Legal Ethics Corner

Ethics Corner is designed to present ethical issues that practitioners might well face on a daily basis. It is a service of the Legal Ethics Committee of the San Diego County Bar Association for SDCBA members.


Taking an Interest Adverse to the Client:  Part One of Three; Adverse Interests in the Fee Arrangement, A Trap for the Unwary Practitioner

In the prior Ethics Corner we looked at the need to comply with Rule of Professional Conduct 3-300 (“Avoiding Interests Adverse to a Client”) when taking an assignment of a client’s right to an attorney fee award as part of the fee arrangement.   However, 3-300 comes into play in other fee arrangements as well. 

First, however, a historical note.  The forefather of the current 3-300 was Rule 4, which simply provided, “A member of the State Bar shall not acquire an interest adverse to the client.”  Thus, even when the terms under which an attorney acquired an adverse interest where completely fair to the client and the client completely understood them, it was still unethical to do so, and attorneys were disciplined for violation of Rule 4. (See, e.g., Ames v. State Bar (1973) 8 Cal.3d 910 [attorney’s purchase of promissory note secured by first deed of trust, although actually done to protect client’s second deed of trust on same property, deemed violation of rule which is absolute].)  In 1975, the categorical prohibition was abandoned, and after a few changes through the years, the State Bar adopted current rule 3-300:

A member shall not enter into a business transaction with a client; or knowingly acquire an ownership, possessory, security, or other pecuniary interest adverse to a client, unless each of the following requirements has been satisfied:

    (A) The transaction or acquisition and its terms are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which should reasonably have been understood by the client; and

    (B) The client is advised in writing that the client may seek the advice of an independent lawyer of the client's choice and is given a reasonable opportunity to seek that advice; and

    (C) The client thereafter consents in writing to the terms of the transaction or the terms of the acquisition.

An attorney’s failure to comply with the above can constitute not only a possible ethical violation but can also result in the attorney missing out on significant financial gain.  The case of Passante v. McWilliam (1997) 53 Cal.App.4th 1240 is a striking example.  Therein, attorney for defendant start-up baseball card company helped acquire $100,000 in financing that was apparently vital to the survival of the company.  In gratitude, the defendant company’s board of directors agreed among themselves that the corporate attorney should receive three percent of the company’s stock.  Ultimately, however, “the company just outright reneged on its promise,” and the attorney sued.  The jury awarded attorney close to $33 million—the value of three percent of the stock.  However, the trial judge granted post-trial motions for judgment notwithstanding the verdict and for a new trial, and entered judgments for the defendants.  The Court of Appeal affirmed.  Despite repeatedly noting the moral obligation to honor the promise of three percent of the stock, the Court held that because attorney’s acquisition of the $100,000 in financing was not done as an agreed upon exchange for the stock, the company’s decision to give him the stock was an unenforceable promise unsupported by consideration.  Furthermore:

…if the stock promise was truly bargained for, then he had an obligation to the [company], as its counsel, to give the firm the opportunity to have separate counsel represent it in the course of that bargaining.  The legal profession has certain rules regarding business transactions with clients. Rule 3-300 of the California Rules of Professional Conduct (formerly rule 5-101) forbids members from entering "a business transaction with a client" without first advising the client "in writing that the client may seek the advice of an independent lawyer of the client's choice."

Here it is undisputed that [attorney] did not advise the [company] of the need for independent counsel in connection with its promise, either in writing or even orally. Had he done so before the [company] made its promise, the board of directors might or might not have been so enthusiastic about his finding the money as to give away three percent of the stock. In a business transaction with a client, notes our Supreme Court, a lawyer is obligated to give " 'his client "all that reasonable advice against himself that he would have given him against a third person." ' " ([Citations].)  Bargaining between the parties might have resulted in [attorney] settling for just a reasonable finder's fee. Independent counsel would likely have at least reminded the board members of the obvious-that a grant of stock to [attorney] might complicate future capital acquisition. (Id. at 1247-1248.) 

A case that applies 3-300 in quite a different factual setting is In re Silverton (2005) 36 Cal.4th 81.  Therein, attorney handled clients’ personal injury claims under a contingency fee arrangement.  Once the case against the tortfeasor settled, he offered clients a few hundred dollars in exchange for the right to keep any reduction he could negotiate for the outstanding medical bills.  The Supreme Court agreed with the State Bar Court’s conclusion that this arrangement violated 3-300 because attorney:

(1) failed to disclose to the [clients] information necessary for a reasonable understanding of the transaction, (2) failed to provide the [clients] with written notice of their right to seek independent legal counsel, and (3) failed to discharge his burden to show the transaction was fair and reasonable to the [clients]. In particular, Silverton failed to share with his clients, as he had with cocounsel Watson, his confidence that the medical bills could be compromised at a lower amount. (Id. at 86, 89.)

For an attorney to give a client ‘all that reasonable advice against himself/herself that s/he would have given as against a third person’ is no mean feat.  Thus, one can readily see the need for 3-300 in protection of clients, the public, and for the public’s esteem in the legal profession.

In the next two Ethics Corner pieces we will look at 1) 3-300’s application to taking a security interest for payment of fees (liens and promissory notes) and 2) its application to business transactions with clients that do not involve the fee arrangement.

--Luis E. Ventura

**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.**