Business Transactions With Clients
Is a lawyer with business dealings with a client protected if the client
relies on independent counsel?
By Steven A. Lewis
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Lewis |
While most lawyers know there are rules and risks associated with entering
into business transactions with clients, many lawyers assume they are protected
if they advise the client to consult with independent counsel and the client
does so. In this article, we will set up a plausible scenario and then examine
whether a lawyer is in fact protected when the client hires independent counsel.
Scene 1: CLIENT INVITES ATTORNEY TO PARTICIPATE IN A JOINT VENTURE
Carl Client retained Anne Attorney to obtain a prescriptive easement for use
of parking spaces on an adjacent parcel. The parties were in the midst of expensive
discovery when opposing counsel called Anne and conveyed an offer: His client
would settle if Carl would purchase the parcel with the parking spaces together
with a larger adjoining parcel and dismiss his lawsuit.
Complying with Rule 3-500, Anne explained the settlement offer to Carl. Anticipating
that Carl would be interested in the deal but unable to afford it, Anne told
Carl that another one of her clients, Donna Developer, might be interested in
exploring a joint venture and arranged for them to meet.
Carl and Donna hit it off and decided they wanted to buy both parcels, but
that they should bring one other person into the deal. Not surprisingly, they
invited Anne Attorney to become the third member of their joint venture. Anne
replied, "Deal me in."
Scene 2: FORMATION OF THE JOINT VENTURE
At the meeting, Carl, Donna and Anne agreed they would each contribute 1/3
of the capital and obtain a 1/3 voting interest in the venture. Because dismissal
of the lawsuit was a condition of the deal, Anne suggested they put the litigation
on hold, and Carl agreed. Anne then decided she better put the parties' agreement
into writing, so she prepared and signed Articles of Organization naming the
joint venture "CAD." Anne then drafted a proposed Operating Agreement which
(1) stated she was not representing Carl or Donna on this deal and (2) advised
them both to have the agreement reviewed by independent counsel. Carl took Anne
up on her suggestion and hired Indy Counsel.
Scene 3: INDEPENDENT COUNSEL ENDS THE DEAL
Indy reviewed the draft Operating Agreement and told Carl not to sign it because
certain provisions were not fair to him. On May 1st, Carl Client and Indy Counsel
met with Anne Attorney and Donna Developer. At that meeting, Carl tendered his
1/3 capital investment to Anne and Donna, but did so with a letter stating that
he would not sign the Operating Agreement unless changes were made allowing
him to exercise control over the parcel with the parking spaces. With Carl's
knowledge, Donna signed a purchase and sale agreement on behalf of CAD.
Anne Attorney and Indy Counsel continued to discuss Carl's problems with the
terms of the deal, but they could never reach an agreement. Hence, the joint
venture unraveled, and Anne substituted out of the prescriptive easement lawsuit.
Carl, who still needed the parking spaces for his business, purchased the property
with other partners and dismissed his prescriptive easement lawsuit.
Scene 4: ATTORNEY SUES CLIENT TO RECOVER
HER INTEREST IN THE PROPERTY
Angry over having lost the investment opportunity, and knowing the purchase
and sale agreement had been in the name of the joint venture, Anne filed a suit
on behalf of CAD, Donna and herself against Carl and his new partners to establish
their 2/3 interest in the property. Carl defended, asserting that the May 1st
oral joint venture was void because Anne, as his lawyer, had entered into a
business transaction with him without full written disclosure and advice, and
without obtaining his written consent, all in violation of Rule of Professional
Conduct 3-300 and Probate Code §16004.
Anne shot back: "Carl, you never relied on me as your attorney on the joint
venture. I told you in writing I was not your lawyer on this deal and that you
should hire independent counsel. And you did so! All you are doing is trying
to become unjustly enriched at Donna's and my expense. See you in court."
Scene 5: THE OUTCOME ACCORDING TO BGJ
ASSOCIATES, LLC V. WILSON (Dec. 2003) 113 Cal.App.4th 1217, 7 Cal.Rptr.3d
140
What standards apply when an attorney enters into a business transaction with
a client? Are those standards altered when the client is represented by independent
counsel? Will Anne prevail in her action against Carl? These and other questions
were recently addressed in BGJ Associates, LLC v. Wilson, supra,
where the court began its analysis by looking at Rule of Professional Conduct
3-300.
RULE 3-300. Pursuant to Rule 3-300, when an attorney enters into a business
transaction with a client, or acquires an ownership, possessory, security or
other pecuniary interest adverse to a client:
- The transaction must be: (1) fair and reasonable to the client; and (2)
fully disclosed and transmitted in writing to the client in a manner reasonably
understood by the client; and
- The client must: (1) be advised in writing to seek the advice of independent
counsel of the client's choice; (2) be given a reasonable opportunity to
consult with independent counsel; and (3) consent to the transaction in writing.
