The Crux of the Issue: What is Rule 5.4, and Should it Be Changed?

The State Bar's Task Force on Access Through Innovation of Legal Services (ATILS) issued its report making tentative recommendations aimed at improving access to justice on July 11, 2019.  Public comment was received through September 23, 2019.  Most comments were negative, and most of that negativity was directed at the alternative recommendations regarding current California Rule of Professional Conduct 5.4 that would recognize the division of fees with non-lawyers and allow non-lawyer investment in entities providing legal services.

The brouhaha over Rule 5.4 means that change is not likely to move as swiftly as in some other states like Utah and Arizona, states much further along in opening up the guild to participation by non-lawyers.  Nothing happens quickly in California; it took us 18 years to revise our Rules of Professional Conduct.  It is a good time to refresh our understanding of what the ethical rules say about the whole topic of non-lawyer involvement and our experience with it.  

Evaluation of proposals to amend or repeal the prohibitions against non-lawyer participation in the delivery of legal services, chiefly centered in California Rule 5.4, but also reflected in the Business and Professions Code statutes regarding the unauthorized practice of law (sections 6125 through 6127) and wrongful solicitation of clients and legal referral services (sections 6152 through 6155) require evaluation of issues of public policy that involve more than legal ethics.  The public policy underlying Rule 5.4 is succinctly summarized in the comments to ABA Model Rule 5.4:

[1] The provisions of this Rule express traditional limitations on sharing fees. These limitations are to protect the lawyer's professional independence of judgment. Where someone other than the client pays the lawyer's fee or salary or recommends employment of the lawyer, that arrangement does not modify the lawyer's obligation to the client. As stated in paragraph (c), such arrangements should not interfere with the lawyer's professional judgment.

[2] This Rule also expresses traditional limitations on permitting a third party to direct or regulate the lawyer's professional judgment in rendering legal services to another. See also Rule 1.8(f) (lawyer may accept compensation from a third party as long as there is no interference with the lawyer's independent professional judgment, and the client gives informed consent).

Note the use of the word “traditional.” California’s relatively new version Rule 5.4 closely tracks the ABA Model Rule and the same public policy underlies it

Rules 5.4, titled, Financial and Similar Arrangements with Nonlawyers, effective November 1, 2018, has six parts.

Section (a) prohibits a lawyer or law firm from sharing legal fees "directly or indirectly with a nonlawyer or with an organization that is not authorized to practice law" with some limited exceptions, including fees paid to State Bar certified Legal Referral Services.

Section (b) forbids a lawyer from forming "a partnership or other organization with a nonlawyer if any of the activities of the partnership or other organization consist of the practice of law."

 

Sections (a) and (b) track previous California Rules of Professional Conduct, but section (c) is wholly new. It states that a lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s independent professional judgment or interfere with the lawyer-client relationship in rendering legal services."

Section (d) is also new and updates the prohibition on forming a partnership to include other types of business entities " authorized to practice law for a profit if: (1) a nonlawyer owns any interest in it, except that a fiduciary representative of a lawyer’s estate may hold the lawyer’s stock or other interest for a reasonable time during administration; (2) a nonlawyer is a director or officer of the corporation or occupies a position of similar responsibility in any other form of organization; or (3)a nonlawyer has the right or authority to direct or control the lawyer’s independent professional judgment." (Emphasis added.)

Non-lawyers seemingly have a greater scope of permissible involvement in non-profit entities, although such entities also have their own section, Section (f). That section prohibits a lawyer from practice with or in the form of a nonprofit legal aid, mutual benefit or advocacy group if the nonprofit organization allows any third person to interfere with the lawyer’s independent professional judgment, or with the lawyer-client relationship, or allows or aids any person to practice law in violation of these rules or the State Bar Act."

Sandwiched between these two thought-provoking slices is Section (e), which blandly authorizes the Board of Trustees to formulate Minimum Standards for Lawyer Referral Services that are binding on lawyers.  But it gets spicier in the last sentence which provides a lawyer shall not accept a referral from, or otherwise participate in, a lawyer referral service unless it complies with those standards.

The essence of the Rule has been around since original Rule 3 of California’s first set of Rules of Professional Conduct approved in 1928.  And with good reason.  Non-lawyers have always been a part of the practice of law.  They have often been deeply involved in the marketing of legal services (i.e., getting clients) and the management of legal service providers.  Plaintiff's personal injury practice has been especially problematic, and it is specifically mentioned in Rule 3 and colorfully described in early Rule 3 cases like Townsend v. State Bar of California (1930) 210 Cal. 362, 364.  The legal profession in the early 20th century owes much of growth to the invention of automated transportation.  Much of the impetus for the invention of the State Bar was a perceived need to crack down on "ambulance chasers."

