State Bar of Arizona Ethics Opinions

06-02: Conflict of Interest; Bankruptcy; Referral Fee
4/2006

A lawyer cannot accept a referral fee from an automobile dealer in return for referring “credit challenged” clients who purchase vehicles to the dealer. [1] This form of arrangement violates the dictates of ERs 1.7 and 1.8.

[1] The issue presented to the Committee on the Rules of Professional Conduct only involved “credit challenged” customers. This opinion should not be read to suggest that referral fees in transactions involving “non-credit challenged” customers are permissible.

FACTS[2]

An automobile dealer has offered bankruptcy lawyers a payment for each referral of a client who purchases a vehicle from the automobile dealer.  The offers are directed to bankruptcy lawyers with respect to “credit challenged” clients who have filed consumer (Chapter 7 or 13) bankruptcy cases.

QUESTION PRESENTED

Do the Arizona Rules of Professional Conduct (“Ethical Rules”) prohibit a lawyer from receiving a fee for referring clients to automobile dealers in the described circumstances?

RELEVANT ETHICAL RULES

ER 1.7. Conflict of Interest: Current Clients.

(a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest.  A concurrent conflict of interest exists if:

(1) the representation of one client will be directly adverse to another client; or

(2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.

(b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if each affected client gives informed consent, confirmed in writing, and:

(1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client;

(2) the representation is not prohibited by law; and

(3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal.

ER 1.8. Conflict of Interest: Current Clients: Specific Rules.

(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 in a manner that can be reasonably understood by the client;

(2) 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; and

(3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.

(b) A lawyer shall not use information relating to representation of a client to the disadvantage of the client unless the client gives informed consent, except as permitted or required by these Rules.

[The remaining subparts of ER 1.8 are not relevant]

RELEVANT ARIZONA ETHICS OPINIONS

Ariz. Ethics Ops. 95-10, 98-09, 95-01

OPINION

The Committee has previously addressed fees paid to lawyers for the lawyers’ referrals of clients to non-lawyers in the context of medical practitioners (Op. 95-10) and investment advisory firms (Ops. 98-09 and 05-01).  Generally, the Committee has not approved of referral fees paid to lawyers in return for referring their clients to non-lawyers for services.

In Op. 95-10, the Committee opined that a lawyer could not accept a referral fee from a marketing and consulting service for medical practitioners in return for directing the lawyer’s clients to the medical practitioner.  The Committee noted, first, a comment in In re Breen, 171 Ariz. 250, 830 P.2d 462 (1992).  There, the Arizona Supreme Court, disciplining a lawyer for, among other misconduct, directing clients into oil and gas investments, wrote:

We wish, however, to emphasize that when a lawyer receives a personal benefit apart from the client's fee from a transaction in which he represents a client, the lawyer's ethical obligation is not always fulfilled by merely disclosing the existence of the personal stake, explaining the potential consequences, and obtaining the client's consent. There is an inherent potential for a conflict of interest in such situations, and the lawyer must always ensure that his or her personal interest does not interfere with the unfettered exercise of professional judgment the client is entitled to expect under the circumstances.

Id. at 254, 830 P.2d at 466.

Using the comment in Breen as a general guide, the Committee (in Op. 95-10) noted five problems with the referral program.  Two are directly relevant here.  First, disclosure of the referral fee would be required, and the need to disclose “could have the effect of undermining the trust and confidence a client should have in relying on the advice and counsel of an attorney.”  Second, “if the client has any difficulty with the doctor, the payment of the referral fee places the lawyer in an awkward position with respect to resolving the difficulty for the client.”

The Committee believes the relevant factors support not permitting a referral fee in the situation presented here.  First, the consumer bankruptcy setting presents conflict of interest factors not present in other settings in which a lawyer and client may be involved in a business transaction that implicates ERs 1.7(a)(2)(the lawyer’s “personal interest”) and 1.8(a).  A consumer bankruptcy lawyer may advise a client whether to keep or surrender a vehicle.  Relevant factors include the value of the vehicle, the amount owed on any debt secured by a lien on the vehicle, and the client's ability to obtain alternative transportation.  The referral program at issue in this opinion adds a personal interest of the lawyer–the referral fee–to the calculation, inasmuch as the lawyer may have an incentive to advise the client to surrender a vehicle and purchase another one.  Thus, before the lawyer reaches the “should I recommend Dealer A or B” issue, a conflict of interest is present to the extent by which the lawyer’s advice about keeping or surrendering a vehicle is affected by the potential referral fee.  See ER 1.7(a)(2) (“representation of one or more clients will be materially limited by ... a personal interest of the lawyer”).  Bankruptcy procedures “front load” this decision in most instances; thus, the conflict of interest will, in most instances, present itself at the outset.

The Committee does not believe the conflict of interest – as between the lawyer’s “personal interest” in a referral fee and the need to advise the client about buying a new vehicle or keeping an existing vehicle and, if a new vehicle should to be purchased, from whom it should be purchased – can be waived.  ER 1.7(b)(1) only permits representation, in the face of a conflict of interest, if the client gives informed consent, confirmed in writing, and if “the lawyer reasonably believes [he or she] will be able to provide competent and diligent representation to each affected client.”  Generally, the Committee does not believe a lawyer can provide competent and diligent representation to a consumer debtor, in bankruptcy proceedings, when the lawyer also has a financial interest in the client’s decision about a vehicle.

Notwithstanding the Committee’s belief that a per se rule should apply here, the comments to ER 1.7 do not suggest that a per se rule necessarily applies.  Comment 15 to ER 1.7 states, in pertinent part, that “[c]onsentability is typically determined by considering whether the interests of the clients will be adequately protected if the clients are permitted to give their informed consent to representation burdened by the conflict of interest.”  Contrariwise, Comment 16 describes situations where substantive law makes a waiver of a conflict of interest impermissible. 

