an independent lawyer of the client's choice and isgiven a reasonable opportunity to seek that advice.
  • The client thereafter consents in writing to the terms ofthe transaction or the terms of the acquisition.
Rule 3-300 is intended to apply where the member wishes to obtainan interest in client's property in order to secure the amount ofthe member's past due or future fees (amended by order of SupremeCourt, operative 14th September, 1992).
It is not intended to apply:
  • To the agreement by which the member is retained by theclient, unless the agreement confers on the member an ownership,possessory, security, or other pecuniary interest adverse to theclient. Such an agreement is governed, in part, by rule 4-200(fees for legal services).
  • Where the member and client each make an investment on termsoffered to the general public or a significant portion of thepublic.