Ethics Opinions
Iowa Supreme Court Board of Professional Ethics and Conduct




Date of Opinion: 09/18/2002

Opinion Number: 02-01

Title: EQUITY INTEREST IN A START-UP

Opinion: You are a patent attorney who represents start-up businesses. These clients seek your services to protect their intellectual property and sometimes request that you perform legal services in exchange for an equity interest in the client. You ask if this is permissible, provided the following precautions are taken:

1. The attorney reasonably believes the attorney’s representation of the client will not be adversely affected by the equity investment;
    2. The equity investment and terms on which the attorney acquires it are fair and reasonable to the client, as determined by an impartial third party,

    3. The attorney fully discloses and transmits to the client in writing the terms, risks and benefits of the equity investment, including a detailed recitation of potential conflicts which may manifest themselves over the course of the proposed engagement in a manner the client can reasonably understand;

    4. The attorney consults with the client after full disclosure of the proposed transaction and its terms;

    5. The attorney gives the client a reasonable opportunity to seek the advice of independent counsel about the equity investment;

    6. The client consents in writing, after consultation and a full disclosure of the material facts, to the equity investment in exchange for legal services; and

    7. Every time a change of circumstances arises during the term of the engagement in which conflicts may resurface of appear in new manifestations, the attorney shall provide a fresh, detailed disclosure of the circumstances and potential conflicts in the same level of detail noted above, and obtain from the client a new consent in writing after consultation and a full disclosure of the material facts.

    The primary rule involved is DR 5-104(A):
          “A lawyer shall not enter into a business transaction with a client if they have differing interests therein and if the client expects the lawyer to exercise professional judgment therein for the protection of the client, unless the client has consented after full disclosure.”
    In this situation, the lawyer and the client do have differing interests. See Committee on Professional Ethics v. Mershon, 316 N.W.2d 895, 898 (Iowa 1982). It is also clear that the client expects the lawyer to exercise professional judgment for the protection of the client. Thus, the primary concern is giving full disclosure and obtaining client consent. The precautions you propose appear, in general, to be well suited to accomplish that purpose. However, it is insufficient merely to give the client reasonable opportunity to seek the advice of independent counsel; in addition, the attorney must explain why the client should consult independent counsel and recommend that the client do so. Board of Professional Ethics v. Walters, 603 N.W.2d 772, 775 (Iowa 1999); Board of Professional Ethics v. Fay, 619 N.W.2d 321, 326 (Iowa 2000).

    The other ethical rule which may be involved is DR 2-106(A), “A lawyer shall not enter into an agreement for, charge, or collect an illegal or clearly excessive fee.” There can be no guarantee, therefore, that the approval of “an impartial third party,” as proposed in your second precaution, will automatically suffice to comply with the disciplinary rule. Instead, the fee must not be clearly excessive at the time it is agreed to and at the time it is collected. As the court stated in In re Swartz, 141 Ariz. 266, 686 P.2d 1236, 1243 (1984),
      “Respondent is correct in contending that the one-third contingent fee initially agreed upon was within customary limits for the type of case and was not excessive. We do not believe, however, that recognition of the propriety of the initial fee arrangement gives the lawyer carte blanche to charge the agreed percentage regardless of the circumstances which eventually develop. Either a fixed or contingent fee, proper when contracted for, may later turn out to be excessive. . . . [A] fee agreement between lawyer and client is not an ordinary business contract. The profession has both an obligation of public service and duties to clients which transcend ordinary business relationships and prohibit the lawyer from taking advantage of the client. Thus, in fixing and collecting fees the profession must remember that it is “a branch of the administration of justice and not a mere money getting trade.” . . . We hold, therefore, that if at the conclusion of a lawyer’s services it appears that a fee, which seemed reasonable when agreed upon, has become excessive, the attorney may not stand upon the contract; he must reduce the fee. What is reasonable and within permissible limits will be determined by the circumstances, including the factors listed in DR 2-106.”
        For further guidance, the Board recommends a reading of ABA Formal Opinion 00-418, issued July 7, 2000, titled “Acquiring Ownership in a Client in Connection with Performing Legal Services.” The Board is in general agreement with that opinion.




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