Business Transactions with Clients - A Trap for The Unwary Practitioner

The Lawyer’s Lawyer is turning its attention to a situation that most of you have probably not considered in your practice, but have unknowingly participated in – business transactions with a client.  The significance of this is that not recognizing when you are involved in a business transaction with a client, you have set yourself up for a breach of fiduciary duty claim and potentially an inquiry, or worse, a Notice of Disciplinary Charges, from the State Bar.  This article will explore what constitutes a business transaction with a client and what you must do as the ethically responsible practitioner to satisfy your fiduciary duty and comply with the California Rules of Professional Conduct.

What Constitutes a Business Transaction with a Client?

California Rules of Professional Conduct, rule 1.8.1 deals with business transactions with client and what a lawyer must do if he or she wishes to engage in a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client.  (See also Prob. Code § 16004; Ramirez v. Sturdevant (1994) 21 Cal.App.4th 904, 917 [holding Probate Code section 16004 applies to the fiduciary relationship between attorney and client].)  Unfortunately, the Rule itself does not define is what exactly is a business transaction that would implicate this rule.  Nor do the comments to the Rule necessarily help.  The California Supreme Court in Fletcher v. Davis (2004) 33 Cal.4th 61, did however, address the issue of what constitutes a pecuniary interest adverse to a client and defined it as “when the lawyer possesses a legal right to significantly impair or prejudice the client’s rights or interests without court action.”  (Id. at 68; see also Rule Prof. Cond., rule 1.8.1, cmt. 1.)

Although Rule 1.8.1 does not define what transactions constitute business transactions with a client, some are clearly obvious.  For example, the following are business transactions with a client: forming a partnership with client to invest in real estate (Fair v. Bakhtiari (2011) 195 Cal.App.4th 1135, 1144); an oral joint venture agreement with a client to purchase real property (BGJ Associates, LLC v. Wilson (2004) 113 Cal.App.4th 1217, 1225-1226); borrowing money from a client (In re Matter of Johnson (1995) 3 Cal.State Bar Ct. Rptr. 233, 242); purchasing a promissory note secured by first deed of trust that was the subject of litigation that attorney handled for client where client had promissory note on the same property secured by a second deed of trust. (Ames v. State Bar (1973) 8 Cal.3d 910, 918-920); confession of judgment to secure legal fees (In re Matter of Lane (1994) 2 Cal. State Bar Ct. Rptr. 735, 745); and obtaining a deed of trust from the client to secure legal fees (Hawk v. State Bar (1988) 45 Cal.3d 589, 598-601).

Conversely, the case law and/or ethics opinions have identified some not so obvious transactions as business transactions with clients subject to Rule 1.8.1.  For instance: when an attorney who is also a real estate broker sells a house to a client (Cal. Eth. Op. 1995-141 *4); when an investment advisor, who is also an attorney, provides incidental legal services to his or her investment clients (Ibid.); when a lawyer receives a referral fee from a third party for referring the client to the third party for non-legal services (Cal. Eth. Op. 1999-154 *6); or when the lawyer places a charging lien to secure attorney’s fees on the client’s claim based upon an hourly fee agreement (Fletcher, supra, 33 Cal.4th at 71-72.)

The examples in the preceding paragraph, with exception of the last one, involve the concept of the lawyer acting in a dual role providing legal and non-legal services to a client, which can be the subject of its own article.  Suffice it to say that we as lawyers do not get the luxury of taking off our lawyer hats when it comes to clients even if we are providing non-legal services to the client, provided there is an existing attorney-client relationship or the non-legal services arose from the fruits of the lawyer’s legal representation.  (See, e.g., In re Matter of Allen (2010) 5 Cal. State Bar Ct. Rptr. 198; Hunniecutt v. State Bar (1988) 44 Cal.3d 362, 372.)  Thus, we always have to be mindful of any dealings with clients.

So, what constitutes a “business transaction” with a client for purposes of Rule 1.8.1 is clear as mud.  In discussing Rule 3-300, the predecessor to Rule 1.8.1, the Supreme Court in Fletcher, supra, stated’ “[a]lthough it is difficult to anticipate with precision the myriad of transactions that may arise between and attorney and a client, an attorney generally, ‘must avoid circumstances where it is reasonably foreseeable that his acquisition may be detrimental, i.e., adverse, to the interests of his client.’”  (Fletcher, supra, 33 Cal.4th at 62 quoting Ames v. State Bar (1973) 8 Cal.3d 910, 920.)

For those of us who are traditional defense lawyers, there is no recovery or settlement, typically, for which to place a lien on the client’s recovery.  Thus, we generally do not have to worry about Rule 1.8.1. in our practice.  That is typically left to plaintiff lawyers.  However, the case law is clear that a charging lien on the recovery of the client’s claim in a case involving a contingency, or hybrid contingency, fee agreement is not subject to Rule 1.8.1.  (See Plummer v. Day/Eisenberg (2010) 184 Cal.App.4th 38, 48-50.)  That is not the case where there is an attorney lien asserted based upon an hourly fee agreement.  So, for those of us who are not the traditional insurance defense lawyers and take on other cases where we are paid on an hourly fee basis, we need to be mindful of Rule 1.8.1 if we seek to assert a lien as part of our legal services agreement.

What Do We Have To Do If We Have a Business Transaction or Pecuniary Interest That Implicates Rule 1.8.1 In Order To Comply With the Rules of Professional Conduct?

