On The Case

Prominent shareholder firm must face fee-splitting claims: Penn. Supreme Court

(Reuters) - The justices of the Pennsylvania Supreme Court’s Eastern District couldn’t quite agree on why a law firm shouldn’t be allowed to duck behind ethics rules to avoid liability under an unethical fee-splitting contract. The six justices who heard the case of a consultant who claims Barrack Rodos & Bacine reneged on an oral contract to pay him a share of its profits produced four different opinions Tuesday as they attempted to figure out whether the public’s best interest lies in a hard-and-fast rule that unethical contracts cannot be enforced or in a more flexible, fact-specific approach. But all of the Pennsylvania justices, whether in dissent or concurrence, agreed on one thing: Law firms that dupe unsuspecting non-lawyers into unethical agreements must be held accountable.

For Barrack Rodos, the judgment of the Supreme Court, written by Chief Justice Thomas Saylor for himself and Justice Kevin Dougherty, means it must return to trial court to defend the breach of contract allegations by a onetime employee, Scott Freda, who contends the firm owes him more than $1.5 million for acting as a liaison between Barrack Rodos and institutional investors who retained the firm to represent them in securities class actions.

The terms of any agreement between Barrack Rodos and Freda’s consulting firm, SCF Consulting, are hotly disputed. According to Freda’s brief at the state Supreme Court (2017 WL 4476503), Barrack Rodos hired him in 2003 to pitch the law firm’s services to state, municipal and union investment funds. Freda allegedly worked at the firm until 2006, then founded SCF Consulting. He contends he continued to serve Barrack Rodos as a consultant until 2014.

Freda claims he and Barrack Rodos founder Leonard Barrack had an oral fee-splitting agreement in which the firm paid Freda a fixed annual consulting fee plus 5 percent of the firm’s annual profits in cases Freda originated and worked on and 2.5 percent of profits in other cases.

According to a chart Freda included in his Supreme Court brief, his profit-sharing fees between 2008 and 2014 ranged from $125,000 to $500,000, on top of his fixed consulting fee of $150,000 until 2012 and $210,000 thereafter. Freda’s lawyers at Bochetto & Lentz argued that Barrack Rodos broke the oral contract in December 2014, when Freda was owed more than $1.5 million for his work on a long-running case against Apollo Group.

Barrack Rodos denies it had any sort of fee-splitting deal with Freda and SCF Consulting. The firm acknowledged in a trial court motion for sanctions against Freda that it paid him hundreds of thousands of dollars as a consultant, but it said that whatever he received in excess of his annual consulting fee was a discretionary bonus – not profit-sharing or fee-splitting. Moreover, according to Barrack Rodos’ lawyers at Ballard Spahr, Freda initiated a split with the firm in 2014, when he wasn’t hired to manage the firm. Only a year later, according to Barrack Rodos’ motion for sanctions, when Freda sued the firm, did he concoct his “sensational” account of a fee-splitting agreement.

Barrack Rodos’ sanctions motion was one prong of its defense against Freda’s allegations. The other was a motion to dismiss SCF’s suit because, as a matter of public policy, a law firm’s fee-splitting agreement cannot be enforced. Regardless of the contested facts of its arrangement with SCF, the firm argued, courts cannot undermine the client protections embedded in the ethics rules prohibiting fee-splitting by allowing a suit based on an unethical agreement to proceed.

Using ethics rules as a shield against liability for entering an unethical contract may seem like a defense that only a lawyer could love. But believe it or not, most of the jurisdictions that have been asked to enforce fee-splitting contracts have refused to do so on precisely those grounds, even when the law firm’s fee deal was with a non-lawyer. Barrack Rodos’ brief (2017 WL 4476503) at the Pennsylvania Supreme Court runs through precedent from a range of state and federal courts; the Supreme Court’s majority opinion cited in particular a 2002 Pennsylvania state appellate decision, Wishnefsky v. Riley & Fanelli (799 A.2d 827) and a 1989 ruling from the Illinois Supreme Court, O’Hara v. Ahlgren Blumenfeld & Kempster (537 N.E.2d 730) that held the public interest is best served by refusing to enforce agreements in violation of the rules of professional conduct, even if the refusal leaves a non-lawyer without recourse.