There are many reported decisions involving Rule 3, but strangely, very few under Rule 3’s successors, Rule 3-102 and Rule 3-120, whose reign was relatively brief 14 years from 1975 to 1989.  That may reflect some of the problems the discipline system was experiencing as it was swamped by the explosive growth of the legal profession and an organizational structure that might be characterized as a "Mom and Pop" operation.

The pace picks up in the 1980's, and the reform of the discipline system, including a new full-time State Bar Court empowered to write precedential opinions.  Most of those cases involve personal injury practice, and they reflect various degrees of abdication of responsibility by the respondent lawyers, e.g.

  • paying a capper for cases and allowing the capper to interfere the client's choice of counsel (In the Matter of Nelson (Review Dept. 1990) 1 Cal. State Bar Ct. Rptr. 178, 1990 WL 140525) (6 months actual suspension);
  • allowing a non-lawyer to operate an entire law practice of hundreds of cases with almost no lawyer involvement In the Matter of Jones (1993) 2 Cal. State Bar Ct. Rptr. 411 1993 WL 156262 (two years actual suspension); and

 

  • allowing a non-lawyer to exercise almost all power in a law practice even after the respondent lawyer knew that he was stealing from both the lawyer and the clients (In the Matter of Steele (Review Dept. 1997) , 3 Cal. State Bar Ct. Rptr. 708, 1997 WL 438845.)

More recent cases have involved lawyers involved with non-lawyers in providing loan modification services in the wake of the Great Recession. Both In the Matter of Huang (Review Dept. 2014) 5 Cal. State Bar Ct. Rptr. 296, 2014 WL 232686 and In the Matter of DeClue (Review Dept. 2016) 5 State Bar Ct. Rptr __, 2016 WL 3004465) involved lawyers who allowed non-attorneys to run every aspect of the loan modification practice; in fact, both cases involved the same non-attorneys, who left a number of damaged lawyers in their wake.

The point is not that personal injury lawyers are bad people. Non-lawyers exercising significant control or de facto ownerships of a legal service provider occur in many practice areas involving consumer clients, family law, consumer bankruptcy, immigration;  the PeopleLaw hemisphere, as Professor Henderson labels. His study of the Legal Services Landscape was the impetus for creating ATILS. The changes in the economics of the delivery of legal services are set forth in Professor Henderson’s study are well documented and consistent with the experience of many lawyers in the PeopleLaw hemisphere of law practice.

The point is that personal injury is an especially lucrative area of law practice. The discipline experience suggests non-lawyers seeking to invest in an enterprise will want to go, like Willy Sutton, to where the money is.

There is no doubt that there are many legal service providers where non-lawyers are deeply involved, often in violation of Rule 5.4, often disguised with various structural arrangements designed to make the non-attorney invisible or inconspicuous. In the last ten years, Legal Zoom, UpCounsel, Avvo Legal Services and other legal service providers leveraging technology to provide low-cost legal services have emerged and openly challenged traditional rules regarding the unauthorized practice of law and division of legal fees with non-lawyers with mixed results. Some of those platforms seem to operate very much as legal referral services.  Non-attorney involvement in providing legal services, disguised and explicit, is manifest even if the extent isn’t clear. 

What is very clear is the magnitude of the unmet need for legal services, especially in areas like family law, where self-represented litigants are the rule.  Some part of the increase in non-attorney involvement is probably related to unmet need, sometimes called "the justice gap."

The only empirical evidence ATILES cites is a law review article by Nick Robinson When Lawyers Don’t Get All the Profits: Non-Lawyer Ownership, Access, and Professionalism, from 2016.  In examining what Alternative Business Structures in Great Britain, entities where non-lawyers can now hold equity, Robinson finds the top market share held by these providers in the personal injury practice (33.5%), consumer protection (19.77%) and general non-litigation practice (16.8%), while family law, a dramatic example of the justice gap with most litigants unrepresented, reflecting a market of only 5.27%.  Robinson, at 20. Robinson notes that personal injury is a particularly profitable practice area which also requires large upfront costs and would naturally attract outside investors for that reason (Robinson, at 21.)

This is consistent with the historical discipline caselaw cited above.  It suggests that changing Rule 5.4 might help to legitimize and regulate the non-lawyer involvement that currently exists but might not lead a rush of innovation in areas where the expected return on investment is not so high.  Investors, after all, are in it to make money.

David C. Carr is founder of  the Law Office of David C. Carr. 

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**No portion of this summary is intended to constitute legal advice. Be sure to perform independent research and analysis. Any views expressed are those of the author only and not of the SDCBA or its Legal Ethics Committee.**