State Bar Ethics Opinions cite the applicable California Rules of Professional Conduct in effect at the time of the writing of the opinion. Please refer to the California Rules of Professional Conduct Cross Reference Chart for a table indicating the corresponding current operative rule. There, you can also link to the text of the current rule.
Is it ethically permissible for a lawyer to advise a client to purchase insurance, refer client to an insurance agent from whom the recommended insurance may be purchased, and then accept compensation from the insurance agent to whom the client is referred?
A lawyer ethically may advise the client to purchase the insurance and also accept compensation from the insurance agent for the referral if the lawyer: (1) makes full disclosure in writing under rule 3-310(B)(4) of the California Rules of Professional Conduct1 of all the relevant circumstances surrounding the referral arrangement and all actual and reasonably foreseeable consequences to the client from that arrangement; (2) complies with all of the requirements of rule 3-300 including obtaining the client's written consent to the arrangement; and (3) can competently advise the client under the circumstances.
Rules 3-110, 3-300, 3-310, and 3-500 of the Rules of Professional Conduct of the State Bar of California.
Business and Professions Code section 6068, subdivision (m).
An estate planning lawyer recommends that clients purchase life insurance to provide liquid funds to pay estate taxes at the time of death. The lawyer also refers clients to specific insurance agents from whom the recommended life insurance can be purchased. One of these insurance agents has promised to compensate the lawyer with a rebate or commission on any life insurance that the agent sells to any clients referred by the lawyer.
Rule 3-310(B)(4) of the California Rules of Professional Conduct provides:
(B) A member shall not accept or continue representation of a client without providing written disclosure to the client where:
. . . .
(4) The member has or had a legal, business, financial, or professional interest in the subject matter of the representation.
The California Supreme Court has recently stated that "[t]he primary purpose of this prophylactic rule [rule 3-310(B)(4)] is to prevent situations in which an attorney might compromise his or her representation of the client in order to advance the attorney's own financial or personal interests." (Santa Clara County Counsel Attys. Assn. v. Woodside (1994) 7 Cal.4th 525, 546 [28 Cal.Rptr.2d 617].)
In the hypothetical presented, the lawyer advises clients on the issue of whether to purchase life insurance for estate planning purposes and from whom. As such, the scope of the lawyer's representation of a client includes the client's decision to purchase insurance or not and, if the client decides to purchase insurance, from whom the client should purchase the insurance. The lawyer has a business or financial interest in that representation because the lawyer stands to obtain compensation from the insurance agent if the client decides to purchase insurance from the insurance agent with whom the lawyer has made the referral arrangement. Rule 3-310(B)(4)'s written disclosure requirement is directly implicated because the lawyer in the hypothetical has an interest in the client's representation and may well compromise that representation "in order to advance the attorney's own financial or personal interests." (Rule 3-310 B)(4).)
The lawyer's acquisition of a personal financial stake in the client's representation is also a "significant development" relating to the lawyer's representation of the client. Therefore, rule 3-5002 and Business and Professions Code section 6068, subdivision (m)3 require disclosure to the client of the arrangement.
The minimum disclosure in writing that must be provided to the client under rule 3-310(B)(4) is set out in rule 3-310(A)(1), which provides that "[d]isclosure means informing the client or former client of the relevant circumstances and of the actual and reasonably foreseeable adverse consequences to the client or former client." (Rule 3-310(A)(1).) Accordingly, the lawyer in the hypothetical must detail in writing for the client all of the factual circumstances underlying the referral arrangement including the fact that the lawyer will receive compensation from the insurance agent as a result of the client's purchase of insurance, exactly how the lawyer will be compensated, how much the lawyer will be compensated, whether comparable insurance or insurance that better meets the clients needs is available from other insurance agents with whom the lawyer has no compensation arrangement, the relative cost of such insurance and whether the client may receive a rebate of the insurance agent's commission through the purchase of the insurance in question or other insurance. Additionally, the lawyer must disclose in writing to the client all of the reasonably foreseeable adverse consequences from the referral arrangement including the fact that the lawyer's potential compensation from the referral arrangement will or at least may interfere with the lawyer's independent judgment on behalf of and advice to the client, that the lawyer's compensation arrangement may cause the lawyer to recommend the purchase of insurance where it might not be appropriate, that the client may not obtain as good a deal on the insurance to be purchased as might be possible without the lawyer acting as the insurance broker's referral agent and that the quality of service the client receives from the agent may be lessened due to the reduction in commission the agent receives as a result of the rebate to the lawyer. These are just some of the matters that would have to be disclosed.4
No matter how much disclosure is made, a lawyer may not represent a client when the lawyer cannot competently represent the client's interests. (See rule 3-110 and L.A. Cty. Bar Assn. Formal Opn. No. 471.) The duty to competently represent and advise a client requires a lawyer to consider the client's interests without regard to the lawyer's financial interest in the representation. Where, as a result of the financial interest, the lawyer cannot objectively evaluate the client's needs or the alternatives available to meet the client's needs, the lawyer may not ethically represent the client in the matter.
