The following is a case update written by the Hon Meredith Jury (United States Bankruptcy Judge, C.D. Cal. Ret.), analyzing a recent decision of interest:
The United States Court of Appeals for the Fifth Circuit ruled that when a law firm’s contingency fee agreement with its client would give the firm a fractional share in an equity interest of the client, such agreement calls into play Rule 1.8(a) of the Louisiana Rules of Professional Conduct (virtually identical to the ABA Model Rule of Professional Conduct 1.8(a)), which requires the firm to advise the client of her right to seek independent legal advice before signing the agreement. Failure to so comply, as occurred in the case on appeal, renders the fee agreement void. Wiener, Weiss & Madison v. Fox, 2020 U.S. App. LEXIS 26730 (5th Cir. 8/21/20).
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Four years into a contentious divorce between Leslie Fox and Harold L. Rosbottom, Jr., the divorce court appointed a receiver to assume control of the community estate, which consisted primarily of “state-licensed gaming enterprises” that operated in Louisiana. Within hours Rosbottom filed a chapter 11 bankruptcy in Louisiana. Fox engaged Wiener, Weiss and Madison, APC, and Kantrow, Spaht, Weaver & Blitzer (the Firms) to represent her in all matters related to the bankruptcy case. Originally the Firms agreed to represent Fox on an hourly fee basis, but since her assets were tied up in the bankruptcy proceedings, the Firms agreed to seek their fees directly from the court, payable from the community estate. This arrangement was followed for a year and the bankruptcy court granted a “Substantial Contribution” fee application for $1.2 million in 2010, which was paid by the estate.
The Firms believed it was unlikely the court would grant another such motion, but there was much more work to be done to secure for Fox her share of the assets. Therefore, they proposed a contingency fee agreement which assigned the Firms up to a 35% interest in the gross proceeds (cash or property) that Fox received for her claims against the estate and as an equity owner of the bankruptcy estate assets. Fox signed this agreement in 2010. The bankruptcy proceeding continued for another three years, resulting in a Plan of Reorganization which granted Fox 100% interest in a holding company comprised of the community gaming entities. Fox would not receive her entire interest until all creditors were paid under the plan,
Due to this further delay, the Firms advised Fox she must increase their contingency fee to 40% of the gross proceeds, including her rights as the full equity owner of the holding company. Fox again agreed and signed this 2013 agreement. The Firms then assisted the holding company in finding a lender to pay the remaining creditors so that Fox could receive her interest; Fox exclusively guaranteed that loan. Finally, in 2016, just before Fox was to receive her full ownership, the Firms declared the 2013 agreement unwieldy and sought to amend it so that the Firms receive 40% of any distributions of property or cash that Fox received rather than outright ownership. For the first time, the Firms recommended that Fox seek independent legal advice about whether to execute this new agreement. Fox did just that; her new counsel advised against her signing and she did not. Their relationship broke down and eventually a district court suit followed, whereby the Firms sought to enforce the 2013 agreement. Fox countered that the agreement was void because of their failure to comply with Rule 1.8(a) of the Louisiana Rules of Professional Conduct. Fox’s arguments did not prevail. The district court eventually granted summary judgment for the Firms and ordered Fox to specifically perform the 2013 agreement.
Fox appealed to the Fifth Circuit (the Circuit), which determined the contingency fee agreements from 2013 and 2010 were void, vacated the summary judgment, and remanded.
After satisfying itself that it had jurisdiction over the merits of the appeal, the Circuit took up Fox’s argument that the agreements were void for their failure to comply with Rule 1.8(a) which provided that “[a]lawyer shall not enter into a business transaction with a client” unless, among other things, the client is (1) advised in writing “of the desirability of seeking” the advice of independent legal counsel; and (2) given a reasonable opportunity to do so. It was undisputed that the Firms did not comply with that Rule in 2010 and 2013, but they asserted that the contingency fee agreements were not a “business transaction” because they did not convey a present interest in property; they only provided the Firms a future claim to 40% of the proceeds of the bankruptcy proceedings that might include property as well as cash. The Circuit found this definition of “business transactions” strained and counter to the purpose of the rule which is to prevent conflicts from arising between lawyers and their clients
The Circuit looked to other state and federal cases which considered what were “business transactions” in relationship to contingency fee arrangements with clients. Universally these authorities rejected that the “future” nature of the contingency agreements did not remove them from the realm of business transactions with clients. The Circuit agreed with the generally accepted conclusion that a fee arrangement that results in an attorney receiving stock in exchange for services or the attorney owning part of the client’s business or assets, whether now or prospectively, results in the attorney entering into a business transaction with the client and must comply with Rule 1.8(a). The failure of the Firms to give Fox the meaningful opportunity to receive independent legal advice before signing the contingency fee agreements rendered them void. The Circuit vacated the judgment and remanded for the district court to consider the Firm’s quantum meruit claims.
One of the authorities which the Circuit looked to was the American Bar Association comments on its Model Rule of Professional Conduct 1.8(a), a rule identical to the Louisiana Rule 1.8(a) and similarly adopted in the vast majority of the states (the primary exception being California, which has a similar requirement for review by independent counsel in a different rule). This opinion therefore is instructive to attorneys everywhere. The concept of what is a business transaction with a client is broad and will cover a fee arrangement which might vest in the lawyer any kind of interest in a client’s corporate shares, business operations, or assets. If the result of the agreement is the lawyer might co-own something with the client, then Rule 1.8(a) must be followed. Failure to do so makes the fee agreement void, not just voidable. And if that occurs, the lawyer will be looking to the good graces of a court in hopes that a quantum meruit claim will be awarded in some sum, often a smaller amount than a successful contingency fee would have achieved.
The policy behind this interpretation is simple: a lawyer must avoid any arrangements with his or her clients which might create a conflict as to whose best interest is being served unless the client knowingly waives that potential conflict. In Fox, the conflict was real because the Firms arranged a loan beneficial to their own interests which was exclusively guaranteed by Fox. The better practice would be to avoid this type of agreement altogether.
These materials were authored by the Hon Meredith Jury (United States Bankruptcy Judge, C.D. Cal. Ret.) a member of the ad hoc group, with editorial contributions by Adam Lewis, Senior Counsel, Morrison & Foerster LLP, a member of the ad hoc group. The opinions expressed herein are solely those of the author. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.