The Money Pit

The Money Pit is a 1986 film directed by Richard Benjamin and starring Tom Hanks and Shelley Long. Hanks plays Walter Fielding, a young New York entertainment lawyer, who with his girlfriend Anna (Long) are forced to find a new place to live on short notice when Anna’s ex-husband returns from Europe, tossing them out of his apartment, where they had been living. They discover what appears to be a lucky break in the form of a stately old mansion which is being forcibly sold to pay for legal fees.

Walter is himself in fairly hot water when the movie begins. Sometime prior to the events of the film, his father, a former partner in what seems to have been a father-and-son law practice, absconded with $2.9 million in client funds. It’s not clear precisely how this was done, but the substance of it seems to be that he made off with the firm’s trust account. Walter is left paying the bill.

To secure the sale of the house, Walter borrows $200,000 from a client. The client happens to be a minor and a stupidly successful pop star, so he can afford it.

So the questions here are (1) whether Walter really would be left to pay his father’s debts, and (2) whether it’s legal and ethical to borrow money from a client under those circumstances.

I. Law Firm Partnerships

The movie clearly indicates that because Walter and his father were partners in a law firm, when the father takes off for Rio with the trust account funds, Walter is responsible for paying the bill. Is this true?

Yes, but probably not anymore. Until the early 1990s, most law firms were general partnerships, a business form wherein any partner can bind the partnership, and all partners are personally responsible for the liabilities of the entire partnership. Scary as that sounds, the form does have several advantages. For one thing, it’s simple. Just like a solo business person who doesn’t take any special steps is operating as a sole proprietorship, two or more people that go into business together who take no special steps are a general partnership. This provides maximal authority—and thus maximal flexibility—for all of the partners. Also, partnerships offer a simplified taxation scheme compared to a corporation, as partners only pay taxes on income they actually realize from the enterprise. The partnership can even hold property in its own name, so that one partner’s personal problems won’t affect the larger partnership. And what’s more, the fact that any partner can bind all the partners gives some incentive to keep tabs on what the other partners are doing. Most law firms and other professional groups operated as general partnerships until the early 1990s, significantly for that last reason. It was thought that operating as a general partnership was something of a demonstration of bona fides to clients, i.e., all of the partners stand by the work and competence of all of the other partners.

So as this movie was released in 1986, it’s safe to assume that this is how things operated. If dad incurred a major debt on the firm, Walter is going to be left holding the tab.

What happened in the 1990s that caused the change? The introduction of limited liability partnerships. And why were they introduced? Because in the aftermath of the savings and loan crisis of the late 1980s, a number of law firms and accountancy firms went belly up when some of their partners—frequently a very small percentage—did some really dumb and even criminal stuff. This led to innocent and upstanding professionals being bankrupted, which was considered to be somewhat unfair. So states introduced the LLP, which treats partners more like owners in a corporation in terms of liability. The particular rules vary from state to state, but the general rule is that the liabilities of the partnership are only liabilities of the partnership, and that partners are not personally liable. Even the biggest law firms have moved away from the general partnership model by now, and most are LLPs, or occasionally PCs (professional corporations). Under that regime, Walter would not be personally liable for the firm’s debts, and there would be nothing to stop him from simply withdrawing from the firm and taking his clients with him.

II. Borrowing From Clients

Then there’s the question of whether it’s ethical to borrow money from clients, particularly clients who are minors. As a first-order matter, it’s worth pointing out that if they were trying to put together money for a down payment, borrowing that money probably constitutes mortgage fraud. Using borrowed money for a down payment without disclosing that the money is borrowed would constitute a material misrepresentation on the application. This is a felony. People go to prison for that. But we’ll assume that they were simply paying cash, because that’s plausible under the circumstances.

So is it ethical to borrow money from clients? Well. . . it can be. Under certain circumstances. Now we’re getting into the nitty-gritty of Rule 1.8. And under that rule, this is clearly unethical. The loan would need to occur under the following criteria:

(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.

None of those requirements were met here. Even if the terms were “fair and reasonable,” there was no writing. The client was not advised to seek independent counsel, nor given opportunity to do so. And the client did not give informed consent in the form of a signed writing. So that’s right out.

Further, this client, as a minor, falls under the protections of Rule 1.4. Here, Walter clearly took advantage of the client’s minority. The inducement to lend the money? “I won’t like you anymore!” Clearly not something one would try with a normal client.

III. Conclusion

So the movie is actually an accurate picture of the way law firm obligations existed in the mid-1980s. The savings and loan crisis was just starting to get going when the movie was released, and it would be five-odd years before law firm obligations would really start moving towards its modern form. But the loan from the client is unethical. It could have been done ethically, but it wasn’t.

14 responses to “The Money Pit

  1. Why did it take so long for problems to start to show up in the general partnership system? You would think that crises would have shown up well before the late ’80s through ’90s.

    • No doubt some law firms experienced problems before then, but it took the crisis to force broad reform. The legal profession is very conservative in many ways. A small example: many, many law firms continued to use WordPerfect a decade or two after Microsoft Office had become the de facto standard in virtually every other industry (for better or worse).

    • One might just as well ask why the Romans didn’t invent steam power. They had all the requisite theoretical insights and most of the technological ones too. But things just failed to come together.

