State Bar of Arizona Ethics Opinions
92-08: Sale or Lease of a Law Practice; Goodwill of a Law Practice (Invalidated by Op. 06-01)
Sole practitioner proposes to turn over his law practice to a law firm while he goes on a one-year leave of absence. Discussion of whether a law practice has a salable goodwill. (Invalidated by Op. 06-01)
The inquiring attorney proposes that his law firm enter into an agreement with a sole practitioner whereby the firm would agree to take over the sole practitioner's law practice for a year while he goes on a leave of absence.
The proposed lease agreement generally provides for the following:
1. The law firm will sublease the sole practitioner's office space and equipment under the terms and conditions of his leases. The law firm will also employ the sole practitioner's secretary at her annual salary.
2. The law firm will "service and complete" all client matters pending on the date the sole practitioner goes on the leave of absence (or sabbatical) and arising thereafter during the lease term.
3. The law firm's agreement to represent any of the sole practitioner's clients is contingent on that client's consent and execution of a substitution of counsel document.
4. The sole practitioner will resume representation of the clients when he returns from his leave of absence.
The proposed lease agreement presents two primary issues:
1. Do any of the payments to be made by the inquiring attorney's law firm pursuant to the lease represent consideration for the sole practitioner's "goodwill", client referrals or anything other than payments for the use of the physical assets of his law practice and the annual salary of his secretary?
2. Are the sole practitioner's clients given the option of choosing counsel other than the inquiring attorney's law firm?
ETHICAL RULES INVOLVED
ER 1.5(e). Fees
ER 1.6. Confidentiality of Information
ER 1.7. Conflict of Interest: General Rule
ER 1.9. Conflict of Interest: Former client
ER 1.10(a). Imputed Disqualification: General Rule
ER 1.16(d). Declining or Terminating Representation
ER 7.2(c). Advertising
The ethics inquiry before us presents only issues raised by an attorney's transferring his law practice to another attorney for a limited time. However, in this opinion, we consider the ethical propriety of both the sale and the lease of a law practice. This is because ethics opinions in other jurisdictions have rarely addressed the ethical issues arising from one attorney's leasing his law practice, while many jurisdictions have issued opinions concerning the ethical propriety of the sale of a law practice when an attorney retires, has died, or has been disbarred. The ethical concerns are nearly identical in both situations.
a. Sale or Lease of Goodwill
This committee addressed the issue of whether goodwill may be included as part of the sales price of a law practice in its Opinion No. 73-37 (October 30, 1973):
Thus, a lawyer's assets include only claims against his clients for services rendered for which payment has not yet been received, the lawyer's library, furniture, fixtures, and the unexpired term and any renewal privileges on the lease of his office. There can be no appraisal or sale of a lawyer's "goodwill."
Id. at 3. Most jurisdictions are in agreement that it is ethically improper for an attorney to sell anything other than the physical assets and accounts receivable of his or her law practice. See, e.g., Pennsylvania Bar Association Opinion 89-246 (12/13/89) (ABA/BNA Lawyers' Manual on Professional Conduct, p. 901:7324); Philadelphia Bar Association Opinion 86-93(9/11/86) (ABA/BNA Lawyers' Manual, supra, p. 901:7506); State Bar of Michigan Informal Opinion CI-1145 (4/16/86) (ABA/BNA Lawyers' Manual, supra, p. 901:4754); Kentucky Bar Association Opinion 324 (9/87) (ABA/BNA Lawyers' Manual, supra, p. 901:3903); Vermont Bar Association Opinion 88-3 (undated) (ABA/BNA Lawyers' Manual, supra, p. 901:8606); Walsh v. Brousseau, 815 P.2d 828 (Wash. Ct. App., 9/9/91) (ABA/BNA Lawyers' Manual, supra, vol. 7, No. 17, p. 287). Cf. Oregon State Bar Opinion 508 (10/86) (ABA/BNA Lawyers' Manual, supra, p. 901:7101); and American Bar Association Model Rule of Professional Conduct ER 1.17 (ABA/BNA Lawyers' Manual, supra, pp. 01:139-01:142) (both permitting the sale of the goodwill of a law practice).1
Our Opinion No. 73-37 (October 30, 1973) based its conclusion on the belief that there was no such thing as the goodwill of a law practice. The committee accordingly reasoned that the sale of “goodwill” was more in the nature of a referral fee, which was prohibited by then-applicable DR 2-107(A) of the Code of Professional Responsibility. However, since the issuance of that opinion, Arizona case law has established that a measurable goodwill does in fact exist as an asset of a professional corporation or partnership. See Wisner v. Wisner, 129 Ariz. 333, 336-338, 631 P.2d 115, 118-120 (App. 1981) (plastic surgeon' s professional corporation) ; Mitchell v. Mitchell, 152 Ariz. 317, 319-321, 732 P.2d 208, 210-212 (1987) (accounting partnership).
