MARYLAND STATE BAR ASSOCIATION, INC.

COMMITTEE ON ETHICS

ETHICS DOCKET NO. 2016-03

May nonlawyers serve on the advisory board of directors of a Maryland nonstock corporate law firm, which provides pro bono and discounted legal services, while that corporation’s application for tax-exempt status is pending determination by the IRS? & If the IRS grants that corporation’s application for tax-exempt status, may nonlawyers serve on either the corporation’s advisory board or its governing board of directors?

You are a Maryland attorney who has formed a Maryland nonstock corporation, Main Street Legal Aid Services, Inc. (“MSLAS”), to provide free or discounted legal services.1 You explain that MSLAS’s mission “is to provide free and reduced rate legal services to those Maryland residents who are disqualified from receiving legal aid from other non-profit law firms because their income is above the poverty threshold but who may not be able to afford market rates.”

When you requested our opinion, you were the only member of that corporation’s board of directors, but you said you would like to form an “advisory board” and you would also like to add other members to the board of directors.2 You told us that MSLAS intends to seek tax-exempt status and that, when it does, the Internal Revenue Service will require MSLAS “to demonstrate that it has a larger Board consisting [of] ‘unrelated’ individuals.” MSLAS would therefore like “to include citizens from the community it primarily serves,” so some potential members of its “advisory Board and Board are nonlawyers.” You sought an opinion addressing the following two questions (which we paraphrase from the questions posed in your request):

1) May nonlawyers serve on the advisory board of directors of a Maryland nonstock corporate law firm, which provides pro bono and discounted legal services, while that corporation’s application for tax-exempt status is pending determination by the IRS?

2) If the IRS grants that corporation’s application for tax-exempt status, may nonlawyers serve on either the corporation’s advisory board or its governing board of directors?

Md. Rule of Professional Conduct 5.4 (d) provides, in pertinent part:

A lawyer shall not practice with or in the form of a professional corporation or association authorized to practice law for a profit, if:

. . . .

(2) a nonlawyer is a corporate director or officer thereof or occupies the position of similar responsibility in any form of association other than a corporation; or

(3) a nonlawyer has the right to direct or control the professional judgment of a lawyer.

(emphasis added).

Your inquiry focused on the language “for a profit,” and you specifically asked whether a law firm operating through a tax-exempt entity would be viewed as practicing “law for a profit?” If not, the proscriptions provided in Rule 5.4(d) would not apply. As we will explain, we conclude that the Maryland Rules of Professional Conduct allow a nonlawyer to serve on either an advisory board or the board of directors of a Maryland corporation that provides pro bono or discounted legal services, if that corporation attains tax-exempt status from the IRS.3

Advisory boards We start by addressing whether a nonlawyer may serve as a member of an “advisory board.” Unlike the board of directors that manages and governs a corporation’s affairs,4 an “advisory board” is typically viewed as a group of individuals that gives suggestions and advice to a corporation, but which lacks any legal or governing authority. Comment 2 to Rule 5.4 explains that the Rule “expresses traditional limitations on permitting a third party to direct or regulate the lawyer’s professional judgment in rendering legal services to another.” As an advisory board functions strictly in an advisory manner, with no legal or governing authority over the corporation’s affairs – and assuming it has no authority to direct or regulate a lawyer’s professional judgment in rendering legal services – having a nonlawyer serve as a member of an advisory board does not run afoul of Rule 5.4(d). This would be true regardless of the entity’s tax-exempt status.

Boards of directors We now address the second issue: may nonlawyers serve on the board of directors of a tax-exempt corporation authorized to practice law? If a corporation that has attained tax-exempt status from the IRS is, by definition, not “authorized to practice law for a profit,” then Rule 5.4(d) would allow that entity to have nonlawyers serve – not only as members of an “advisory” board – but also as members of the corporation’s board of directors.5 But what if the phrase “authorized to practice law for a profit” is not the opposite of the term “tax-exempt entity?” In that case, whether an entity is “authorized to practice law for a profit” would not depend on whether that entity enjoys tax-exempt status, and merely attaining that status would not remove the entity from the strictures of Rule 5.4(d). Particularly given the use of the term “nonprofit organization” elsewhere in Rule 5.4, but not in paragraph (d), we think the language in Rule 5.4(d) is unclear and ambiguous. Thus, we must look to sources other than the language itself to determine the provision’s objectives and purposes in order to answer the question.

