Law Firm Growth During an Uncertain Legal Climate – Part 2: How to Ethically Use Freelance Lawyers & Referral Fees

By Erin Giglia and Laurie Rowen

As we approach the end of 2020, we are all hopeful that the economic effects of the pandemic are improving. Law firms are addressing increased client demands, and are addressing their attorney staffing needs.  Many courts have opened back up, increasing litigation work. Business transactions are exploding, causing small law firms to become swamped.  These busy law firms, however, are not certain their work flow will stay consistent in 2021 with the coronavirus case levels increasing.  When a law firm has too much work – but is unsure as to whether they have enough work to justify hiring a full-time associate – what are the best options?

We recently published the second part of our article in the Fall 2020 Issue of The Practitioner: “Law Firm Growth During an Uncertain Legal Climate, Part I: How to Ethically Use Freelance Lawyers & Referral Fees.” Hiring freelance/contract attorneys or referring cases to colleagues are excellent options to provide immediate relief to law firms, but firms need to make sure they comply with complex ethical rules.  Part II of the article discusses hiring contract/freelance attorneys periodically, on an hourly or flat fee basis, as well as opportunities to refer matters to lawyers outside the firm, possibly in exchange for a referral fee in place of hiring a traditional associate attorney.

To read the first part of the article published in Summer 2020, view it here: Law Firm Growth During an Uncertain Legal Climate, Part I: How To Ethically Use Of Counsel Relationships.

Law Firm Growth During an Uncertain Legal Climate – Part 2: How to Ethically Use Freelance Lawyers & Referral Fees (Fall 2020, Volume 26, Issue 4)

I. Freelance Attorney Relationships

Firms often rely on freelance lawyers, also known as temporary or contract lawyers, to assist with legal projects during periods of increased work such as trial preparation, to add specific expertise, to creatively lower fees to firm clients, or to cover for vacation and maternity leave.  While many ethical rules apply the law firm/freelance lawyer relationship, the most commonly misunderstood rules involve (1) Aiding and Abetting the Unauthorized Practice of Law; (2) Fees to Client/Upcharging; and (3) the Duty to Disclose.

A. Aiding And Abetting The Unauthorized Practice Of Law

No person may practice law unless the person is an active member of the State Bar of California.  See Cal. Bus. Prof. Code § 6125; Birbower, Montalbano, Condon & Frank, PC v. Superior Court, 17 Cal.4th 119, 128 (1998).  Rule of Professional Conduct 5.5 states, “A lawyer admitted to practice law in California shall not knowingly assist a person in the unauthorized practice of law in that jurisdiction.”

While the California State Bar Act does not define the “practice of law,” courts have discussed its meaning, which is not as stringent a requirement as it initially appears.  “The primary inquiry is whether the unlicensed lawyer engaged in sufficient activities in the state or created a continuing relationship with the California client that included legal duties and obligations.” California ethical rules permit law firms to contract with out-of-state attorneys to handle many legal projects including drafting legal pleadings, research and writing, as long as the law firm remains ultimately responsible for the final work product.  Birbower, (1998) 17 Cal.4th 119, 129.

Winterrowd v. Am. Gen’l Annuity Ins., 556 F.3d 815 (9th Cir. 2009) is instructive on this issue.  In Winterrowd, a lawyer barred in Oregon but not in California assisted a California lawyer litigating a case before the United States District Court for the Central District of California.  The Oregon attorney did not “appear” before the court, did not sign any pleadings, and had little contact with opposing counsel or clients, and the California attorney supervised the Oregon attorney. The court held that there was no ethical violation under these circumstances. See Orange County Bar Association Formal Opinion 2014-1 (concluding that “the mere act of Out-of-State Lawyer’s ghostwriting a document for California Counsel of Record is not likely to constitute the unauthorized practice of law in California.”); San Diego County Bar Association Ethics Opinion 2007-1 (“the attorney does not aid in the unauthorized practice of law where he retains supervisory control over and responsibility for those tasks constituting the practice of law.”)

Simply engaging an out-of-state contract lawyer to ghost-write generally does not violate ethical rules, so long as an attorney licensed by the state retains full control over the representation and exercises independent judgment in reviewing the non-licensed attorney’s work.

