State Bar of Arizona Ethics Opinions

94-15: Contingent Fees; Patent Assignments
12/1994

An attorney may take a contingent fee in the form of a partial patent registration assignment for prosecution of a patent application at the U.S. Patent and Trademark Offices as long as the attorney complies with the requirements of ER 1.8 with respect to entering into a business transaction with a client.



FACTS[1]

A law firm actively involved in the preparation and prosecution of patent applications before the United States Patent and Trademark Office inquires as to the ethical propriety of accepting a partial assignment of a patent in return for rendering legal services in preparing and prosecuting a patent before the Office. If the patent does not issue, the firm would receive nothing for the portion of the services representing the assignment, making the arrangement analogous to a contingent fee.

 

QUESTIONS PRESENTED

1. Is it consistent with the Arizona Rules of Professional Conduct for a law firm to accept a partial assignment of a patent, on essentially a contingency fee basis, in return for rendering legal services in preparing and prosecuting the patent?

2. What procedures should an attorney who utilizes the proposed fee arrangement follow to ensure that a future conflict does not arise?

 

ETHICAL RULES INVOLVED

Arizona Rules of Professional Conduct, Supreme Court Rule 42, 17A A.R.S.:

 

ER 1.5.                   Fees

(c) A fee may be contingent on the outcome of the matter for which the service is rendered, except in a matter in which a contingent fee is prohibited by paragraph (d) or other law. A contingent fee agreement shall be in writing and shall state the method by which the fee is to be determined, including the percentage or percentages that shall accrue to the lawyer in the event of settlement, trial or appeal, litigation and other expenses to be deducted from the recovery, and whether such expenses are to be deducted before or after the contingent fee is calculated. Upon conclusion of a contingent fee matter, the lawyer shall provide the client with a written statement stating the outcome of the matter and, if there is a recovery, showing the remittance to the client and the method of its determination.

 

ER 1.8.                   Conflict of Interest: Prohibited Transactions

(a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a 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 which can be reasonably understood by the client;

(2) the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and

(3) the client consents in writing thereto.

(j) A lawyer shall not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except that the lawyer may:

(2) contract with a client for a reasonable contingent fee in a civil case.

 

OPINION

 

A.            The Fee Arrangement is Consistent with the Arizona Rules of Professional Conduct.

The Arizona Rules of Professional Conduct prohibit a lawyer from acquiring an interest in a cause of action or the subject matter of litigation which the lawyer is conducting for the client. ER 1.8(j). The Arizona Supreme Court summarized the policy rationale underlying the rule, explaining that "if an attorney acquires an interest in the outcome of a suit in addition to his fees, it can lead to the attorney placing his own recovery ahead of his client." In re Stewart, 121 Ariz. 243, 245, 589 P.2d 886, 888 (1979) (analyzing DR5-103(A) the predecessor to ER 1.8(j)).

Rule 1.8(j), however, provides a specific exception allowing an attorney to "contract with a client for a reasonable contingent fee in a civil case." ER 1.8(j) (2).[2] Contingency fee arrangements are "often thought to be necessary in civil cases, so that lawyers will be encouraged to represent clients with meritorious claims who could not otherwise afford to pre-pay the costs of litigation." 1 Geoffrey C. Hazard & W. William Hodes, The Law of Lawyering: A Handbook on the Model Rules of Professional Conduct, § 1.8:1101, at 286.1 (1993). The policy rationale supporting the contingency fee exception to ER 1.8(j), therefore, appears particularly suited for the proposed fee arrangement because individual inventors and small start-up companies often lack the requisite resources to pay for the preparation and prosecution of a patent before the United States Patent and Trademark Office.

Neither the Arizona courts nor the Committee on the Rules of Professional Conduct specifically have addressed the ethical propriety of accepting a partial assignment of a patent in return for prosecuting a patent before the United States Patent and Trademark Office.[3]  Courts and ethics committees in other jurisdictions, however, have specifically held that the acceptance of a partial assignment of a patent on a contingency fee basis is ethically proper. 

For instance, the court in Beatie v. DeLonq, 561 N.Y.S. 2d 448 (App. Div. 1990) affirmed a jury's finding that an attorney's partial assignment of his client's patents was reasonable. The contingency fee arrangement in Beatie provided the attorney with 30% of all revenues generated by the patents in return for representing the client in a suit to recover the client's right to use and commercialize the patents. The court analyzed the issue under DR 5-103, the predecessor to ER 1.8(j), and ruled that the partial assignment of the revenues generated by the patents in no way violated the rule against obtaining an interest in the litigation because the arrangement clearly fell within the exception relating to contingency fees. Id. at 451.

