First published in BanklessDAO’s Decentralized Law, “Market Crashes and Crypto Regulation,” February 2, 2022.
Attorneys practicing in the United States are required to follow certain accounting and ethical standards when receiving and retaining client funds as payment for future costs and services. Each state adopts its own set of standards, though they are similar enough to discuss as monolithic requirements for U.S. attorneys. Funds received for future work are generally called a “retainer” and the transaction is ideally—though not always—documented by a written “retainer agreement.” When an attorney or a law firm holds fiat funds as a retainer, or in escrow or anticipation of disbursing a settlement, a trust account must be used to segregate these funds and avoid commingling between operating and other accounts. Attorney trust accounts are subject to stringent requirements, including approval of the banking entity by the state’s bar association. As written and implemented, these requirements create a significant, if not total, impediment to the retention of cryptocurrencies in attorney trust accounts. Based on current guidance the general rule seems to be that an attorney may accept and retain crypto as advance payment for future work provided that the fee is reasonable, the agreement is affirmed in writing demonstrating the client’s understanding and informed consent, and that the fee arrangement otherwise complies with the jurisdiction’s rules of professional conduct.
The IRS Treats Crypto as a Commodity
Legal ethical rules in most U.S. jurisdictions treat cryptocurrencies as a commodity and recognize it as a property asset with its value tied to market demand, as opposed to a form of traditional fiat currency. This characterization is based upon the U.S. Internal Revenue Service’s definition of “virtual currencies.” These same ethical rules allow attorneys to accept a variety of property assets in addition to cryptocurrencies, including gold, artwork, and ownership interest in the form of corporate stock as advance payment for future work. Payment in non-fiat assets must be documented in a written “alternative fee agreement” to comply with ethical requirements. Alternative fee agreements are subject to the same general requirements as other attorney-client fee agreements—however volatility and the property-like nature of non-fiat assets create additional ethical considerations and require additional disclosures and confirmation of client understanding which are not required when utilizing fiat funds.
Additional Ethical Concerns for Attorneys Retaining Client Funds in Crypto
As with client retainers paid in fiat funds, attorneys engaging in alternative fee agreements and entrusted with the property of clients must hold that property with the care required of a professional fiduciary. This means the attorney or firm must be competent in the underlying technology in order to ensure the safety and protection of client funds and must appropriately segregate the assets from those of the attorney and other clients. These requirements are meant to eliminate the risk of commingling or other potential impropriety. The quickest and most likely way for a U.S. attorney to be disciplined or disbarred is to allow the comingling of a client retainer and firm or personal funds before the fees are earned. In addition to concerns regarding segregation of retainers from other funds, payment in crypto implicates two additional potential issues. First, there is a prohibition against agreements for “unreasonable fees.” The shifting value of non-fiat assets and desire to protect the client from over or underpayment is stated as the primary reason for this concern. The second concern is that an alternative fee agreement contains the qualities of a business transaction with the client. Engaging in business transactions with a client will generally require providing the client an opportunity to obtain separate counsel to negotiate the fee agreement, due to the potential conflict of interest between client and putative counsel. To alleviate these issues, a comprehensive alternative fee agreement can address the potential ethical concerns and ensure compliance with relevant ethical rules.
Current Advisory Opinions Are Only Somewhat Helpful
In the context of attorneys who are operating in the crypto space, current ethics opinions regarding acceptance and retention of crypto payments seem only somewhat helpful. Because each U.S. jurisdiction sets and implements its own rules of professional conduct, there are often technical differences in the requirements for each jurisdiction and the current opinions provide an incomplete framework of guidance. Additionally, ethics opinions often only address very specific, often esoteric, ethical issues and regularly reach similarly narrow conclusions. For example, the New York City Bar’s opinion is premised on the proposition that an attorney is requiring clients to pay in crypto. It seems less likely that a firm would demand payment in crypto from an unsuspecting and unsophisticated client, as opposed to the client expecting the firm to accept crypto. Nebraska’s opinion requires an attorney receiving crypto as a retainer to immediately convert it into U.S. dollars to allow the funds to be deposited into a trust account. Requiring a law firm to exchange crypto into dollars upon receipt seems problematic for a variety of reasons that should be readily apparent. A further problem is that legal ethics opinions are usually written for a generalized audience, meaning explanations of crypto are framed in simplistic language that often misses or misstates technical nuances between types of assets and mechanisms of payment. Current U.S. legal ethics opinions don’t seem to consider that attorney-client agreements and payments in the crypto space are generally taking place between sophisticated individuals and entities who are familiar with how cryptocurrencies operate and their inherent volatility.
Because current ethics opinions are targeted for the widest potential audience, alternative or more technical mechanisms that might be used by sophisticated practitioners and their clients to retain and disburse crypto client retainers are not usually contemplated or addressed. One example of a technical, decentralized, and blockchain-centric mechanism to hold and disburse client funds in a manner that arguably complies with ethical requirements for holding client assets may be LexDAO’s LexLocker. LexLocker is an on-chain “multi-track, arbitrable escrow for Ethereum business transactions summoned by LexDAO legal engineers.” Using LexLocker, users can lock funds in the contract pursuant to their legal agreements and settle the payments encoded therein as work is completed. This mechanism arguably mirrors disbursements of fiat funds from a trust account once work has been performed. This is just one potential mechanism that would facilitate safeguarding client retainers. However, the U.S. legal field tends to demand skeuomorphic solutions to issues presented by changes in the technological landscape. Escrowing funds in a smart contract may ultimately prove too novel a concept for recommendation by a legal ethics committee or widespread adoption among current practitioners.
TL;DR: This is Not Legal Advice and DYOR
Attorneys practicing in U.S. jurisdictions with crypto-centric clients should be able to receive payment in crypto for flat-rate and invoiced work without issue. However, when receiving and holding client retainers for future work, attorneys must ensure they comply with the jurisdiction’s rules of professional conduct. It is important to note that the potential risks faced by an attorney accepting cryptoassets as a retainer are entirely based on the strict construction and application of the relevant ethical rules, which could eventually be modified so payment of a retainer in cryptocurrency is treated the same as payment in fiat funds. Additionally, and potentially most important, attorneys who accept retainers in cryptocurrencies must be competent in utilizing the technology and able to protect the client’s assets. In this case, competence requires that attorneys understand and safeguard against the many ways cryptocurrency can be stolen or lost. In the same way an attorney might be disciplined for depositing a fiat client retainer into their personal account or the firm’s operating account, an attorney accepting a crypto retainer could be disciplined for falling prey to a phishing attack, for losing access to the wallet containing the funds, or for simply sending funds to be disbursed back to the client to the wrong wallet address.
lawpanda is a U.S. attorney with an active litigation and counseling practice. He is a member of BanklessDAO’s Legal Guild, LexDAO, the LexPunkArmy, and member/consultant/contributor to a variety of DAOs and protocols. When he’s not writing for Decentralized Law, he is working to reduce operational and governance friction between on-chain and legacy entities through corporate structuring and common-sense legal solutions. Connect on Twitter, LinkedIn, or at lawpanda.eth@gmail.com.