Payments Tied to a Sale

Payments Tied to a Sale

The conditions taught so far govern the seller's exit, the files that move, what clients are told, and what clients pay afterward. The seller must stop practicing, or stop practicing the area sold, in the geographic area or jurisdiction where the practice was conducted.¹ None of the conditions sets the price or says when the money changes hands. The price is a business term, and Rule 1.17 leaves it to the two lawyers to bargain at arm's length.

The money still invites two objections, each raised by a rule outside Rule 1.17. The first is fee sharing. The price buys a practice that earns legal fees, and the person who receives it may be a retired lawyer or, after a death or disability, an estate whose representative is not a lawyer. The second is payment for referrals. The buyer pays for good will, meaning the likelihood that the practice's clients will keep coming to the lawyer who now runs it, and a seller paid while clients move to the buyer resembles a lawyer paid for a recommendation. If either rule reached the price, no practice could lawfully change hands, and every condition already taught would govern a sale that could never close.

Both objections are answered through the legitimacy of the sale. A payment that is the price of a transaction satisfying Rule 1.17 is a payment for a practice, and the sale framework is what lets the money reach the seller or the seller's estate, and cover good will, without breaching the fee-sharing or referral rules. A payment made outside a genuine Rule 1.17 sale has no such shelter. Fee sharing comes first because it governs who may receive the price and in what form.

Fee-Sharing and the Purchase Price

Rule 1.17 does not address how a practice or practice area should be valued. It leaves the price to the buyer and the seller, negotiating at arm's length.² That silence leaves the price subject to two other limits: the rule governing how fees may be divided between lawyers, Rule 1.5(e), and the general prohibition on sharing legal fees with nonlawyers.³ Rule 5.4(a) states the second limit directly: "[a] lawyer or law firm shall not share legal fees with a nonlawyer," subject to four exceptions. Its purpose, in the words of Comment 1, is "to protect the lawyer's professional independence of judgment."⁴

Both limits guard against outside persons who interfere with, or direct, the buying lawyer's exercise of professional judgment.⁵ The mechanism is a financial stake. A person who takes a share of the fees from a client's matter profits from how the matter is handled, and a lawyer who owes that person a cut may shape the work around the payee's interest instead of the client's. A purchase price therefore raises one question: does the arrangement give the seller or the seller's estate a stake of that kind in any client's matter?

When the price is a fixed sum, the answer is no. A set price may be paid immediately or over a reasonable period of time without infringing any ethical expectation.⁶ The reason lies in what the payment is measured by. The amount was settled when the contract was made, so it does not rise or fall with the fees from any client's matter. The buyer owes the same installments whether the inherited clients generate a great deal of work or very little. The seller holds a claim for the price of something already transferred and has no interest in how the buyer handles a file.

When the price goes to a nonlawyer, Rule 5.4(a)(2) answers the objection in its own terms. It is the second of the four exceptions to the ban on sharing fees with nonlawyers: "a lawyer who purchases the practice of a deceased, disabled, or disappeared lawyer may, pursuant to the provisions of Rule 1.17, pay to the estate or other representative of that lawyer the agreed-upon purchase price."⁷ The phrase "pursuant to the provisions of Rule 1.17" ties the exception to a genuine sale, so a payment shelters under it only when the transaction meets the conditions taught earlier in this chapter. The phrase "agreed-upon purchase price" matches the arm's-length bargaining that Rule 1.17 leaves to the parties.

A price expressed as a percentage of the practice's future profits is the harder case. The payments would be calculated from legal services the buyer performs after the sale and the earnings those services produce. That supports a stronger argument that the arrangement shares fees for legal services with a lawyer outside the firm, if the selling lawyer receives the payments, or with a nonlawyer, if the selling lawyer's estate or representative receives them.⁸ The fixed price lacked that feature, because its amount did not depend on the buyer's later work. A profit formula ties the seller's receipts to that work, which is the connection the fee-sharing limits distrust.

Four considerations support the buyer in that dispute, and together they explain why the profit formula can be defended.

