Other People’s Money (Special Credit)
What are the ethics rules when a third party is paying the client’s legal fees?
If the practice of law were a midway carnival, the title of California Rule of Professional Conduct 3-310—titled “Avoiding the Representation of Adverse Interests”—would hang over its funhouse mirrors, likely with a subtitle: “Enter at your own risk.”
It is in the nature of conflicts of interest that people who have them do not see them. Instead they see distorted images that cloud their judgment and misdirect their thinking. When lawyers have conflicts, there can be cascading negative effects for both lawyer and client from a single error in professional judgment.
It is small wonder that lawyers might approach the labyrinthine lawyer-client relationships described in rule 3-310 with fear and avoidance. There are many compelling reasons for a lawyer to decline a particular client matter based on a conflict of interest, but the lawyer’s reluctance to grasp the rule’s terms of engagement should not be one of them. When lawyers shy away from entire tranches of potential clients because the rules governing those representations appear foreboding, the public is underserved.
A Necessary Rule
Rule 3-310(F) addresses what to do when the client’s legal fees are being paid by a third party. In that situation, conflict is baked into the client’s legal matter and therefore cannot be avoided; for the client to be represented at all, the conflict must be managed.
The good news is that the rule provides the tools necessary to make these relationships work. A practitioner’s understanding of rule 3-310(F) not only protects but empowers the client, for it illuminates opportunities even as it exposes risks. The rule is, in fact, a microcosm of a lawyer’s core duties to a client: competence, confidentiality, and loyalty. Yet it is also forward-thinking, acknowledging the realities of a marketplace in which legal fees and costs may be subsidized by an outsider.
Rule 3-310(F) begins with a prohibition: a lawyer shall not accept compensation for representing a client from one other than the client unless: (1) there is no interference with the lawyer’s independent professional judgment [competence]; information relating to the representation is protected [confidentiality]; and (3) the lawyer obtains the client’s informed written consent [loyalty].
Core values notwithstanding, there is a streak of exceptionalism in the rule that seems designed to smooth the flow of resources for legal services. For example, sections (F)(3) and (4) provide that the client’s informed written consent to third party payment is not required if the nondisclosure is otherwise authorized by law or if the lawyer is rendering legal services on behalf of a public agency. The rule is simple in concept, but learning it by rote is not enough for a lawyer to navigate the universe of its potential applications, which may justly be described as Shakespeare described Cleopatra, as being of “infinite variety.”
The key is for lawyers to internalize the principles so that they become instinctive rather than just rationalized. Following are some scenarios, both real and hypothetical, that apply rule 3-310(F) to third party payment of legal fees. Collectively, they suggest strategies for practitioners and clients to manage their relationship (and utilize the “outside” financial resources) with confidence.
Friends and Family
The State Bar of California’s Committee on Professional Responsibility and Conduct considered one of the most common sources of third party payment of legal fees in Formal Opinion 2013-187. In the hypothetical, a spouse retains a lawyer to handle a dissolution of marriage. The spouse’s parent agrees to pay the lawyer’s fees on an hourly basis (as well as costs), and advances a sum to the lawyer for that purpose. The lawyer makes all the required disclosures to the spouse and obtains the spouse’s written consent. The parent also signs an agreement acknowledging the financial arrangements as well as the restrictions specified in rule 3-310(F). Upon conclusion of the representation, the lawyer files an appropriate withdrawal. What was not addressed in the written agreements was that there may be unused funds left in the lawyer’s trust account. In the hypothetical, both the Spouse (client) and parent (third party payor) make competing demands for the release of the trust fund balance.
The opinion concluded that under these circumstances the lawyer has a fiduciary duty to advise the third party payor of the availability of the funds and to pay them to payor. Even though rule 4-200(B)(4) requires a lawyer to promptly deliver to a client on demand funds in the lawyer’s possession, such funds are qualified by the phrase “which the client is entitled to receive.”
As Formal Opinion 2013-187 notes, third party payors may have a protected interest in the disposition of funds paid to the lawyer on the client’s behalf but not exhausted during the representation.
Under some circumstances third party payors may also may have a claim on the lawyer’s duties as a fiduciary, even if that claim is in conflict with the lawyer’s duties to the client. It is prudent for a lawyer in that situation to do everything done by the hypothetical lawyer in Formal Opinion 2013-187, plus include provisions in both agreements—the representation agreement with the client who will be the focus of the representation, as well as the agreement with the third party who will be paying the fees—as how to distribute unused funds held in trust. While it is impossible to cover all eventualities, many potential disputes are foreseeable and the best practice is to anticipate and plan ahead with designated resolutions set down in writing for future reference.
