A Philadelphia law firm, or a subsidiary thereof, (the "Firm") wishes to form a real estate broker company and a mortgage broker company (the "Companies"). The members of the Firm, who are shareholders in the Companies will refer business to such entities and will share in real estate brokerage commissions and/or brokerage fees generated by sales of real estate and the subsequent issuance of a mortgage.
The inquirer seeks the Committee's opinion on several different issues in order to determine whether the proposed business relationships of the Firm and the Companies comply with the Pennsylvania Rules of Professional Conduct (the "Rules").
The inquirer's first question is whether the Firm may become a limited partner of both the Companies. Under Rule 5.4(b), a lawyer is not permitted to form a partnership with a non-lawyer if any of the activities of the partnership consist of the practice of law. Therefore, provided the Companies do not perform any legal services, such a business relationship is permitted.
The inquirer then asks several questions regarding the "consumers and/or customers" of the Companies. The Committee points out that guidance on these questions is different, depending on whether the "consumers and/or customers" are also "clients" of the Firm. Thus, each question will be answered for both situations.
1) Must the lawyers of the Firm who are the shareholders in the Companies have to disclose to all consumers and/or customers of the Companies the amount of the fee the attorney will earn in each such entity for providing non-legal services?
If the consumers and/or customers are not clients of the Firm, then no disclosure of the relationships or the lawyers' involvement in the Companies is required. If the consumers and/or customers are clients of the Firm, then the lawyer must adhere to disclosure and waiver provision of Rule 1.7(b) (Conflict of Interest).
2) What Rules are to be considered if the lawyers in the Firm do not provide legal representation and services to the consumers and customers of the Companies?
If the consumers and customers are not clients of the Firm, the lawyers involved are not required to disclose the business relationships. However, due to the potential for a misunderstanding on behalf of the consumer/customer as to the existence and protection of the lawyer-client relationship, the inquirer must be very careful of the provisions of Rule 5.7 (Responsibilities Regarding Nonlegal Services). That Rule provides in part that:
(c) A lawyer who is an owner, controlling party, employee, agent, or is otherwise affiliated with an entity providing nonlegal services to a recipient is subject to he Rules of Professional Conduct with respect to the nonlegal services if the lawyer knows or reasonably should know that the recipient might believe that the recipient is receiving the protection of a client-lawyer relationship.
(d) Paragraph¼(c) does not apply if the lawyer makes reasonable efforts to avoid any misunderstanding by the recipient receiving nonlegal services. Those efforts must include advising the recipient that the services are not legal services, and that the protection of a client-lawyer relationship does not exist with respect to the provision of nonlegal services to the recipient.
The Comment to Rule 5.7 provides in part that:
The Potential for Misunderstanding
Whenever a lawyer directly provides non-legal services, there exists the potential for ethical problems. Principal among these is the possibility that the person for whom the non-legal services are performed may fail to understand that the services may not carry with them the protection normally afforded by the client-lawyer relationship. The recipient of the non-legal services may expect, for example, that the protection of client confidences, prohibitions against representation of persons with conflicting interests, and obligations of a lawyer to maintain professional independence apply to the provision of non-legal services when that may not be the case. The risk of such confusion is especially acute when the lawyer renders both types of services with respect to the same matter.
[end of comment]
In the present inquiry, if a reasonable person would or should know that the consumer/customer might believe that he or she is receiving the protection of the client-lawyer relationship the inquirer must comply with Rules 5.7(c) and (d) supra.
If the consumers and customers are also clients of the law firm, then in addition to compliance with Rule 5.7, the inquirer must also comply with the strict disclosure and waiver provisions required by Rule 1.8 (a) which addresses conflicts of interest caused by having business dealings with a client.
3) Do the consumers and customers need to be advised that information they provide to either one or both of the Companies is neither confidential nor privileged?
