The murky situation of law firms investing in a client’s business is becoming a common question. Should they do it? Does this count as a conflict of interest?
The short answer is that it might be legal for attorneys to invest if they have a conflict of interest, but it still carries risks. Each attorney and law firm must weigh the risks, mitigate them, or avoid them altogether.
What is a conflict of interest?
It’s important to understand what a conflict of interest is and why it poses a threat to attorneys and law firms.
Clients can sue attorneys for malpractice if they feel like the attorney is acting in the attorney’s own interests above the client’s. In other words, if the attorney protects their financial interests more than their client’s, this is a conflict of interest.
A conflict is always going to be present when an attorney attempts to be both a legal counsel and an investor.
Is investing in a client’s business a conflict of interest?
Yes, investing in a client’s business, or taking stocks in lieu of traditional legal fees, can be seen as a conflict of interest.
There is a way to tell if there is a chance an investment could be a conflict of interest. Could the investment possibly impair the lawyer’s ability to provide objective counsel?
If the size of the investment is so large that it impairs the lawyer’s ability to provide independent judgment on behalf of the client apart from their stake in the decisions, then it might be a conflict of interest.
Risks of Attorneys Investing if They Have Conflicts of Interest
There really isn’t a right or wrong answer, but there are lots of risks that lawyers take on when they choose to invest in their client’s businesses. These are the most common ones that they face.
Accusations of Self-Dealing
The biggest risk is that the client will accuse the attorney of making decisions that benefit the attorney more than the client in order to protect their investment.
Lawyers should never put their own interests ahead of the interests of their clients.
Anytime attorneys or law firms are accused of putting their interests ahead of their client’s it brings a lot of negative publicity.
This has the potential to damage their reputation, which could cause some current clients to go elsewhere or make future clients untrusting.
As an attorney, your reputation and respect go a long way. It’s important to protect your name so you can keep the trust of your current clients and gain the faith of future ones.
The combination of attorneys investing in their client’s business and the business going through a bad financial time is the perfect storm for a malpractice suit.
Unfortunately, clients are more than happy to allow attorneys to trade stock for services when business is good. If the business hits hard times, they might try to sue the investing attorney for malpractice, blaming them for acting in their own interest.
Not only is a malpractice suit expensive, but the burden of proof lies entirely on the attorney. The lawyer will have to prove they did everything right. One misstep and they could lose the suit.
How to Mitigate the Risks
There are ways to minimize the risks if a lawyer or law firm wants to make these investments. These actions are explained in detail in a recent ABA report about conflict of interest.
Explain the Conflict of Interest Clearly
It is entirely the attorney’s responsibility to disclose the conflict of interest clearly to the client. Attorneys must establish informed consent and make sure the transaction is fair.
Contracts must be clear, upfront, and extremely detailed about every possible conflict of interest that might arise. Explain this to the client and make sure they understand the terms of the investment.
The detailed disclosure must have these three things:
Provide detailed information so the client understands the transaction.
Describe the degree of the attorney’s interest.
Advise the client to see independent counsel about the investment.
Advise the Client to Seek Independent Counsel
If the attorney is trading stocks for services, they should encourage the client to seek independent counsel in order to protect the client’s interests.
If an attorney fails to advise the client to obtain this counsel, they are at risk for a conflict of interest.
Update the Agreement and Disclose Again When Things Change
Anytime anything changes, the attorney must provide the same level of adequate and extensive disclosure.
The client must continually understand the current status of the attorney’s financial stake in their business and how it affects their counsel.
Invest as a Firm
It’s always better to invest in a client’s business as a firm, not as an individual lawyer. Anytime that an attorney has a personal stake in something - independent of the firm - it might impair their ability to think on behalf of the client.
When the firm invests together, they hold each other accountable and make smarter decisions.
Investments Should Not Be the Exclusive Form of Payment
It’s easier to prove a conflict of interest if the attorney’s only form of payment is the stock in the company. It’s better to accept monetary payment.
Make Small Investments
If the attorney or the law firm really wants to invest in a client’s business, the investment should be so small that it is non-material to the law firm and/or client.
Mitigate the risk of a conflict of interest by refusing to take so much stock that the attorney or law firm gains controlling interest in the client’s business.
Play It Safe
So, can an attorney invest if they have a conflict of interest? Honestly, it’s best to play it safe and refuse to accept stock in place of traditional legal fees.
If a malpractice suit arises, the courts might assume the business transactions are fraudulent. Then, the attorneys bear all the burden to prove otherwise.
Contact Power Forward Group
If you have further questions about law firms investing in clients, please contact our staff. We offer financial planning for lawyers and are ready to answer your questions. We will discuss your current situation and future goals, helping you reach your financial milestones.