Transactions with Client: Reviewing the No-Nos

Current Issue, NYLER Archive, NYPRR Archive, Uncategorized

By Lazar Emanuel

[Originally published in NYPRR October 1999]

The amendments to DR 5-104 emphasize the intent of the New York courts to expand the controls upon transactions between a lawyer and his clients. [22 NYCRR §1200.23.] The changes bring the New York rules closer in scope and language to ABA Model Rule 1.8(a) and (d).

The text of New York’s DR 5-104 was amended in June 1999 to read as follows: (Note: text that is underscored was added to the original Rule by the Amendments.)

Transactions Between Lawyer & Client

(a) A lawyer shall not enter into a business transaction with a client if they have differing interests therein and if the client expects the lawyer to exercise professional judgment therein for the protection of the client, unless:

(1) The transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner that can be reasonably understood by the client

(2) The lawyer advises the client to seek the advice of independent counsel in the transaction: and

(3) The client consents in writing, after full disclosure, to the terms of the transaction and to the lawyer’s inherent conflict of interest in the transaction.

(b) Prior to conclusion of all aspects of the matter giving rise to employment, a lawyer shall not negotiate or enter into any arrangement or understanding:

(1) With a client or a prospective client by which the lawyer acquires an interest in literary or media rights with respect to the subject matter of the employment or proposed employment.

(2) With any person by which the lawyer transfers or assigns any interest in literary or media rights with respect to the subject matter of employment by a client or prospective client.

Disclosure & Consent Must Be in Writing

Before the June changes, DR 5-104 required only that the attorney make “full disclosure” before entering into a business transaction with his client. The Rule did not specify how the client was to manifest his understanding of the disclosure or his consent to the transaction.

The Rule now requires that both the lawyer’s disclosure and the client’s consent be in writing. Furthermore, the lawyer’s disclosure must be communicated in “a manner that can be reasonably understood by the client.”

The effect of the changes is to require full documentation of the lawyer’s disclosure and the client’s consent. This requirement enables a disinterested observer to determine whether another new ingredient of the Rule — that “the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client” — has been satisfied.

Advice of Independent Counsel

DR 5-104 now requires the lawyer to advise his client “to seek the advice of independent counsel in the transaction.” Before the amendments, the Rule made no mention of the need to advise the client to seek independent counsel. However, the New York courts had grafted the requirement onto the Rule over a number of decisions.

The amendments bring the Rule more closely into line with the decided cases and with ABA Rule 1.8(a)(2), which reads:

“…the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction.”

The New York Rule is now broader than the existing ABA Rule in that it requires the attorney to take affirmative action to advise his client to seek out independent counsel. Although there is no specific requirement that the advice be in writing, it would seem only prudent, and in the spirit of the new provision, that the advice be made an integral part of the written communication disclosing and describing the proposed business transaction between lawyer and client.

In line with amended DR 5-104, the Ethics 2000 Commission appointed by the ABA to consider and recommend changes in the ABA Rules has proposed expanding Rule 1.8(a)(2) to require that the advice be in writing. Its proposal reads:

“…the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction…”

Recognition of Inherent Conflict

Before the June 1999 amendment, the New York Rule did not require either the attorney or the client to acknowledge and recognize the inherent conflict of inherent in a business transaction between them. The new Rule not only recognizes the inherent conflict but also requires the lawyer to make full disclosure of the conflict and to obtain the client’s written consent to the transaction only after such disclosure. DR 5-104(a)(3).

The new Rule recognizes that it’s not enough simply to describe the proposed transaction in language which suggests an inherent conflict. The client’s consent should contain specific consent by the client to the possible conflict. The consent might read as follows:

You (the client) have been advised and understand that the transaction described herein is one in which we have adverse interests and which contains within it an inherent conflict between us. In considering and consenting to the terms of the transaction, you consent to and assume the consequences of this conflict of interest between us.

This suggested language would be in addition to the other written requirements under DR 5-104.

Broad Range of Possible Transactions

In construing the importance of DR 5-104, we need to remember the broad range of transactions which can and do frequently take place between lawyer and client. Simon’s New York Code of Professional Responsibility Annotated lists a number of possible transactions (1999 Ed., p. 263):

• Loan from lawyer to client

• Loan from client to lawyer

• Investment by lawyer in client’s business

• Joint business venture by lawyer and client

• Investment in third-party business by lawyer and client

• Investment by client in a business of the lawyer

• Agreement between lawyer and client for labor and services by client

• Agreement between lawyer and client for non-legal services or advice by lawyer

In all of these transactions and in all others between lawyer and client — limited only by man’s imagination and ingenuity — it’s a foolish lawyer who does not commit the transaction to the most detailed of written documents containing all the elements of new DR 5-104, subscribed by the client’s clear and unequivocal consent.

The July 1999 New York amendments added a new requirement that prohibits a lawyer from negotiating or entering into an agreement:

“with any person by which the lawyer transfers or assigns any interest in literary or media rights with respect to the subject matter of employment by a client or prospective client.” [DR 5-104(b)(2).]

This language is not as clear or free of ambiguity as one would wish, but it would seem to prohibit any transaction between a lawyer and any third person concerning any literary or media rights inherent in or growing out of any matter affecting a present or prospective client.

The change responds to criticism by the courts and by ethics committees to the “practice of attorneys arranging to benefit from publication of their clients’ stories.” [Simon’s New York Code Annotated, p. 453, citing N.Y. City 1988-6.]

It’s important to note that transactions by lawyers in literary or media rights either with their clients or with third parties are not discretionary — they are simply prohibited. No amount of disclosure to the client and no degree of consent by the client can endorse the transaction.

The reasoning behind this absolute prohibition grows increasingly clear as the range of available media expands and the rewards for publication of lurid materials multiply.

The reasoning is best expressed in EC 5-4 (before the June 1999 amendments):

If…a lawyer is permitted to receive from the client a beneficial ownership in literary or media rights relating to the subject matter of employment, the lawyer may be tempted to subordinate the interests of the client to the lawyer’s own anticipated pecuniary gain. For example, a lawyer in a criminal case who obtains from the client television, radio…newspaper…book, or other literary or media rights… may be influenced…to a course of conduct that will enhance the value of the…rights to the prejudice of the client… Such arrangements should be scrupulously avoided prior to the termination of all aspects of the matter giving rise to the employment, even though the employment has previously ended.

Lazar Emanuel is the Publisher of NYPRR.

DISCLAIMER: This article provides general coverage of its subject area and is presented to the reader for informational purposes only with the understanding that the laws governing legal ethics and professional responsibility are always changing. The information in this article is not a substitute for legal advice and may not be suitable in a particular situation. Consult your attorney for legal advice. New York Legal Ethics Reporter provides this article with the understanding that neither New York Legal Ethics Reporter LLC, nor Frankfurt Kurnit Klein & Selz, nor Hofstra University, nor their representatives, nor any of the authors are engaged herein in rendering legal advice. New York Legal Ethics Reporter LLC, Frankfurt Kurnit Klein & Selz, Hofstra University, their representatives, and the authors shall not be liable for any damages resulting from any error, inaccuracy, or omission.

Attorney-Client Relationship Conflicts of Interest Disclosure Lazar Emanuel