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California Legal Ethics
1.17:100 Comparative Analysis of CA Rule
CRPC 2-300 shares most of the same limitations regarding sale of a law practice and its goodwill. But, in some respects MR 1.17 differs from CRPC 2-300. Most notably, MR 1.17(b) mandates the sale of the entire practice and that the seller ceases to engage in the private practice of law in the geographical area or jurisdiction. The California rule makes no express reference to cessation of practice and allows an attorney to retain one or two clients who have such a long-standing relationship that transfer of those clients' files is not feasible. 1 Witkin, Cal. Procedure (4th ed. 1996) Attys, §490, p. 525. Further, California law limits the nature of restrictive covenants that can attend the sale of law partnerships. B&PC § 16602; see CRPC 1-500. This may preclude an outright prohibition on future practice, at least in some instances. [See Rule 5.6 Restrictions on the Right to Practice, infra].
Common to both CRPC 2-300(A) and MR 1.17(d), fees charged to clients cannot be increased by reason of the sale. However, MR 1.17(d) explicitly allows the purchaser to refuse to undertake representation of the seller's clients unless these clients agree to pay the purchaser's fee at rates not exceeding the fees charged by the purchaser for substantially similar services prior to the sale negotiations.
Both CRPC 2-300(B) and MR 1.17(c) require written notification that informs the client of the proposed sale and his right to retain other counsel or take possession of any client papers and property, although the California requirements are more detailed and distinguish between estates or conservatorships and other situations. CRPC 2-300 contains no requirement of court approval in lieu of the notification procedures. Both rules provide for a presumption of consent if no objection is received within a specified time. CRPC 2-300 provides a presumption of consent 90 days after sending notification, while MR 1.17 requires 90 days after the client's receipt of notification. In addition, MR 1.17(c)(2) explicitly requires disclosure of any changes to the fee arrangement allowed under MR 1.17(d).
CRPC 2-300 distinguishes between deceased and living sellers. For deceased sellers, CRPC 2-300(B)(1)(a) permits the purchaser to act on behalf of the client in the event the client's rights would be prejudiced. MR 1.17 does not have a corresponding exception. Also, in such cases, CRPC 2-300(B)(1)(a) requires the purchaser to send written notification of the sale.
Finally, CRPC 2-300 also includes express provisions regarding substitution for pending matters, see CRPC 2-300(C), compliance with conflicts of interest rules as to adverse interests, see CRPC 2-300(D), nondisclosure of confidential information to a nonmember, see CRPC 2-300(E), and provides that admission to or retirement from a law partnership or law corporation does not constitute a sale, see CRPC 2-300(F).
MR 1.17 had no counterpart in the Model Code. However, EC 4-6 set an aspirational goal that a lawyer should not attempt to sell a law practice so as to avoid disclosure of client confidences and secrets.
1.17:200 Traditional Rule Against the Sale of a Law Practice
The traditional rule was that a lawyer or the lawyer's estate could not sell the lawyer's interest in a law practice. See 1 G. Hazard & W. Hodes, Law of Lawyering § 1.17:102 (2d ed. 1990); Wolfram § 16.2.1; Schoenwald, Model Rule 1.17 and the Ethical Sale of Law Practices: A Critical Analysis, 7 Geo. J. Legal Ethics 395, 399-401 (1993).
A leading California case on the sale of a law practice is Lyon v. Lyon (2nd Dist. 1966) 246 Cal.App.2d 519, 54 Cal.Rptr. 829. A law partnership was dissolved and a new partnership formed that excluded the plaintiff because of his unauthorized draw of partnership funds. The Court ruled that the practice of law is not a commercial business and there is no goodwill (in the form of expectation of future business) which one lawyer can sell to another. The Court held that goodwill of this nature is personal to the individual partner and it is professionally improper for lawyers to attempt to buy or sell the relationship which a lawyer has established with his clients.
Prior to the adoption of CRPC 2-300, the fact that a law firm could pay the estate of a deceased lawyer an amount measured by earnings from the deceased lawyer's former clients was held not to permit the estate of a sole practitioner to make the same arrangement with another lawyer or firm. Geffen v. Moss (2nd Dist. 1975) 53 Cal.App.3d 215, 125 Cal.Rptr. 687.