We have found no evidence that either the Court of Appeals, in adopting Rule 5.4(d) – or the ABA in adopting Rule 5.4 of the ABA Model Rules of Professional Conduct – specifically intended that the phrase “authorized to practice law for a profit” should be read to automatically exclude all tax-exempt entities or nonprofit organizations from the restrictions imposed by paragraph (d). And as we noted above, in Rule 5.4(a)(5), the Court of Appeals expressly refers to a “nonprofit organization,” a term often used to refer to tax-exempt entities.6 For consistency, it could have used language similar to that found in paragraph (a)(5) or could have referred specifically to tax-exempt entities.

For example, in its version of Rule 5.4, the Massachusetts Supreme Judicial Court refers to an organization that “is tax-exempt under federal law” in its paragraph (a)(4), which regulates a lawyer’s right to share fees with a nonlawyer and is comparable to Maryland’s paragraph (a)(5). By contrast, the Massachusetts Court, like the Maryland Court of Appeals, uses the phrase “authorized to practice law for a profit” in its version of paragraph (d). Again, this could imply that an entity not “authorized to practice law for a profit” is something different than a “tax-exempt entity” or “nonprofit organization,” and that whether an entity is “authorized to practice law for a profit” does not necessarily depend on whether it has been granted tax-exempt status. Indeed, depending on how operating “for a profit” is defined, tax-exempt entities may generate “a profit.”

North Carolina shows how a jurisdiction can choose to authorize lawyers to practice through tax-exempt nonprofit corporations that have nonlawyers serving as directors or officers. First, N.C. Gen. St. § 84-5.1, entitled “Rendering of legal services by certain nonprofit corporations” provides:

(a) Subject to the rules and regulations of the North Carolina State Bar, as approved by the Supreme Court of North Carolina, a nonprofit corporation, tax exempt under 26 U.S.C. § 501(c)(3), organized or authorized under Chapter 55A of the General Statutes of North Carolina and operating as a public interest law firm as defined by the applicable Internal Revenue Service guidelines or for the primary purpose of rendering indigent legal services, may render such services provided by attorneys duly licensed to practice law in North Carolina, for the purposes for which the nonprofit corporation was organized. The nonprofit corporation must have a governing structure that does not permit an individual or group of individuals other than an attorney duly licensed to practice law in North Carolina to control the manner or course of the legal services rendered and must continually satisfy the criteria established by the Internal Revenue Service for 26 U.S.C. § 501(c)(3) status, whether or not any action has been taken to revoke that status.

(b) In no instance may legal services rendered by a nonprofit corporation under subsection (a) of this section be conditioned upon the purchase or payment for any product, good, or service other than the legal service rendered.

(emphasis added). Thus, North Carolina law expressly authorizes North Carolina lawyers to provide legal services through those tax-exempt entities that also operate either as a “public interest law firm” or “for the primary purpose of rendering indigent legal services.”7

Second, North Carolina’s version of Rule 5.4 does not prohibit nonlawyers from serving as officers or directors of any corporations that provide legal services, whether or not those corporations are “authorized to practice law for a profit.” North Carolina’s Rule 5.4(d) states, in itsentirety:

(d) A lawyer shall not practice with or in the form of a professional corporation or association authorized to practice law for a profit, if:

(1) a nonlawyer owns any interest therein, except that a fiduciary representative of the estate of a lawyer may hold the stock or interest of the lawyer for a reasonable time during administration; or

(2) a nonlawyer has the right to direct or control the professional judgment of a lawyer.

Comment 3 explains: “Although a nonlawyer may serve as a director or officer of a professional corporation organized to practice law if permitted by law, such a nonlawyer director or officer may not have the authority to direct or control the conduct of the lawyers who practice with the firm.”

Finally, in North Carolina State Bar 2013 Formal Ethics Opinion 9, the Ethics Committee of the North Carolina State Bar Council was asked whether a North Carolina lawyer may “work for a 501(c)(3) corporation in which a nonlawyer serves as the executive director or as the manager of the satellite office where the lawyer works?” The question was posed by a staff lawyer for Immigrant Aid Corporation, “a public interest, nonprofit corporation that provides services to immigrants with limited income.” The Committee provided the following answer:

Yes. Pursuant to NC Gen. Stat. §84-5.1, a nonprofit corporation, tax exempt under 26 U.S.C. §501(c)(3), organized or authorized under Chapter 55A of the General Statutes of North Carolina, and operating as a public interest law firm as defined by the applicable Internal Revenue Service guidelines, may render legal services provided by lawyers licensed to practice law in North Carolina for the purposes for which the nonprofit corporation was organized. “The nonprofit corporation must have a governing structure that does not permit an individual or group of individuals other than an attorney duly licensed to practice law in North Carolina to control the manner or course of the legal services rendered and must continually satisfy the criteria established by the Internal Revenue Service for 26 U.S.C. §501(c)(3) status, whether or not any action has been taken to revoke that status.” NC Gen. Stat. §84-5.1(a). See also Rule 5.4, cmt. [3] (nonlawyer may serve as a director or officer of a professional corporation organized to practice law if permitted by law).