We do not believe that it necessarily follows, however, that goodwill may be factored into the sale or lease of a law practice. In both Mitchell and Wisner, the issue was whether the goodwill of a professional practice was a community property asset subject to division in a dissolution proceeding. In holding that goodwill was a community asset, the Mitchell court quoted from the case of Golden v. Golden, 270 Cal. App. 2d 401 at 405, 75 Cal. Rptr. 735 at 738 (1969):
Under the principles of community property law, the wife, by virtue of her position as wife, made to that value [goodwill] the same contribution as does a wife to any of the husband's earnings and accumulations during marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.
152 Ariz. at 320, 732 P.2d at 211. The purchaser (or lessee) of a law practice has, of course, not contributed to the existence of any goodwill which an attorney's professional corporation or partnership may possess, such that any equitable considerations present in a domestic relations proceeding are not present.
Moreover, it is difficult to place a value on an intangible asset such as goodwill. In a contested domestic relations proceeding, expert witnesses may testify and other evidence may be introduced to enable the trier of fact to determine the value of the goodwill for purposes of equitable division thereof. In the context of the sale or lease of a law practice, the figure assigned to goodwill will more likely be arbitrary and subjective based on the selling or lessor attorney's own opinion as to the value of the goodwill of his or her law practice, and on the amount of money the purchasing attorney is willing to pay. We believe that this does not accurately reflect the goodwill of the attorney's law practice, but instead results in a bargained-for referral fee included in the sales price of the law practice. Such referral fees are prohibited by ER 1.5(e) and ER 7.2(c). See our Opinion No. 81-1 (January 16, 1981) (referral fees prohibited by DR 2-107(A), the predecessor to ER 1.5(e)).
Therefore, we conclude that the lease payments to be made may not properly include any payment or bonus for the sole practitioner's goodwill.
b. Client Referrals
The lease agreement sets forth the division of fees agreed to between the inquiring attorney's law firm and the sole practitioner. Such a fee division must comply with ER 1.5(e), which provides that a division of fees between lawyers who are not in the same law firm may be made only if: (a) the division is in proportion to the services performed by each lawyer or, by written agreement with the client, each lawyer assumes joint responsibility for the representation; (b) the client, having been advised of the participation of all lawyers involved, does not object thereto; and (c) the total fee is reasonable. Similarly, it would be unethical for the law firm to enter into such a lease agreement where the sole practitioner agrees to refer his clients to the firm as part of the consideration for the lease. Such an agreement would violate ER 7.2(c), which prohibits an attorney from giving anything of value to another person for recommending the attorney's legal services. Therefore, the lease agreement may not properly require the sole practitioner to refer his clients to the inquiring attorney's law firm as part of the consideration for the lease.
Clients’ choice of counsel
It is important that each of the sole practitioner's clients have the absolute right to retain someone other than the inquiring attorney's law firm when the sole practitioner goes on his leave of absence. This does not preclude the sole practitioner from notifying his clients that he has arranged for the inquiring attorney's law firm to take care of his caseload while he is away, but it does prohibit him from transferring his clients to the firm without their consent.