However, more than written disclosure of the referral arrangement under rule 3-310(B)(4) is required to make the arrangement permissible under the California Rules of Professional Conduct. This is because the arrangement also falls within the parameters of rule 3-300, which states:
A member shall not enter into a business transaction with a client; or knowingly acquire an ownership, possessory, security, or other pecuniary interest adverse to a client, unless each of the following requirements has been satisfied:
(A) The transaction or acquisition and its terms are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which should reasonably have been understood by the client; and
(B) The client is advised in writing that the client may seek the advice of an independent lawyer of the client's choice and is given a reasonable opportunity to seek that advice; and
(C) The client thereafter consents in writing to the terms of the transaction or the terms of the acquisition.
Courts interpreting rule 3-300 have made it clear that the rule applies to situations where a lawyer acquires a financial or business stake in the representation of a client or simply engages in a business transaction with a client.5 (See Beery v. State Bar (1987) 43 Cal.3d 802, 806 [239 Cal.Rptr. 121] (former rule 5-101, the predecessor to rule 3-300, violated where lawyer solicited client's investment in a corporation in which lawyer was a principal and where lawyer personally guaranteed client's investment); Silver v. State Bar (1974) 13 Cal.3d 134, 139 [117 Cal.Rptr 821] (former rule 4, the predecessor to former rule 5-101, violated because the lawyer acquired "an interest in the subject matter of the litigation" by levying pursuant to a writ of execution on a property to pay the lawyer's fees where the lawyer's client had also obtained a writ of execution on that property to satisfy a judgment in favor of the client which the lawyer was charged with protecting on appeal); Ames v. State Bar (1973) 8 Cal.3d 910, 919 [106 Cal.Rptr. 489] (in violation of former rule 4, the predecessor to former rule 5-101, lawyer acquired "an interest in the subject matter of the litigation" by purchasing a promissory note secured by a first deed of trust while the lawyer's client held a promissory note secured by a second deed of trust on the property which was the subject of the lawyer's representation of the client).)
As noted above, the lawyer in the hypothetical posed has acquired a financial and business stake in the client's representation because the lawyer, directly as a consequence of the lawyer's advice to purchase insurance and from whom, will be paid a commission on any insurance bought by the client from the insurance agent who has made the referral arrangement with the lawyer. One of the purposes of rule 3-300 is " . . . to protect clients from their attorneys' self-interested use of financial information gained from confidences disclosed during the attorney-client relationship." (Arden v. State Bar (1987) 43 Cal.3d 713, 726 [239 Cal.Rptr. 68]; cf. David Welch Co. v. Erskine & Tulley (1988) 203 Cal.App.3d 884, 891-892 [250 Cal.Rptr. 339] (defendant-lawyers breached their fiduciary duties to their client by using confidential information from their client to solicit and obtain collection work from companies who had been customers of the client).) Here, the lawyer has learned of the client's life insurance needs directly as a consequence of the lawyer's confidential estate planning work for the client. The lawyer may not ethically use that information to refer the client to the insurance agent and obtain compensation for that referral without fulfilling rule 3-300's requirements.
