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PA Supreme Court: Unethical Fee-Splitting Not Automatically Unenforceable

December 19, 2017 | Posted in : Ethics & Professional Responsibility, Fee Agreement, Fee Allocation / Fee Apportionment, Fee Issues on Appeal

A recent Legal Intelligencer story, by Zack Needles, “Unethical Fee-Splitting Agreements Not Automatically Unenforceable, Justices Say,” reports that, in a closely watched case that waded into the murky ethics of business arrangements between lawyers and nonlawyers, a majority of the Pennsylvania Supreme Court could agree on only one thing: fee-splitting arrangements between lawyers and nonlawyers are not per se unenforceable just because they violate attorney ethics rules.

But beyond that, a majority of the six-member court—Justice Sallie Updyke Mundy recused because of her participation on the lower court panel—was unable to reach a consensus in SCF Consulting v. Barrack, Rodos & Bacine.  The larger questions of how best to deter unscrupulous lawyers from entering into unethical agreements and what responsibility, if any, nonlawyers have to avoid such agreements remain without definitive answers.

The overall effect of the decision was to reverse a ruling by a split three-judge panel of the state Superior Court, which held that a consultant to Philadelphia securities litigation firm Barrack, Rodos & Bacine was not entitled to an allegedly promised cut of the firm’s profits from cases he worked on because that type of fee-splitting agreement violates Rule 5.4 of the Pennsylvania Rules of Professional Conduct.  The high court remanded the case to the Philadelphia trial court to determine whether this particular agreement is enforceable.

But other than proceeding with the understanding that there is no bright-line rule rendering an unethical fee-sharing agreement unenforceable, ”the common pleas court will be in a position of making its own judgment as to the relevance of any wrongful conduct on [the nonlawyer party’s] part, without present guidance from this court,” Chief Justice Thomas G. Saylor wrote in the opinion announcing the judgment of the court (OAJC), which was joined by Justice Kevin M. Dougherty.

In SCF Consulting, the Superior Court said the alleged arrangement in which Scott C. Freda—SCF Consulting’s sole member—was to receive 5 percent of the firm’s annual profits generated by cases he assisted with violated Rule 5.4, which bars, with few exceptions, attorneys from sharing legal fees with nonlawyers.

According to court documents, SCF alleged it was induced by Barrack Rodos to work exclusively on the firm’s behalf in securities class actions in exchange for both a fixed annual consulting fee and a 5 percent cut of any profits gained from cases SCF worked on.

SCF alleged that the firm subsequently refused to make the profit-share payments, however, court documents said.  Following discovery, the firm moved for summary judgment and Philadelphia Court of Common Pleas Administrative Judge Gary S. Glazer granted the motion, finding that the fee-sharing aspect of the alleged payment arrangement ran afoul of Rule 5.4.

On appeal, Senior Judge James J. Fitzgerald III, joined in the majority by Judge Jacqueline O. Shogan, affirmed Glazer’s ruling rejecting SCF’s argument that the agreement fell within the exception to Rule 5.4 that allows nonlawyer employees to participate in profit-sharing compensation or retirement plans.

“As the trial court accurately noted, appellant was not an employee of the firm participating in a formalized program benefiting employees based upon the profitability of the firm,” Fitzgerald said.  “Therefore, the exception in Rule 5.4(a)(3) is unsustainable in the instant case because there is a direct link between the specific fees and specific payment to appellant, a nonlawyer.”

The Supreme Court granted allocatur in the case in February, agreeing to decide “whether the trial court and Superior Court erred in sustaining [respondent's] demurrer to all [c]ounts of [petitioner's] complaint, where, even assuming arguendo that the compensation plan was in violation of Rule 5.4, Pennsylvania law, public policy and the interests of justice require such an agreement to be enforced because an attorney must not be shielded from liability, nor financially rewarded for violating the Rules of Professional Conduct.”  The high court heard arguments in the case in October.

In their Dec. 19 OAJC, Saylor and Dougherty took the position that while an unethical fee-splitting agreement between a lawyer and a nonlawyer is not per se unenforceable, it may still be deemed unenforceable if it’s determined that the nonlawyer party bore some responsibility for the ethical violation.

“The ultimate outcome of this case may turn on factual findings concerning Appellant’s culpability, or the degree thereof, relative to the alleged ethical violation,” Saylor said in the OAJC.

But Justice Max Baer, in a concurring and dissenting opinion joined by Justice Debra Todd, said that while he agreed with the OAJC’s rejection of a bright-line prohibition on enforcing unethical fee-sharing agreements, he disagreed with the notion that a nonlawyer could bear any culpability for a breach of ethics rules that only govern attorneys.

Baer said he would have held that the agreement between Barrack Rodos and plaintiff SCF Consulting was enforceable and did not violate public policy.  “I agree with the OAJC insofar as it holds that a fee-sharing agreement between a lawyer and a non-lawyer in violation of Rule of Professional Conduct 5.4(a) is not per se unenforceable as a violation of public policy,” Baer said.  “However, because a nonlawyer is not bound by the Rules of Professional Conduct, the non-lawyer committed no unethical or illegal act by entering into the agreement and, thus, can bear no measure of responsibility relative to the law firm’s material violation of the rules governing the profession.”

“To ensure compliance with the professional conduct rules prohibiting the type of fee-sharing agreement at issue, I would refer the law firm or responsible attorney to the Disciplinary Board for prosecution of purported ethical violations and imposition of disciplinary sanctions,” Baer added.

Justice David N. Wecht, joined by Justice Christine L. Donohue, penned a dissenting opinion, supporting a third approach: adopting a bright-line rule rendering unethical fee-splitting agreements unenforceable while still allowing nonlawyer parties to seek relief in equity.

“To prevail in equity (as distinct from a claim at law in tort or contract), the nonlawyer would have to demonstrate all of the predicates of an equity claim, such as unjust enrichment, unclean hands, or other elements, and would have to show that he or she entered into the agreement with clean hands,” Wecht said.  “In my view, this time-honored standard best accommodates the OAJC’s recognition that the parties’ relative levels of responsibility should be considered.”

Dougherty, in an opinion concurring with the OAJC, expressed concern that a bright-line rule rendering all unethical fee-splitting agreements unenforceable might actually encourage dishonest attorneys to enter into such agreements knowing they’ll never have to uphold their end of the deal.

Wecht acknowledged that allowing nonlawyer parties to pursue equitable remedies may still not be enough to deter such practices by lawyers.  In response to that anticipated criticism, he made a recommendation similar to Baer’s.

“Courts that encounter such fee-splitting agreements, whether in enforcement pleadings or equity actions, should report the attorneys involved to the Office of Disciplinary Counsel for investigation,” he said.  “Further, in principle, I see no impediment that would bar the Disciplinary Board itself from requiring disgorgement of fees when appropriate.”

SCF’s attorney, George Bochetto of Bochetto & Lentz in Philadelphia, noting that the Supreme Court offered “broad guidance” but left a lot of details to be worked out in the trial courts, said he foresees additional litigation stemming from fee-splitting arrangements.