By David M. Majchrzak
Note: This article originally appeared in the Solo and Small Firm Section’s Spring 2019 issue of “The Practitioner.”
In a traditional transaction, California lawyers receive U.S. dollars in exchange for providing legal services. But it is not unheard of to see transactions where lawyers are compensated in different ways. Most typically, alternate payments come through the provision of goods. But, of course, there are other options. And perhaps the most recent trend is toward the use of cryptocurrency.
California does not yet have any opinions—whether through case law or from its several ethics organizations—on this subject. So, this piece addresses what the author believes would be a common-sense approach to addressing a situation that is perhaps ahead of even the recently revised Rules of Professional Conduct.
John Oliver has quipped, “Cryptocurrency is everything you don’t know about money combined with everything you don’t know about computers.” Yet, it is not new. Cryptocurrency has been around at least since 2009, when Bitcoin first released its open-source software. Since then, over 4,000 alternative cryptocurrencies have emerged. It is transferred using blockchain technology. That means that each unit has a provenance encoded so that the names of each registered owner may be traced back to when the coin was initially mined or otherwise offered. Despite the increasing availability of cryptocurrency, it is still not in mainstream usage and, at the very least, presents unique challenges to handle properly, especially in the legal profession, where ethical rules govern lawyers’ conduct.
Nebraska’s First Take
Less than 18 months ago, Nebraska issued Ethics Advisory Opinion for Lawyers No. 17-03, the first published analysis of the circumstances, if any, under which lawyers may receive digital currencies as payment for legal services. While concluding it was permissible to receive cryptocurrency, Nebraska’s Lawyers Advisory Committee concluded that there were some significant restrictions.
For example, it concluded that, to ensure that the fee charged remains reasonable, lawyers should mitigate the risk of volatility and possible unconscionable overpayment for services by (1) notifying the client that they will not retain the digital currency units, but instead will convert them into U.S. dollars immediately upon receipt; (2) converting the digital currencies into U.S. dollars at objective market rates immediately upon receipt through the use of a payment processor; and (3) crediting the client’s account accordingly at the time of payment. And, lawyers may hold digital currencies in escrow or trust for clients or third parties so long as the attorney holds the units of such currencies separate from the lawyer’s property, kept with commercially reasonable safeguards and records are kept by the lawyer of the property. Authors of the opinion noted that, since cryptocurrency is property rather than actual currency, it cannot be deposited into a client trust account.
Whereas Nebraska’s opinion provides a great outline for conversation, it does not necessarily reflect how an analysis under California law would come out. For that reason, it makes sense to explore how the matter might be treated in our state.
Payment in General
Rule of Professional Conduct 1.5 provides in part that a lawyer shall not make an agreement for, charge, or collect an unconscionable fee. Given the acknowledged volatility of cryptocurrency valuation against the U.S. Dollar, the most likely question to arise is when to assess whether the fees is unconscionable.
Subdivision (b) of the rule provides that unconscionability is determined based on all the facts and circumstances existing when the agreement is entered into “except where the parties contemplate that the fee will be affected by later events.” There are two schools of thought on what that last clause might mean. On the one hand, it could refer to whether the liquidated value of the fee could be affected by later events. In the context of payment through cryptocurrency, that could mean that lawyers must consider market fluctuations that occur during the representation, and before accepting the payment that the lawyer and client agreed to at the beginning of the representation.
On the other hand, the concluding clause could simply refer to what the lawyer receives from the client could be affected by later events. Such an interpretation would mean that the conscionability analysis would properly take place after the engagement agreement where the amount of cryptocurrency could fluctuate (i.e., how many coins are paid), but not necessarily in instances where the comparative market value of the cryptocurrency changed.
The Nebraska opinion impliedly adopts the first point of view. It notes that the impact of fluctuations in the valuation of cryptocurrency could effectively convert payment for legal services at $200 per hour in one month to payment of an hourly rate of $500 the next. To safeguard against this, Nebraska lawyers have been advised to convert the cryptocurrency upon receipt to US dollars.
So long as the client consents, that appears to be a conservative and safe approach to handling the matter. And it would also make the handling of the funds much simpler, since they could be placed in a traditional client trust account, something discussed in more detail below. But it is unclear that such a step is necessary.