In the committee's view, rule 3-300 applies to the referral arrangement described in the hypothetical regardless of the fact that the commission is paid to the lawyer by the insurance agent, and not directly by the client to the lawyer. In Rose v. State Bar (1989) 49 Cal.3d 646 [262 Cal.Rptr. 702], the California Supreme Court concluded that a lawyer should be disciplined for violating rule 5-101, the most recent predecessor to rule 3-300, as a result of a similar third-party payment to the lawyer. In Rose, a lawyer, on behalf of a third party, solicited his client's investment in a restaurant venture. The third-party had agreed that the referring lawyer would receive a 25% stock interest in the corporation which owned the restaurant venture for such an investment referral. (Id. at pp. 659-661.) The California Supreme Court held that "[t]he facts established by the record present a classic case for application of rule 5-101 . . . ." and that the lawyer had violated rule 5-101 by referring his client to the restaurant venture from which he was to receive compensation for the referral without complying with the disclosure, consent, and other requirements of rule 5-101. (Id. at pp. 662-663.)
Similarly, in Rodgers v. State Bar (1989) 48 Cal.3d 300 [256 Cal.Rptr. 381], the California Supreme Court held that a lawyer who had induced financial transactions between a client and a third party which resulted in financial benefits to the lawyer violated rule 5-101. Specifically, in Rodgers, a lawyer had induced a client to make loans to a former client of the lawyer who still owed fees to the lawyer. (Id. at pp. 306-307.) The Supreme Court rejected the lawyer's claim that he had merely facilitated a loan between his client and a third party (his former client) and had not obtained any interest adverse to his client. (Id. at pp. 312- 313.) The Supreme Court held that the lawyer had induced the loans and benefitted from those loans because the lawyer received proceeds from the loans to cover the fees owed by the former client to the lawyer. (Ibid.) As such, the Supreme Court held that the lawyer had thereby " . . . put himself in a position in which he might have been required to choose between conflicting duties to his clients and his own financial interest." (Id. at p. 313.) As the Supreme Court summarized, "[a] review of the record demonstrates that Rodger's [the lawyer's] involvement in Penery's [the client's] loans to Panky [third party former client] violated rule 5-101." (Id. at p. 314.)
Finally, in Kapelus v. State Bar (1987) 44 Cal.3d 179 [242 Cal.Rptr. 196], the California Supreme Court held that former rule 4 was violated where the lawyer owned a partnership interest in an entity involved in several business transactions with the lawyer's client. In that case, the lawyer owned a partnership interest in an entity whose only assets were provided by the lawyer's client. In return for these assets, the lawyer's client had obtained from the partnership a non-recourse loan. (Id. at pp. 188-193.) The Supreme Court found that the lawyer had put himself in a position "where his personal financial interest was in conflict with LAPSC's [the client's] interest in obtaining full repayment of its loan" and that the lawyer "violated former rule 4 by acquiring an interest adverse to" the client's interest. (Id. at pp. 193-194.)
Rule 3-300 was intended to regulate both business transactions involving lawyers and their clients and the acquisition by lawyers of pecuniary interests adverse to their clients. (Santa Clara County Counsel Attys. Assn. v. Woodside, supra, 7 Cal.4th at p. 545 [citing State Bar, Request that the Supreme Court of Cal. Approve Amendments to the Rules of Professional Conduct of the State Bar of Cal., & Memorandum Supporting Documents in Explanation (1987) at p. 33].) The hypothetical presented may be viewed either as a "business transaction with a client" or as a lawyer's acquisition of a "pecuniary interest adverse to a client." The situation is a business transaction with a client because the lawyer is soliciting a client's participation in a business transaction in which the lawyer will receive a financial benefit. (See Rodgers v. State Bar, supra, 48 Cal.3d at p. 313; Rose v. State Bar, supra, 46 Cal.3d at pp. 662-663; See also Beery v. State Bar, supra, 43 Cal.3d at p. 806.) Although the hypothetical presented is in the committee's view at least a business transaction with a client, it also arguably involves a lawyer acquiring a pecuniary interest adverse to a client because the lawyer obtains compensation from the client through the insurance agent that might otherwise wholly or in part have been pocketed by the client in the form of a reduced insurance premium or rebate made to the client. (See Kapelus v. State Bar, supra, 44 Cal.3d at pp. 193-194.) Either way, the rigorous protocol of rule 3-300 must be followed, as described in the next section.