• A fixed price and a profit-based price both turn largely on the practice's predicted future success, because the negotiated figure reflects each side's appraisal of how likely the practice is to show a profit. Looking forward is not peculiar to the profit formula.⁹
• Because the entire practice or area must be sold, a price pegged to the profits of the practice as a whole may not be viewed as a direct sharing of the fees earned in any particular matter.¹⁰
• Rule 5.4(a)(2) excepts payment of the "agreed-upon purchase price" from the ban on sharing fees with nonlawyers.¹¹
• Because the seller must have ceased practice in the practice or area sold, the concern that an outsider will interfere with or direct the buyer's professional judgment is less likely to arise.¹²

The last consideration ties this section to the cessation requirement. A seller who has left the field cannot press the buyer on how to handle a file, so the danger behind the fee-sharing limits shrinks. The treatment of profit-based prices remains unsettled. The answer is not certain, and post-sale profit-sharing arrangements are apparently common.¹³ An exam answer should set out the argument for challenge and the arguments for defense, then conclude that the arrangement is open to question, without calling it plainly valid or plainly barred.

Referral Payments

The price of a practice also resembles a payment for a recommendation. When a lawyer buys a practice as Rule 1.17 permits, the payment for the practice and its good will effectively obtains a recommendation of the buyer's services to the prospective clients, who are the seller's own clients.¹⁵ The seller earned those clients' trust and then steps aside, the clients are pointed toward the buyer, and the buyer's money is what makes that arrangement worth bargaining for. Apart from the sale, this is the transaction the ban on paying for referrals targets. A lawyer may not give something of value to someone for recommending the lawyer's services, and a payment made solely for a referral remains prohibited.¹⁶

The ban exists because a recommendation carries weight with a client only when it reflects the recommender's honest view of who will serve the client best. A person paid by one lawyer has a financial reason to name that lawyer whether or not the lawyer is the right choice. If that reasoning reached the price of a practice, the permission to sell would be empty. The buyer pays for good will, so every sale would be an improper payment for the very thing being sold.

The rules avoid that result directly. They recognize the legitimacy of a sale of a law practice, subject to safeguards, and Rule 7.2(b)(3) specifically excludes payments for a law practice under Rule 1.17 from the anti-referral prohibitions.¹⁷ The safeguards justify the exclusion, and the rest of Rule 1.17 supplies them. The seller must cease practice in the area sold and the place where the practice was conducted, so the seller does not collect the buyer's money while remaining a competing lawyer who steers clients.¹⁸ The seller must also give each client written notice of the transfer, and each client keeps the right to move the matter to another lawyer.¹⁹ The distortion the ban fears finds little room in that structure, because the client is told what is happening and holds the power to choose someone else. A payment with no sale behind it gets no help from the exclusion.

Dollar amounts do not separate that scene from a lawful purchase, since a large price for a real practice is permitted and a small per-client fee for names is not. A label cannot supply a missing sale either. Suppose a contract calls the per-client payment a purchase price while the seller goes on practicing the area sold. The transaction then fails the cessation condition of Rule 1.17(a), is not a Rule 1.17 sale, and leaves the exclusion with nothing to protect.²⁰

The opposite instinct appears when the facts show clients moving to the buyer in large numbers. Many clients will remain with the practice after the transfer to the buying lawyer, and a reader might conclude that a payment so closely tied to that movement must be a referral fee.²¹ Client movement is a consequence of the sale, and the safeguards keep it voluntary. Each client stays only after written notice and keeps the right to move the matter, so staying is the client's own choice.

In both scenes money passes from one lawyer to another and clients end up with the payer, so those facts decide nothing. The question to ask is what the money bought. A payment that is the price of a genuine Rule 1.17 sale is excluded from the ban on paying for referrals, and a payment whose only function is to reward a recommendation is not. The exclusion answers the referral objection only, so the sale must still satisfy the fee-sharing limits taught in the preceding subsection and each condition of Rule 1.17.