As a preliminary matter, there does not appear to be such a restriction on any other form of payment. That is, if a client wanted to pay in foreign currency, with stock, or through cases of wine, there would not be an assessment later on whether the fee makes sense simply because the market for the form of payment may change over the course of the representation. Ultimately, payment through such a form should be a business decision, not an ethical one, where an informed client and lawyer agree to shift the risk of loss or gain to the lawyer.
A contrary view, that we can only evaluate the conscionability of cryptocurrency at the time it is earned as opposed to the time of contracting, may reflect a reluctance to acknowledge that there are currencies other than the U.S. Dollar and that valuation need not be based on a single monetary system, simply because it has been around the longest. If a client agrees to a flat fee of, for example, 100 coins at the beginning of a representation, then there is a good reason to assess whether 100 coins was a fair fee amount at the beginning of the representation. We would do the same thing if the agreement was for payment of $10,000.
Let us assume that a lawyer has agreed that the client may pay for fees with cryptocurrency. And, since the lawyer believes that collections work is not fun, she requests a retainer. The client is willing to do so, but, since payment is to be made in cryptocurrency, the client asks what needs to be done.
Rule of Professional Conduct 1.15 addresses the safekeeping of client funds and property. It provides that all funds received or held by a lawyer must be deposited in a trust account. To the extent that lawyers receive securities or property of a client, they must identify and label the property promptly and place them in a safe deposit box “or other place of safekeeping” as soon as practicable. And, of course, lawyers or proscribed from commingling their funds and property with their clients’.
Compliance with these requirements is unclear when lawyers receive cryptocurrency. First, there is inconsistent government treatment of whether cryptocurrency should be classified as “funds” or “property.” California’s Money Transmission Act does not define virtual currency and the state’s Department of Business Oversight (DBO) has not published any guidelines. In 2014, the IRS released Notice 2014-21, which defined cryptocurrency as “a digital representation of value that functions as a medium of exchange.” Despite this acknowledgement that cryptocurrency serves the same function as more traditional funds, the notice stated that the IRS would treated virtual currency as property for federal tax purposes.
But there are several instances where courts have indicated that cryptocurrency should be treated as funds. (See, e.g., United States v. Ulbricht (S.D.N.Y. 2014) 31 F.Supp.3d 540 [creator of website for selling drugs convicted of money laundering bitcoin because cryptocurrency was used to pay for goods and services]; United States v. Faiella (S.D.N.Y. 2014) 39 F.Supp.3d 544 [concluding, “Bitcoin clearly qualifies as ‘money’ or ‘funds’ under these plain meaning definitions. Bitcoin can be easily purchased in exchange for ordinary currency, acts as a denominator of value, and is used to conduct financial transactions.”]; Securities and Exchange Commission v. Shavers (E.D.Tex. 2013) 2013 U.S. Dist. LEXIS 110018 [rejecting argument that Bitcoin is not money and, therefore, investing in it is not an investment in a security].)
Regardless of whether cryptocurrency is properly considered as property or funds, it seems clear that, at present, it cannot be kept in a trust account. Accordingly, there is some risk that regulators may conclude that lawyers may not accept cryptocurrency as payment of advance fees, settlement funds, or anything other than payment of earned fees. One safeguard against this might be attempting to deposit into a client trust account and then obtaining a document indicating that the unconverted cryptocurrency could not be accepted into the account.
But that does not alleviate the lawyer of responsibility. Funds must still be held in a place of safekeeping. The nature of the payment raises a whole new world of possible issues in security and protection of client funds, primarily involving hacking and cybersecurity.
If lawyers cannot hold funds in trust, then what options do they have? Any solution should focus on giving security to the funds and segregating from the lawyer’s personal property. Options may include simple solutions such as using the blockchain system in the same way a trust account is used. For example, the lawyer and client could both create electronic wallets. The lawyer would create two addresses within her wallet, one for client trust funds and one for earned funds. Upon engagement, the client could transfer the retainer amount (and then subsequent replenishments) to the client trust account wallet. The lawyer would then transfer the funds to the operating account wallet once they are earned.
Cryptocurrency is just another means of transferring money. There should be no unique ethical issues to the process. Still, there are reasons to be cautious, including the facts that there is no consistent current treatment of what cryptocurrency even is and that the Rules of Professional Conduct may not have caught up to this aspect of the marketplace. Ultimately, the same concepts of protecting the client’s property and funds should apply regardless of the form of payment.
David M. Majchrzak is a shareholder with Klinedinst PC who practices in the areas of legal ethics and professional liability claims. He can be reached at email@example.com.