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Should
Your Lawyer Own a Piece of Your Dot-Com?
By
Jay Hollander
Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.
The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances. Summary: It's
not uncommon for lawyers representing Internet companies
to receive some stock in lieu of legal fees. Although this
kind of arrangement may benefit both lawyer and company,
it also involves some risks and raises some ethical issues.
This article helps to explain how a technology company
can decide whether it's a good idea to pay a lawyer with
stock.
Introduction
I guess we all knew that it was just a matter of time. How
long could there be talk of repeated dot-com riches without
start-up companies' lawyers resenting how much value their
legal services created for these companies and how little of
the rewards were actually shared with them?
Eventually,
customarily risk-averse lawyers found a way to participate
in the Internet gold rush with little risk and at favorable
prices. This has been -- and is -- done by taking stock
in the client's company as part of the fee for legal services.How
should clients deal with this issue? Is it fair? Is there
a choice? Is there a benefit? Does it pose any problems?
For all these questions, the lawyerlike answer is... it
depends.
Not a Completely New Issue
First, let's realize
that this issue, while dressed up in Internet clothes of
late, is not completely new. Warnings against "greedy" attorneys
preying on unsuspecting clients have been a constant standard
for tort reformers for quite some time, seeking to curb
the fees obtained by class-action and other contingency-fee
attorneys. Also, despite recent attention, lawyers have
taken stock in their start-up company clients for a very
long time.What's different now is the amount of money and
speed of gains involved, as well as the increasing frequency
of the practice. When shepherding profitless companies
to IPO in months or a year or so provides one-day stock
pops worth millions, the obvious question arises of whether
it's right for lawyers to be paid this way. Even more so
when one considers that, in many cases, the stock comes
in addition to hourly rates. More still when one considers
the glaring inconsistency between a lawyer's ability to
do this compared with, say, accountants, who are currently
forbidden from such equity participation in their clients,
or even judges, who must excuse themselves from participating
in cases where they have financial interests.So, why, exactly,
is it a problem, if, in fact, it is one? Basically, the
oodles of real and potential paper profits coming from
stock gains is rubbing up against time-honored ethical
obligations that attorneys owe to their clients, obligations
requiring fair dealing, reasonable fees, exercise of judgment
in the client's best interest, and avoidance of even the
appearance of impropriety.There is also the perception
among some that this is a no-lose situation for lawyers
who get stock at venture-capital prices while taking little
or none of the risk, on behalf of clients who need legal
services and don't have the money to go down the block
to attorneys who don't insist on being one-way partners
on the upside of the client company's value.But is this
a fair criticism? Certainly, it is true that start-up companies,
who want certain top-notch lawyers but lack the funds to
pay for them, might feel they are being strong-armed into
excessive fees or dilution of their ownership stake. But
is this really different from personal-injury victims who
hire lawyers on contingency and potentially give away substantial
portions of their recoveries?Arguably, yes. Some might
argue that the risks of recovery, both as to outcome and
amounts, are much more substantial for personal-injury
attorneys than in the case of pre-IPO start-ups. Of course,
this argument is ultimately more anecdotal than theoretical.
Many a contingency attorney has settled a case quickly,
thereby benefiting from percentage compensation, and there
are some companies that don't do well on IPOs, or that
tend to perform poorly afterwards.
Reasonableness of
Fees
Then there is the question of reasonableness of
fees. If a law firm is retained to provide services that,
in the firm's experience, have a fairly predictable fee
range, is it reasonable to exact stock as a fee when the
value of that stock can appreciate to many times the worth
of the services provided on an hourly basis? Here, too,
the answer is not as clear as it might appear at first
glance. Certainly, $100 worth of services shouldn't wind
up costing $10,000 solely due to stock-price appreciation.
But, shouldn't lawyers be entitled to some premium for
taking stock in lieu of fees from companies that otherwise
lack the funds or the know-how to get off the ground at
all? What would be the value of the stock of a company
that didn't have the resources, personal contacts or legal
knowledge to obtain proper financing in a sound manner,
or to go public while the market for its goods or services
is at its peak? In an era of Internet frenzy, it's also
important to look at it from the attorney's point-of-view.
