Playing the Percentages: Is It Ethical?
LACBA Update, October 2010

By Ellen Pansky of Pansky Markle Ham LLP, advisors to the legal profession. Pansky is an assistant vice president of LACBA, a former chair of LACBA’s Professional Responsibility and Ethics Committee, and former disciplinary counsel to the State Bar. The law firm represents attorneys in litigation and in State Bar disciplinary matters, counsels attorneys on legal ethics compliance, and provides expert testimony on legal ethics and standard of care issues. The opinions expressed are her own.

As outsourcing becomes more prevalent, lawyers and law firms are looking at new methods to improve the bottom line of their law practices, including finding ways to use third-party vendors. One new opportunity relates to the use of an outside billing service to prepare, transmit, and collect fees for legal services. LACBA’s Professional Responsibility and Ethics Committee received an inquiry from a lawyer whose client requires that all service providers use an electronic billing service that is owned, controlled, and managed by nonlawyers. The outside billing service charges an annual fee that is based on a percentage of the amount of legal fees billed to the client. The percentage varies from 2% down to 1.2% depending on the amount of fees billed in the year. Under this proposal, the lawyer will be obligated to pay the outside service without reference to whether the billed fees are actually collected, and the lawyer is obligated to pay the percentage even if none of the fees are ultimately received. The question arises whether this is an unethical fee splitting arrangement.

Rule 1-320 of the California Rules of Professional Conduct expressly prohibits both the direct and indirect sharing of a lawyer’s legal fees with a nonlawyer. It has long been established that “[a] law firm may not enter into an arrangement with another party, whereby the other party shares in the legal fees paid by its client for legal services rendered by the law firm.” (See Los Angeles County Bar Association Ethics Opn. No. 431, involving an entertainment business firm that sought to hire a law firm to advise the business firm’s customers on legal issues. The Professional Responsibility and Ethics Committee concluded that it would be an improper fee splitting arrangement if the entertainment business firm added a 20% surcharge to the amounts billed to the business firm by the law firm and passed that amount through to the client.)

Similarly, in Opinion No. 488, the committee concluded that Rule 1-320 would be violated if a lawyer paid a “turn-key” law office management service a percentage of fees collected by the lawyer from clients of the firm. However, Opinion 488 noted that there would be no violation of Rule 1-320 if the law office management service was paid a monthly fee or on another basis that did not involve actual fee splitting. For example, in Opinion 461, the committee had previously concluded it was not unethical fee splitting for a lawyer to accept free office space and support services in exchange for legal services provided to an office management firm at reduced rates, notwithstanding the fact that the reduced rate attorney fees were paid by individual limited partnerships that comprised the office management firm.

The distinguishing feature between the underlying facts in the ethics opinions that find unethical fee splitting and the facts in this inquiry is that the billing service contingent fee at issue here is not based on fees collected by the law firm but rather on amounts billed. The use of a formula based on the gross amounts billed is analogous to fees charged by credit card companies, which typically are based upon a percentage of the amount collected by the credit card company for the lawyer. Both the State Bar of California and the Los Angeles County Bar Association have acknowledged the use of credit card transactions, and it is universally recognized that accepting payment for legal fees by credit card is perfectly ethical. Recently, in Formal Ethics Opinion No. 2007-172, the State Bar’s Standing Committee on Professional Responsibility and Conduct reiterated that an attorney may ethically accept a payment of advance and earned fees from a client by credit card. Although there is no ethics opinion that specifically extends the reasoning of opinions such as 2007-172 to other types of service providers used by lawyers, there does not appear to be a substantive difference between allowing attorneys to compensate credit card companies based on a percentage of fees processed by the credit card company and permitting a lawyer to pay a billing service based on a percentage of the amount billed. Such a conclusion is also bolstered by the reasoning in such ethics opinions as State Bar Standing Committee Formal Opinion No. 1994-138, which concludes that there is no improper fee splitting—and therefore no ethical requirement to comply with the provisions of Rule 2-2001—when a lawyer uses the services of a contract attorney, who is paid regardless of whether the lawyer ever receives payment from the client, and who is not receiving a percentage of fees collected by the hiring lawyer.

In the situation presented by this inquiry, the lawyer is not dividing fees actually collected with a nonlawyer. Rather, the percentage is simply a method used to calculate the amount of the fee the lawyer will pay, regardless of whether the attorney collects any portion of the billed fee. Under these circumstances, by analogy to other situations in which it has been concluded that no improper fee splitting is presented, it appears to the majority of the Los Angeles County Bar Professional Responsibility and Ethics Committee members that a lawyer may ethically enter into such an arrangement with a third-party vendor.

1 As interpreted by the California Supreme Court in Chambers v. Kay, 29 Cal. 4th 142 (2002), a lawyer who wishes to collect a portion of a fee paid to another lawyer working on the client’s matter is required to provide the client with a writing setting forth not only the fact that a division of fees will occur but also the terms of such division. It is also required that the client provide a signed writing for the fee splitting arrangement to be enforceable. It should be noted that there is a pending recommendation by the Rules Revision Commission—which is recommending changes to the entire set of rules of professional conduct—for a modification of the rule regulating financial arrangements among lawyers, which would require the lawyers to obtain the client’s written consent at the inception of the fee splitting arrangement. Contrary to current case authorities (see, e.g., Mink v. Macabee, 121 Cal. App. 4th 835 (2004)), a writing obtained from a client subsequent to the agreement to enter into the fee splitting arrangement would not suffice to satisfy the ethical duty under this proposed new rule.