Variations on that argument worked for Barrack Rodos in the trial and intermediate appellate courts, which ruled Freda could not move ahead with his breach of contract suit. (The trial judge denied the law firm’s motion for sanctions, without explanation.) The Pennsylvania Supreme Court agreed to take the case “to consider whether, or under what circumstances, the professional conduct rules may be invoked as a defense by a law firm breaching its own ethical obligations by entering into an impermissible fee-splitting arrangement.”

Freda’s brief did a good job of explaining the ironic internal contradiction of a per se rule that allows law firms to use ethics rules to evade responsibility for entering unethical contracts. “Our system of justice cannot countenance such an outcome,” the brief said. “This Court – vested with the constitutional power to regulate the practice of law – cannot allow its practitioners to brazenly utilize the very code of conduct that regulates an attorney’s interactions with the public to reap a windfall by avoiding obligations under a contract that violates those very rules. Such an outcome is inequitable, unfair, and perverts the Rules of Professional Conduct.”

But the question isn’t as easy as Freda would have it. The Pennsylvania Bar Association filed an amicus brief (2017 WL 4476504) laying out the conundrum. “Allowing a non-lawyer to enforce a fee sharing agreement that violates (ethics rules) runs the risk of being a disservice to the client, either because the non-lawyer’s influence impairs the quality of professional services or collusion between the lawyer and non-lawyer achieves a result inconsistent with the client’s best interests,” the bar brief said. “On the other hand, the PBA recognizes that a lawyer should not be permitted to intentionally take advantage of an innocent non-lawyer, by entering into an agreement violating (ethics rules) and then raising that violation as a defense to a claim for the agreed upon compensation.”

The bar association agreed with Freda that the court system should not be perceived as abetting lawyers’ misconduct by barring relief for these innocent counterparties. But instead of pursuing breach-of-contract claims stemming from unenforceable contracts, the bar brief said, counterparties could instead seek equitable relief, like a suit for unjust enrichment or conversion. In egregious cases of lawyer misconduct, the bar said, the state disciplinary board could order disgorgement.

The Supreme Court, as I mentioned, couldn’t reach consensus on an overarching rule for the justiciability of contract suits stemming from improper fee-sharing agreements. The court’s judgment only held that such suits are not absolutely barred. “The ultimate outcome of this case may turn on factual findings concerning (Freda’s) culpability, or the degree thereof, relative to the alleged ethical violation,” the judgment said. “We would hold only that the contract cause of action is not per se barred by the purported infraction on (Barrack Rodos’s) part and, accordingly, the county court’s bright-line approach to the unenforceability of the alleged consulting agreement should not be sustained.”

In a dissent, Justice David Wecht, joined by Justice Christine Donohue, said he favored the bar association’s suggestion of equitable relief for innocent non-lawyers who enter improper agreements with lawyers. Justice Max Baer, joined by Justice Debra Todd, argued for a stringent rule to hold lawyers accountable for entering improper contracts. “This court can both avoid the perils arising from unethical fee-sharing contracts and preserve contractual agreements so as to ensure that the parties obtain the fair and reasonable compensation to which they are entitled by enforcing such feesharing contracts, but sanctioning, swiftly and harshly, attorneys who violate the disciplinary rules in this regard,” he wrote.

Freda’s counsel George Bochetto told me the justices seemed bothered by the idea of lawyers foisting the consequences of their misconduct onto non-lawyers. “You can’t punish the non-lawyers,” he said.

Barrack Rodos’ lawyer, Raymond Quaglia of Ballard Spahr, said the firm denies it ever had a fee-sharing agreement with Freda, as its sanctions motion explains. He declined to comment on the Supreme Court ruling.