Recognizing the importance of representing clients unable to pay, the Committee on Professional Ethics of the Association of the Bar of the City of New York also upheld a law firm's partial assignment of a client's patent in exchange for the preparation and prosecution of a patent application on behalf of the client. Comm. on Prof. Ethics of the Assn of the Bar of the City of New York, Op. No. 80-14 (undated), Laws. Man. on Prof. Conduct (ABA/BNA), p. 801:6304. Specifically, the Committee ruled that "[a] law firm may prepare and prosecute a patent application on behalf of an inventor in exchange for a one-third interest in the rights to the invention as a fee where the inventor is unable to pay on a timecharge basis and desires to retain the same firm that has represented him in the past." Id.[4]

Moreover, the United States Patent and Trademark Office Code of Professional Responsibility, while generally prohibiting patent attorneys from obtaining an interest in a litigation or proceeding before the Office, explicitly permits the prosecution of patents before the Office on a contingency fee basis.[5] Thus, the weight of authority strongly suggests that it is consistent with the Arizona Rules of Professional Conduct to retain a partial assignment of a patent in return for legal services in preparing and prosecuting a patent. Answering this question in the affirmative, however, does not end an attorney's ethical responsibility.

 

B.            Business Transaction with Clients: Procedures Necessary to Avoid a Conflict of Interest.

Under the fee arrangement contemplated by the present inquiry, the attorney (or the firm) and the client become joint owners of the underlying patent upon the successful prosecution of the patent. As in any business transaction between an attorney and client, a plethora of future conflicts may arise between the parties as joint owners of the patent. For example, the attorney and the client may disagree as to the future licensing, sales, and/or commercialization of the patent. Recognizing the multitude of conflicts that may arise in business dealings between attorneys and clients, courts and ethics committees strictly scrutinize such transactions. Indeed, one court has gone so far as to state that "there are no transactions that courts will scrutinize with more jealousy than dealings between an attorney and his clients." Hazard & Hodes, § 1.8:200, at 262 (citing Spilker v. Hankin, 188 F.2d 35 (D.C. Cir. 1951)).

In Arizona, ER 1.8(a) is instructive. While not completely prohibiting business dealings between an attorney and client, ER 1.8(a) places stringent requirements on such transactions. ER 1.8(a) requires that: 

(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 which can be reasonably understood by the client;

(2) the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and

(3) the client consents in writing thereto.

Such rules are necessary to protect clients because “[a] lawyer's legal skill and training, together with the relationship of trust and confidence required between client and lawyer, create the possibility of overreaching when a lawyer enters into a business transaction with a client." Restatement of the Law, The Law of Governing Lawyers § 207 cmt. b (Tentative Draft No. 4 1991).

While Arizona has not addressed the issue, ethics committees in other jurisdictions have validated business transactions between attorneys and clients analogous to the fee arrangement proposed by the present inquiry. For example, the Legal Ethics Committee of the District of Columbia Bar analyzed a situation in which a lawyer who represented a business in an action to obtain a government license accepted legal fees in the form of an equity interest in the business. Legal Ethics Comm. of the D.C. Bar Op. No. 179 (3/17/87) Laws. Man. on Prof. Conduct (ABA/BNA), p. 901:2306. In noting the validity of such a fee arrangement, the committee stated that "[a] lawyer may become a partner or shareholder in a client's business, rather than accept a cash fee for legal services." Id. Similarly, the Committee on Legal Ethics and Professional Responsibility of the Pennsylvania Bar Association allowed a law firm to accept a minority interest in the stock of a corporate client as payment for legal services, even though the committee determined that such an arrangement constituted a business transaction between the attorney and the business. Comm. on Legal Ethics and Professional Responsibility of the Penn. Bar Assn. Op. No. 89-158 (undated) Laws. Man. on Prof. Conduct (ABA/BNA), p. 901:7321.[6]

To ensure that the proposed fee arrangement is consistent with the Arizona Rules of Professional Conduct, however, an attorney should be extremely cautious in complying with the requirements of ER 1.8(a). First, the terms of the transaction must be fair and reasonable and must be fully disclosed to the client. "[F]ull disclosure requires not only that the lawyer make proper disclosure of non-representation, but that he also must disclose every circumstance and fact which the client should know to make an intelligent decision concerning the wisdom of entering the agreement." In re Neville, 147 Ariz. 106, 113, 708 P.2d 1297, 1304 (Ariz. 1985) (citing Committee on Professional Ethics v. Mershon, 316 N.W.2d 895 (Iowa 1982)). The Arizona Supreme Court further cautioned:

The rule is strict. The lawyer must give the client that information which he would have been obliged to give if he had been counsel rather than interested party, and the transaction must be as beneficial to the client as it would have been had the client been dealing with a stranger rather than with his lawyer.

Id. (citing In re McGlothlen, 99 Wash. 2d 515, 525, 663 P.2d 1330, 1335 (1983)).

