Ethics for New Attorneys: AB 2305: The Legislature’s Latest Blow in the Long-Running Battle Over Outside Funding of Lawyers
An ethical issue that may not be forefront in your day-to-day practice, but which is crucial to understand, is whether and to what extent you and your firm can ethically and legally accept non-lawyer funding or partner with non-lawyer entities. This is a decades-long debate that I first witnessed via heated discussions at the 1996 ABA meeting in New York. Then, the conversation focused on ABA Model Rule 5.4, which is the basis for California’s current Rule 5.4. Rule 5.4 includes a long list of prohibited conduct, including sharing fees with nonlawyers, forming partnerships with nonlawyers, and allowing a lawyer referral service to interfere with a lawyer’s judgment. Rule 5.4 is viewed as embodying the “core values” of our profession, namely that the preservation of lawyer control is essential if the profession aims to ensure justice, not just make money.
This article provides an overview of historical trends and current developments in this area. In recent weeks, the California Assembly passed AB 2305,[1] and the bill, authored by Ash Kalra, is headed to the State Senate for action. If enacted, this would be one of the country’s most sweeping prohibitions of outside corporate investment in litigation practices. As described in the Legislative Counsel’s Digest, the bill would:
- prohibit a corporate investor involved in any litigation practice, among other things, from interfering with a substantive litigation decision or exercising control over a litigation function;
- prohibit a corporate investor, or an entity it controls, from entering into any contract, agreement, or arrangement with a litigation practice if the contract would enable prohibited interference or control under these provisions.
- deem a violation of these provisions as cause for the imposition of State Bar discipline subject both the attorney and the corporate investor to statutory or actual damages, attorney’s fees and costs, and other relief
The history that brought us AB2305 provides the foundation for understanding the current proposed rules. The modern battle over the participation of non-lawyers in litigation funding can be divided into three fairly distinct phases:
- 1990s: Accounting Firms, Insurance Companies, and Multi-disciplinary Practice
In the 1990s, the perceived threat was large accounting firms and insurance companies that wished to make the provision of legal services part of their portfolios through what was described as “multi-disciplinary practice” (MDP), the idea that one-stop shopping would bring economies of scale and expand the availability of legal services. The MDP concept lost some momentum after the Enron scandal demonstrated that large accounting firms did not necessarily have their clients’ interests at heart. But large accounting firms have nonetheless persevered and have expanded their provision of legal services, especially in the United Kingdom.
- 2018-2024 Tech Firms and Access to Legal Services
The ongoing problem of the lack of affordable legal services persists to this day. The “core values” of the legal profession, as reflected in Rule 5.4, were targeted by those seeking to take down the Guild (as the legal profession was perceived to be) by a movement that caught fire in the immediate pre-COVID era. At the same time, technology began to be touted as an almost magical solution to every human problem. In 2017, the State Bar of California Board of Governors (as they were then styled) stated as part of their Strategic Plan, the goal of:
Commencing in 2018 and concluding no later than March 31, 2020, study online legal service delivery models and determine if any regulatory changes are needed to better support and/or regulate the expansion of access through the use of technology in a manner that balances the dual goals of public protection and increased access to justice.
In 2018, the Board created the Task Force on Access Through Innovation of Legal Services (ATILS), charged with developing technological solutions and the regulatory reforms necessary to support them. Among the regulatory reforms recommended in the ATILS final report dated March 6. 2020 was the study of revisions to Rule 5.4, which was derided as a “significant inhibitor” of innovation:
ATILS also generally recommends an ongoing study of other amendments to the rule that could promote collaboration, innovation, and investment in new delivery systems that lower costs and increase access to legal services. The members of the ATILS Task Force have identified revisions to rule 5.4 as being central to advancing innovation in the delivery of legal services. Rule 5.4 has been identified as a significant inhibitor of innovation that could be provided by non-lawyer entities, including individuals, organizations, and technologies. While the Task Force only approved a revision to the rule, which will allow expanded fee sharing with nonprofit organizations, a substantial majority of the members agree that additional revisions may be warranted. Still, that further study and data informing the specifics of those revisions is needed.[2]
In part because of the lack of empirical data supporting the efficacy of these possible reforms in meeting the demand for low-cost legal services, ATILS proposed the creation of a “sandbox” to test different models for ushering in this brave new world. “Sandbox” is a computer coding term describing an isolated environment used to test new code without affecting the larger computer system, and its use reflects the tech background of several ATILS members.
