Whether a Nonlawyer Employed by a Law Firm May Be Partly Compensated by a Percentage of the Profits of the Cases on Which He Works
A law firm may not compensate a nonlawyer employee, hired to work on designated class action claims against defendants who are members of a particular industry, based on a percentage of the profits earned from those cases. If the lawyers in the firm and the nonlawyer were to establish a separate partnership or other form of organization to litigate the class action cases, the fee arrangement would be permissible, provided that there were compliance with the restrictions of Rule 5.4(b) and other relevant rules governing such organizations.
The firm has hired—as an employee—a nonlawyer, who has worked as a consultant in the relevant industry, to assist it in this series of cases. The employee is currently paid a modest base salary and is paid on an hourly basis for the time that he spends on the series of cases. The firm wishes to alter the compensation system for this employee. It proposes to continue paying him a modest salary, but for future cases, plans to compensate him from the revenue received from the series of class actions. The compensation would work in the following fashion: The employee and the firm’s lawyers would keep track of their hours spent working on this series of cases as well as their expenses. As fees from these cases were received, they would be used to pay the employee for his expenses and for his time spent on the series of cases at an agreed-upon hourly rate. The firm also would be paid for its lawyers’ expenses and time spent as fees were received. If the fees were insufficient to compensate both the employee and the firm for the time spent prior to receipt, the fees would be divided on a pro rata basis between the employee and the firm, and the uncompensated hours, as well as any additional hours spent, would be compensated from the next fees that were received. If the fees were more than sufficient to compensate the employee and the firm for expenses and hours, the remaining funds would be divided between the employee and the lawyers on a pro rata basis depending on their respective contributions of expenses plus hours times hourly rates. The employee could never receive more than 49 percent of those fees. If the fees did not materialize, the employee would receive no compensation other than his modest base salary. If the fees were inadequate to compensate the employee and the lawyers for all their hours at their agreed-upon hourly rates, they would share proportionally in the shortfall.
The following example illustrates the proposal:
Assume that the employee has worked 90 hours and has expenses of $1,000. Assume
his hourly rate
is $100 per hour. Assume that the lawyer1 has worked 75 hours, that
his hourly rate is $200 per hour, and that he has incurred $5,000 in
expenses. These hours are not spent by either the employee or the lawyer
on just one case, but on a series of cases. One of these cases settles,
resulting in fees of $100,000. The employee would be paid $10,000 ($1,000
in expenses + 90 hours x $100). The lawyer would be paid $20,000 ($5,000
in expenses + 75 hours x $200). That would leave $70,000 in fees. These
fees would be divided based on the respective “investments” of
the employee and the lawyer or at a ratio of $10,000 to $20,000 or
1 to 2. Thus, of the remaining $70,000, the employee would receive
$23,333, and the lawyer would receive $46,667. If fees for the same
hours and expenses were only $21,000, the employee would receive $7,000,
the lawyer would receive $14,000, and the uncompensated hours and expenses
($3,000 and $6,000 respectively) would be carried over and added to
future hours and expenses until another fee was received. That fee
would then be divided using the ratio of hours times hourly rate plus
expenses invested as of that time, which might differ from the first
ratio. If no more fees were earned, there would be no compensation
for these hours and expenses.
A lawyer or law firm may include nonlawyer employees in a compensation . . . plan, even though the plan is based in whole or in part on a profit-sharing arrangement.
If this proposed compensation system does not fall within this exception, the inquirer asks whether, pursuant to Rule 5.4(b), the firm and the employee could enter into a joint venture arrangement. The employee would be a principal of and have a financial interest in the joint venture, which would represent the plaintiffs in this series of class actions. Were such an organization formed, could it use the proposed compensation system?
Previous Committee Opinions
In Opinion 233 (1993) this Committee described
two historical motivations for prohibiting fee-sharing with nonlawyers in addition
independent professional judgment: (1) preventing the unauthorized
practice of law and (2) preserving client confidences. It is not immediately
apparent how fee-sharing would threaten client confidences, at least
in the context of this inquiry. It would appear that the employee would
have the same job and presumably the same access to client confidences
regardless of how he is paid. Nonlawyer exposure to client confidences
by consultants, expert witnesses, secretaries, paralegals, and law
clerks is, of course, common. We are not sure that preventing unauthorized
practice is conceptually different from preserving professional independence.