In Good Hands
In a key case under rule 3-310(F), the court of appeal held that when an insurance company selects and pays for the insured’s counsel in a legal matter arising from a covered event, both the insurer and the insured are clients. See State Farm Mut. Auto. Ins. Co. v. Fed. Ins. Co., 72 Cal.App.4th 1422 (1999). The normal “Cumis” situation (as described in San Diego Navy Fed. Credit Union v. Cumis Ins. Soc’y, Inc., 162 Cal.App.3d 358 (1985)) is an identity of interests between the insurer and the insured, in that they have a shared goal of minimizing or eliminating the insured’s liability for claim. That’s not to say there is a perfect balance of power between them, but it is customary for the insurer to control the defense it provides. See State Farm, 72 Cal.App.4th 1429.
But that being said, it is also worthy of note that the tripartite relationship—which exists between the retained attorney, the insurance carrier who is paying the fees, and the insured client—also triggers special protection for the insured under rule 3-310(F). If the lawyer accepts compensation from the insurer to represent the insured, the lawyer must obtain the insured’s “informed written consent,” defined in rule 3-310(A)(2) as the client’s written agreement to the representation following written disclosure. Rule 3-310(A)(1) defines “disclosure” as informing the client of the relevant circumstances and of the actually and reasonably foreseeable adverse consequences to the client.
An engagement letter that complies with 3-310(F) is an excellent opportunity to create a sound working relationship from the outset between insurance counsel and the insured. The best of these letters includes a disclaimer as to scope of representation; describes types of information shared with the insurer; explains who has settlement authority; and outlines how the insured may fulfil its duty to cooperate in the defense.
Misalignment of shared interests between the insurer and the insured are never more than a coverage quibble away. The Cumis decision established that when an insurer provides the insured with counsel but reserves the right to assert noncoverage at a later date, the insured has a right to independent counsel whose fees are also to be paid by the insurer. In 1989, the Legislature codified the Cumis rule (see Cal. Civ. Code § 2860) and addressed some the more contentious issues associated with it, such as the tension between both lawyers’ duty of confidentiality to the insured and the insurer’s need for sufficient information about the matter to protect its own interests as indemnifier.
With an express nod to Cumis, the comment to rule 3-310 states that subsection (F) is not intended to abrogate existing relationships between insurers and insureds whereby the insurer has a contractual right to unilaterally select counsel for the insured.
Rule 3-310(F)(3)(a) also acknowledges the realities of the insurer/insured relationship in what may be an oblique reference to section 2860. The rule creates an exception to the requirement for disclosure and the client’s informed written consent if nondisclosure is “authorized by law.” Section 2860(d) imposes an affirmative duty on both the insured and its Cumis counsel to disclose to the insurer all information concerning the action except privileged materials relevant to coverage disputes. Injection of the Cumis counsel relationship does introduce new dynamics for all parties, including the potential for spirited fee disputes between the insurer and Cumis counsel that can impact the insured. (Section 2860(c) also provides that the insurance company has the right to insist that the retained attorney have certain minimum qualifications and carry errors and omissions insurance.)
In one case, the insured narrowly dodged the bullet as a potential recourse to the insurer for reimbursement of excessive fees received by Cumis counsel. See Hartford Cas. Ins. Co. v. J.R. Marketing, L.L.C., 61 Cal.4th 988 (2015). The Hartford case serves as another powerful reminder that careful compliance with 3-310(F) will include a thoughtful (and thorough) fee agreement between Cumis counsel and the insured that addresses foreseeable disputes, such as what happens if the insurer challenges or fails to pay the fees of Cumis counsel.
Fortunately for practitioners, the State Bar provides sample written fee agreements on its website, including an optional disclosure clause entitled “Other Payor-Insurance” that provides a model for Cumis counsel. The agreements can be accessed at at http://www.calbar.ca.gov/Attorneys/Forms.
What About Champerty?
For plaintiffs’ counsel, the not-so-final frontier of rule 3-310(F) is Alternative Litigation Finance (ALF), a term applied generally to investors’ nonrecourse payment of money to parties in litigation (usually plaintiffs) in exchange for a share of the proceeds of the action.
If ALF raises a visceral aversion in many lawyers, it is not surprising. Medieval abuses of the legal system known as maintenance, champerty, and barratry still haunt the recesses of legal consciousness. From the website of one international ALF firm, Burford Finance www.burfordcpital.com, come the following useful definitions:
- “Maintenance” is helping someone else maintain a lawsuit, generally by providing financial assistance;
- “Champerty” is maintenance for profit; and
- “Barratry” is serial maintenance, such as being a runner or capper.
The feudal practices to which these terms refer (perhaps most notably the purchase of meritorious claims by lords for a pittance from impoverished peasants and manipulation of courts for profit) are no more. Philosopher and jurist Jeremy Bentham (1748-1832) famously declared the charge of “maintenance” to be legally obsolete. So influential was Bentham in laying a foundation for modern litigation financing that international ALF provider IMF Australia changed its name to IMF Bentham Limited in his honor.