(emphasis added).

To remove any doubt on this issue, Maryland could follow the course charted by North Carolina. The General Assembly could enact a statute similar to N.C. Gen. Stat. § 84-5.1, the Court of Appeals could amend Rule 5.4(d) to clarify that its prohibitions do not extend to lawyers working for tax-exempt entities that either qualify as public interest law firms or operate for the primary purpose of rendering legal services on a no-cost or low-cost basis to either indigent or low-income clients (or eliminate the provision banning nonlawyers from boards of directors generally) , or both bodies could take those steps.

But that suggestion does not resolve the matter before us, which is what was the intent and purpose behind Rule 5.4(d)? ABA Formal Opinion 93-374 (June 7, 1993) provides some guidance:

The four paragraphs of [Rule 5.4] – in each instance substantially identical to a provision in the predecessor Model Code of Professional Responsibility – must accordingly be viewed as addressed to one or another circumstance or course of conduct that, by reason of a nonlawyer’s having an economic interest in what the lawyer is doing for another who is the lawyer’s client, may significantly threaten interference in the lawyer-client relationship. Thus, paragraph (b) prohibits a lawyer’s forming a partnership with a nonlawyer if any of the partnership’s activities consist of the practice of law; and paragraph (d) provides that a lawyer ‘shall not practice [law[ with or in the form of a professional corporation or association authorized to practice law for a profit” if, in specified respects, a nonlawyer has a financial interest or right of direction in the organization: these two provisions, taken together, address the risk of undue influence that may be exercised by a lay partner, principal or stockholder in a firm in which a lawyer practices law – but in the case of a corporation or association makes exception for a law firm that is not for profit.

Id. at pp. 3-4 (emphasis added) (footnotes omitted). One of those omitted footnotes explains: “[t]he reason for the exemption from paragraph (d) of Rule 5.4 of corporations or associations engaged in the practice of law other than for profit is to allow for lawyers’ participation in prepaid legal services plans.” Id. p. 4 n. 9 (citing G. Hazard and W. Hodes, THE LAW OF LAWYERING, B 5.4:500.03; C. Wolfram, MODERN LEGAL ETHICS B 16.5.5 (1986)).

Rule 5.4 is entitled “Professional Independence of a Lawyer” and “expresses traditional limitations on permitting a third party to direct or regulate the lawyer’s professional judgment in rendering legal services to another.” Comment 2 to Rule 5.4 (citation omitted). “The most obvious threat to the lawyer’s independent judgment is intervention of a nonlawyer in the attorney-client relationship.” ABA Formal Opinion 93-374 at p. 3 (footnote omitted). The risk of a nonlawyer’s intervention in the attorney-client relationship increases when financial interests either incentivize interference by the nonlawyer or tempt the lawyer to succumb to that interference. Rule 5.4(d) recognizes that where “a nonlawyer has a financial interest or right of direction in the organization,” there is “a risk of undue influence that may be exercised by a lay partner, principal or stockholder in a firm in which a lawyer practices law,” but that risk dissipates if the law firm “is not for profit.” Id. at p. 4 (footnotes omitted).

In other words, the risk that a nonlawyer serving on a law firm’s board of directors might interfere with the independent professional judgment of the firm’s lawyers is minimal where the firm is not designed or structured to generate a profit. There is neither financial incentive for the director to interfere nor financial temptation for the lawyer to be influenced by the director.

So where does that take us? In order to attain tax-exempt status as a 501(c)(3) corporation, a law firm would need to be organized for a charitable purpose, which could involve promoting relief of the poor, the distressed, or the underprivileged. See IRS Publication 4220, p. 4. In addition, the law firm would have to ensure that its earnings do not inure to the benefit of any private shareholder or individual, and it could not operate for the benefit of private interests such as those of its founder, its shareholders, or persons controlled by such interests. Id. The tax-exempt law firm would be required to serve the disadvantaged and eschew personal financial benefits that could be enjoyed by the firm’s lawyers and governing directors.