Rule 3-300 was triggered here because Anne was Carl's attorney at the time
of the transaction. However, Rule 3-300 can also be triggered in a deal between
an attorney and former client, where the former client trusted the attorney
because of the prior relationship. (Hunniecutt v. State Bar (1988) 44
Cal.3d 362, 371-372.)
Looking at our scenario, the BGJ court determined that Anne failed to comply
with the first two requirements of Rule 3-300. First, the court determined that
the deal was not fair and reasonable to Carl because: (1) putting Carl's lawsuit
for a prescriptive easement on hold benefited Anne and Donna, but did not benefit
Carl; (2) the deal required the dismissal of Carl's lawsuit, but never gave
Carl the objective of his lawsuit (the parking spaces); and (3) the proposed
operating agreement allowed Anne and Donna to override Carl by a simple majority
vote.
Second, the court concluded that despite the written Operating Agreement, the
deal was not fully disclosed in writing, finding: (1) Anne and Carl never reached
agreement on a document embodying the essential terms of the joint venture,
as the Operating Agreement was never signed; and (2) Anne failed to give Carl
advice against herself that she would have given had Carl been coming to her
about a deal with a third party.
Anne did satisfy the next requirements of Rule 3-300, as she notified Carl
in writing of his right to independent counsel and gave him an opportunity to
do so. However, she failed to comply with the Rule's final requirement, obtaining
Carl's written consent.
Although Anne did not formally comply with each and every one of the specific
requirements of Rule 3-300, she argued that because Carl was actually represented
by Indy Counsel in connection with the transaction, her non-compliance should
be excused. In this regard, Anne claimed that Indy gave Carl all the advice
against Anne that he needed. Carl, on the other hand, argued that strict compliance
with the letter of the rule is required.
The BGJ court resolved this dispute by holding that: Even if a client
entering a business transaction with a lawyer is represented by independent
counsel, the lawyer must still satisfy all of the elements of Rule 3-300. As
the rule contemplates a situation where a client both consults with independent
counsel, and consents in writing to the terms of the agreement, both are required.
[Accord, Chambers v. Kay (2002) 29 Cal.4th 142, a fee splitting agreement
could not be upheld under Rule 2-200 without written consent even if the lawyer
provided written disclosure.]
As Anne violated rule 3-300, Carl asserted the case was over. However, the
BGJ court found that while the violation meant Anne had committed a disciplinable
offense, it did not automatically render the transaction void or voidable. Noting
that in addition to the rules of professional conduct, statutes and principles
generally governing fiduciary relationships help define the fiduciary duty of
attorneys, the court turned its analysis to Probate Code §16004(c).
PROBATE CODE §16004(c). Pursuant to Probate Code §16004(c)
a transaction between a trustee and beneficiary occurring during the relationship
that is advantageous to the trustee is presumed to be a breach of fiduciary
duty and to have been entered without sufficient consideration and under undue
influence. The presumption affects the burden of proof.
Although §16004 expressly applies to the relationship of trustees and
beneficiaries, it also applies to the relationship between attorneys and clients.
In fact, since the 19th century, transactions between attorneys and clients
have been "scrutinized . . . with jealous care, and . . . set aside at the mere
instance of the client" unless the attorney has overcome the presumptions by
showing, through extrinsic evidence, that:
- The client acted with full knowledge of the facts;
- The client fully understood their effect;
- The deal was fair and just; and
- The client was fully advised, which means that the attorney must prove
that he/she gave the client all that reasonable advice against the attorney
that the attorney would have given the client against a third party. (Felton
v. Le Breton (1891) 92 Cal. 457, 469.)
In analyzing our scenario, the BGJ court pointed out that the deal was not
fair and just, citing the same facts upon which it concluded the deal was not
fair and reasonable under Rule 3-300. The court also noted that Anne never fully
advised Carl against herself, as she never informed Carl: (1) whether he was
better served through the joint venture or prosecuting his easement action;
or (2) of the value of his easement lawsuit to the joint venture. Hence, Anne
could not overcome the presumptions that she breached her fiduciary duty to
Carl, provided insufficient consideration and exercised undue influence.
The net result of Anne's inability to overcome the presumptions of Probate
Code §16004(c) was that the transaction between Anne and Carl was voidable
at Carl's election. As a result, and based upon Carl's legal challenge, the
joint venture between Carl, Anne and Donna was deemed void, and all of the claims
advanced by Anne and the CAD joint venture, including their claim of unjust
enrichment, failed.
Scene 6: DOES A THIRD PARTY INVESTOR
FALL WITH THE ATTORNEY?
But what about Donna Developer's claims inasmuch as she was not an attorney
and had no obligations under rule 3-300 or Probate Code §16004? In answering
that question, the BGJ court stated that Donna lost all of her rights
in the transaction as well because she stood to benefit from the unfairness
of the deal. In other words, Donna's fates were tied to, and fell with Anne's
claims.
