Nonlawyer Officers Prohibited in Law Firms

Last month, the Professional Ethics Committee of the State Bar of Texas issued Ethics Opinion 642, which addressed two questions:

May a Texas law firm include the terms “officer” or “principal” in the job titles of the firm’s non-lawyer employees?
May a Texas law firm pay or agree to pay specified bonuses to non-lawyer employees contingent upon the firm’s achieving a specified amount of revenue or profit?

The answer to both questions was no.

As to the first question, the opinion noted that the Texas Disciplinary Rules of Professional Conduct do not permit non-lawyers to have ownership interests in law firms, and that using the terms “officer” or “principal” would be misleading to the public, because those terms commonly indicate an ownership interest or control over the firm or significant portions of its operations.

The opinion cites the Texas rule (Rule 5.4) prohibiting lawyers from sharing legal fees with non-lawyers or from practicing law with any organization in which a non-lawyer is a corporate director or officer, or in which a non-lawyer has the right to direct or control the professional judgment of a lawyer. Lawyers cannot form partnerships with non-lawyers if the purpose of the partnership is the practice of law.

With respect to the second question, the opinion states unequivocally that any bonuses paid to non-lawyers that are tied to achieving a specified level of revenue or profit are prohibited because these types of bonuses

would provide an incentive for the firm’s non-lawyer employees to increase revenues, which could be accomplished through soliciting clients, or to reduce expenses, which could be accomplished by interfering with a lawyer’s independent judgment in practicing law. Furthermore, tying a bonus to achieving a specified level of profit is similar to tying a bonus to achieving a specified level of revenue because profit is a function of revenue and expenses.

However, a law firm is permitted to take profit into account when determining whether to pay bonuses and what the amount of those bonuses should be.

Non-Lawyer Officers in Law Firms

The Texas opinion does not mark the first time the issue of nonlawyer officers in law firms has sparked discussion regarding legal ethics. When Pepper Hamilton appointed a nonlawyer CEO in 2012, there was much discussion about whether the appointment was a breach of professionalism. And after the ABA Standing Committee on Ethics and Professional Responsibility issued Opinion 464 in August of 2013, additional debate about nonlawyer ownership emerged (See this article from the ABA Journal).

Earlier this year, an article in Above the Law suggested that, “When law firms have to rely on banks for loans, they’ve already forfeited some measure of firm control,” and that if firms had the opportunity to bring in (nonlawyer) investment partners committed to the long term survival and success of the firm, perhaps some large firm collapses would not have occurred.

In November of 2012, the New York State Bar Association issued the Report of the Task Force on Nonlawyer Ownership, and at the House of Delegates Meeting of the New York State Bar Association held the same month, the House approved the recommendations contained in the report, opposing nonlawyer ownership of law firms, despite the growth of nonlawyer ownership in other jurisdictions, including the United Kingdom, Australia, Canada and the District of Columbia. None of the 50 United States currently permit nonlawyer ownership in law firms.

Although I am unaware of any opinions in New York which address the issue of non-lawyer officers in New York firms, it is clear that New York prohibits nonlawyer ownership of law firms. New York’s Rule 5.4 (Professional Independence of a Lawyer) says:

(a) A lawyer or law firm shall not share legal fees with a nonlawyer, except that:

(1) an agreement by a lawyer with the lawyer’s firm or another lawyer associated in the firm may provide for the payment of money, over a reasonable period of time after the lawyer’s death, to the lawyer’s estate or to one or more specified persons;

(2) a lawyer who undertakes to complete unfinished legal business of a deceased lawyer may pay to the estate of the deceased lawyer that portion of the total compensation that fairly represents the services rendered by the deceased lawyer; and

(3) a lawyer or law firm may compensate a nonlawyer employee or include a nonlawyer employee in a retirement plan based in whole or in part on a profit-sharing arrangement.

(b) A lawyer shall not form a partnership with a nonlawyer if any of the activities of the partnership consist of the practice of law.

(c) Unless authorized by law, a lawyer shall not permit a person who recommends, employs or pays the lawyer to render legal service for another to direct or regulate the lawyer’s professional judgment in rendering such legal services or to cause the lawyer to compromise the lawyer’s duty to maintain the confidential information of the client under Rule 1.6.

(d) A lawyer shall not practice with or in the form of an entity authorized to practice law for profit, if:

(1) a nonlawyer owns any interest therein, except that a fiduciary representative of the estate of a lawyer may hold the stock or interest of the lawyer for a reasonable time during administration;

(2) a nonlawyer is a member, corporate directtor or officer thereof or occupies a position of similar responsibility in any form of association other than a corporation; or

(3) a nonlawyer has the right to direct or control the professional judgment of a lawyer.

Nonlawyer Compensation in New York

Rule 5.4 also governs compensation of nonlawyers in law firms, as shown above. But there is a notable difference in the New York and Texas rules. In Texas, Rule 5.4(a)(3) states, "a lawyer or law firm may include non-lawyer employees in a retirement plan, even though the plan is based in whole or in part on a profit-sharing arrangement."

However, the New York rule permits law firms to not only include non-lawyer employees in retirement plans based on profit-sharing, but also to compensate non-lawyers based on profit sharing. Although the New York rule used to mirror the Texas rule in this regard, the New York rule was amended in 1999. (The ABA Model Rule contains the same language as the New York rule).

Comment [1B] to New York’s Rule 5.4 notes that:

Paragraph (a)(3) permits limited fee sharing with a nonlawyer employee, where the employee’s compensation or retirement plan is based in whole or in part on a profit-sharing arrangement. Such sharing of profits with a nonlawyer employee must be based on the total profitability of the law firm or a department within a law firm and may not be based on the fee resulting from a single case.

In October 2000, the New York State Bar Association Committee on Professional Ethics issued Opinion 733, which addressed the question of whether a nonlawyer employee was permitted to be paid a percentage of profits or fees attributable to specific client matters referred by the employee. The opinion concluded that the firm was not permitted to base compensation on the success of specific efforts by employees to solicit business for lawyers or law firms.

But the situation gets a bit sticky if the nonlawyer employee is a marketer.

In November 2011, New York issued Opinion 887, which addressed the issue of compensation of a non-lawyer marketer. The opinion stated that bonuses for non-lawyer employees cannot be based on referrals of particular clients or matters, and may not be based on the profitability of the firm or the department for which the employee markets if such profits are substantially related to the employee's marketing efforts. However,

Where profits of the firm or the department are not directly correlated with the employee's marketing efforts, a bonus plan based on a percentage of the employee's salary or a percentage of the overall profits of the firm would pass muster under the Rule.

It is difficult to ascertain the circumstances under which this might apply. After all, the assumption would be that the marketer would deserve a bonus if their efforts were successful in bringing business to the firm, which would assume that the profits upon which their bonus was based would be "substantially related" to their marketing efforts.

In March of 2012, New York State Opinion 917 was issued, which concluded that

A law firm may ethically pay a bonus to a nonlawyer employee engaged in marketing based on the number of clients obtained through advertising provided the amount paid is not calculated with respect to fees paid by the clients. The law firm may not pay a fee for the referral or recommendation of a specific client.

Thus, it seems that successful nonlawyer marketers may be compensated with profit sharing based on the number of clients obtained, but not based upon the profits resulting from those clients.

What do you think: would nonlawyer ownership be good or bad for the legal profession and the clients it serves? Should nonlawyers be permitted to be "officers" in law firms, even if they don't have an ownership interest?