Rule 3-300 does not allow a lawyer to enter into a business transaction with a client or acquire an ownership, possessory, security, or other pecuniary interest adverse to a client " . . . without undergoing an extensive protocol for gaining the client's consent."6 (Santa Clara County Counsel Attys. Assn. v. Woodside, supra, 7 Cal.4th at p. 545.) Specifically, a lawyer must meet five prerequisites in order to enter into a business transaction with a client or to obtain a pecuniary interest adverse to a client. First, the transaction and its terms must be "fair and reasonable to the client." Second, the transaction and its terms must be "fully disclosed and transmitted in writing to the client in a manner which should reasonably have been understood by the client." Third, the client must be "advised in writing that the client may seek the advice of an independent lawyer of the client's choice." Fourth, the client must be "given a reasonable opportunity to seek that [independent] advice." Fifth, the client must thereafter consent "in writing to the terms of the transaction. . . ." (Rule 3-300.) Because of the danger to the lawyer-client fiduciary relationship when a lawyer has pecuniary dealings with a client, the requirements of rule 3-300 are strictly enforced. (See Rodgers v. State Bar, supra, 48 Cal.3d at p. 314; In the Matter of Lane (Review Dept. 1994) 2 Cal. State Bar Ct. Rptr. 735, 745 ["[a] violation of any part of former rule 5-101 gives rise to culpability."].)
As an initial matter, it must be noted that the lawyer will bear the heavy burden of proof " . . . to show that the dealings between him and his client were fair and reasonable." (Rodgers v. State Bar, supra, 48 Cal.3d at p. 314 citing Hunniecutt v. State Bar (1988) 44 Cal.3d 362, 372-373 [243 Cal.Rptr. 699].) One prerequisite in the hypothetical posed for meeting the "reasonableness" prong would be that the client would not pay a higher insurance premium than could be obtained from other insurance agents as a result of compensation being paid to the lawyer for the referral to the insurance agent. (Cf. former rule 2-108, the predecessor to rule 2-200(A)(2) ["A member shall not divide a fee for legal services . . . unless . . . [t]he total fee charged by all lawyers is not increased solely by reason of the provision for division of fees . . . ."].) Other factors may include: whether the purchase of the insurance is in the client's best interests; the availability of other insurance that meets the client's needs; whether the amount of compensation to the lawyer is reasonable under the circumstances; and whether the transaction interferes with the lawyer's competent representation of the client. It is beyond the scope of this opinion to set out all of the possible determinants by which the fairness and reasonableness of the rule 3-300 transaction or pecuniary acquisition will be evaluated. Suffice to say that it will be up to the lawyer to demonstrate that the client was not taken advantage of in any way.
With respect to disclosure, as noted above in connection with the discussion of rule 3-310(B)(4)'s disclosure requirement, rule 3-300 requires that the lawyer disclose the transaction and its terms including how the lawyer will benefit from the transaction. Courts have carefully examined whether the lawyer has disclosed his or her actual or potential conflicts of interest in engaging in the transaction or acquisition at issue, including whether the lawyer emphasized to the client the fact that the lawyer is profiting by the client following the lawyer's advice and recommendations concerning the insurance issues. (See Rose v. State Bar, supra, 49 Cal.3d at p. 663 [lawyer's disclosure inadequate under former rule 5-101 because the lawyer failed to emphasize his own profit from the client's participation in the transaction].) The disclosures must be explicit; it is not enough to give the client an opportunity to discover, through documents or otherwise, all of the facts surrounding the transaction or acquisition at issue. In Rose v. State Bar, the California Supreme Court found a violation of rule 5-101 in part because, even though certain conflicts of interest could have been determined by the client from certain documents that were provided, the lawyer had failed to disclose explicitly to the client the lawyer's actual and potential conflicts of interest. (Id. at p. 663; see also rule 3-300(A) [disclosures must be made in a manner " . . . which should reasonably have been understood by the client . . . ."].) In short, the disclosure to the client under rule 3-300 must be extensive and be made in a manner and in terms reasonably calculated to be understood by the client.
