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Rule and Regulation Update: Article #6

Regulatory Spotlight: California Nonlawyer Ownership and Fee Sharing Rules

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In 2019, the California State Bar’s Board of Trustees (“Board”) directed the formation of the Task Force on Access Through Innovation of Legal Services (the “Task Force”) to address three areas that, if changed, could significantly alter how the legal market in the state exists today:

  • the definition of the unauthorized practice of law;
  • lawyer marketing, advertising, partnerships and fee splitting; and
  • nonlawyer ownership or investment in law firms.

Following the Task Force’s Final Report and Recommendations in March 2020, the Board approved, among other things:

  • proposals to amend rules 1.1 and 5.4 of the California Rules of Professional Conduct (the “Rules”); and
  • the establishment of a working group to explore development of a “regulatory sandbox.”

What does this all mean to California practitioners and the future of the U.S. legal industry?

Change is on the horizon.

Below we’ve summarized some of California’s recent regulatory changes and how they arose.

  1. Reason for change

What was the driving force behind this shift in perspective?

The creation of the Task Force followed consideration by the Board of the Legal Market Landscape Report commissioned by the State Bar of California (the “Report”), part of which examined new technologies and business models used in the delivery of legal services, with a special focus on enhancing access to justice.

The Report, in pertinent part, found that ethics rules prohibiting nonlawyer ownership (Rule 5.4) and the unauthorized practice of law (Rule 5.5) were the primary detriments of how the current legal market was structured.

The author of the Report, Professor William D. Henderson, concluded lawyers could benefit from rules facilitating close collaboration with nonlawyers. Some of the noted benefits included:

  • driving down the overall costs of services;
  • improving access to justice for the poor, working and middle class;
  • improving the predictability and transparency of legal services;
  • aiding the growth of new businesses; and
  • elevating the reputation of the legal profession as one serving the broader needs of society.
  1. Establishment of a Working Group to Explore Nonlawyer Ownership

Rather than proposing sweeping amendments to California’s rules and laws concerning nonlawyer ownership based upon the Report, the Task Force advocated for a working group to explore development of a “regulatory sandbox” framework, which “could provide data on any potential benefits to access to legal services as well as the potential for consumer harm if prohibitions on unauthorized practice of law, fee sharing, nonlawyer ownership, and other legal restrictions [were] modified or completely suspended for authorized sandbox participants.”

In a 9-2 vote, the Board approved the motion for a regulatory sandbox working group on May 14, 2020.

Under the Task Force’s proposed framework, designed to emulate Utah’s structure shown in the infographic below, the California State Bar and/or the California Supreme Court, in coordination with the California Legislature, would create an oversight body with regulatory authority. The oversight body would operate much like a professional licensing board and have the power to certify and decertify entities, impose compliance requirements and exercise enforcement rights.

(See, Utah’s regulatory sandbox description on pages 16 – 17 of its report posted at: https://www.utahbar.org/wp-content/uploads/2019/08/FINAL-Task-Force-Report.pdf)

Once formed, California’s oversight body could consider applications from those desiring to participate in the program. Participants would be able to propose any type of business model, service or product that couldn’t be offered under current rules and statutes for providing legal services.

Upon conclusion of the temporary sandbox period (e.g. after a two to three year period), then there might be a time for participants to seek an extension, however, there would be no guarantee of achieving permanent authority to operate an innovative business model or continuing to sell a novel product or service.

While the Task Force’s specific framework outlined above was not approved, the vote to establish a working group to explore the development of a regulatory sandbox to evaluate possible changes to existing laws and rules, such as consumer facing technology that provides legal advice and services and other new delivery systems created through the collaboration of lawyers and nonlawyers, was accepted.

The new working group charter can include: (1) examination of amendments to Rules 5.4 and 5.7; (2) exploration of amendments to the Rules governing lawyer advertising and solicitation; and (3) evaluation of amendments to the statutes and Rules of the State Bar governing Certified Referral Services.

  1. Revision to Rule 5.4(a)(5)

Even though there wasn’t a momentous modification to Rule 5.4, the Task Force’s recommended adjustment to the Rule did broaden the rule against nonlawyer fee sharing.

Under current Rule 5.4(a)(5), a lawyer can only share a court-awarded fee with a nonprofit organization. The amendment would also permit fee sharing with organizations that qualify under Section 501(c)(3) of the Internal Revenue Code where the award arises from a settlement or other type of resolution, as long as the lawyer continues to exercise independent professional judgment in the client’s best interest.

The recommendation was authorized for a 60-day comment period ending May 18, 2020.

  1. A New Comment to Rule 1.1

The Task Force also recommended that a new comment be added to Rule 1.1 concerning lawyer competence.

Rule 1.1 provides “a lawyer shall not intentionally, recklessly, with gross negligence, or repeatedly fail to perform legal services with competence.”

The new comment would be a variation of a similar Comment to ABA Model Rule 1.1 and would provide that the duty of competence includes “the duty to keep abreast of the changes in the law and its practice, including the benefits and risks associated with relevant technology.”

As with the proposed amendment to Rule 5.4(a)(5), the recommendation was authorized for a 60-day comment period ending May 18, 2020.

What happens next?

Categories: Rule and Regulation Update

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