The Committee believes the arrangement raised by the inquiry clearly implicates the lawyer’s own interest and, thus, raises ER 1.7(b) concerns.  The Committee also believes, however, that the lawyer has a pecuniary interest in the “credit challenged” client’s vehicle purchase, raising ER 1.8(a) issues.  To the extent by which the Committee’s position in this matter conflicts the comment in footnote 2 to Op. 98-09 – in which the Committee said referral fees in the investment advisor situation do not involve a lawyer “acquiring a business interest adverse to the client” – the Committee believes the factual difference (investment advisor referral fees v. a referral fee associated with a vehicle sale) supports the difference in approach.  Dealers have a certain amount of profit to be made in a given transaction, and they are not in business to sell vehicles at a loss.  Motor vehicle sales often involve a negotiated price.  Money paid for a referral fee could reduce the dealer’s ability to charge a lower price for a vehicle and, thus, make it more difficult for the client/customer to negotiate a better deal.  The referral fee may, in fact, constitute a payment that is really paid by the client/customer, not by the dealer.  Thus, a vehicle purchase is different from investment adviser services because there will not likely be a “fixed pot” from which the service provider can make money.  An investment adviser will not often know how much money can be made in a given situation.  The amount of money to be paid to the referring lawyer may not have a significant bearing on the amount of money the client will pay for services rendered.

The Committee does not believe informed consent can be provided, given the fact pattern presented here.  Further, the Committee does not believe the lawyer can provide competent and diligent representation, in relation to the vehicle issue, when his or her interest in the referral fee is present.  At a minimum, the presence of his or her interest in the referral fee will call into question whether the lawyer is focused on the client’s interests.  See Breen, 171 at 254, 830 P.2d at 466.

ER 1.8(a) would require disclosure because the lawyer would have a “pecuniary interest” in the transaction.  The fee would only be paid if the vehicle sale were consummated, giving the lawyer an incentive to recommend that clients surrender vehicles in bankruptcy proceedings and have clients buy vehicles from dealers who pay referral fees.  The incentive is present without regard for the benefit or detriment to the client.

ER 1.8(a) requires that, in any situation in which the lawyer obtains a “pecuniary interest adverse to a client,” the terms be “fair and reasonable to the client.”  For the reasons stated in the preceding paragraphs, the Committee does not know whether any given transaction would be fair and reasonable to the client.  Even if fairness could be presumed, however, meaningful disclosure presents practical problems.  The Committee doubts whether a disclosure can be drafted, for use with “credit challenged” consumer debtors in bankruptcy proceedings, that would meet the requirement of ER 1.8(a)(1) (“in writing in a manner that can be reasonably understood by the client”).  Further, the Committee questions the likelihood of a meaningful suggestion to a client, made in writing, that he or she might want to seek counsel about the vehicle purchase and the fact that the lawyer will receive a referral fee, despite the fact that ER 1.8(a)(2) requires that disclosure.  It is likely that a typical “credit challenged” consumer debtor in bankruptcy proceedings would not have funds available to pay a lawyer to provide the independent review contemplated by ER 1.8(a)(2), and bankruptcy law would require that the advising lawyer be appointed a special counsel by the Bankruptcy Court, in order to permit him or her to receive a fee from the debtor.  Finally, the client would have to give informed consent with respect to the arrangement.  See ER 1.8(a)(3).  In sum, the Committee cannot envision meaningful compliance with the requirements of ER 1.8(a).

The other factor presented by the Committee in Op. 95-10 – that a dispute might arise between the client and the party paying the referral fee – is certainly present here.  While most transactions involving vehicle sales do not result in a dispute between buyer and seller, disputes do arise from time to time, and a dispute would immediately call into question the lawyer’s loyalty to his or her client. 

In Op. 98-09, the Committee addressed fees paid by investment advisory firms.  The Committee relied, in part, on Op. 95-10 and In re Breen.  It disapproved of referral fees in that context.  The Committee believes the reasoning in Op. 98-09 remains sound.  In particular, the Committee notes the comment that the lawyer’s “professional judgment may be affected, perhaps unconsciously, by the knowledge that with each referral, he or she will receive a percentage of the fee the client pays to the investment adviser firm.”

The Committee did, in Op. 05-01, recognize that lawyers who also happen to be investment advisors can receive referral fees, but only in connection with their activities as investment advisors.  The Committee’s action reflects a recognition of ER 5.7 (Responsibilities Regarding Law-Related Services) as of December 1, 2003.  The Committee does not believe Op. 05-01 has any bearing on the appropriateness of lawyers, acting as lawyers, receiving referral fees, and it certainly provides no support for lawyers receiving referral fees in the context presented here.

CONCLUSION

The Committee has previously expressed significant concern about referral fees being paid to lawyers in return for referring their clients to others.  Only in the context of law-related services, where the lawyer is separately operating an investment advisory firm in a manner consistent with the dictates of ER 5.7, has the acceptance of referrals fees been approved.  The referral fee inquiry presented here presents what is probably, in almost every instance, a non-waivable conflict of interest.  Even if, in a particular instance, the facts might suggest that a conflict of interest could be waived, the Committee does not believe it is likely that adequate disclosure could occur under ER 1.8.  For these reasons the Committee sees no reason to deviate from its prior opinions regarding referral fees.

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[1] The issue presented to the Committee on the Rules of Professional Conduct only involved “credit challenged” customers.  This opinion should not be read to suggest that referral fees in transactions involving “non-credit challenged” customers are permissible.

[2] 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.  (c) State Bar of Arizona 2006