Moreover, the fact that transaction is fair in no way obviates the need for full disclosure. In re Weiner, 120 Ariz. 349, 352, 586 P.2d 194, 197 (1978) (ruling that providing clients with investment advice without disclosing conflicts of interest warrants disbarment and stating, "[f]ull disclosure of all pertinent information, including the presence of any conflicts of interest, is independently required”) (emphasis added).

Second, the attorney must provide the client with the opportunity to seek the advice of independent counsel. Although the comment to ER 1.8 merely states that "a review by independent counsel on behalf of the client is often advisable," an attorney contemplating the utilization of an arrangement contemplated by the present inquiry would be prudent to encourage the client to seek the advice of independent counsel. See. e.g., Laws. Man. on Prof. Conduct (ABA/BNA), p. 51:504 ('1[f]or the lawyer to fulfill his obligation under this requirement, more than a casual suggestion that the client consult with another is needed," citing Smyzer, 527 A. 2d 857, 862 (N.J. 1987)). Providing the client with the opportunity to obtain the advice of outside counsel serves two important objectives: (1) it assures that the client has time to consider the transaction and that the lawyer is not applying undue pressure on the client; and (2) an independent adviser can bring an objective eye to the proposed arrangement. Restatement, supra, cmt. e, at 98.

Finally, ER 1.8(a) insists that the client consent in writing. The writing requirement insures that the client is aware of his or her right to withhold consent. Restatement, supra, cmt. f, at 98. Additionally, the written consent has significant evidentiary value should a dispute later arise between the attorney and client. Id. Thus, written consent from the client is an indispensable element of entering the fee arrangement contemplated by the present inquiry.

 

C.            CONCLUSION

The present inquiry asks whether an attorney or law firm may retain a partial assignment of a patent in return for legal services earned in preparing and prosecuting a patent before the United States Patent and Trademark Office. Although neither the Committee nor the Arizona courts have addressed the issue, decisions of courts and ethics committees in other jurisdictions analyzing the issue under similar ethical provisions, suggest that the proposed arrangement is consistent with the Arizona Rules of Professional Conduct. In order to avoid violating the Ethical Rules, however, an attorney must fully comply with the rules regulating business transactions between attorneys and clients. See ER 1.8(a). Specifically, the attorney must ensure that: (1) the terms of the contemplated fee arrangement are fair and reasonable and fully disclosed; (2) the client is given a reasonable opportunity to seek the advice of outside counsel; and (3) the client consents in writing.

 

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 1994 



[1] 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.

[2] A full statement of the exception for reasonable contingent fees is set forth in E.R. 1.5(c) above.

[3] One Arizona court, however, upheld a client's assignment of the subject matter of litigation, in this case a deed of trust, where the assignment was to secure payment of a fee and was not irrevocable. Skarecky & Horenstein v. 3605 N. 36th St., 170 Ariz. 424, 825 P.2d 949 (Ct. App. 1991). In Skarecky, the court analogized the acceptance of an assignment as security to a contingency fee and stated that "[b]oth fee arrangements could arguably affect an attorney's independent judgment, but both provide greater access to legal services." Id. at 428, 825 P.2d at 953.

[4] But cf., Legal Ethics Committee of the District of Columbia Bar Opinion 195, where the Committee held that a lawyer who is prosecuting a patent application for his client could not have the client assign all rights for the patent to the lawyer with the understanding that the rights will be reassigned to the client after payment of the fees. The Committee found that such an arrangement constituted acquiring an interest in the subject matter of litigation, and did not fall within the exceptions for liens or contingent fee contracts. Legal Ethics Comm. of the D.C. Bar Op. No. 195 (12/13/88) Laws. Man. On Prof. Conduct (ABA/BNA), p. 901:2311. Note, however, that this opinion dealt with a full assignment of the patent as security, as opposed to a contingent partial assignment of the patent in lieu of fees.

[5] 10.64   Avoiding acquisition of interest in litigation or proceeding before the Office.

(a) A practitioner shall not acquire a proprietary interest in the subject matter of a which the practitioner is conducting for a client, except that the practitioner may:

(3) In a patent case, take an interest in the patent as part or all of his or her fee.

37 C.F.R. Ch. 1, § 10.64 (1993).

[6] See also, Hazard and Hodes, § 1.8:202, p. 263, "Illustrative case: Taking an Interest in a Client's Business in Lieu of a Fee" (hypothesizing a situation in which the lawyer retains a 5% interest in a small corporation in lieu of a fee for legal services provided and finding. such an arrangement valid, assuming the requirements of Rule 1.8(a) of the ABA Model Rules of Professional Procedure, the corollary to Arizona E.R. 1.8(a), are met).

 




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