Rule against Outside Investment in Law Firms Stifles Innovation
The time has come to re-consider rules barring outside investment in law firms. I start with a specific example of where outside investment could benefit the profession and society and discuss a potentially better way to think about the question more generally.
I recently corresponded with a lawyer who has an innovative and entrepreneurial idea. He wants to create a law firm based on technology that will automate high volume legal work for insurers. In addition to the usual risks of any start-up, he faces an additional, unique challenge: he cannot, doing business as a law firm, raise capital to build and market new technology.
Lets’ stipulate that automating corporate legal work benefits both clients and society by reducing legal costs. Without the ability to raise outside capital, however, we limit the potential positive impact of law practice automation. Good technology takes investment. Legal market providers can and do invest but they cannot combine their systems with law practice.
Which brings us to the rule prohibiting outside investment in law firms. Many argue this rule protects clients; in my opinion, it simply stifles innovation. I struggle to see how, where a law firm serves insurers, outside investment harms anyone.
Insurers might eagerly do business with a firm funded by investors, especially if it really reduces cost and improves service. Today, they simply do not have the option. If indeed investment means danger, insurers can evaluate the trade-offs (and, if not, state regulators should worry about their management).
The putative danger of outside investment seems theoretical and, in my opinion, remote. Meanwhile, the harm of prohibiting it seems concrete and immediate:
- Legal costs remain higher than they otherwise would be
- Lawyers cannot pursue professionally rewarding paths
- Investors miss an opportunity to earn a return
- Society continues to pay more for law that is possible or necessary
- Innovations these firms create cannot “trickle down” to conventionally owned law firms
Perhaps I am wrong; perhaps little is gained and much is risked. Today, we have an irrebuttable presumption that outside investment is bad. Why not make the presumption rebuttable? Why not shift the presumption and burden of proof? A bright line rule is draconian – a rule of reason would yield better results for lawyers, clients, and society. For example, if a firm serves only corporate clients above a certain size – those that have the resources to evaluate their providers – perhaps we should allow outside investment.
I was struck by a letter nine general counsels wrote in 2012 to the ABA arguing against outside investment. The market now knows these GCs prefer conventional law partnerships. This market offers a multitude of a law firms so why not let the market decided. Some firms will keep their all-lawyer ownership to serve those GCs who oppose outside investment. But why not allow other firms to take outside investments? Many companies will happily do business with them, especially if they use the investment to improve efficiency and reduce cost.
[Updated of 11 Dec 2013: Two other bloggers have responded to this post:
Robert Anderson, Associate Professor Pepperdine University School of Law, at his blog Witnesseth: Law, Deals, Data: Outside investment in law firms.
Brian Focht, The Cyber Advocate, a civil litigation attorney in Charlotte, North Carolina at the law firm Stiles Byrum & Horne, LLP, in his blog The Cyber Advocate: Who Wins with Non-Lawyer Ownership? Just the Bankers (Part 1) and Who Wins with Non-Lawyer Ownership? Just the Bankers (Part 2)
End of Update]
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