Can lawyers in a firm buy charged-off debts from a client, former client, or non-client, and can an LLC owned by the firm's lawyers hire the firm to collect those debts?

Plain-English summary

Lawyers in a firm proposed a business arrangement to purchase charged-off debts, either directly or through an LLC whose members are the lawyers, and then collect on them. They asked whether they may buy uncollected debts from a client, former client, or non-client, and whether an LLC of firm members may hire the firm to collect the debt.

The committee answered yes to both, with conditions. On the purchase, it explained that Rule 1.8(i) prohibits a lawyer from acquiring a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, but does not reach these charged-off debts because they are assumed not to be the subject matter of litigation the lawyer was conducting for the creditor. The committee drew a line: if the lawyer had already been involved in collecting the debt as the seller's lawyer, or if the creditor had approached the lawyer in an attorney-client context about these accounts, purchasing the debt would be improper. What matters is whether the lawyer represented the client as to these particular accounts, not whether the lawyer represents the client on other matters.

The committee read Comment 1 to Rule 1.8 as contemplating the arrangement, noting the rule does not apply to standard commercial transactions for products or services the client generally markets to others, where the lawyer has no advantage in dealing with the client. It pointed to Rule 1.8(a) (business transactions with a client) as the more applicable provision, and quoted Comment 17's explanation that acquiring a security interest in property other than that recovered through the litigation is a business transaction governed by paragraph (a), with the general rule grounded in the common law doctrines of champerty and maintenance and aimed at preventing the lawyer from acquiring too great an interest in the representation. Because the debts were already charged off and there was no prior representation as to those accounts, the lawyer acquires no interest in a representation and acts as a businessman, not as a lawyer, so the general conflict-of-interest rules for lawyers doing business with clients apply.

On the LLC, the committee held that forming an LLC does not relieve a lawyer of ethical duties; a lawyer cannot use a subterfuge to carry on unethical conduct, and should be mindful of Rule 1.7 conflicts with current clients. The arrangement is not per se unethical under Rule 1.8 if these guidelines are followed. The committee, while declining to give substantive-law advice, strongly encouraged the inquirer to review S.C. Code 40-5-340 (fining and barring an attorney who buys a note for the purpose of putting it in suit when the holder otherwise would not sue) and directed the inquirer to Osprey v. Cabana Limited Partnership discussing that statute, adding that a violation of 40-5-340 may also be a Rule 8.4 violation.

In practice

Under this opinion, lawyers may buy charged-off debts and collect them, including through an LLC of firm members that hires the firm, when they did not represent the creditor as counsel on those particular accounts. The committee held Rule 1.8(i) does not bar the purchase because the debt is not the subject matter of litigation the lawyer is conducting for a client; instead the transaction is governed by Rule 1.8(a) as a business transaction with a client, and the lawyer acts as a businessman rather than as counsel. It held that using an LLC does not change the ethical analysis and that Rule 1.7 conflicts must still be watched, and it flagged S.C. Code 40-5-340 and Osprey v. Cabana as legal limits whose violation could also implicate Rule 8.4.

Common questions

Q: Can a lawyer buy a debt from a client and then sue on it?

A: The committee concluded a lawyer may buy charged-off debts the lawyer never handled as counsel for the creditor. Rule 1.8(i) only bars acquiring an interest in the subject matter of litigation the lawyer is conducting for a client, which is not the case for already-charged-off debt with no prior representation on those accounts.

Q: When would buying the debt be improper?

A: The committee said it would be improper if the lawyer had already been collecting the debt as the seller's lawyer, or if the creditor had approached the lawyer in an attorney-client context about those accounts. What matters is representation as to these particular accounts.

Q: Does routing the purchase through an LLC change anything?

A: No. The committee held forming an LLC does not relieve the lawyer of ethical duties and cannot be used as a subterfuge for unethical conduct; the lawyer must still mind Rule 1.7 conflicts.

Q: What non-ethics law did the committee flag?

A: It strongly encouraged review of S.C. Code 40-5-340, which fines and bars an attorney who buys a note to put it in suit when the holder otherwise would not sue, and cited Osprey v. Cabana Limited Partnership; a violation may also be a Rule 8.4 violation.

Background and rules framework

The opinion applies South Carolina Rule 1.8(i) (no proprietary interest in the cause of action or subject matter of litigation), Rule 1.8(a) (business transactions with a client), and Rule 1.7 (concurrent conflicts), which correspond to the like-numbered Model Rules, along with Rule 8.4 (misconduct). It relies on Comments 1 and 17 to Rule 1.8 and reads the rules against the South Carolina champerty-and-maintenance statute, S.C. Code 40-5-340.

Citations and references

Rules of Professional Conduct:

• MR 1.8 / SC Rule 1.8(i) (no proprietary interest in the subject matter of litigation), Rule 1.8(a) (business transactions with a client), Comments 1 and 17
• MR 1.7 / SC Rule 1.7 (concurrent conflicts of interest)
• MR 8.4 / SC Rule 8.4 (misconduct)

Statutes:

• S.C. Code 40-5-340 (1976, as amended) (penalty for an attorney who buys a note for the purpose of putting it in suit when the holder otherwise would not sue)

Cases:

• Osprey, Inc. v. Cabana Limited Partnership, 340 S.C. 367, 532 S.E.2d 269 (2000), discussing S.C. Code 40-5-340

Other opinions cited:

• None.

