Decision Alert: PA Court Deems Fee-Splitting Rule "Not Absolute"

February 21, 2018

Decision Alert: PA Court Deems Fee-Splitting Rule "Not Absolute"

ABA Model Rule 5.4 prohibits lawyers from sharing legal fees with non-lawyers except under limited circumstances like including non-lawyer employees in compensation or retirement plans. It has been adopted in some form by each state. The underlying purpose of Rule 5.4 and its state counterparts is to preserve the independent professional judgment of attorneys. In other words, it is designed to prevent impairment or influence of a lawyer’s provision of legal services to his or her client when a non-lawyer is receiving part of the lawyer’s fee, or recommends employment of the lawyer. But read literally, the rule would prohibit payments to all sorts of lenders and vendors necessary to the operations of every law firm, such as paying rent or compensating court reporters. 

In a closely watched case, the Pennsylvania Supreme Court addressed the question of whether fee-splitting arrangements between lawyers and non-lawyers are per se unenforceable as violations of attorney ethics rules. In SCF Consulting v. Barrack, Rodos & Bacine, case no. 7 EAP 2017, a consultant to Philadelphia securities litigation firm Barrak, Rodos & Bacine sued for nonpayment on an agreement that allegedly promised the consulting firm a five percent cut of the firm’s profits on cases in which it was involved. SCF alleged the firm refused to make the profit-sharing payments. In its defense, the law firm argued that the profit-sharing provision of the consulting agreement was unenforceable as a violation of Rule 5.4. The Pennsylvania Bar Association appeared as amicus and noted the dilemma of, on the one hand, not approving a fee-sharing arrangement that violates the ethical rules, but on the other not wanting to reward a law firm that deceived a non-lawyer consultant into thinking it had a valid fee-sharing agreement and then violating it. The majority of the Court agreed with SCF that the case should not have been dismissed and held that a fee-sharing agreement between a law firm and non-lawyers was not per se unenforceable.

The rule against fee-splitting often also arises in the context of litigation finance. There, a third-party provides capital to cover the fees and costs of the litigation or helps cover operating expenses for the plaintiff during the course of the case in exchange for a portion of the litigation proceeds. In many cases, litigation finance firms provide funding directly to claimants, making rules restricting splitting fees with lawyers irrelevant.

However, law firms recognizing the advantages that litigation finance affords have also begun to seek funding in recent years. The solution that funders have offered to meet this demand without running afoul of Rule 5.4 is commonly known as “law firm portfolio financing.” In this arrangement, funders provide financing to law firms collateralized by a portfolio of three or more cases. Having multiple cases in portfolios allows firms to cross-collateralize their litigation assets, with funders receiving their returns from the successful cases within the portfolios. With the financing spread across a number of cases, funders are more analogous to banks in these transactions and are further removed from the outcome of – and any impairment of the lawyer’s representation of its client in – a specific case. 

SCF Consulting demonstrates that the rule against fee-splitting is not absolute. However, the rule is not invalidated by the decision.

When it comes to contracting with third party financiers to share risk and potential upside, one way firms may seek to avoid the fee splitting issue is to use portfolio funding. Following this course of action will help ensure the firms obtain the funding they need while meeting their ethical obligations. For more information about how firms benefit from this type of financing, see Portfolio Funding: A Creative Approach to Managing Risk.

To work with a reputable funder that has extensive experience providing law firm portfolio financing, please contact us.