If that is the situation, then why should we discuss these terms today? Because obsolete or not, maintenance, champerty, and barratry keep resurfacing in ethics-based arguments opposing ALF.
In October 2011 the American Bar Association’s Commission on Ethics 20/20 released a White Paper on Alternative Litigation Finance that provides a 360 degree review of related ethics issues. A must-read for any lawyer considering ALF, the White Paper is a very accessible handbook for successfully navigating ALF’s ethical landscape. (It is available at http://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20111212_ethics_20_20_alf_white_paper_final_hod_informational_report.authcheckdam.pdf.)
Three specific conclusions of the White Paper are pertinent here: first, advising on, or being involved with, ALF agreements is not unethical per se; second, non-recourse litigation funding is not champerty; and third, ABA Model Rule 1.8(f), the counterpart to Rule 3-310(F), doesn’t apply to ALF transactions that do not involve payment of “compensation for representing a client.”
The example given in the White Paper is a tort plaintiff receiving $10,000 from a supplier in exchange for a promise to repay the supplier out of the proceeds of a judgment or settlement. Since there is no payment of the lawyer’s fees, the transaction is a passive investment and the rule does not apply. For the same reason, the rule would not apply to a share of plaintiff’s claim assigned to the supplier for its $10,000 investment.
Formal Ethics Opinion 2011-2 of the New York City Bar Association reached similar conclusions: non-recourse litigation funding is not unethical per se; such agreements are not champertous under New York law (nor in California, which never adopted the doctrine of champerty and maintenance, see Martin v. Freeman, 216 Cal.App.2d 639, 641-42 (1963)); and a lawyer may turn over a portion of the client’s recovery to a funding company pursuant to non-recourse agreement. Because the last would be a share of the client’s proceeds and not attorney fees, the disclosure and consent requirements of ABA Model Rule 1.8(f) would not attach. Even so, an arrangement of that sort would quite likely raise other issues, such as ethical concerns for the lawyer in compromising confidentiality and exercise of independent professional judgment; and there is a potential waiver of attorney-client privilege from sharing information with an investor. Nevertheless, both the White Paper and the New York opinion suggest that those are manageable risks, and they describe ALF as a growth industry. As if on cue, in 2011 IMF Bentham launched Bentham, its United States subsidiary.
Clearing the Path for ALF
A 2014 decision from Illinois closed the circle by expressly finding that the doctrines of champerty and maintenance “have been narrowed to a filament” and did not apply to the plaintiff’s ALF deal documents so as to render them discoverable as part of an unclean hands defense. See Miller UK Ltd v. Caterpillar, Inc., 17 F.Supp3d 711, 728 (N.D. Ill. 2014). The court quoted the ABA’s 2011 White Paper that “society’s embracing of credit as a financial tool have paved the way for a litigation financing industry that appears poised to continue to grow…” Id. at 727. Miller UK reinforced the idea that the infusion of other people’s money into litigation via ALF presents no issues under 3-310(F). Lawyers can safely consider ALF as the new normal rather than as an ethical tripwire.
ALF may be growing as an industry, but it does not follow that it has achieved its potential as a resource to clients. In a 2015 article in California Lawyer magazine, Senior Editor Thomas Brom related the story of a breakout session in a midweek conference entitled, “Open Coffers.” Four representatives of large ALF suppliers appeared on a panel to discuss the world of third party litigation funding and find themselves addressing an audience of—one. Panelists described an intricate process that includes multiple nondisclosure agreements, analysis by in-house claims experts, and approval by all partners. All of the panelists limited their investments to business-to-business disputes such as contracts, antitrust, and intellectual property. See Brom, “Full Disclosure: Capital Comes Calling,” California Lawyer, Oct. 2015 at 12-14. There may be barriers to the ALF industry, but they are not ethical barriers.
In the end, other people’s money may be a path to justice for people who have no other way to get into court. Their best opportunity for obtaining the resources they need is a lawyer who can confidently navigate through the channels of public protection afforded by the rules of professional conduct. Mindful compliance with rule 3-310(F) provides guidance, support, and may even present opportunities.
Much more dangerous for lawyers is avoidance and ignorance of the rule and its strictures, for counsel who fails to heed rule 3-310 risks representing clients in complex litigation where the lawyer becomes trapped, exhausting her own financial resources and being unable to competently proceed or, worse, being forced to withdraw for ethical reasons.
Victorian author Anthony Trollope may have articulated it best when he told the story of a man who finally discovered his bliss after challenging the authority of his domineering but nurturing spouse: “There is no greater source of felicity in life than a wife [or rule] well obeyed.”
Teresa J. Schmid is a professional responsibility attorney and consultant in management and public policy. A former executive director for the State Bar of Arizona and for the Oregon State Bar, and former Assistant Chief Trial Counsel for the State Bar of California, she is chair of the Professional Responsibility and Ethics Committee for the Los Angeles County Bar Association.