Valuable legal talent has been siphoned off to venture-capital
firms and general-counsel positions in high-tech companies
because of their ability to offer stock-investment opportunities
to their employees. Allowing stock investment in clients
is, in a very real way, an exercise in employee-retention
for many law firms, especially those involved in corporate
and securities practices.And, after all, the process is
not completely risk-free for the lawyers. Even though getting in
on the ground floor increases the chances that the lawyer
will profit from stock appreciation in the short term,
there are malpractice risks down the road if and when the
stock falls off a cliff. Don't discount the willingness
of disgruntled public investors to sue lawyers for malpractice
when highly touted companies don't perform well, while
being advised by attorneys who have already sold their
own stock before the price plummets.Finally, it should
be noted that some clients actually like the idea of their
lawyers accepting fees in stock because it makes them feel
that the lawyer is aligned with their interests and will
be thinking of the client first, even in the lawyer's own
self-interest.
Ethical Issues and Opinions
Still other
questions linger, as stock-related profits of law firms
allow their compensation to rival those of early investors.
Clients have every right to ask, "Are there no limits to
this?" "What if a law firm represents an actual or potential
competitor and also has stock in that company?" "What do
we do to prevent our lawyers from creating a good-old-fashioned
conflict of interest, that is, acting in their own self-interest
rather than ours?"Increasingly, national and local bar
associations have sought to address these thorny and persistent
issues, setting voluntary parameters that may serve as
a guidepost for lawyers and law firms seeking to make stock
participation a component of their fee arrangements with
client companies.Interestingly, despite the potential for
abuse, illustrative ethics opinions that have come out
do not call for a blanket prohibition on lawyers taking
equity positions in their corporate clients. Instead, they
tend to reinforce traditional obligations of reasonableness
and fairness to the client, and client consent.The American
Bar Association's Standing Committee on Professional Conduct,
for example, has issued Opinion
Number 00418. In the main, the opinion construes the
Association's Model Rules on Professional Conduct to allow
either taking stock in place of fees or allowing investment
in clients in addition to fees, provided that the transaction
is fair and reasonable; the terms of the transaction, as
well as their potential consequences, are disclosed and
reasonably understood by the client; the client is given
a fair chance to seek a second opinion; and the client
furnishes written consent to the transaction in advance.Recently,
in New York City, the home of Wall Street and Silicon Alley,
the Association of the Bar's Committee on Professional
and Judicial Ethics also weighed in on the subject, releasing Formal
Opinion 2000-3. In a lengthy and careful examination,
the Committee did not completely prohibit the practice
of accepting stock, either in lieu of or in addition to
traditional compensation. Instead, it was again subject
to guidelines for fairness, potential to give rise to conflicts
of interest, and for concerns about excessive fees.To be
sure, there are some things that can be done to minimize
some of the feared consequences of lawyer equity participation
in their clients. Committees, made up of lawyers not directly
working for the client, can be organized to handle the
firm's investments. Also, there can be limits to how much
stock is taken from a particular client, so the lawyer
or firm can argue that the amounts weren't enough to cloud
or influence their judgment to the client's detriment.
What
to Do
So, what should a client do in evaluating whether
to give lawyers stock, either as fees or in addition
to hourly rates? Well, the obvious first answer is that,
unless you're a client that thinks it's an advantage
to have your lawyers as partners, you could try to avoid
it and go down the block to the next firm. In areas such
as Silicon Valley, this may not be so easy, but it is
not impossible.Another avenue for exploration would be
to try to measure what the estimated cost of the contemplated
legal services are and back into a stock allocation that,
at present value, is somewhat less than the full value
of services, with the lawyer taking the risk that good
work will lead to appreciation and, ultimately, the equivalent
of full compensation with a reasonable bonus.Yet another
thing to consider is how many of your present or anticipated
competitors are represented by the law firm you are interviewing.
Clearly, if there is any potential or actual opportunity
for mixed loyalties, you should consider going elsewhere.
As
the formal ethical opinions indicate, though, the best
bet is to obtain appropriate disclosures from the contemplated
law firm, then to invest in independent advice from a disinterested
lawyer so that you know what you are getting into. Then,
whichever choice you make, it will be a reasonably well-informed
one. Copyright © Jay Hollander, 2007. All Rights Reserved.
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