ILR’s first research paper of 2023, Selling Out: The Dangers of Allowing Nonattorney Investment in Law Firms, examines efforts in several states to erode or even remove their versions of the American Bar Association’s (ABA) Model Rule of Professional Conduct 5.4, which bans nonlawyers from owning law firms or splitting fees with attorneys. Rule 5.4 protects the confidentiality rights of clients and ensures that lawyers serve the interests of their clients. The rule is so crucial that in August of 2022, the ABA passed a resolution affirming support for Rule 5.4 at its annual meeting.
Selling Out notes that without Rule 5.4, third party litigation funders could directly invest in—and even own—law firms. Third party litigation funding (TPLF) has rapidly grown in the U.S. and around the globe into a multibillion-dollar industry. TPLF allows hedge funds and other financiers to invest in lawsuits in exchange for a percentage of any settlement of judgment. Allowing funders to own law firms threatens the professional judgment of lawyers, who might be obligated to make decisions that serve the best interest of litigation funders, not their clients.
We’ve seen that when litigation funders have outsized control over lawsuits, clients get served last. Look at what’s happening with the infamous California plaintiffs’ lawyer Tom Girardi, who was recently indicted by grand juries in Los Angeles and Chicago for stealing more than $18 million from clients. A bankruptcy trustee, who oversaw Girardi’s now-defunct law firm, sued a litigation funder to recover $6.3 million for a former client of Girardi’s. The lawsuit accused the funder of helping “Girardi ‘loot’ more than $23 million from client trust accounts.”
In September of 2022, a California law was passed and signed by Gov. Gavin Newsom limiting the ability of the California State Bar to explore and implement a “regulatory sandbox,” which would involve increasing the scope of practice for paralegals or nonattorneys and opening the door to nonlawyer ownership of law firms. The law created major obstacles for efforts to amend the state’s version of Rule 5.4. Any spending on the regulatory sandbox will require lawmakers’ approval. As it stands now, on January 1, 2025, the State Bar’s reporting requirements from AB 2958 will automatically sunset.
Unfortunately, some states, like Arizona and Utah, have modified or eliminated Rule 5.4, and nonattorneys are ready to invest.
On January 1, 2021, Arizona instituted an “alternative business structure program” (ABS), which licenses businesses combining lawyers and nonlawyers, and is already seeing nonattorneys partner with plaintiffs’ firms to share verdicts or settlements from cases. According to a recent Bloomberg Law article about the increase in ad spending for Camp Lejeune-related claims, marketing firms, litigation funders, and plaintiffs’ firms are teaming up to co-own firms in the Grand Canyon State.
In August 2020, the Utah Supreme Court created its own two-year regulatory sandbox, which allowed nonlawyer ownership or investment in law firms and permitted legal services providers to try new ways of serving clients during the pilot period. But, as Arizona shows, it’s only a matter of time before outside investment in law firms can have unintended consequences.
State bar associations, courts, and legislators should reject any changes that would weaken Rule 5.4, because doing so will give outsiders with a financial stake in litigation more control over cases, create conflicts of interests, and put a client’s best interests last.
For more information on Rule 5.4, check out 101 Ways to Improve State Legal Systems: A User’s Guide to Promoting Fair and Effective Civil Justice – Seventh Edition 2022 and ILR’s blog post.