The Committee points out that there are substantive laws regarding release of confidential financial information which is beyond the scope of this inquiry. However, from an ethical perspective, Rules 5.7(c) and (d) again come into play. If the lawyer knows, or reasonably should know, that the recipient of the services might believe the recipient is receiving the protection of a client-lawyer relationship, then the lawyer must make reasonable efforts to avoid and correct any misunderstanding by the recipient receiving those nonlegal services. This same analysis applies whether or not the consumer and customer is a client of the Firm as well. Should there not be compliance with Rule 5.7(d), the attorney will be responsible for assuring that both the attorney's conduct and to the extent required by Rule 5.3, that of the non-lawyer employees of the Firm, comply in all respects with the Rules of Professional Conduct which includes adherence to the requirements of Rule 1.6 relating to disclosure of confidential information.
4) Do the consumers and customers of the Companies need to be advised to consult with an attorney?
If the consumer/customer is a client of the Firm, the provisions of Rule 1.8(a) are triggered, and the attorney must advise and give reasonable opportunity for the client to seek the advice of independent counsel in the transaction (Rule 1.8(a) (2)).
If the consumer/customer is not a client, Rule 5.7(c) would again apply. If the lawyers do not comply with the requirements of Rule 5.7(d), the attorney will again be responsible for assuring that both the attorney's conduct and to the extent required by Rule 5.3 that of the Firm's non-lawyer employees, comply in all respects with the Rules of Professional Conduct. The lawyer must take special care to heed the proscriptions of the Rules addressed to conflict of interest. (Rules 1.7 through 1.11, especially Rules 1.7(b) and 1.8(a) (b) and (f)). (See comment to Rule 5.7 "Responsibilities Regarding Nonlegal Services" supra).
5) What disclosures regarding potential conflicts of interest inherent in the provision of the real estate and broker services by the Companies are required?
Again, in situations where the consumers/customers are not clients of the Firm, the potential for conflicts of interest may be avoided by adherence to Rule 5.7(c). If the consumer/customer is a client of the Firm, the relationship is fraught with potential conflicts of interest. For example, if the client/customer does purchase a property and secure a mortgage through the related entities, and later defaults on the mortgage, the lawyer and the law firm have a conflict of interest. Even if the client is not in default of the mortgage, but the Firm has an interest in an entity providing a mortgage to the client, it can, depending upon the specific facts of the relationship, create a conflict of interest. Therefore, the lawyer is under the obligation to provide a complete disclosure to the client in accordance with Rule 1.8(a) should mortgage or broker services be provided to a client.
6) Are there any ethical constraints that would require the lawyers participating in the business ventures to provide the consumers/customers with any disclosures prior to referring such consumers and/or customers to the Companies?
If the consumers/customers are not clients of the Firm, there is no other disclosure required other than the precautions set forth in Rule 5.7(c) and (d). If the consumer/customers are clients of the Firm, then the disclosures required under Rule 1.8(a) must be provided.
7) What ethical disclosures are required should the Firm discount its legal fees by the commissions received and represent the consumers and/or customers in a related real estate transaction involving the Companies?
Obviously, this question can only be analyzed one way, since it presumes that the customers/consumers are in fact clients of the Firm, but the analysis of the facts is in no way affected by any discount on the fee. The proposed conduct raises a conflict of interest problem for the lawyer and the Firm. The comment to Rule 1.8 concerning transactions between the client and the lawyer provides "as a general principle, all transactions between client and lawyer should be fair and reasonable to the client." In a situation where the lawyer has an interest in the mortgage company who has granted a mortgage to the client, the lawyer may not be able to provide independent advice to his client concerning the terms of the mortgage, etc. The same is true where the lawyer has an interest in the real estate company who has arranged the sale or purchase of the property to be sold. Such situations may present a non-waivable conflict under 1.7(a)(1). If not, the lawyer must comply with requirements provided in Rule 1.8(a).
The Committee does not herein address the definition of "client." However, such expectations may trigger Rule 5.7(c)(d). The reasonable expectations of persons (that they are "clients") is addressed, supra.