California courts that addressed the issue ruled that goodwill in a law firm is not capable of being valued. These courts took the view that lawyer-client relationships are not fungible assets. See Fraser v. Bogucki (2nd Dist. 1988) 203 Cal.App.3d 604, 250 Cal.Rptr. 41 (partner not entitled to compensation for goodwill upon dissolution of law partnership) L.A. Op. 1976-361 (agreement for sale and transfer of a law practice is improper). The court's opinion in Fraser relies on the perception that there is a high degree of trust and confidence inherent in the lawyer-client relationship. The court found no sound basis for compensating a lawyer in a law partnership upon dissolution for expected future profits from clients who elect not to retain his services after dissolution.
The relationship between members of the legal profession and clients cannot be likened to the relationship of a merchant to his customer. Barton v. State Bar (1930) 209 Cal. 677, 289 P. 818; Jones v. Fakehany (2nd Dist. 1968) 261 Cal.App.2d 298, 67 Cal.Rptr. 810.
Distinguishing marital dissolution from law partnership dissolutions, California courts have recognized an exception to the traditional rule. Goodwill accumulated during marriage has been consistently ruled as divisible community property capable of being valued. See In re Marriage of Fortier (2nd Dist. 1973) 34 Cal.App.3d 384, 109 Cal.Rptr. 915 (divisibility of goodwill of spouse's medical practice contrasted with partnership dissolution); In re Lopez' Marriage (3rd Dist. 1974) 38 Cal.App.3d 93, 113 Cal.Rptr. 58 (goodwill of a law practice as a divisible community property); Golden v. Golden (2nd Dist. 1969) 270 Cal.App.2d 401, 75 Cal.Rptr. 735.
The following comments are taken from Karpman & Margolis page 29 with certain conforming changes:
The law practice of a lawyer, living or deceased, may be sold, provided that all clients receive written notification advising them of their right to select counsel of their own choice, in compliance with CRPC 3-700(D), provided that the format of such notice is not false, misleading or coercive, and provided that such notice complies with provisions pertaining to lawyer-client fee arrangements. All clients must consent in writing to the purchaser-lawyer assuming responsibility for their cases. This rule allows the “goodwill” of a law practice to be sold. However, the sale of the practice must not increase the total fees charged to the clients. Prior to enactment of this rule, sale of law practice goodwill was illegal. Geffen v. Moss (2nd Dist. 1975) 53 Cal.App.3d 215, 125 Cal.Rptr. 687.
Valuation of a law practice may require the deduction of operating costs. In re Marriage of Kilbourne (1st Dist. 1991) 232 Cal.App.3d. 1518, 284 Cal.Rptr. 201, 205-206.
Transfer of individual client matters is governed by CRPC 2-200 and CRPC 3-700. Payment of fee to non-lawyer broker arranging the sale or purchase of a law practice is governed by CRPC 1-320. Superior Court intervention when incapacity forces dissolution of law practice, B&PC § 6180.5. Notice to clients must conform with CRPC 1-400(D) and CRPC 3-700. For disclosure to clients regarding fee arrangements, see B&PC § 6147 and B&PC § 6148, and CRPC 4-200. L.A. Op. 1976-361 (duty to former clients).
S.D. Op. 1968-5 (purchase of practice and goodwill of deceased lawyer).
1.17:300 Problems in Sale of Practice
Conflict of Interest
The sale of a law practice may create a conflict of interest between the seller and his clients. In effect, the seller's referral of his clients to the buyer may be based on financial self-interest and not the competence of the buyer. The disclosure requirements for the proposed sale under CRPC 2-300 may mitigate this danger. Furthermore, CRPC 2-300(D) specifically requires compliance with CRPC 3-300, avoiding interests adverse to client, and CRPC 3-310, avoiding representation of adverse interests.
The price of a law practice may be based on expected future profits. Effectively, the sale provides a de facto, fee splitting mechanism for pending cases. Such a fee split may create an incentive for buyers to take shortcuts to compensate for the split.
During a sale of a law practice, a breach of confidentiality may occur. CRPC 2-300 addresses this issue by mandating notification of clients of their rights to retain another attorney and take possession of their legal files. Also, CRPC 2-300(E) prohibits disclosure of confidential information to nonmembers of the California Bar in connection with the sale.
The use of the seller's name after the sale may mislead the public. Gayle L. Coy, Permitting the Sale of a Law Practice: Furthering the Interests of Both Attorneys and Their Clients, 22 Hofstra L. Rev. 969, 979 (1994).
Value of Goodwill
In practice, the value of goodwill may be difficult to determine. But methodologies do exist to estimate its worth, many of which can be found in cases involving marital dissolutions. Informed, arms-length dealing mitigates the possibility of unwarranted valuations.