B. Upcharing/Fees Charged to Client

When a law firm uses a freelance attorney for a legal project, the firm can elect to bill the client in several different ways: (1) absorb the cost; (2) pass the cost to the client at the same rate the firm paid the freelance attorney; (3) mark up the cost and pass the marked up cost to the client; or (4) pass a flat fee cost to the client.   Each of these fee arrangements are permissible in California, assuming the fee passed to the client is not otherwise unconscionable pursuant to Rule of Professional Responsibility 1.5, and the attorney satisfies the California Business and Profession Code sections 6147-6148; 6068(m) requirements regarding fee arrangements.

California case law is clear that that the amount a law firm pays to a freelance attorney is irrelevant to whether a fee is unconscionable, and nothing in Rule 1.5 suggests that the attorney’s profit margin is relevant to determine unconscionability.   Shaffer v. Superior Court, 33 Cal. App. 4th 993 (1995); Bushman v. State Bar (1974) 11 Cal. 3d 558, 564 (1974) (a fee which “shocks the conscience” is unconscionable); see also ABA Formal Ethics Opinion 2000-420 (“When costs associated with legal services of a contract lawyer are billed to the client as fees for legal services, the amount that may be charged for such services is governed by the requirement of ABA Model Rule 1.5 that a lawyer’s fee shall be reasonable. A surcharge to the costs may be added by the billing lawyer if the total charge represents a reasonable fee for services provided to the client.”); but see Texas Opinion No. 577 (ruling that in Texas, law firms may not mark-up fees of temporary lawyers absent meeting certain requirements).

Thus, adding a surcharge to a freelance attorney’s rate is ethically permissible in California and most states that follow ABA rules. If the firm chooses to add a surcharge to the freelance attorney rate, however, it may constitute a “significant development” sufficient to trigger client disclosure rules.

C. Duty to Disclose

Law firms often resist using freelance lawyers under the mistaken belief that they always have to notify their clients if they are using a freelance attorney.  California rules are clear that there is no duty to disclose unless the work by the outside lawyer constitutes a “significant development” in the representation. Under Rule of Professional Responsibility 1.4, “A member shall keep a client reasonably informed about significant developments relating to the representation, including promptly complying with reasonable requests for information and copies of significant documents when necessary to keep the client so informed.”

         1. When is Disclosure Required?

What constitutes a “significant development” for disclosure purposes depends on the individual case and circumstances. COPRAC Opinion 1994-138 enumerates examples of relevant factors to determine whether a firm is required to disclose the freelance attorney relationship, including: (i) whether responsibility for overseeing the client’s matter is being changed; (ii) whether the new attorney will be performing a significant portion or aspect of the work; or (iii) whether staffing of the matter has been changed from what was specifically represented to or agreed with the client.  See San Diego County Bar Association Formal Opinion 2007-1 (discussing COPRAC 2004-165, and stating that in addition to the three factors listed in COPRAC 1994-138, whether use of a temporary lawyer constitutes a “significant development” also depends on whether the client had a “reasonable expectation under the circumstances” that a contract lawyer would be used to provide the service.)

It should be noted that in California, if a firm chooses to add a surcharge to a freelance attorney rate, i.e. pay a freelance attorney $150 but charges its client $250, this likely constitutes a “significant development,” regardless of the type of work the contract attorney intends to perform. LA County Bar Association Formal Opinion 518; OCBA Formal Opinion 2014-1.

      2. Scope and Manner of Disclosure

If disclosure is required, California ethics opinions suggest that disclosures should be in writing in a fee agreement at the outset of the case, or as soon use of the contract attorney is anticipated. See OCBA Formal Opinion 2014-1 (stating “where the lawyer reasonably expects, at the outset of the case, that he will use the services of a contract lawyer to perform significant functions, he also should include such a disclosure in a written fee agreement.”)

