Risk Reading — Private Equity Buying Law Firms, Pizza Shop Conflict, Confidential Information Disclosure During Client Intake

David Kluft notes: “If I consult briefly with a fellow attorney representing a pizza shop, can I later be adverse to the pizza shop?” —

• “A CT lawyer knowledgeable in eviction law gave some general information to a fellow attorney who was defending a pizza place against a commercial eviction, including listing some possible defenses and providing a sample motion to dismiss.
• “When the fellow attorney asked her to work on the case, she declined. The fellow attorney sent her some more information unsolicited to tempt her to take the case, but she remained firm. A few years later, she appeared in a commercial eviction matter for a different landlord but against the same pizza place.”
• “The pizza place moved to disqualify. The Court found that because the lawyer never spoke with or formed an attorney client relationship with the pizza place, there was no reason to ask if the matters were substantially related. She also had no duties to the pizza place as a prospective client, because she received no significantly harmful information, and any unsolicited information after she clearly declined representation doesn’t count.”

ALAS notes this twist in Winter v. Menlo —

• “When does disclosure of confidential information by a prospective client require disqualification under California Rule of Professional Conduct 1.18?”
• “In a case of first impression, the California Court of Appeal decided that materiality should be evaluated at the time a party moves to disqualify. It also held the information must be materially harmful to the prospective client, declining to define ‘material’ to mean the information is directly at issue in the case or of critical importance.”
• “In this case, the potential client disclosed not only his intention to sue the law firm’s client, but also his theory of the case and documents supporting it. Accordingly, the appellate court affirmed disqualification.”
• Decision: here.

“It’s illegal in most states for private equity to buy a law firm. Lawyers have figured out a workaround” —

• “Nearly every state has adopted a professional ethics rule from the American Bar Association forbidding lawyers from working for nonlawyer-owned firms.”
  “Lawyers, of course, have figured out a way around it.”
• “The loophole, known as a ‘managed services organization’ — or MSO — allows non-lawyers to effectively own part of law firms through a second corporate entity.”
• “Business Insider spoke to two attorneys who advise law firms on the arrangement, which they said is becoming increasingly common.”
• “In June, Puerto Rico’s high court allowed non-lawyer investment in law firms in order to spur economic development in the territory. Arizona, the only state that has done away with the ABA rule, in 2020, now has over 100 law firms that are open to outside investors, according to a recent Stanford Law School study. Large companies like KPMG and Rocket Lawyer now own law firms in the state outright.”
• “The MSO model, which isn’t limited to only Arizona, could appeal to law firm owners who want to retire or who don’t want to hand their firms over to a law partner.”
  “‘We’re in the midst of the largest rolling retirement of lawyers in history,’ said Lucian Pera, a legal ethics attorney at Adams & Reese who advises lawyers and businesses about setting up MSOs.
• “Using an MSO can give private equity firms — or other kinds of companies — a chance to effectively buy a slice of legal practices. And it gives lawyers the chance to sell stakes of their companies for cold, hard cash.
• “Traditionally, law firms have operated as partnerships among attorneys, where equity partners own shares in the firm and help manage it. That’s partly because of ethics rules designed to maintain attorney independence, such as ABA Model Rule 5.4(d), which largely prevents nonlawyers from owning law firms or from having the right to control the professional judgment of a lawyer.”
• “The ABA’s rules have made law practices distinct from many other white-collar professions, like finance or consulting, which may have robust ethical rules and norms but don’t impose such stringent limits on ownership. There are plenty of publicly traded banks and consulting firms, but no publicly traded law firms.”
• “As a workaround, the law firms can set themselves up as two corporate entities, Pera said. One is the law firm itself, composed exclusively of lawyers and owned only by lawyers. The second is the service organization, which can be owned by anyone and acts as a vendor for the law firm. It is essentially the back office, taking care of all non-lawyer tasks, including marketing, accounting, human resources, real estate leases, and employing paralegals. The two corporate entities enter into a long-term contract.”
• “Under this MSO arrangement, non-lawyers can invest in the service corporation, though not the law firm itself. Presto! You have an ethically independent group of lawyers who are exclusively working with a company that can sell shares, Pera says.”
• “According to Pera, no state bars have issued ethics opinions that expressly bless the MSO model, but no court or regulator has found a problem with it, either.”
• “‘The pieces fit well, and there’s no regulatory approval required for a law firm to do it, just like there’s no regulatory approval required for a law firm to take out a bank loan,’ Pera said.”
• “A spokesperson for the American Bar Association said its Center for Professional Responsibility doesn’t have any ethics opinions on non-lawyers investing in MSOs.”
• “Because law firms aren’t required to disclose their use of service organizations, it’s difficult to know how widespread the practice is.”
• “Pera said he knows of one firm that used the structure as far back as 2006. In more recent years, more law firms and investors have become interested in using MSOs, Pera and Lenfestey said.”
• “‘There are many more that are in process right now, and some of them are quite large,’ Pera said. ‘There’s a fairly large insurance defense firm in this country that’s looking at doing this. There’s a fairly large AmLaw-ranked law firm that’s looking at this. So there’s a non-trivial number of these that are going on.’”