Both reasons add up to discouraging nonlawyers from influencing or
making decisions about the practice of law, which should be reserved
for lawyers. Arguably, if the employee had a more direct stake in the
outcome of the class action cases, he might be tempted to interfere
improperly in those cases. But if the law firm met the requirements
set out in Rule 5.4(b) for admitting nonlawyers to the firm as partners
(particularly assuring that they comply with the Rules of Professional
Conduct), the threat to independent professional judgment or of unauthorized
practice does not seem appreciably greater than in the case of a nonlawyer
In addition to the Illinois opinion,
we have found one other opinion that permits a nonlawyer to be compensated
by a percentage of a subset
of a law firm’s profits, as opposed to its total profits. MI
Eth. Op. RI-143 (1992) approved payment of a percentage of the net
profits from a law firm’s sports and entertainment practice
area to a legal assistant who worked in that practice area. The Michigan
committee had earlier approved paying a nonlawyer employee a bonus
calculated on a lawyer’s gross or adjusted gross income, but
not tied to the employee’s efforts to solicit clients. The
committee did not think that basing the employee’s compensation
on the net profits of a practice area, rather than the net profits
entire firm, jeopardized a lawyer’s exercise of professional
judgment. It stated that the result might be different if the compensation
plan were based on the fees generated from a particular case or a
particular client. Like the Illinois opinion, this opinion is cryptic,
assume that the sports and entertainment practice of the law firm
was extensive enough so that compensation was not tied to a handful
cases or clients, which is not the case with the proposal we confront.
Prohibition on Sharing Fees from a Distinct
Set of Cases
Establishing a Joint Venture Organization
A lawyer may practice law in a partnership or other form of organization in which a financial interest is held or managerial authority is exercised by an individual nonlawyer who performs professional services which assist the organization in providing legal services to clients, but only if:From the description the inquirer has provided, we assume that the employee “performs professional services which [would] assist the organization in providing legal services to clients.” Rule 5.4(a)(4) provides, “Sharing of fees is permitted in a partnership or other form of organization which meets the requirements of paragraph (b).”
The District of Columbia Court of Appeals, which governs the D.C. Bar, has determined that lawyers and nonlawyers should be permitted to form a partnership or some other form of business venture. This reflects a judgment that clients can be better served when lawyers and other professionals combine to provide professional services to the public. See D.C. Rule 5.4, comments , , and . Our Court of Appeals has decided that so long as the principals of these business units adhere to the Rules of Professional Conduct, such ventures are permissible.
We conclude, therefore, that forming such an organization is permissible under Rule 5.4(b). In reaching this conclusion, we recognize that it would clearly be permissible under Rule 5.4(b) for the law firm to admit the consultant as a partner. Partners are compensated in a myriad of ways, and compensation could be based on the success of the cases on which the partner/consultant works. If the compensation system could be effected in this fashion, we see no impediment to the consultant and lawyers entering into the proposed joint venture arrangement. We take comfort from Rule 5.4(b)’s requirement that nonlawyer partners adhere to the Rules of Professional Conduct and that their lawyer partners are responsible for seeing that they do. Because the cases on which the consultant/partner would work are class actions, and because all members of the class are unknown, some of the joint venture’s “clients” will not know that a nonlawyer is a principal in the joint venture. This also would be the case if a law firm with a nonlawyer partner wants to bring a class action, and the joint venture would have to adhere to the various special rules that govern class actions and protect class members.
We point out, however, that the organization must adhere to the restrictions set out in Rule 5.4(b) as well as other restrictions set out in the Rules and elsewhere. For example, Rule 7.5(d) would require clients to be informed with clarity whether they were being represented by the law firm or by the joint venture organization, which would have to have a different names. These two entities would have to be separate entities in fact. Efforts would have to be made to protect the client secrets of the law firm from the members of the joint venture organization who were not firm members. Many of the considerations set forth in our Opinion No. 303, which concern the sharing of office space by unaffiliated lawyers, would apply. These would include separate letterhead, separate filing systems, appropriate signage if the same offices are utilized by both entities, proper telephone greetings by the receptionists, restrictions on access to computerized records, and the like.
We also believe that there would be some substantial practical barriers to the formation of such a joint venture organization unless the class action cases were all brought in the District of Columbia. No other U.S. jurisdiction permits lawyers and nonlawyers to practice together in this fashion. In fact, a member of the Virginia bar, who practices in a District of Columbia law firm that includes a nonlawyer as a partner, apparently may not engage in the practice of law in Virginia. VA Eth. Op. 1584 (1994). Were this joint venture organization to litigate any of these class actions in jurisdictions other than the District of Columbia, it might well face a claim that under the rules of the forum jurisdiction, it had entered into an unethical fee arrangement. See Rule 8.5(b) (choice of law rule applies disciplinary rules of foreign jurisdiction to conduct in connection with judicial proceedings in that jurisdiction.) In short, we believe that these practical limitations, plus the requirement that separate firms adhere to the appropriate formalities to operate in fact separately, may mean that such arrangements will be of utility only in limited circumstances.
Nevertheless, our Rules permit such organizations, and we see little distinction between forming such a joint venture organization with a consultant as a principal and the formation of a small public utilities law practice with an economist as principal. In each case the nonlawyer shares the fees, has a say in the organizational governance, and may be involved in every case. Rule 5.4 expressly allows the latter structure, and Comment 7 expressly endorses an economist’s joining a public utility practice. If our Rules allow one, they should allow both. So while the compensation plan would violate Rule 5.4(a) if implemented by a law firm, it is permitted by Rule 5.4(b) if the firm and the nonlawyer employee form a joint venture organization, provided that they adhere to the restrictions that the Rules impose on such an organization.
Adopted: February 16, 2004