Ethics Opinion

Opinion 2014-4

April 2014

Summary: The purchase price of the practice of a lawyer taking retirement status pursuant to Rule 4:02 may include a portion of legal fees earned in the future from representation of current and former clients of the retiring lawyer. It may not, however, include a portion of legal fees earned from representation of new clients referred by the retired lawyer.

Facts: A lawyer inquires whether in purchasing the practice of a lawyer retiring pursuant to Rule 4:02, a portion of the purchase price may involve a percentage of legal fees to be earned from future business of current and former clients of the retired lawyer. The inquiry also asks whether some of the contemplated payments may include work that will result from the referral of new clients by the retired lawyer.

Discussion: When the Supreme Judicial Court in 1998 adopted Massachusetts Rule of Professional Conduct (MRPC) 1.17, which permits the sale of a "law practice, including good will," on certain conditions, it left untouched a number of other Rules that relate to the main issue presented by this inquiry.

In the first place, Rule 4:02(5), by making a retired lawyer ineligible to practice law, except in a supervised pro bono setting, indicates that retired lawyers are not lawyers who are permitted to receive compensation for legal services. Moreover, MRPC Rule 5.4(a) provides, in relevant part, (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, partner, or associate 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 purchases the practice of a deceased, disabled, or disappeared lawyer may, pursuant to the provisions of Rule 1.17, pay to the estate or other representative of that lawyer the agreed upon purchase price;
  3. a lawyer or law firm may include nonlawyer employees in a compensation or retirement plan, even though the plan is based in whole or in part on a profit sharing arrangement; . . .

Rule 5.4(a) states the governing principle that a lawyer may not share fees with a nonlawyer except in three circumstances, none of which apply to the facts set forth in this inquiry. The first scenario clearly does not apply. The second, which applies to sales of law practice, permits the payment of the purchase price to the nonlawyer representative of a deceased, disabled, or disappeared lawyer. It does not include representatives of retired lawyers or retired lawyers themselves. The third scenario involves the inclusion of a nonlawyer employee of a law firm or lawyer in a retirement plan. That is not the scenario of this inquiry.

Rule 7.2(c) provides, in relevant part that "A lawyer shall not give anything of value to a person for recommending the lawyer's services, except that a lawyer may . . . (3) pay for a law practice in accordance with Rule 1.17; [and] (4) pay referral fees permitted by Rule 1.5(e). . . ." While Rule 7.2(c) makes an exception for the sale of a law practice, it does not explicitly deal with the issue of sharing future legal fees.

We are thus faced with reconciling the spare words of Rule 1.17, permitting sale of a "law practice, including good will" with the explicit prohibitions that existed prior to the adoption of that Rule. The New York State Bar Association has recently considered this very question in its Opinion 961 (2013). Much of its discussion deals with New York's very different rules relating to the sharing of referral fees. However, we agree with the underlying reasoning of the Opinion as its relates to the permission granted by Rule 1.17 to sell "good will." The Opinion states:

By its nature, the inclusion of "goodwill" in a sale of a law practice entails a payment on account of legal fees that the buyer is expected to receive in the future. There is no question that the parties to the sale could attempt to assign a present value to that flow of fees and include that value in a lump-sum purchase price. . . . But it can be very difficult to assign a present value to an on-going book of business of a law practice, and even more difficult to estimate what value will flow from new business that may come to the law practice on account of the reputation and contacts built up by the selling lawyer over time. And young lawyers who are the typical buyers of law practices often do not have access to capital to provide upfront payments for goodwill in any case. The question presented is the extent to which lawyers can structure the payment for the law practice as a payout over time measured by the actual fees earned by the practice after the sale.

We conclude that Rule 1.17 must be viewed as an exception to Rule 1.5(g) [New York's referral rule] - that is, that the payment for "goodwill" that is explicitly permitted by Rule 1.17 permits a payment that is made in the future after the fees that reflect "goodwill" are earned. We reach this conclusion for several reasons. First, we think that Rule 1.17 should be viewed as the more specific of the two rules - targeted as it is to a particular setting in which lawyers might wish to share fees - and thus subject to the interpretive principle favoring the more specific rule over the more general. Second, a lump-sum payment for goodwill is intended to be economically identical to the present value of the actual fees earned over time. The rules should be as transparent and rational as possible, so in the absence of a strong reason to the contrary, parties to a sale of a law practice should be able to use a method of payment that is the economic equivalent of one that is clearly permitted.

