December 2005

Ethics and the Law

Referral Fees Paid  by Other Professionals: Are They Ever Permissible?

by Kevin Bank

Ethical conundrum: Your old college roommate is a financial advisor who has just established her own business. She is eager to attract new clients. She is particularly interested in the type of clients you serve in your law practice — people with substantial assets who seek your advice on estate planning and business matters. Your former roommate is willing to offer you a percentage of her ongoing management fees for each referral — money you could put to use for your teenager’s college fund. Alternatively, she suggests a one-time “referral fee” each time she obtains a new client from you. Can you accept either type of compensation in exchange for your referrals?

There is no case or formal opinion in Washington that directly answers this question. However, the Washington State Bar Association’s Rules of Professional Conduct Committee (RPC Committee) has issued two informal opinions,1 and bar associations elsewhere have wrestled with this topic. Some state bars say that referral fees from a nonlawyer are prohibited, a position endorsed by the RPC Committee in two specific factual scenarios. Other bar associations have condoned referral-fee arrangements, but have imposed stringent disclosure requirements to address concerns about conflicts of interest, independent professional judgment, and undue influence. Thus, Washington lawyers would be wise to avoid accepting a referral fee from another professional, regardless of how the fee is paid.2

1. The View that Referral Fees Constitute an Unwaivable Conflict

Several state bar opinions hold that referral fees from other professionals are never permissible. These include Kentucky, New York, Texas, Iowa, New Hampshire, and Maine. The primary rationale is that acceptance of a referral fee results in an unwaivable conflict of interest for the lawyer under Rule of Professional Conduct (RPC) 1.7(b), 1.8(a), 2.1, or similar rules under the Code of Professional Responsibility. Under RPC 1.7(b), a lawyer cannot represent a client if the representation will be “materially limited” by the lawyer’s own interests. The conflict can be waived, but only if the lawyer “reasonably believes” the representation will not be adversely affected. RPC 1.8(a), which concerns business relationships with clients, requires that any business transaction with the client be on terms that are “fair and reasonable to the client.” RPC 2.1 states that a lawyer must exercise independent professional judgment in advising a client.

The “no” states have concluded that payments of referral fees to lawyers create conflicts of interest that are “likely to interfere materially, on a continual basis, with the lawyer’s independent professional judgment in objectively considering the client’s best interests.”3 Our RPC Committee deemed two proposed arrangements unethical and inconsistent with a lawyer’s duty to exercise independent judgment — one where an investment firm would pay a lawyer a referral fee based on the dollar amount of the investment assets of the client he referred, and the second involving a referral fee of one percent of the gross amount of loans made by a financial company to clients referred to the company by the lawyer.4 Because the states that bar referral fees regard them as an unwaivable conflict, it is very unlikely that the form of the fee — whether a percentage of management fees or a one-time fixed payment each time a referral is made — would change the analysis.5

2. The View that Referral Fees Are Permissible If the Client Gives Informed Consent

The “yes but” states would permit referral fees if the lawyer makes appropriate disclosures to the client and obtains the client’s informed consent. These states include Florida, Connecticut, Utah, California, and Pennsylvania. All the state bar opinions permitting referral fees emphasize the need for comprehensive disclosure to, and consent from, the client. For instance, the Connecticut Bar decided not to prohibit an arrangement where a lawyer would refer clients needing financial management to an investment advisory firm in exchange for a split of the management fees, but then qualified its approval by detailing the extensive disclosure and waiver requirements the lawyer would have to meet to comply with ethics rules. First, the lawyer must have a reasonable, objective belief that the conflict of interest is waivable under Connecticut’s equivalent of RPC 1.7(b). If so, the lawyer would need to obtain the client’s informed written consent to share confidential information with the financial advisor (to comply with Rule 1.6), and also obtain a written waiver of the potential conflict of interest between the lawyer and the client (to comply with Rule 1.7(b) and 1.8(a)). In addition, the lawyer must make sure that the terms of the arrangement are fair and fully disclosed to the client, and advise the client to consider consulting independent counsel (to comply with Rule 1.8(a)).6

Connecticut’s stringent disclosure obligations are not atypical. Every state opinion permitting referral fees requires substantial disclosure and client consent. For instance, although a Florida Bar opinion appears to require less disclosure, it still warns that the attorney receiving the referral fee must: (1) conduct an independent investigation that the investment or referral is a proper one under the circumstances; (2) make full disclosure to the client of all the facts, including the fact that the lawyer will obtain the referral fee; and (3) obtain the client’s consent in writing to the referral fee.7

In sum, referral fees paid to lawyers by other professionals implicate serious issues of self-interest versus client interest. You might want to tell your old roommate that paying you a referral fee would open the door to questions about whose best interest is being served — yours or your client’s. 

Kevin Bank has been a disciplinary counsel at the WSBA since 1999. He graduated from New York University Law School in 1987 and practiced in a small private firm and with the federal government prior to joining the WSBA.
 
NOTES

 1  Informal opinions are issued in response to specific inquires, and reflect the opinion of the Rules of Professional Conduct Committee only. They are not individually approved by the WSBA Board of Governors and do not reflect the official opinion of the Association. Informal opinions can be accessed on the WSBA’s website at http://pro.wsba.org/io/search.asp.
 
2  Likewise, Washington lawyers should avoid paying referral fees to other professionals to refer clients to them. See RPC Committee Informal Opinion 1951 (2001).
 
3  Kentucky Ethics Op. E-390 (1996).
 
4  RPC Committee Informal Opinions 1853 (1998) and 1399 (1991).

 5  See Ohio Supreme Court Ethics Op. 2001-4 (regardless of how referral fee is negotiated, it would still create an unwaivable conflict of interest).
 6  Connecticut Informal Ethics Op. 97-6 (1997).

 7  Florida Ethics Op. 02-8 (2004).