California Supreme Court Reiterates Risk of Attorney-Client Transaction Being Nixed
LACBA Update, October 2004
By Joel D. Ruben of Lipofsky & Ruben. Ruben is a member of LACBA’s Professional Responsibility & Ethics Committee. The opinions expressed are his own.
For more than 200 years, attorneys have been legally and ethically constrained from entering into business transactions with their clients absent full disclosure, and fair and adequate consideration. In 1801, Lord Eldon, Lord Chancellor of England, elegantly expressed the rule that in such a transaction the attorney must give the client “all that reasonable advice against himself that he would have given him against a third person.” Gibson v. Jeyes, 6 Ves. 728.
The California Supreme Court adopted this principal of jurisprudence 113 years ago in Felton v. Le Breton (1891) 92 Cal. 457, 469 by quoting Lord Eldon with approval after explaining:
While an attorney is not prohibited from having business transactions with his client, yet, inasmuch as the relation of attorney and client is one wherein the attorney is apt to have very great influence over his client, especially in transactions which are part of...the very business in reference to which the relation exists, such transactions are always scrutinized by courts with jealous care, and are set aside at the mere instance of the client, unless the attorney can show by extrinsic evidence that his client acted with full knowledge of all of the facts connected with the transaction, and fully understood their effect...
These concerns found expression during the last century in Rule 4, then in Rule 5-101, and in current Rule 3-300 of the Rules of Professional Conduct of the State Bar of California, Avoiding Interests Adverse to a Client. Early this year, in Fletcher v. Davis (2004) 33 Cal. 4th 61, the California Supreme Court rendered an expansive interpretation of Rule 3-300 and reiterated the attorneys’ burden of giving advice against themselves to their client.
Specifically, the Supreme Court held that an attorney who bills hourly for representation in a lawsuit is subject to Rule 3-300 if the attorney obtains the client’s agreement to a charging lien on the recovery in the case. Since attorney Fletcher did not comply with the requirements of Rule 3-300, the Supreme Court held that “Fletcher’s lien may not be enforced in this proceeding.”
The Supreme Court rejected the argument that Rule 3-300 would only apply if the attorney’s lien could be used “to summarily extinguish” the client’s interest in the property. Instead, the Supreme Court enunciated a broader test for defining an adverse interest and applying Rule 3-300: “[W]as [it] reasonably foreseeable that the charging lien [i.e., the interest obtained by the attorney in the property of the client] could become detrimental to the client.” In the case of the charging lien, since it was “reasonably foreseeable” that a dispute between the attorney and client could result in the client’s recovery being “tied up” until the dispute was amicably settled or resolved by a declaratory relief action, the charging lien was an adverse interest.
A number of lessons can be drawn from reading Fletcher v. Davis:
Lord Eldon lives on. An attorney must advise a client in writing of the foreseeable detrimental consequences that could arise from the acquisition of the attorney’s interest in the client’s property. This is a crucial element in obtaining the client’s informed consent. In the context of a charging lien, Fletcher v. Davis provides a roadmap of the foreseeable detrimental consequences that may arise from a charging lien (33 Cal. 4th 68-70). But there are many other attorney-client transactions where an exhaustive recitation by the attorney of the foreseeable detrimental consequences to the client will be far more challenging (for example, where the attorney acquires shares in the client’s start-up corporation). The attorney should follow both the spirit of Lord Eldon’s 1801 admonition and the letter of Rule 3-300.
In reported cases involving “attorney-client deals,” attorneys invariably lose. Since Fenton v. LeBreton was decided in 1891, attorneys have a consistent losing record in cases arising from transactions with clients. See Vapnek et al., "California Practice Guide —Professional Responsibility" (TRG 2003) Secs. 4:265 et seq. and cases cited therein. Fletcher v. Davis is no exception. But defeat is not inevitable if the attorney follows Rule 3-300 to the letter and provides the client with fair and adequate consideration and gives the client all of the advice against himself that a competent independent attorney would render if actually consulted by the client.
If a fee agreement may result in tying up part or all of the client’s recovery, the attorney should follow Rule 3-300. In footnote 3, the Supreme Court stated it was not deciding “whether rule 3-300 applies to a contingency-fee arrangement coupled with a lien on the client’s prospective recovery in the same proceeding.” But if the test discussed above is applied to a charging lien on a contingent fee recovery, and if the attorney can tie up the client’s recovery, it logically follows that this is an adverse interest that triggers Rule 3-300.