Third, we note that Rule 1.5 itself contemplates payments of fees over time in the closely analogous setting of a lawyer who leaves or retires from a law firm and receives a payment for his or her interest in the firm in the form of a separation agreement or retirement package. . . . [See MRPC 1.5(e).] Likewise, Rule 5.4(a)(1) permits law firms to agree with lawyers in the firm to share legal fees with the estate of a lawyer in the firm, or with anyone else, "over a reasonable period of time after the lawyer's death." If a lawyer leaving a law firm, or the lawyer's estate, may receive a portion of future fees earned on account of the goodwill of the firm that the lawyer helped to build up, we see little reason why a lawyer retiring from a solo practice should be barred from structuring a payment similarly. Comment [1] to Rule 1.17 fortifies this analogy. It states, "Pursuant to this Rule, when a lawyer or an entire firm ceases to practice, and other lawyers or firms take over the representation, the selling lawyer or firm may obtain compensation for the reasonable value of the practice, as may withdrawing partners of law firms." (Emphasis added.) Indeed, equalizing the treatment of retiring members of law firms and retiring sole practitioners was the principal purpose of the Rule permitting sales of law firms. One of the impetuses for adopting Rule 1.17 was the previous practice of "quickie partnerships," whereby a solo practitioner would take on a junior partner for a short period before retiring under a retirement package that provided for an extended payout.

We recognize that there are counter-arguments to these points. One could conclude that the express exception for fees paid as part of a separation or retirement agreement, when there is not one for sale of a law practice, means that fees may not be shared in the latter context. We are not persuaded by that counter-argument, however, because, as noted above, we perceive no reason for making that distinction, particularly in light of the policy underlying the Rule to equalize the treatment of retirements from law firms and sales of law practices.

We also recognize that the purposes of the prohibition on fee sharing are implicated, at least in part, by any provision for fee sharing after sale. For example, one purpose of the prohibition is to limit the risk of outside influences on a lawyer's independent judgment. A lawyer with an economic interest in a matter who is not sufficiently involved in the work and does not take responsibility for it may press the lawyer handling the matter to cut corners or settle too early. . . . But these policies have often been tempered by other considerations, as demonstrated by the exceptions for retirement plans, separation agreements and agreements for sharing fees with the estate of a lawyer in a law firm. . . .

After concluding that the permission to sell good will authorized the sharing of legal fees from future business, the New York committee went on the state a limitation to the principle:

While we approve in concept that goodwill in a sale of a law practice under Rule 1.17 may be measured by future fees as actually earned, we believe that there are necessarily limits to such arrangements. The extent of fee sharing must bear a reasonable and bona fide relationship to the value of the "goodwill" involved. Even the most well-known lawyer's reputation and connections fade over time. Any provision for fee sharing must therefore be limited in amount and in time. The parties might agree, for example, that the selling lawyer will receive 20% of the seller's net income for three years. If that is a reasonable estimate of the value of the "goodwill" of the practice, then Rule 1.17 permits it.

We agree with the general concept identified in the New York Opinion that there is a limit to the amount and time involved in sale of good will. However, MRPC 1.17 does not consider the details of the permission granted as they relate to purchase price. Whether in any particular agreement the receipt of a percentage of future fees over a period of years constitutes in fact a permitted sale of "good will" and not a prohibited division of legal fees with someone not entitled to receive compensation for legal services will depend on a number of factors, such as the size and income of the firm being sold and the nature of its clientele. In the absence of further guidance from the SJC, we are not in any position to advise further on the specific provisions of any particular agreement.

We also believe that in view of the tension that exists between Rule 1.17 and the other Rules cited above, the better interpretation of "goodwill" is one that is limited to the potential of future business from the client base as it exists at the time of sale. Sharing legal fees on account of payment by a client with whom the retired lawyer had no legal relation either at or previous to the time of sale seems more like a prohibited sharing of legal fees with someone not entitled to receive compensation for legal services than like a receipt from the sale of good will. As the New York committee put it in its Opinion 961:

While the fact that a new client may have approached the selling lawyer after the sale may be due to the lawyer's reputation, we are concerned that permitting sharing of fees if the selling lawyer refers the business to the buying lawyer implicates the different set of policies barring payments for referrals under Rule 7.2. . . . Put another way, we do not see a payment for business referred after the sale as simply a convenient method of measuring the value of the goodwill of the practice, but rather more as a payment for the new service of making the referral, and such a payment is barred.

We conclude therefore that whatever computation is used to fix the sale price of the good will of the practice being purchased, it may not include fees earned from persons referred by the retired lawyer who were never clients before the lawyer retired.

This opinion was approved for publication by the Massachusetts Bar Association's House of Delegates on May 8, 2014.