The first rule of thumb is to error on the side of caution.  If you are unsure whether the transaction you are involved in with a client implicates Rule 1.8.1, govern yourself as if Rule 1.8.1 applies.  You will thank yourself later should things go south.  Alright Lawyer’s Lawyer, I am going to take your advice.  So what do I need to do?

Preliminarily, you as the practitioner should be thinking about, “what would I need to prove if the client sued me for breach of fiduciary duty based upon a transaction that I was involved in with the client?”  In this regard, you must overcome the presumption that there was insufficient consideration and undue influence.  (Fair, supra, 195 Cal.App.4th at 1152; Lewin v. Anselmo (1997) 56 Cal.App.4th 694, 701 [holding that a transaction between attorney and client during the representation is presumed to violate the attorney’s fiduciary duty and to have been entered into without sufficient consideration and under undue influence].)

Thus, to overcome this presumption, Rule 1.81. requires: (1) the lawyer fully explain and fully disclose the terms and conditions of the transaction; (2) the terms and conditions of the transaction must be fair and reasonable to the client; (3) the client must consent in writing to the terms and conditions of the transaction; and (4) the client must be advised, and given a reasonable opportunity, to obtain the advice of independent counsel regarding the transaction.  (Rules Prof. Cond., rule 1.8.1(a)-(c).)

Using a charging lien on an hourly fee agreement as an example, the lawyer would need to explain to the client what a lien means, what happens once there is a settlement or judgment to which the lien would attach, and what would happen in the event the client did not honor the lien, or there was a dispute about the attorney’s fees and costs owed.  On this latter point, the lawyer would need to explain that asserting the lien could hold up distribution of any settlement/judgment to the client until the issue of the lien was resolved.  Of course, if there was a portion of the attorney’s fees and costs that were not in dispute, the lawyer could not hold up that portion of the settlement/judgment.  (See Rule Prof. Cond., rule 1.15(c)(2).)

Regarding the fairness and reasonableness of the terms of the lien, set forth the reason for the lien.  Typically, a lien is asserted in order to ensure payment of any outstanding attorney’s fees and costs in the event the client gets behind in payments.  There is nothing inherently unfair about this as the lawyer is entitled to be paid.  Moreover, reiterate to the client that asserting a lien does not allow the lawyer to simply take the money.  Rather, there needs to be a judicial determination whether the fees and costs are owed in the event of a dispute.  In the attorney-client context, this means that the lawyer must comply with the Mandatory Fee Arbitration statutes set forth in the State Bar Act in the event of any fee dispute.  (See Bus. & Prof. Code § 6200 et seq.)  This explains to the client that there are remedies available to him or her in the event of a dispute. 

In advising the client to seek the advice of independent counsel, it is important that the lawyer give the client reasonable time to seek this advice.  Presenting the aforementioned disclosure to the client regarding the terms and conditions of the lien, or transaction, requesting that he or she sign it that same day will not suffice and is probably a per se violation.  Rather, send the letter setting for the terms and conditions of the lien, or transaction, to the client and give the client at least two weeks to obtain this advice.  Be careful about referring the client to a specific lawyer that you are friendly with or have a professional relationship with as it would require disclosure of the relationship (see Rule Prof. Cond., rule 1.7(c)) and could suggest that the advice will not truly be independent.  Rather, it is better practice to not refer the client to a specific lawyer.  Additionally, include a provision in this disclosure that the client was given the opportunity to seek the advice of independent counsel and voluntarily chose to waive this right.  If the client chooses to not seek the advice of independent counsel and signs the disclosure, they cannot be heard to complain later.

Lastly, and most important, do not proceed with any proposed transaction without obtaining the client’s signature on the disclosures and consent to the terms and conditions of the transaction.  Otherwise, the efforts to comply with Rule 1.8.1 will be for naught.  All of the disclosures in the world and referrals to independent counsel are meaningless for purposes of Rule 1.8.1 without the client’s written consent.  So be diligent.  If the client pushes back and executing the disclosure and consent, you as the lawyer should seriously consider not proceeding as that is a clear red flag of things to come, particularly if the transaction does not work out or there is a breakdown with the attorney-client relationship.

Conclusion

Transactions with clients are not per se impermissible.  However, as the lawyer, you should understand that you are in fact involved in a transaction with a client in the first instance and then govern yourself according to Rule 1.8.1.  The time it takes to do what you need to do to comply with Rule 1.8.1 is de minimis when considering what could happen if you do not.  As Benjamin Franklin said, “An ounce of prevention is worth a pound of cure.”  Good luck and until next time!

William A. Muñoz, Esq, is a Civil Trial Attorney, Legal Ethics Expert, and Third-Party Neutral with over 20 years of experience defending attorneys, and other professionals such as architects and engineers, real estate agents/brokers, real estate appraisers, and insurance brokers, as well as defending personal injury, toxic torts, products liability, defamation, wrongful termination / harassment, wage and hour and discrimination claims.

Mr. Muñoz also serves as a Dispute Resolution Conference judge for El Dorado County Superior Court, a judge pro tem for Sacramento County Superior Court’s Settlement Conference Department, and more recently, a mediator for the Third District Court of Appeals Mediation Program. His approach is further informed by the renowned Straus Institute for Dispute Resolution at Pepperdine University Caruso School of Law mediation training program and the National Conflict Resolution Center mediation training program.

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