2019 Formal Ethics Opinion 5

Receipt of Virtual Currency in Law Practice

Opinion rules that a lawyer may receive virtual currency as a flat fee for legal services, provided the fee is not clearly excessive and the terms of Rule 1.8(a) are satisfied. A lawyer may not, however, accept virtual currency as entrusted funds to be billed against or to be held for the benefit of the lawyer, the client, or any third party.

Introduction:

Virtual currency[1] – most notably, Bitcoin – is increasingly used for conducting business and service-related transactions.[2] Although advocates for and users of virtual currency treat these assets as actual currency, the Internal Revenue Service in 2014 classified virtual currency as property, not recognized currency. See IRS Notice 2014-21, https://www.irs.gov/pub/irs-drop/n-14-21.pdf. Accordingly, for the purpose of determining a lawyer’s professional responsibility in conducting transactions related to her law practice using virtual currency, this opinion adopts the IRS’s position and views virtual currencies as property, rather than actual currency.

Inquiry #1:

Client wants to retain Lawyer for representation in a pending matter. Lawyer charges Client a flat fee for the representation. Client wants to pay Lawyer using virtual currency. May Lawyer accept virtual currency from Client as a flat fee in exchange for legal services?

Opinion #1:

Yes, provided the fee is not clearly excessive and the lawyer complies with the requirements in Rule 1.8(a).

A flat fee is a “fee paid at the beginning of a representation for specified legal services on a discrete legal task or isolated transaction to be completed within a reasonable amount of time[.]” 2008 FEO 10. With client consent, a flat fee is considered “earned immediately and paid to the lawyer or deposited in the firm operating account[.]” Id. Rule 1.5(a) prohibits a lawyer from making an agreement for, charging, or collecting an illegal or clearly excessive fee. Comment 4 to Rule 1.5 states that “a fee paid in property instead of money may be subject to the requirements of Rule 1.8(a) because such fees often have the essential qualities of a business transaction with the client.” Rule 1.8(a) prohibits a lawyer from entering into a business transaction with a client unless the following provisions are met:

(1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner that can be reasonably understood by the client;

(2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and

(3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.

Rule 1.8(a)(1) – (3).

As of the date of this opinion, the value of virtual currencies fluctuates significantly and unpredictably from day to day. Considering this extreme fluctuation, any transaction involving virtual currencies inherently involves a great deal of risk by the parties on the ultimate value of the services rendered. Without an express agreement between Lawyer and Client on when the valuation of the virtual currency is determined, Lawyer could receive an inappropriate windfall in the form of extreme overpayment for legal services. Accordingly, considering the nature of the property at issue in this exchange, Client’s payment of virtual currency to Lawyer for legal services has “the essential qualities of a business transaction with the client.” Rule 1.5, cmt. 4. As such, Lawyer must comply with the requirements of Rule 1.8(a) when conducting a transaction wherein legal services are exchanged for virtual currency. Therefore:

1. Lawyer must ensure the terms of the transaction are fair and reasonable to Client, and Lawyer must fully disclose the terms in writing to Client in a manner that can be reasonably understood by Client. To ensure a flat fee, which is earned upon receipt (see 2008 FEO 10), is not clearly excessive under Rule 1.5, and for the purposes of any potential required refunds following withdrawal or termination from the representation, Lawyer and Client must reach a mutually agreed upon determination of the value of the virtual currency exchanged at the time of the transaction. That valuation must be included as part of the written terms of the transaction;
2. Lawyer must advise Client in writing of the desirability of seeking independent legal counsel on the transaction, and Lawyer must give Client a reasonable opportunity to obtain that counsel; and
3. Lawyer must obtain Client’s written, informed consent to the essential terms of the transaction as well as Lawyer’s role in the transaction. Although Rule 1.8(a)(3) contemplates that Lawyer could represent Client in this transaction, Lawyer’s potentially significant monetary interest in acquiring the virtual currency suggests that Lawyer may not represent Client in the transaction.

This opinion does not reach the legal issues surrounding an individual’s receipt of and transacting in virtual currency. Before transacting in virtual currency, lawyers should apprise themselves of the legal ramifications surrounding the use of virtual currency, including potential tax and criminal implications. As with other forms of payment, lawyers should take the appropriate steps to ensure any virtual currency received is not the product of or otherwise connected to illegal activity.

Inquiry #2:

May Lawyer accept virtual currency from a third party on behalf of Client as a flat fee in exchange for legal services rendered?

Opinion #2:

Yes. Lawyer may receive compensation from a third party for the benefit of Client provided that a) Client provides informed consent to Lawyer regarding the third party’s virtual currency payment, b) there is no interference with Lawyer’s independence of professional judgment, or with the client-lawyer relationship, and c) information obtained by Lawyer during the client-lawyer relationship remains confidential and protected in accordance with Rule 1.6. See Rule 1.8(f). See also Answer #1.

Inquiry #3:

Client wants to retain Lawyer for representation in a pending matter. Lawyer plans to charge Client an hourly rate for the representation, and Lawyer wants Client to deposit a set amount of virtual currency with Lawyer to be billed against as work is completed by Lawyer. May Lawyer accept virtual currency from Client as an advance payment, against which Lawyer will bill Lawyer’s hourly rate?

