The Ethics of Crowdfunding for Lawyers: Uncharted Territory or Familiar Terrain?

Posted in: Law Practice

Technological innovations continue to impact the legal profession more and more each day, with attorneys increasingly embracing tech solutions as part of their practice. Cloud storage, social media marketing, and virtual offices are becoming familiar fixtures across the legal industry, making it only a matter of time before law firms looking to meet basic needs such as raising capital turned to the internet as well. Historically associated primarily with tech startups, crowdfunding, or soliciting money from numerous individuals via an online platform, has in recent years become a viable option for lawyers seeking funding for law firm operations or specific legal matters.

Many in the legal world predict that this kind of financing will continue to have a growing impact on litigation in the years ahead, particularly in light of the access to justice issues and high unemployment rates that continue to plague the legal industry. However, some also warn of the dangers of embracing this new funding avenue too quickly. Indeed, while crowdfunding may appeal to recent law grads looking to start a law practice without incurring more debt, or established attorneys seeking to fund a particular case or cause, crowdfunding isn’t without its ethical risks. But are these actually new risks, or is this another situation where lawyers are required to simply apply old rules to new technology?

Alternative Litigation Finance and Legal Ethics

Alternative litigation finance (ALF), also known as third party litigation finance, is a method of legal funding that generally involves seeking financing from corporate entities for specific litigation matters. ALF, which has historically been relatively unregulated, is not a new phenomenon in the legal industry, though it has been garnering more attention of late with regard to ethics and other legalities. For example, the New York City Bar Association put forth a 2011 opinion illustrating the ethical risks of non-recourse litigation financing by corporate investors. Primarily, financing companies often request confidential information in order to analyze whether a case is a good investment, and attorneys must be vigilant about the extent to which this information is revealed and any privileges potentially waived due to an ALF agreement. ALF investors may also seek to direct the litigation from a cost standpoint, such that favorable discovery strategies or settlement options may be discouraged, and attorneys must maintain independent judgment in response to efforts of this nature. ALF was also the subject of an American Bar Association white paper in 2012, which similarly discussed the ethical duties lawyers should observe in this context, highlighting rules related to maintaining independent judgment, conflicts of interest, excessive fees, fee sharing with non-lawyers, effects on settlement, confidentiality, and competence in advising a client regarding an ALF agreement, among other issues. This study also noted that lawyers in a small number of states should be aware of the potential role of historic doctrines such as usury and champerty, but noted that these rules have become less relevant over time in most jurisdictions in relation to ALF.

Crowdfunding and Legal Ethics

So what are the ethical pitfalls that legal practitioners should be aware of before embracing third party finance in the tech-friendly and arguably more accessible form of crowdfunding? And what distinguishes crowdfunding from “traditional” ALF involving single investors?

Early adopters of crowdfunding models have relied on longstanding rules of professional responsibility to navigate ethical challenges, and recently have received more specific guidance in the form of two ethics opinions. Though most states do not yet have authority on point in this area, so far the consensus seems to be that crowdfunding is generally allowed, and while it represents a somewhat (but not completely) new way of doing business, it should not require an entirely novel approach to ethics compliance. Like older forms of ALF, it simply must be undertaken with caution in light of well-established rules against things like non-lawyer ownership of law firms, fee-splitting with non-lawyers, divulging confidential information, and permitting third parties to control litigation. The crowdfunding approach would also arguably eliminate some of the ethical risks associated with single-investor litigation finance.

Crowdfunding to Finance Specific Cases

In 2015 the Philadelphia Bar Association’s Professional Guidance Committee (“Committee”) considered a scenario in which the inquiring lawyer hoped to use crowdfunding to finance litigation on behalf of a plaintiff who was suing a government entity. The plaintiff was seeking equitable relief rather than damages, and because the client was unable to personally pay the attorney for their time, the lawyer proposed to put any crowdsourced funds toward the attorney fees the plaintiff could be eligible for if they won the case.

In addressing the propriety of the crowdfunding proposal, the Committee initially analyzed whether the lawyer could accept a fee from someone other than the client, which is not a novel scenario, the crowdfunding aspect notwithstanding. As in any other situation where a non-client might be paying the legal fees, in this case the lawyer primarily needed to ensure that the client had given their informed consent, and that the lawyer’s professional judgment was not compromised by this arrangement. The Committee stated that it did not see why obtaining financing via crowdfunding would cause the lawyer to run afoul of these rules provided that the lawyer did not give funders the impression that they would be given any control or stake in the litigation. Further, given that crowdfunding by definition involves securing funding from numerous sources rather than a single stakeholder, the crowdfunding approach would seem to diffuse the extent to which any individual donor would be in a position to influence litigation strategy as compared to single-investor or corporate ALF suppliers.

