The Risk Manager, Spring 2019

What Could Go Wrong With That?

Editor’s Note: We know of no Kentucky authority providing guidance on lawyer fees paid by crowdfunding. This article is a synthesis of ethics opinions by the D.C. Bar Legal Ethics Committee Opinion 375, (11/18); New York State Bar Association Committee on Professional Ethics Opinion 1062 (6/29/15); and the Philadelphia Bar Association Professional Guidance Committee Opinion 2015-6 (12/ 2015). All three bar associations have rules of professional conduct virtually identical to the Kentucky Rules of Professional Conduct and all are well reasoned. Accordingly, we consider them valid secondary authority for Kentucky lawyers considering receipt of crowdfunding fee payments.

What is Crowdfunding

The D.C. Bar describes crowdfunding as:
[T]he process of raising money from third parties for the benefit of another. While the term is most often used to describe the practice of raising small amounts of money from numerous people through social media and other platforms, as used in [the D.C.] opinion, “crowdfunding” refers to the solicitation and acceptance of such funds to pay for someone else’s legal representation.

Crowdfunding is generally structured in one of two ways:

  1. equity-based funding, in which the investor retains an ownership interest in either the recipient (here, the law firm or its client) or in future recoveries/earnings/profits of the firm or matter, or
  2. donation-based funding, in which the donor receives no financial interest in the legal matter, but may receive other incentives. This opinion focuses solely on donation-based funding ….

There is agreement in the opinions that there is nothing in the rules that per se prohibit a lawyer from accepting fees raised by crowdfunding. This does not mean, however, that there are not a number of risks of violating laws or professional conduct rules when accepting crowdfunding fees. The threshold question is whether the funds are raised by the client or by the lawyer.

Client Independently Raises Fee Payment by Crowdfunding

The D.C. Bar opinion points out that clients often depend on family and friends for help in paying fees. This does not automatically trigger ethics issues for lawyers. Similarly, clients independently soliciting donations from friends and strangers on the Internet do not necessarily create ethics issues. Nonetheless, lawyers should take these precautions with clients who use the Internet to raise funds:

The client should be counseled about disclosures to third parties whether family or on social media. While some information must be revealed to interest potential donors in participating, clients must understand the risk of waiving the attorney-client privilege or revealing case strategy.

The client should be warned about giving misleading information about the matter to encourage donations. Angry donors may resort to legal remedies for fraud.

There is a heightened risk of fraud, money laundering, and scams with crowdfunding. Lawyers must be careful to avoid becoming involved in a client’s illegal acts. If a lawyer knows or suspects fraud, the lawyer is required to counsel the client of the limitations on his ability to represent the client in these circumstances. Lawyers must avoid the accusation of engaging in or assisting the client in unethical or illegal conduct.

Lawyers must be sure that crowdfunding by a client does not result in a violation of SCR 3.130(1.5)’s prohibition of excessive fees and complies with the writing requirement of the Rule. Paragraph (b) of the Rule provides:

The scope of the representation and the basis or rate of the fee and expenses for which the client will be responsible shall be communicated to the client, preferably in writing, before or within a reasonable time after commencing the representation….

Lawyer Managed Crowdfunding

When a lawyer controls crowdfunding several ethics rules are triggered dealing with accepting fees from third parties, client confidentiality, misleading statements, excessive fees, and use of client trust accounts for crowdfunding donations. What follows are the key considerations for each of these issues.

Accepting fees from third parties.

The Kentucky Rules of Professional Conduct permit lawyers to accept payment from third parties if certain conditions are met. SCR 3.130(1.8) Conflict of Interest: Current Clients; Specific Rules provides:

(f) A lawyer shall not accept compensation for representing a client from one other than the client unless:
(1) the client gives informed consent;
(2) there is no interference with the lawyer’s independence of professional judgment or with the client-lawyer relationship; and
(3) information relating to representation of a client is protected as required by Rule 1.6.

Misleading statements.

When crowdfunding, lawyers must not let donors influence the purpose of the representation or legal strategies in any way. The Philadelphia Bar opinion nicely lays out a lawyer’s duty not to mislead donors:

Finally, the [lawyer] also should consider the duties owed to non-clients. The Rules refer in several places to the obligation of lawyers to be truthful in all respects to third parties. Rules 4.1* states that “[i]n the course of representing a client a lawyer shall not knowingly ... make a false statement of material fact or law to a third person. Rule 7.1* requires that lawyers not make false or misleading communications about the lawyer or the lawyer’s services, noting that a communication is false or misleading if it contains a material misrepresentation of fact or law or omits a fact necessary to make the statement considered as a whole not materially misleading.

*Note: Kentucky Rules of Professional Conduct, SCR 3.130 (4.1 and 7.10)

Publicizing the crowdfunding drive and client confidentiality.

The Philadelphia Bar opinion explains well the enhanced sensitivity to client confidentiality that crowdfunding requires:
In order to seek funds on a crowdsourcing site, the lawyer will of course have to reveal certain information about the matter sufficient to interest the public in making contributions. That will require obtaining the informed consent of the client. The [lawyer] indicates he is aware of this requirement and provided the [lawyer] obtains the informed consent of the client by satisfying the requirement of having “communicated adequate information and explanation about the material risks of and reasonably available alternatives to the proposed course of conduct” (see Rule 1.0e)*, the Committee believes that is possible. Care should be taken, of course, to keep information revealed about the client and the matter to the minimum necessary to achieve the purpose.