      In this case, however, it was probably the birth of the corporate law firm that made this particular crisis a problem. In the early 1960s, there were only twenty-one firms in New York with more than fifty lawyers, and only seventeen more in the rest of the country combined. Now, the largest firm in the world–currently Baker & McKenzie–has over 3,800. But the trend towards growth really picked up in the 1980s. That’s when we started to see firms with multiple offices in multiple cities.

      So if you’re talking about a few dozen people, tops, all of whom are located in the same city, a general partnership makes a certain amount of sense. The odds of everyone in the partnership being at least aware of what the other partners are doing is pretty decent. And remember, general partnerships can be dissolved a lot easier than other business entities, so partners that didn’t like the look of what Jones was doing down the hall could effectively kick him out relatively easily.

      But when you’re taking about hundreds or even thousands of lawyers in a handful of cities, something you started to see in the 1980s in the sort of firm that was involved in the savings and loan debacle, this makes a lot less sense. It’s not really possible, let alone practical, to run that sort of enterprise as a general partnership. So when the savings and loan crisis came along and pointed that out, the LLP was introduced relatively quickly.

      • James Pollock

        This is probably a major factor, but the fact that corporate form was flatly prohibited for certain professionals probably had a bigger one. As the strains of general partnership began to show, states began to create new forms… the professional corporation, the limited liability company, and then eventually the limited liability partnership.

  2. Could Hanks have sued his father (as his own account or the firm’s) for the 2.9 million? I’m sure his father wouldn’t show up to court leading to a quick ruling and separate criminal charges to boot. His father also probably fled the country with real estate that could have been seized and liquidated (I mean who’s not going to notice his father selling his house?)

    • Theoretically. The main problem is that the father had decamped to Rio, making him difficult to get at. One presumes that Hanks had pursued all reasonable options and was still a few million in the hole.

    • He could have mortgaged his house (and any other real property) and taken the cash with him. He didn’t have to actually sell it to drain the value.

    • I think in general one does not flee the country leaving behind assets of more value than the money you have illicitly acquired precipitating the flight, if one is pre-planning.

      If one is looking at a plan that involves stealing some amount of money and fleeing the country, I would expect the amount of money would have to at least equal the total value of all assets that must be left behind, plus relocation expenses, plus current salary times years expected to live (so that one may maintain a certain lifestyle without having to find new work), plus a subjective ‘inconvenience fee’, i.e. some dollar value assigned to the intangible of giving up one’s established life, family, and friends to go on the lam.

      If 2.9 million is sufficient to satisfy that equation for the character’s father, I wouldn’t expect more than a couple hundred thousand in liquidatable assets.

  3. Could the client have given Hank’s character the money as a “pre-paid legal services” fee or something similar? (Assuming that the client knows what’s going on and wants to help him out)
    It would effectively be a “loan” which is paid back with the money he would have later gotten from legal fees, but seems like it would avoid a lot of the ethics issues above.

    • That’s an interesting idea, but I think the facts in this scenario militate against it. First of all, their existing relationship appears to be for payment in arrears, i.e., Fielding performs legal services and then gets paid. Making a change like this is permissible, but doing it in the context of what would otherwise be a loan is going to raise eyebrows. The courts tend to privilege substance over form, so disguising a loan in the form of a change to the fee agreement is going to be problematic in any resulting ethics analysis.

      Second, the provision of pre-paid legal services is a regulated activity, and this isn’t how that works. In New York, they’re actually regulated as an insurance product. So it would be illegal for Fielding to construe his relationship as pre-paid legal services, because he wouldn’t be complying with the New York Department of Financial Services’ regulations on the subject. And Fielding is a relatively high-end entertainment lawyer. Pre-paid legal services are generally limited to low-end, retail law like criminal defense, family law, simple estate planning, that sort of thing. Not the negotiation of royalty contracts and multi-million dollar tax avoidance schemes.

      So it’s a good thought, but I don’t think it’d work in this instance.

      • James Pollock

        I think a shorter answer is that if it is payment in advance for legal services to be provided in the future, it has to go into the trust account and stay there until it is earned.

      • Ryan Davidson

        I was treating the term “pre-paid legal services” as a term of art. Obviously, any time a regular client pays in advance for legal services–other than a flat fee–it goes into the trust account. But pre-paid legal services are a bit different. There, the client generally pays what amounts to premium. This is handled differently than regular client payments, though I’m not an expert on exactly how these financial regulations work.

      • James Pollock

        I am not qualified to make authoritative statements on this subject, but it looks to me like rule 7.3a(2) probably gets around the restrictions of 7.3a. 7.3d sets the restrictions for attempting to sell pre-paid legal services, which are not met, but 7.3a(2) allows in-person solicitation where a prior client relationship already exists. He’s probably skating on thin ice with regards to 7.3b(2), depending on whether “duress” is defined subjectively or objectively. (All bets are off if the state rules are different from the model rules, of course.)

      • Ryan Davidson

        Again, my point is that the question is not whether it would be ethical to pitch pre-paid legal services to the client. It’s whether it’s even legal. I think the answer is “No” because New York regulates pre-paid legal services like insurance. As Fielding has not complied with any of the regulatory requirements for issuing what is deemed to be a financial product, he cannot pitch any services that way. So even if he can ethically do something like that, he can’t legally.

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