September 2011 - Conflicts of Interest in Business Transactions With Clients
by Heather Porter Condon
You are a real estate attorney and a licensed broker. Over the years, in addition to maintaining your legal practice, you also have dabbled in the real estate market. You are having lunch with a client, who recently inherited a large sum of money which he is looking to invest and he asks you for your advice. The conversation naturally evolves into a discussion of the present real estate market and potential investment opportunities. Two days later, your client calls. He has a lead on a lucrative investment opportunity and proposes a partnership with you. Your client continues—he would provide the money and you could provide the legal expertise; he would become the president and you the vice president; and, while the percentage of ownership would be split with him receiving 65% and you 35% of the business, he assures you that you would be generously compensated for your legal and consulting services. You hang up the phone and consider your client’s proposal. After all, what could possibly go wrong? A recent appellate court decision, Fair v. Bakhtiari, bars the attorney’s right to recover attorney fees in a similar scenario where the attorney entered into various real estate partnerships, but failed to comply with ethical requirements set forth by California Rules of Professional Conduct, rule 3-300 (“Rule 3–300”). Fair v. Bakhtiari, Cal.App.4th (2011 Cal.App.Lexis 634) (May 24, 2011, A126844).
It is well recognized that the attorney-client relationship is the cornerstone of the legal system and a fiduciary relation of the highest character. This relationship, however, risks being jeopardized where an attorney and client enter into a business transaction. “While such transactions are not prohibited, they are scrutinized with the utmost strictness for any unfairness. The burden of proof is on the attorney to show that the dealings between him and his client were fair and reasonable.” Rodgers v. State Bar, 48 Cal.3d 300, 314, 256 Cal.Rptr. 381 (1989) (internal citations omitted).
Accordingly, in entering into a business transaction with a client, an attorney is required to comply with the written disclosures and professional obligations set forth by Rule 3–300. Rule 3–300 provides in relevant part that: 1) the transaction and its terms must be fair and reasonable to the client and must be fully disclosed in writing to the client in a manner which the client can reasonably understand; 2) the client must be advised in writing that the client may seek the advice of an independent attorney and must be given a reasonable opportunity to do so; and 3) the client, thereafter, must consent in writing to the terms of the transaction.
An attorney’s failure to satisfy each of the requirements set out in Rule 3–300 may predispose an attorney to disciplinary proceedings, but such failure alone does not provide a basis for civil liability. BGJ Associates, LLC v. Wilson, 113 Cal.App.4th 1217, 1227, 7 Cal.Rptr.3d 140 (2003) (internal citations omitted). That said, recognizing the interrelationship between the rules, statutes, and general principles in defining the fiduciary duty owed by an attorney to his or her client, recent case law has held that an attorney’s violation of Rule 3–300 may trigger the application of Probate Code §16004 and the presumption that accompanies it. Id. Thus, while an attorney’s failure to comply with Rule 3–300, in itself, does not subject an attorney to civil liability, its statutory compliment—Probate Code, §16004—may do so.
Probate Code, §16004, applies to the fiduciary relationship between an attorney and his or her client and provides in relevant part: “A transaction between the trustee and a beneficiary which occurs during the existence of the trust or while the trustee’s influence with the beneficiary remains and by which the trustee obtains an advantage from the beneficiary is presumed to be a violation of the trustee’s fiduciary duties. This presumption is a presumption affecting the burden of proof. . . .” Cal.Prob.Code, §16400, subd.(c). In other words, a “transaction between an attorney and client which occurs during the relationship and which is advantageous to the attorney is presumed to violate that fiduciary duty and to have been entered into without sufficient consideration and under undue influence.” BGJ Associates, LLC v. Wilson, supra at 1227.
The interrelation between Rule 3–300 and its statutory counterpart Probate Code, §16004, was recently discussed in the context of an attorney’s request for quantum meruit recovery in the case entitled Fair v. Bakhtiari, supra. Bakhtiari addresses the issue of whether “an attorney who entered into very successful business transactions with his clients, but did not provide them the written disclosures required under [R]ule 3–300, was properly denied leave to amend his complaint to state a cause of action for the reasonable value of his services.” Fair v. Bakhtiari, supra at 2.
In Bakhtiari, an experienced business attorney entered into various business ventures with his clients, however, in doing so, failed to comply with the requirements of Rule 3–300. Fair v. Bakhtiari, supra at 3–9. The court found that the attorney knowingly acquired interests adverse to his clients, but did not disclose the terms of the transactions in writing, advise his clients in writing of their right to seek independent legal advice, or obtain his clients’ written consent to the terms of the transactions. Id. at 9–10. The trial court held that the transactions were voidable at the election of the attorney’s clients, and unenforceable based on the attorney’s failure to comply with Rule 3–300 and his violation of his fiduciary duties under Probate Code, §16004, subdivision (c). Id. at 14–16.
On appeal, the attorney did not challenge the voiding of the agreements, but instead, challenged the trial court’s refusal to allow the attorney to bring a claim for quantum meruit. Fair v. Bakhtiari, supra at 25. The appellate court affirmed the trial court’s conclusion that the attorney’s breach of his fiduciary duties precluded such recovery. Id. at 71–73. The court concluded—“Absent the required disclosures and consents, by entering into and conducting business transactions with his clients, [the attorney] breached his fiduciary duties to them and he violated rule 3-300—the ethical rule that proscribed the very conduct for which compensation was sought . . . Unlike those rule violations in which counsel has been allowed to recover the reasonable value of services rendered and which involved no serious breach of fiduciary duty, the [trial] court could well determine that [the attorney’s] conduct here was so fundamentally at war with rule 3–300 and section 16400, that it infected the entire relationship between [the attorney] and his clients, and that [the attorney’s] breach of his fiduciary duties under the statute was therefore sufficiently serious as to warrant the denial of quantum meruit recovery.” Id. The court also found substantial evidence of undue influence by the lawyer over his client in connection with the transactions. Id. at 19.
So, what could possibly go wrong? In considering entering into a business venture with a client, lawyers must comply with the requirements of Rule 3–300 and Probate Code, §16004 in order to preserve the right to collect attorney fees and avoid professional discipline.
Heather Porter Condon is an associate with Morgan, Lewis & Bockius LLP in Irvine and a member of OCBA’s Professionalism and Ethics Committee.