Beyond the fairness, reasonableness, and disclosure requirements, courts have also required strict compliance with the requirements of rule 3-300 and its immediate predecessor, former rule 5-101, that a client be advised to seek independent counsel and be given a reasonable opportunity to consult independent counsel. (See, e.g., Rose v. State Bar, supra, 49 Cal.3d at p. 663 [violation of former rule 5-101 when lawyer advised client only that "she could consult" with another lawyer regarding the investment at issue rather than advising her to actually obtain such a consultation]; Ritter v. State Bar (1985) 40 Cal.3d 595, 602 [221 Cal.Rptr. 134] ("To ensure the fairness of such dealings, it is incumbent upon the attorney entering into such transactions to advise the client to seek independent counsel. The failure to do so constitutes a violation of rule 5-101."); In the Matter of Hagen (Review Dept. 1992) 2 Cal. State Bar Ct. Rptr. 153, 165 [lawyer's failure to advise clients to seek advice or independent counsel concerning business transaction with the lawyer was cause for discipline under former rule 5-101].) While it is beyond the scope of this opinion to determine what would be a reasonable amount of time for a client to consult with independent counsel, at a minimum, it would appear that a client cannot provide a valid consent under rule 3-300 immediately upon being presented by the lawyer with the required disclosures. (See Ritter v. State Bar, supra, 40 Cal.3d at p. 602 [rule 5-101 violated where the clients signed the investment agreement within minutes after it was first presented to them by the lawyer].)
Lastly, it is simply not enough to advise the client to seek some "second opinion." Clients must be advised to seek truly independent counsel. (See Connor v. State Bar (1990) 50 Cal.3d 1047, 1059 [269 Cal.Rptr. 742] ("We conclude, as a general rule, that a member, associate, or partner of a law firm cannot serve as the 'independent counsel' required by former rule 5-101.").)
The committee notes that a lawyer will not be insulated from civil liability in connection with the referral arrangement merely because the lawyer has complied with the California Rules of Professional Conduct. Rule 1-100(A) of those rules specifically provides that "[t]he prohibition of certain conduct in these rules is not exclusive." The discussion to rule 1-100 further emphasizes that the rules " . . . are not intended to supersede existing law relating to members in non-disciplinary contexts." Accordingly, a lawyer who has complied with the written disclosure requirements of rule 3-310(B)(4) as well as the protocol set out in rule 3-300 may potentially still be held civilly liable, for example, for breach of fiduciary duty or negligence if the client is harmed by the lawyer's self-interested arrangement.
It is fundamental that "[t]he relationship between an attorney and client is a fiduciary relationship of the very highest character. All dealings between an attorney and his client that are beneficial to the attorney will be closely scrutinized with the utmost strictness for any unfairness." (Clancy v. State Bar (1969) 71 Cal.2d 140, 146 [77 Cal.Rptr. 657]; see also Ritter v. State Bar, supra, 40 Cal.3d at p. 602; David Welch Co. v. Erskine & Tulley, supra, 203 Cal.App.3d at p. 890 [attorney owes the "most conscientious fidelity" to the client].) In the hypothetical posed, the possibility at least exists that the lawyer who operates under the referral arrangement with the insurance agent will refer clients not to the best insurance agent but to the insurance agent with whom the lawyer has a compensation arrangement. (Cf. Linnick v. State Bar (1964) 62 Cal.2d 17, 21 [41 Cal.Rptr. 1] (under former rule 3 of the California Rules of Professional Conduct, a lawyer may not keep the best interests of his client paramount when he profits from his referrals; a lawyer " . . . is likely to refer claimants, not to the most competent attorney, but to the one who is compensating him."); L.A. Cty. Bar Assn. Formal Opn. No. 443 [lawyer may not accept compensation for referral of a client to a doctor who provides the client with medical services].) In that instance, the lawyer risks civil liability for breach of fiduciary duty or even for legal malpractice.
This opinion is issued by the Standing Committee on Professional Responsibility and Conduct of the State Bar of California. It is advisory only. It is not binding upon the courts, the State Bar of California, its Board of Governors, any persons or tribunals charged with regulatory responsibilities, or any member of the State Bar.
"A member shall keep a client reasonably informed about significant developments relating to the employment or representation and promptly comply with reasonable requests for information."
"It is the duty of an attorney to do all of the following:
. . . .
(m) To respond promptly to reasonable status inquiries of clients and to keep clients reasonably informed of significant developments in matters with regard to which the attorney has agreed to provide legal services."