Another ethics issue that the lawyer would have to keep in mind in a crowdfunding scenario is confidentiality. The Committee acknowledged that in this situation a certain amount of information about the case would need to be shared with potential funders to convince them to donate money, meaning that the client would need to give their informed consent. However, the Committee stated that the amount of information shared should be limited to what was reasonably necessary to achieve the purpose of the litigation, and that potential funders should not be misled by the way in which the case was presented. None of these requirements would appear to deviate from established norms that would apply in other situations calling for publication of case information or duties owed to non-clients. Moreover, the lawyer and client would be far less likely to find themselves in the more compromising position of having to disclose highly sensitive case details to donors in this scenario than if they were seeking funding from a single ALF investor whose intention was to maximize their returns.

One area in which crowdfunding specific matters could be somewhat distinct in the ethics realm relates to the permissibility of the fee arrangement, though again the novel circumstances could be offset by existing rules. Specifically, in this case the lawyer seemed to envision a scenario in which they would put in significantly more hours than they would be compensated for by the crowdsourced funds, meaning that the lawyer should be entitled to all such funds. However, the Committee pointed out the possibility that the representation could end abruptly, with the lawyer securing a large sum relative to the number of hours worked on the matter, and thus running afoul of rules against excessive legal fees. Conversely, the crowdfunding effort could raise very little money for a case that might continue for years, such that the lawyer may want to withdraw at a certain point. Further, if the fee were payable to the lawyer immediately after the funds were raised, it could be considered a non-refundable retainer that could amount to an excessive fee that would limit the client’s ability to seek other counsel if they were unsatisfied with the attorney’s performance. The Committee stated that in order for the crowdfunding fee arrangement to be permissible under professional ethics rules, the lawyer and the client needed to clearly define and agree on the scope of the representation in terms of what the lawyer was (and was not) bound to do for the client in return for the fee, such that the amount of work the lawyer expended was sufficient to justify the fee amount. The funds were also to be held in trust until they were considered to be earned pursuant to the terms of the fee arrangement.

Crowdfunding to Finance Law Firm Operations

The New York State Bar Association (“Bar”) examined a different approach in a 2015 opinion, in this case analyzing whether it was ethically permissible for a group of recent law school graduates to use crowdfunding to raise capital for a new law firm as an alternative to incurring more debt.

The Bar identified five types of crowdfunding that could apply to these facts, and they were: (1) donation, (2) reward, (3) lending, (4) equity, and (5) royalty. Skipping over the lending model since it would not have served the inquiring attorneys’ goal of avoiding more debt, the Bar evaluated the other four options. The equity and royalty models were dismissed as possibilities given that they would violate rules against fee sharing with and law firm ownership by non-lawyers. However, the Bar found the donation and reward models to be potentially permissible.

The Bar explained that the donation model, which may not be especially attractive to the attorneys given the online platform fees they would have to pay for donations they might be able to secure through other means, was a feasible option. As long as the lawyers made clear that donors would receive nothing in return for the funds, and that the firm was a for-profit entity, the Bar concluded that using this model would not violate ethics rules.

The reward model was also ethically viable in the event that the lawyers offered things like informational pamphlets or pro bono work in exchange for funding. Any such pamphlets were permitted to contain only general legal information, not individual legal advice, and had to comply with applicable legal advertising requirements. The pro bono work could only be undertaken in areas in which the attorneys were competent, and in the absence of any conflicts.

Practical Takeaways

As illustrated above, so far the ethics opinions on crowdfunding suggest that lawyers are not per se prohibited from seeking this kind of financial backing, but must simply do so with caution in light of longstanding rules of professional responsibility. Indeed, given the historic and possibly growing role of corporate or single-investor ALF in litigation, which implicates many of the same ethical issues (and arguably may do so to a larger extent in some situations), many of the questions raised by crowdfunding are not necessarily new. Instead, crowdfunding may simply call on attorneys to re-think the ways in which established ethics rules may apply to new technologies.

And this perhaps highlights the more salient takeaway on the ethics front, which is that attorneys must continue to adapt to a changing profession that is being shaped by technology more each day. As reflected by the number of states that have revised their ethics rules to highlight the importance of technological proficiency as part of the broader duty of competence, having a basic grasp of how technology impacts the legal industry and professional ethical obligations has become a must for lawyers. At the end of the day, crowdfunding itself may or may not be something that appeals to a particular attorney. However, understanding the ways in which existing ethics rules can apply to this innovation or others involving online adaptations of traditional or “brick and mortar” systems can be useful in navigating the analogous challenges that will inevitably arise as part of modern law practice, and help attorneys remain competitive in a continuously evolving digital world.

In sum, lawyers considering a crowdfunding campaign should, as always, research the most recent authority in their jurisdictions, and can also consider seeking an informal opinion from their state bar to address any specific uncertainties, as the two opinions discussed above do not necessarily address all possible ethical considerations in this context. It may also be wise to consult a tax professional or other financial expert to determine the most appropriate way to handle the funds earned in this manner, and to make sure you understand the nuances of any agreement you enter into with the entity running the crowdfunding platform. As in other situations involving integrating tech into your legal practice, it is best to proceed with caution, but the business benefits of embracing a new technology have the potential to far outweigh the risks.

Disclaimer: The information in this blog post (“post”) is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Justia Inc. or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.

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