The same wave of reform swept through other states in 2020. Utah approved its own “sandbox” experiment in 2020. Arizona went even further, repealing its Rule 5.4 entirely and approving a new scheme for creating Alternative Business Structures. California appeared to be boldly heading into a new era of low-cost tech-delivered legal services delivered by corporations controlled by non-lawyers, riding a wave of Rule 5.4 reform sweeping the nation.
But then the wheels came off. In 2022, the Legislature, influenced by a State Bar Auditor’s report that found weak bar policies on disciplinary enforcement, and by the Girardi scandal, passed a law effectively ending the ATILS process[3], with some legislators urging the State Bar to focus on its central responsibility, discipline. Reform, as conceived by ATILS, including non-lawyer control and non-lawyer investment in legal service providers, ground to a halt in California.
No other states adopted the sweeping reforms seen in Arizona or even the limited “sandbox” approach adopted by Utah. Utah made changes to its sandbox in 2024, narrowing the scope “to concentrate on entities offering innovative solutions with potential to substantially impact the access-to-justice gap in Utah,” and reinstituting audits of sandbox providers by experienced Utah-licensed lawyers.[4] Arizona recently enacted changes requiring ABSs to actually provide legal services and not just refer cases to other lawyers. These changes reflect some of the problems with non-lawyer investment that the current California legislation targets.
The fundamental truth that ATILS did not grapple with in supporting private investment and technological innovation in legal practice was that private investors seek the maximum return on their investment, rather than seeking justice. The UK’s experience with ABS revealed that the bulk of private capital (currently styled as “private equity”, presumably to remove any stigma attached to the word “capital”) gravitated toward personal injury and mass torts. In these areas, private investors could reap substantial rewards. Thus, the current phase of the battle.
- Now: The Battle Over “Private Equity” and Law Practice
The enactment of Business and Professions Code section 6034.1 in 2022 was the start of the Legislature’s active involvement in the battle over the legal services market, involvement that has continued with a series of bills, including the ones authored by Assemblyman Kalra.
One way that California lawyers and non-lawyer investors sought to work around the strictures of Rule 5.4 was to divide legal fees with lawyers practicing in jurisdictions where non-lawyer control and investment are legal, such as the District of Columbia, with its idiosyncratic version of Rule 5.4 allowing non-lawyer partners in law firms, or Arizona, where Rule 5.4 has been repealed and ABS structures can be created and operated. Personal injury and mass tort practices typically rely on expensive mass advertising to obtain clients, and “private equity” money can fund such campaigns, sometimes on a nationwide basis. Sometimes the only role of the ABS is to fund the advertising and marketing campaign; sometimes, also to manage it. Thus, the new section 6056, prohibiting fee division with an ABS, the new stricter advertising rules now found in amended section 6157.2, and the stricter legal referral service rules contained in amended sections 6155 and 6155.1.
The new proposed legislation is even broader in scope. It would prohibit any interference by a corporate investor in litigation decisions, essentially directly taking those “core principles” of the lawyer’s independence as reflected in Rule 5.4 and making their violation not only a cause for discipline but apparently also a cause of action for damages by an injured consumer in a new proposed section 6134.10.
Exactly how that would play out in civil litigation is not clear. On the disciplinary side, the State Bar of California takes its cues from the Legislature and, having been given this direction, will likely look for opportunities to put some disciplinary teeth into this new law.
This battle is going to go on for some time.
[1] https://legiscan.com/CA/text/AB2305/id/3396153
[2] ATILS Final Report 3/6/20, page 18, emphasis added (https://www.calbar.ca.gov/sites/default/files/portals/0/documents/publicComment/ATILS-Final-Report.pdf)
[3] Bus. & Prof. Code §6034.1
[4] https://utahinnovationoffice.org/sandbox-phase-2/
David C. Carr dccarr@ethics-lawyer.com Law Office of David C. Carr, legal ethics