As Rule 5.4(d) is intended to prevent a nonlawyer from interfering with a lawyer’s independent, professional judgment; and as the risk of that interference is minimal where the lawyer is practicing in a firm that is not designed to generate a profit; and as a tax-exempt entity must be designed and operated in a manner that does not inure to the private financial benefit of its shareholders or other private individuals (such as the lawyers employed by a tax-exempt law firm and that firm’s directors), we conclude that a law firm that maintains tax-exempt status is not a professional corporation or association “authorized to practice law for a profit,” and is therefore not subject to the restrictions imposed by Rule 5.4(d). Consequently, a nonlawyer may serve on that law firm’s board of directors.

We offer, however, a word of caution. Although the firm would not be subject to Rule 5.4(d)(3)’s prohibition against a nonlawyer having “the right to direct or control the professional judgment of a lawyer,” the law firm should remember that it and its lawyers remain subject to Rule 5.4(c), which provides that “[a] lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering such services.” And the overarching policy behind Rule 5.4 remains the need to safeguard a lawyer’s independent professional judgment. We recommend that the tax-exempt firm’s governing documents contain provisions assuring that nonlawyers – including members of the board of directors and any advisory board – will do nothing to interfere with the lawyers’ independent professional judgment and that those nonlawyers lack the right to direct or control the professional judgment of any lawyer in the firm.

1. We note that, with exceptions that are not applicable here, “a corporation that is eligible to be a professional corporation under this subtitle may not organize under any other corporate form permitted by this article.” Md. Code Ann., Corps. & Ass’ns § 5-102(a)(2). Providing services “that may lawfully be rendered only by” an attorney is a function that may be performed through a professional corporation. Id. § 5-101(g). A majority of the directors of a professional corporation organized to provide legal services must be lawyers. Id. § 5-117(a).

2. Your request was made in a letter dated August 7, 2015, and we issued our initial opinion on January 7, 2016. Based on further research and investigation, however, we have reconsidered and withdrawn that opinion, and now issue this revised opinion.

3. We express no opinion whether that arrangement would comport with Maryland corporate law.

4. Md. Code Ann., Corps. & Ass’ns § 2-401 provides that a corporation’s “business and affairs” are “managed under the direction of a board of directors,” subsection (a), and further provides that a corporation’s powers “may be exercised by or under authority of the board of directors except as conferred on or reserved to the stockholders by law or by the charter or bylaws of the corporation,” subsection (b). Although MSLAS is a nonstock corporation organized under Subtitle 2 of Title 5, “[t]he provisions of the Maryland General Corporation Law apply to nonstock corporations unless: (1) [t]he context of the provisions clearly requires otherwise; or (2) [s]pecific provisions of this subtitle or other subtitles governing specific classes of corporations provide otherwise.” Md. Code Ann., Corps. & Ass’ns § 5-201.

5. Indeed, if a tax-exempt entity is not “authorized to practice law for a profit,” it is not subject to any of the restrictions in Rule 5.4(d), including paragraph (d)(3)’s prohibition against a nonlawyer having “the right to direct or control the professional judgment of a lawyer.”

6. For example, Md. Code Ann., State Gov’t § 10-224(a)(3) defines “nonprofit organization” as “an organization that is exempt or eligible for exemption from taxation under § 501(c)(3) of the Internal Revenue Code.” Similarly, Md. Code Ann., Lab. & Empl. § 8-101 defines a “not for profit organization” as one “described in § 501(c)(3) of the Internal Revenue Code” and “exempt from income tax under § 501(a) of the Internal Revenue Code.” And Md. Code Ann., Econ. Dev. § 5-1202(d) defines a “not-for-profit entity” as a corporation “that has been determined by the Internal Revenue Service to be exempt from taxation under § 501(c)(3), (4), or (6) of the Internal Revenue Code” and that meets other criteria.

7. IRS Manual Part 4 Chapter 76 Section 9 deals with “public interest law firms,” which are “organizations which directly engage in litigation as a substantial part of their activities, for what they determine is in the public good in some chosen area of public interest. Such as, the preservation of the environment and protection of consumer interests.” IRS Manual §4.76.9.1. The Manual further explains that to qualify for the exemption, “[t]he organization’s litigation must be designed to present a position on behalf of the public at large on matters of public interest” and that “examiners of public interest law firms to need to fully analyze the organization’s litigation activities to determine whether such activities serve a public rather than private interest.” Id. §§ 4.76.9.3 1.A; 4.76.9.2 (emphasis added). It is not clear whether a law firm that represents low-income clients on their personal matters, e.g., family law or landlord/tenant cases, would qualify as a “public interest law firm.”