Violation of Rule 1.8 Makes Business Deal With Client Void

By Samson Habte

Nov. 17 — A lawyer's failure to comply with the “explicit requirements” of the ethics rule governing business transactions with clients precludes the lawyer from enforcing a contract with a client under which he demanded a 25 percent commission on the sale of a patent he obtained for the client, the North Carolina Court of Appeals declared Nov. 17.

The case presented a question of first impression regarding the consequences of a lawyer's failing to comply with North Carolina Rule of Professional Conduct 1.8(a) on business transactions with clients.

That rule requires lawyers to make a series of disclosures and get a client's informed consent in writing before entering into a business deal with the client or acquiring an ownership, possessory, security or other pecuniary interest directly adverse to the client.

The plaintiff, the law firm of attorney Peter H. Priest, acknowledged that it failed to comply with those requirements when Priest agreed to prosecute a patent application in exchange for 25 percent of the proceeds from licensing the patent.

But Priest argued that a trial judge erred in holding that his clients could rely on the Rule 1.8(a) violation to defeat a claim alleging they breached the agreement when they refused to pay him when they sold the patent through a third party for $1 million.

The appeals court disagreed.

Rule 1.8(a) “reflects the special obligation the attorneys of this State have when dealing with their clients,” Judge Linda Stephens said, and “for the sake of maintaining the public's trust, attorneys should be held to abide by Rule 1.8(a)'s explicit requirements as a condition of their own recovery when that recovery is based on business transactions with their clients.”

The panel also rejected Priest's argument that Rule 1.8(a) “only applies to ‘a business transaction … directly adverse to the client.'”

“[T]his interpretation of the Rule utterly distorts its meaning by ignoring the disjunctive ‘or' between the Rule's express prohibition against entering into ‘a business transaction with a client,' and its express prohibition against ‘knowingly acquiring an ownership, possessory, security or other pecuniary interest' that is directly adverse to the client,” Stephens said.

“Rule 1.8(a) broadly [applies] to ‘any business transaction' between an attorney and his client, regardless of whether or not their interests are directly adverse,” the court stated.

Finally, the panel rejected Priest's alternative argument “that even if the Agreement is unenforceable based on his violation of Rule 1.8(a), he should still be entitled to recovery in quantum meruit.”

Alternative Fee Structure

The ruling affirms the dismissal of breach of contract and fraud claims that the Priest firm filed against Gabriel Coch and Information Patterns LLC (“IP”), a company in which Coch was a member.

Coch hired Priest to file a patent application for IP in 2005. Priest was initially paid on a “per-task” basis, billed at $250 per hour and capped at $10,000. That amount was exhausted during the early stages of the application, however, and Coch and his partners could not pay Priest's hourly rates for additional services.

Accordingly, the parties reached an agreement that gave Priest the exclusive right to negotiate licenses for the patent, and provided him with 25 percent of revenues from licenses he negotiated.

Priest later testified that he orally advised Coch to have another attorney review the agreement, and that Coch declined because “he didn't feel like that was necessary.” Priest was unable to produce any signed or executed copies of the agreement.

After Priest failed to negotiate any licenses, Coch retained a broker who, with Priest's approval, found a buyer willing to purchase the patent for $1 million.

Priest sought to collect 25 percent of the net revenue from that sale. Coch refused that demand, asserting that Priest was only entitled to 25 percent of licensing proceeds he personally generated, not those generated from a sale brokered by a third party.

Defensive Use of Rule

The trial court dismissed Priest's breach of contract and fraud claims after concluding that the clients could defend those claims “based on [the law firm's] failure to comply with Rule 1.8.”

The appeals court affirmed. It said that although a violation of ethics rules “does not give rise to an independent cause of action,” nothing “prohibits the defensive use of such violations against a lawsuit subsequently initiated by the same attorney.”

“Instead, we conclude … that the question of whether an attorney's violation of a Rule can be used defensively should be answered by examining what public policy that specific Rule aims to promote, or what harm it seeks to prevent, as evidenced by the Rule's plain language, the Comments to it, and related precedent,” Stephens wrote.

Here, she added, Rule 1.8(a) and its comments illustrate “a strong public policy rationale for allowing violations of [the rule] to be used defensively.”

“While this may be an issue of first impression in our State, we note that courts in other jurisdictions have reached the same conclusion as we reach here,” Stephens added, citing Stillwagon v. Innsbrook Golf & Marina, LLC, 2014 BL 240005, No. 2:13-CV-18-D (E.D.N.C. Aug. 29, 2014), and Evans & Luptak PLC v. Lizza, 650 N.W.2d 364, 18 Law. Man. Prof. Conduct 300 (Mich. Ct. App. 2002).

Not a Standard Fee Contract

The court also rejected Priest's contention that the contract at issue was a fee agreement that should be evaluated “under Rule 1.5's less-demanding standard for fee agreements in the context of ongoing representations.”

Stephens pointed to evidence in the record indicating that the 25-percent-of-proceeds deal signaled “a fundamental shift in the nature and objective of the representation” and that it was “‘not a standard transaction' in patent and trademark law.”

Accordingly, Stephens said, the agreement was “more accurately viewed as a business transaction in which Priest and his firm exercised influence and control from a position of trust when dealing with their legally unsophisticated clients to obtain unusually favorable terms for their own compensation.”

Judges J. Douglas McCullough and Valerie J. Zachary concurred.

Bryant & Ivie PLLC represented the Priest law firm. The defendants were represented by Glenn, Mills, Fisher & Mahoney P.A.

To contact the reporter on this story: Samson Habte at

To contact the editor responsible for this story: Kirk Swanson at

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