What are the ramifications of that finding? Anne's next risk: A malpractice
action by Donna asserting that Anne should have explained that if Anne became
a member of the joint venture, Donna's interest was at risk of failing with
her own.
Epilogue
While attorneys are not prohibited from entering into business transactions
with clients, they must proceed cautiously and in recognition of the risks of
State Bar discipline, losing all interests or gains from the transaction, becoming
responsible for all losses, and even exposure to malpractice claims by other
parties to the transaction whose fates are tied to those of the offending lawyer.
The mere fact that a client is represented by independent counsel in connection
with the transaction does not eliminate the lawyer's obligations pursuant to
Rule of Professional Conduct 3-300 and Probate Code §16004. Any attorney
contemplating a business transaction with a client should therefore carefully
study the legal principles applicable to the transaction and seek objective
advice with regard to the disclosures being made.
Steven A. Lewis, a principal of Lewis & Bacon in Sacramento,
has been advising and representing lawyers for more than 25 years. He is a frequent
speaker and author on legal ethics and risk management and is also an adjunct
professor of law at McGeorge School of Law.
Certification
- This self-study activity has been approved for Minimum Continuing Legal
Education credit by the State Bar of California in the amount of one hour
of legal ethics.
- The State Bar of California certifies that this activity conforms to the
standards for approved education activities prescribed by the rules and regulations
of the State Bar of California governing minimum continuing legal education.
Self-assessment test
Answer the following true-false statements after reading the MCLE article on
Rule of Professional Conduct 2-100. Use the answer
form provided to send the test, along with a $20 processing fee, to the
State Bar. If you do not receive your certificate within four weeks, call 415-538-2504.
- An attorney representing a client in a civil action is never ethically bound
to convey an oral settlement proposal to a client.
- It is a violation of the Rules of Professional Conduct for an attorney to
acquire a pecuniary interest adverse to a client.
- Rule 3-300 can apply to business transactions between attorneys and former
clients.
- Rule 3-300 does not apply to a business transaction between an attorney
and client if the attorney states in writing that he or she is not representing
the client with respect to the transaction.
- An attorney satisfies Rule 3-300 if the attorney advises the client in writing
that the client should consult with independent counsel on the transaction
and the client does so.
- An attorney satisfies Rule 3-300 if the attorney states in writing that
he or she is not representing the client on the transaction, and that the
client should consult with independent counsel on the transaction, and the
client hires independent counsel to advise the client with respect to the
transaction.
- If a transaction between an attorney and client is not fair and just to
the client, the client can take all of the benefit of the deal and leave the
attorney with nothing, and the attorney's claim of unjust enrichment will
fail.
- Rule 3-300 applies only when an attorney enters into a business transaction
with a client.
- An attorney complies with the provisions of Rule 3-300 relating to independent
counsel if he or she presents a full and complete disclosure to the client
during an office meeting, and at the attorney's request the client immediately
signs and returns the disclosure during the meeting.
- A deal between an attorney and client is enforceable, even if it is not
fair and just, so long as the attorney has made full disclosure and the client
consents.
- It is an improper conflict of interest for an attorney entering a business
deal with a client to attempt to advise the client against himself or herself
as if the attorney were advising the client against a third person.
- If, at Attorney A's urging, a client hires independent counsel to represent
the client in a business transaction with Attorney A, the client is estopped
from complaining that he or she did not receive full disclosure of the terms
of the deal.
- An attorney who enters into a business transaction with a client that is
not fair and reasonable to the client is subject to State Bar discipline.
- A violation of Rule 3-300 automatically bars the attorney from recovering
anything in a civil action in connection with a business transaction between
the attorney and a client.
- The Rules of Professional Conduct, by themselves, define the duty component
of the fiduciary duty of attorneys.
- Because the attorney-client relationship and the trustee-beneficiary relationship
are distinguishable, Probate Code §16004 does not apply to the attorney-client
relationship.
- The lawyer making a business deal with a client has the burden of proving
through extrinsic evidence that (1) the client acted with full knowledge of
the facts and fully understood their effect, (2) the deal was fair and just,
and (3) the client was fully advised against the interests of the attorney.
- If an attorney fails to demonstrate that (1) the client acted with full
knowledge of the facts and fully understood their effect, (2) the deal was
fair and just, and (3) the client was fully advised against the interests
of the attorney, the deal is automatically void.
- A third party involved in a transaction between an attorney and the attorney's
client can lose his or her interest in the transaction because of the attorney's
failure to overcome the presumptions of Probate Code §16004(c).
- Rule 3-300 contemplates not only full disclosure by the attorney to the
client and written consent, but representation of the client by an independent
attorney.
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