Ethics opinions in other jurisdictions have determined universally that, when an attorney sells his or her law practice, the clients must be privileged to retain an attorney of their choice. See Philadelphia Bar Association Opinion 89-5 (3/89) (ABA/BNA Lawyers' Manual, supra, p. 901:7525) (clients must be “informed of the arrangement and given an opportunity to seek other counsel”); State Bar of Wisconsin Opinion E-87-6 (6/17/87) (ABA/BNA Lawyer’s Manual, supra, p. 901:9105) (an associate may not automatically assume a sole practitioner's cases after the sole practitioner's death; rather, he must notify the clients and inform them of their options); Virginia State Bar Opinion 934 (6/16/87) (ABA/BNA Lawyers' Manual, supra, p. 901:8721) (a lawyer may advise clients of a recently disbarred attorney of his intention to take over the disbarred attorney's practice, but the clients must have the free choice of seeking other counsel); Vermont Bar Association Opinion 88-3 (undated) (ABA/BNA Lawyers' Manual, supra, p. 901:8606) (a lawyer must notify his clients of their right to keep their case files and to retain other counsel when he sells his law practice).
An instructive opinion on this subject has been issued by the Oregon State Bar. In its Opinion 508 (10/86), the Oregon Ethics Committee provided guidelines for what a retiring lawyer selling his law practice should say in letters to his clients:
"The lawyer selling his practice should write a letter to his clients informing them of the following: (1) he is retiring and will no longer handle the client's case; (2) the client is free to select other counsel; (3) the lawyer has entered into an agreement with another lawyer to sell equipment, supplies and other materials necessary to a law practice, and to assign his office lease to the other lawyer; (4) the purchasing lawyer is willing to discuss handling the client's work; and (5) the client should contact the lawyer regarding disposition of the client's files, and failure to respond will not result in the lawyer's automatically turning over the client's files to the purchasing lawyer."
We believe these guidelines are sound and provide a good framework for what should be sent to the sole practitioner's clients. The inquiring attorney should be careful that the notices sent to the clients cannot be construed as client referrals and that they also offer the client the option of choosing his or her own attorney. Also, it is important to realize that the same principles discussed above apply when the lease terminates; it will still ultimately be the decision of the client whether he or she wishes to return to the sole practitioner at the conclusion of his leave of absence. In other words, the clients cannot be automatically transferred back to the sole practitioner pursuant to the lease provisions.
3. Other Ethics Provisions
We list briefly some other ethics rules of which the inquiring attorney should be generally aware: ER 1.6, the rule concerning client confidentiality, prohibits the sole practitioner from transferring files to the inquiring attorney's law firm or disclosing any information relating to the representation of his clients, unless his clients consent to the transfer of information after consultation. Although ER 1.6 does not require it, we believe the best procedure would be to obtain this consent in writing. Additionally, ER 1.16(d), concerning termination of representation, requires the sole practitioner to take steps to the extent reasonably practicable to protect his clients' interests, such as giving reasonable notice to the clients, allowing time for employment of other counsel, surrendering papers and property to which the clients are entitled and refunding any advance payment of fee that has not been earned. When the sole practitioner is winding down his law practice in preparation for his leave of absence, he must give each of his clients adequate time to make an informed decision as to a successor attorney. Additionally, the inquiring attorney's law firm must take similar steps when the lease expires.
Finally, ER 1.7, ER 1.9 and ER 1.10 prohibit the inquiring attorney's law firm from accepting representation of clients of the sole practitioner to the extent that it is representing, or has represented, other clients with conflicting interests. This is an issue that must be resolved on a case-by-case basis, but it is important that the inquiring attorney's law firm review the cases individually, rather than simply agreeing to represent the sole practitioner's clients as a group.
Subject to the above guidelines, we believe that it would not violate the Arizona Rules of Professional Conduct for a law firm to enter into a sale or lease agreement such as the one described in the "Facts" above.
Formal Opinions of the Committee on the Rules of Professional Conduct are advisory in nature only and are not binding in any disciplinary or other legal proceedings.
©State Bar of Arizona 1992
1ABA Model Rule 1.17, concerning the sale of a law practice, was recently approved by the American Bar Association but has not yet been adopted in Arizona.