While there is no formal opinion or Rule that discusses specifically what information a firm must disclose to a client about involving an outside contract attorney, In re Wright, 290 B.R. 145, 151-52 (C.D. Cal. Bkrtcy. 2003) may be instructive.  The Wright Court suggests that, in the bankruptcy context, a lawyer seeking fees for work performed by a contract lawyer must demonstrate that his client consented to the arrangement with the contract lawyer. In re Wright, 290 B.R. at 156.  The lawyer who hired the contract lawyer also must “demonstrate that the client agreed to the use and billing rate of [the] contract attorney if the firm contemplated [his or her] use at the time that the firm was employed.” Id. at 156.

As the OCBA Ethics Committee concluded, “there is nothing inherently unethical with a client or lawyer hiring another lawyer – often a contract lawyer – to ghostwrite a document to be submitted to court, without identifying the contract lawyer or disclosing his involvement. Only when the client or lawyer seeks to recover his attorneys’ fees must the contract lawyer’s role be disclosed to the court. If, however, the involvement of the contract lawyer constitutes a significant development, then his involvement must be disclosed to the client.” OCBA Opinion 2014-1; see also ABA Formal Opinion 88-356 (stating that assuming there is no division of fees, and that the law office does not charge the outside lawyer’s compensation to the client as a disbursement, the law office has no obligation to reveal to the client the compensation arrangement with the outside lawyer whether that attorney is paid by salary or on an hourly basis.)

Financial Arrangements Between Lawyers – Referral Relationships

Small law firms frequently have clients who request assistance adjacent to or beyond a firm’s expertise.  If the firm can ensure competent representation, the firm may choose to handle these matters internally, or with help from an “of counsel,” or a freelance attorney.  There are situations, however, when a firm may best serve the client’s needs, and avoid possible ethics violations, by referring the matter to a different law firm.  Referral relationships have many benefits including cross-referral possibilities, but referrals among lawyers also involve certain ethical considerations.

A. Referrals Between Lawyers

Referrals between California lawyers are governed by Rules of Professional Conduct 1.5.1, 7.1, and 7.2. Attorney advertising and solicitation rules under Rules 7.1 and 1.2 apply to the referral situation because California allows attorneys to pay other attorneys referral fees. Attorneys must comply with Rule 7.1’s advertising and solicitation rules when making referrals the same way every attorney must comply when making statements about themselves.

Rule 7.1 states that an attorney may not make statements to a potential client that are untrue, confusing, or misleading, including when making a referral to an outside firm. Attorneys may not use intimidation, harassment, or coercion, and also may not make any guarantees or predictions when making a referral.

B. Referral Fees

Lawyers receiving referrals from other California lawyers are ethically permitted to pay the referring lawyer a percentage of the fees collected in exchange for the referral.  Under Rule 1.5.1, sharing a client fee among lawyers not in the same firm is ethically permissible if the client consents to the arrangement after a full, written disclosure of the terms of the division.  The fee-division may not increase the total fees charged to the client, and the overall fee may not be unconscionable.

While it may be tempting to create a financial incentive to non-lawyers (including lawyers admitted to practice law outside California) to encourage referrals, Rule 5.4 prohibits sharing legal fees with a non-lawyer.  Rule 5.4 extends beyond a simple percentage referral fee, and further prohibits California lawyers from giving non-lawyers gifts or other compensation in exchange for referrals, or as a reward for making a recommendation resulting in employment of the member’s law firm.

Rule 1.5.1 also requires that the lawyers dividing a legal fee have a written agreement between them.  Rule 1.5.1 requires that the written client disclosure include the (1) fact of division, (2) identity of lawyers or law firms who are dividing the fee, (3) terms of division.  The client must also consent in writing at the time of the agreement to divide the fee, or as soon as possible after the agreement.

While law firms have options when considering accepting matters beyond their current capacity, they must be mindful of the ethical rules that apply to the relationships they form with lawyers outside their law firms.  Law firms may decide to retain matters internally with help from a contract/freelance attorney on a project basis, or consistently work with an attorney who will act as “of counsel” to their firm, so long as the attorneys involved properly clear conflicts of interest, and adhere to the duties of disclosure.  Law firms may also ethically refer matters to other law firms.  Relationships among lawyers of different firms can benefit lawyers and clients alike, both financially as well as in the quality of representation.