See also

• SC Bar Ethics Op. 05-02: Financing a Client's Project
• SC Bar Ethics Op. 20-02: Lawyer Funding a Settlement
• SC Bar Ethics Op. 04-03: Nonprofit-Paid Estate Work

Source

• Landing page: https://www.scbar.org/for-lawyers/quicklinks/legal-resources/ethics-advisory-opinions/ethics-advisory-opinion-07-04/

Original opinion text

Reproduced from the official source for research purposes. The linked source is authoritative.

UPON THE REQUEST OF A MEMBER OF THE SOUTH CAROLINA BAR, THE ETHICS ADVISORY COMMITTEE HAS RENDERED THIS OPINION ON THE ETHICAL PROPRIETY OF THE INQUIRER’S CONTEMPLATED CONDUCT. THIS COMMITTEE HAS NO DISCIPLINARY AUTHORITY. LAWYER DISCIPLINE IS ADMINISTERED SOLELY BY THE SOUTH CAROLINA SUPREME COURT THROUGH ITS COMMISSION ON LAWYER CONDUCT.

Ethics Advisory Opinion 07-04

SC Rules of Professional Conduct: 1.8(a), 1.8(i)

Facts
Lawyer(s) in a Law Firm are considering a business arrangement whereby Lawyer(s) would purchase, either directly or though an LLC with the Lawyer(s) as members, charged-off debts.

Questions
May Lawyer(s) in a law firm purchase uncollected debts from a client, a former client, or a non-client?
May an LLC made up of members of the law firm hire the law firm to collect the debt?

Summary
Yes, Lawyer(s) in a law firm may purchase uncollected debts from a client, a former client, or a non-client.
Yes, an LLC made up of members of the law firm, may hire the law firm to collect the debt, as long as the lawyers adhere to the Rules of Professional Conduct and applicable state laws.

Opinion
Rule 1.8(i) of the Rules of Professional Conduct does not prohibit the arrangement in the first Question unless the debt is the "subject matter of litigation the lawyer is conducting for a client" (emphasis added). Since the matters in question involve debts which have already been charged off by the sellers on the notes, it is assumed for the purpose of this analysis that the lawyer was not actually representing the creditor as a lawyer in the collection matter for the client.

If the lawyer was already involved in attempting to collect the debt as a lawyer for the seller of the note, then it would be improper for the lawyer to purchase the debt. Similarly, if the seller of the note (creditor) had approached the lawyer in the attorney-client context, it would be improper for the lawyer to then purchase the debt. It does not matter if the lawyer is representing the client as to other matters, only if he has represented the client in regard to these particular accounts. Comment 1 to Rule 1.8 seems to contemplate this arrangement:

In addition, the Rule does not apply to standard commercial transactions between the lawyer and the client for products or services that the client generally markets to others. For example, banking or brokerage services. . . . In such transactions, the lawyer has no advantage in dealing with the client, and the restrictions in paragraph (a) are unnecessary and impracticable.

The above Comment references Rule 1.8(a), which is more applicable to the current situation.

Comment 17 of Rule 1.8 states in relevant part: "When a lawyer acquires by contract a security interest in property other than that recovered through the lawyer's efforts in the litigation, such an acquisition is a business or financial transaction with a client and is governed by the requirements of paragraph (a)." Additionally, "Like paragraph (e), the general rule has its basis in common law, champerty, and maintenance and is designed to avoid giving the lawyer too great an interest in the representation."

The proposed conduct does not involve the lawyer's acquiring any interest in the representation, because the debts were already charged off and there was no prior representation as to these accounts. The lawyer is not acting as a lawyer in this case, but as a businessman. All of the general conflict of interest rules involving lawyers who pursue business matters with their clients would be relevant.

The formation of an LLC does not relieve a lawyer of ethical ramifications and duties when entering this type of business arrangement. A lawyer cannot employ a subterfuge to carry on unethical conduct. Therefore, the lawyer should be mindful of Rule 1.7 regarding conflicts of interest with current clients.

However, as set out above, it is not unethical per se, pursuant to Rule 1.8, for a lawyer to enter the business arrangement proposed in Question two, as long as these guidelines are followed. While this committee does not offer advice on issues of substantive law, we strongly encourage the inquiring lawyer to review S.C. Code §40-5-340, which states:

If any attorney, solicitor or counsellor shall enter into any speculating practices, by purchasing or procuring to be purchased any note or other demand for the purpose of putting the same in suit, when otherwise the owner or holder thereof would not sue upon it, such attorney, solicitor or counsellor shall pay a fine of one hundred dollars and shall thereafter be incapable of practicing as such in any court until restored by the Supreme Court.

The Committee also directs the inquirer to Osprey v. Cabana Limited Partnership, 340 SC 367, 532 SE2d 269 (2000), discussing §40-5-340, as the lawyer makes both ethical and legal decisions regarding these business arrangements. If the proposed action does violate §40-5-340, it may also be a Rule 8.4 violation.