*(SCR 3.130(1.0e)


Excessive fees

The overarching problem in avoiding excessive fees when agreeing to accept crowdfunding payment is that it cannot be known how much money will be raised. The Philadelphia Bar opinion offers this analysis:

It cannot be known how much may be raised; and the course of the representation is by no means certain. The litigation could end quickly, either favorably or not; before the litigation’s end the [lawyer] may seek to withdraw or the client may wish to discharge him; or the [lawyer] may or may not succeed in seeking the payment of fees and expenses under an applicable fee shifting statute. Thus, just to give one example, if the matter ends quickly with relatively few hours of work expended, the retention of the entire amount raised on the crowdfunding site may produce an effective hourly rate that is extremely high. Without knowing how much was raised, it would therefore be difficult to determine whether or not the fee would be clearly excessive.

What services do the crowdfunding fees cover?

The Philadelphia Bar opinion raises this issue:
The scope of the [lawyer’s] obligation in return for the payment of the fee also is not clear to the Committee. Does the [lawyer] anticipate that if the client agrees to allow the lawyer to retain the total raised on the crowdfunding site that the [lawyer] is promising that he will handle the matter from its inception to its conclusion in return for whatever the crowdfund raised fee turns out to be? That is, in return for the fee, does the lawyer promise to remain in the case through its termination, regardless of what the fee is, or may he withdraw in the event certain contingencies arise but still keep his fee?

What should the required written fee agreement include and avoid?

The Philadelphia Bar opinion suggests the following:

  • First, the fee arrangement should include terms which describe the lawyer’s obligations including the lawyer’s obligation to remain in the case, assuming the client wishes him to do so, until its conclusion or until some other point at which retention of the total fees paid would not constitute an excessive fee. For example, the fee arrangement with the client could state that the [lawyer] is obligated to remain in the representation until the time expended reaches a total figure such that the total fee paid is reasonable in light of that time expended.
  • Second, the arrangement should require that the amount raised be placed in a trust account established under Rule 1.15 until those amounts are earned in accordance with the terms of the final fee agreement. Until such time that it is determined that the fee is actually earned, the monies raised constitute Rule 1.15 funds and should be held separate from the lawyer’s own property.

The D.C. Bar opinion advises that fee agreements also cover who owns excess crowdfunds raised and who is responsible for payment if the crowdfunds are not enough to cover agreed fees and expenses. It is strongly recommended that letters of engagement signed by the client be used in all crowdfunding representations.

Trust account management

Fees paid by crowdfunding are advanced fees and must be deposited in the lawyer’s client trust account [SCR 3.130, (1.15) Safekeeping Property] and only moved to the operating account after they are earned. The D.C. Bar opinion includes the following guidance for lawyers managing crowdfunds:

  • Crowdfunding may increase the risk of disputed ownership of funds. For example, if a donor claims that he or she donated more money than intended, or directed it to the wrong recipient, a lawyer would mitigate his or her ethical risk by ensuring such funds remain in trust until they are earned.
  • In the absence of an appropriate agreement, unearned crowdfunds are the property of the client and should be returned to the client upon the matter’s conclusion or termination of the representation, unless the client directs the lawyer to do otherwise.
  • A lawyer may suggest that the client donate excess crowdfunds to a charity of the client’s choice. Ultimately, however, the lawyer must abide by the client’s decision and/or an appropriate agreement regarding disposition of unearned crowdfunds.
  • The Committee believes it would be unethical for a lawyer personally to claim unearned crowdfunds at the conclusion of a representation. Unlike a contingency fee case, where a lawyer may on occasion obtain a “windfall” due to an unexpected early settlement or other turn of events (and runs an equal risk of earning nothing at all if an unfavorable outcome results), in this situation the lawyer incurs no equivalent risk.

Summing Up

While we could locate no Kentucky authority on crowdfunded fees, KBA Ethics Opinion E-432 [5/20/2011] is a comprehensive opinion on third-party litigation financing. In that opinion the Committee advised:

  • In the final analysis, the Committee agrees with the numerous other jurisdictions which have concluded that lawyers are not per se prohibited from assisting clients on obtaining funding from a third-party lender.
  • It also agrees that there are serious risks to such participation and that third-party litigation financing frequently does not serve the client’s best interest.
  • Lawyers who assist their client in obtaining funding must be particularly sensitive to the various ethical issues, including:
    • confusion as to the lawyer’s role in the transaction;
    • whether an additional fee will be charged;
    • possible interference with the lawyer’s independent professional judgment by the lender;
    • the need to assist the client in understanding the advantages and disadvantages of the transaction;
    • and the impact that the provision of information to the lender has on the attorney-client privilege and confidentiality.
  • Finally, the Committee recommended that understandings between the lawyer and the client regarding issues raised by third-party financing be in writing.

Opinion E-432 uses the same reasoning and cites the same Rules of Professional Conduct that are cited in the crowdfunding ethics opinions in this article. For this reason, we believe that our risk management advice on crowdfunding is acceptable in Kentucky. Just to be sure, however, we recommend calling the KBA Ethics Hotline for confirmation of any crowdfunding program you want to use.