Opinion #3:

No. An advance payment is “a deposit by the client of money that will be billed against, usually on an hourly basis, as legal services are provided[.]” 2008 FEO 10. The advance payment is “not earned until legal services are rendered” and therefore must be deposited in the lawyer’s trust account, with the unearned portion of the advance payment refunded to the client upon termination of the client-lawyer relationship. Id. Virtual currency is property and not actual currency; accordingly, virtual currency cannot be deposited in a lawyer trust account or fiduciary account in accordance with Rule 1.15-2. Instead, virtual currency – and all other non-currency property received as entrusted property – must be “promptly identified, labeled as property of the person or entity for whom it is to be held, and placed in a safe deposit box or other suitable place of safekeeping.” Rule 1.15-2(d).

Generally, virtual currency is received, held or maintained in, and distributed from an individual’s computer (referred to as “cold storage”) or in a digital “wallet” typically maintained by an individual through a digital asset exchange. Deidre A. Liedel, The Taxation of Bitcoin: How the IRS Views Cryptocurrencies, 66 Drake L. Rev. 107, 111-12 (2018). Holders of virtual currency access and exchange their virtual currency through the use of the holder’s public and private keys associated with their virtual currency activity. See generally Lisa Miller, Getting Paid in Bitcoin, 41 Los Angeles Lawyer 18, 19-20 (December 2018); Carol Goforth, The Lawyer’s Cryptionary: A Resource for Talking to Clients about Crypto-transactions, 41 Campbell L. Rev. 47, 112-13 (2019). Due to the decentralized nature of virtual currency, exchanges of virtual currency from one account to another cannot be reversed, and a virtual currency holder cannot recover a lost private key to access his or her virtual currency.

The methods in which virtual currency are held are not yet suitable places of safekeeping for the purpose of protecting entrusted client property under Rule 1.15-2(d). Rule 1.15-2(d)’s reference to “a safe deposit box or other suitable place of safekeeping” demonstrates that the “suitable place of safekeeping” referenced in the Rule is one that ensures confidentiality for the client and provides exclusive control for the lawyer charged with maintaining the property, as well as the ability of the client or lawyer to rely on institutional backing to access the safeguarded property through appropriate verification should the lawyer’s ability to access the property disappear (be it through the lawyer’s misplacement of a physical key, or the lawyer’s unavailability due to death or disability). The environment in which virtual currency presently exists, however, does not afford similar features that allow clients to confidently place entrusted virtual currency in the hands of their lawyers. A February 2019 report found that even knowledgeable users of virtual currency experienced a variety of complications and concerning issues in exchanging virtual currency that threatened the execution of and confidence in the exchange, including sending virtual currency to the wrong individual by inputting the wrong public key, losing their own private key (thereby rendering the user’s virtual currency permanently inaccessible), or being subject to phishing attacks or other attempted hacks to illegally access their digital wallets. See Foundation for Interwallet Operability, Blockchain Usability Report (February 2019), https://fio.foundation/wp-content/themes/fio/dist/files/blockchain-usability-report-2019.pdf (“While the blockchain industry has grown dramatically over the last year, usability is clearly still an ongoing struggle and the use of blockchain in actual commerce and utility is still very limited. Blockchain transactions are, by definition, immutable. With immutable transactions, users must have extremely high confidence that transactions are occurring as intended, with the right counter party, for the right amount and for the right type of token. Today – blockchain is still far from achieving that high standard.”). Any virtual currency received from a client by a lawyer – including lawyers who are experienced in handling and exchanging virtual currency – is subject to being permanently lost with no recourse available to secure the client’s property as a result of a lawyer’s private key becoming inaccessible, a lawyer’s mistaken input of a public key destination for a transfer of virtual currency, or a sophisticated hack of the lawyer’s virtual wallet.

This opinion does not preclude the possibility that, in time, digital wallets and other methods in which virtual currency may be held and exchanged could improve in terms of security and accessibility. Such improvements may warrant reconsideration of this opinion. This opinion also does not address the difficulty in reconciling the frequent and significant fluctuation in value of virtual currency while held by a lawyer during the representation, nor does the opinion address the need to segregate clients’ virtual currency or the difficulty associated with investigating claims of lawyer misappropriation of a client’s virtual currency. These concerns may present further barriers to a lawyer’s ability under the Rules of Professional Conduct to handle virtual currency in an entrusted capacity. However, as of the date of this opinion, and with the primary interest of the State Bar being the protection of the public, the methods in which virtual currency are held and exchanged are not yet suitable places of safekeeping as required by Rule 1.15-2(d) for the proper safeguarding of virtual currency as entrusted client property. Accordingly, a lawyer may not receive, maintain, or disburse entrusted virtual currency.

Inquiry #4:

Client has retained Lawyer for a pending matter. Client and opposing party settle their dispute. As part of the settlement, Client agrees to provide opposing party with a set amount of virtual currency. Client and opposing party ask Lawyer to hold Client’s virtual currency in trust for the benefit of opposing party via Lawyer’s digital wallet until all settlement terms are satisfied, at which point Lawyer will transfer Client’s virtual currency to opposing party. May Lawyer accept virtual currency as entrusted property to be held for the benefit of a third party?

Opinion #4:

No, a lawyer may not receive, maintain, or disburse entrusted virtual currency. See Answer #3.