Should You Accept It as a Retainer or Fee Payment?
The purpose of this article is to alert Kentucky lawyers to the risk management and professional responsibility considerations of dealing with cryptocurrency or virtual currency. It is beyond the scope of this article to explain the intricacies of how cryptocurrency transactions take place. We urge all Kentucky lawyers and judges to inform themselves on these details because even if you have no intention of using crytocurrencies, clients may seek advice on their use and cryptocurrencies have already been the subject of litigation in Kentucky.
As a frame of reference what follows is the IRS definition of virtual currency: Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency – i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance – but it does not have legal tender status in any jurisdiction.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. (IRS Notice 2014)
NEBRASKA LEADS THE WAY
The only significant ethics opinion at this writing dealing with cryptocurrency is Nebraska Ethics Advisory Opinion for Lawyers No. 17-03 (9/11/2017). The opinion considered and answered three questions.
- May an attorney receive digital currencies such as bitcoin as payment for legal services?
“An attorney may receive and accept digital currencies such as bitcoin as payment for legal services. In order to assure that the fee charged remains reasonable under Neb.Ct. R. Prof. Cond. § 3-501.5(a), which prohibits charging unreasonable fees the attorney should mitigate the risk of volatility and possible unconscionable overpayment for services by (1) notifying the client that the attorney will not retain the digital currency units but instead will convert them into U.S. dollars immediately upon receipt; (2) converting the digital currencies into U.S. dollars at objective market rates immediately upon receipt through the use of a payment processor; and (3) crediting the client’s account accordingly at the time of payment.” (Editor’s note: The Nebraska and Kentucky Rule 1.5 (a) are identical.)
- May an attorney receive digital currencies from third parties as payment for the benefit of a client’s account?
“An attorney may receive digital currencies as payment from third-party payors so long as the payment prevents possible interference with the attorney’s independent relationship with the client pursuant to Neb. Ct. R. of Prof. Cond. §3-501.7(a) or the client’s confidential information pursuant to Neb. Ct. R. of Prof. Cond. §3-501.6 by implementing basic know-your-client (“KYC”) procedures to identify any third-party payor prior to acceptance of payments made with digital currencies.” (Editor’s note: The Nebraska and Kentucky Rule 1.7 (a) are identical. The Nebraska and Kentucky Rule 1.6 are identical with one exception not significant to this question.)
- May an attorney hold digital currencies in trust or escrow for clients?
“An attorney may hold bitcoins and other digital currencies in escrow or trust for clients or third parties pursuant to Neb. Ct. R. of Prof. Cond. §3-501.15(a) so long as the attorney holds the units of such currencies separate from the lawyer’s property, kept with commercially reasonable safeguards and records are kept by the lawyer of the property so held for five (5) years after termination of the relationship. Because bitcoins are property rather than actual currency, bitcoins cannot be deposited into a client trust account created pursuant to Neb. Ct. R. §§ 3-901 to 3-907 (Trust Fund Requirements for Lawyers).” (Editor’s note: The Nebraska and Kentucky Rule 1.15 (a) are identical for all practical purposes. Kentucky does not have a rule comparable to Nebraska 3-901 to 3-907. Currently most authorities consider cryptocurrency an asset or commodity meaning that bitcoins cannot be deposited in a client trust account.)
MANAGING THE RISK
We are in the early phase of the use of cryptocurrencies in the practice of law. The paramount risk management consideration is that lawyers must know what they are doing when dealing with them. Do not accept cryptocurrencies for any purpose until you have thoroughly researched how they operate with special emphasis on client confidentiality and the security of the system. Understand that the cryptocurrency market is constantly changing in the number of currencies available, how these currencies function, and the value of the currency. The big unknown is how the government might choose to control them. This fluid situation requires cryptocurrency continuing education. What follows are our preliminary risk management ideas.
Firm Cryptocurrency Policy:
- Even if a firm has no current intention of dealing in cryptocurrencies, it should now develop a policy on cryptocurrencies; i.e.,
- Whether the firm will or will not accept cryptocurrencies;
- Who the firm will accept them from – only corporate clients or all clients and third parties.
- Whether cryptocurrency will be accepted for all payments, only for legal services rendered and retainers, or only for legal services rendered.
- What payments will be immediately converted to dollars.
- Whether the firm will or will not advise clients on cryptocurrency matters.
- How the firm will gain competence in cryptocurrency systems and maintain it by continuing study of the cryptocurrency market.
- Whether the firm should include in its standard letter of engagement a paragraph covering cryptocurrency.
- What records of cryptocurrency transactions should be maintained to comply with Kentucky Rule of Professional Conduct 1.15(a), Safekeeping property.
Avoiding Illegal Transactions:
- A firm must assure that any cryptocurrency they accept is not contraband, does not violate client confidentiality, and is not part of a money-laundering or tax avoidance scheme.
- The fact that cryptocurrencies can fluctuate widely in value in a short period of time creates the risk that fee agreements that are couched in terms of bitcoins or other virtual currencies can lead to a client paying $300 an hour in one month and $500 an hour the next month. This could easily be seen as an unreasonable fee as prohibited by Kentucky Rule of Professional Conduct 1.5(a), Fees. To avoid this risk fee agreements should be in dollars. To risk manage currency volatility, arrange to convert bitcoins and other digital currencies received for services rendered and retainers into U.S. dollars immediately upon receipt.
- When a lawyer is asked to accept payment of fees by a third-party payer, the lawyer must consider SCR 3.130(1.8)(f ) Conflict of interest: current clients; specific rules:
Cryptocurrency Payments for other than Retainers and Fees, e.g., Settlements and Judgments
- The Nebraska opinion only addresses cryptocurrency payments for legal services. It does not consider other cryptocurrency payments in which clients have an interest such as settlement and judgment payments. It seems obvious, however, that cryptocurrency a lawyer receives for a client’s account should immediately be converted to dollars to avoid any risk of currency fluctuations. There are crpytocurrency payment processors available that will immediately convert cryptocurrency into dollars upon receipt. Law firms dealing in cryptocurrency should make arrangements for immediate conversion of such payments.
Letters of Engagement and Cryptocurrency:
- It is important that clients be advised at the outset of a representation in a letter of engagement how cryptocurrency payments are managed. This information should include:
- Which cryptocurrency payments will be converted into dollars immediately upon receipt.
- That this conversion will be by a payment processor at current market rates.
- That the client’s account with the firm will be credited at the time of payment for the converted amount.
- That future fluctuations in the cryptocurrency will neither increase nor decrease the amount credited to the client’s account.
- That any cryptocurrency the client requests be held in trust and not converted into dollars is solely the client’s risk for currency value fluctuations and will be paid out in kind.
There is considerable disagreement over the legitimacy of cryptocurrencies. At this time it looks like they are here to stay and lawyers must be competent in dealing with them. We hope this article starts you thinking of what your firm needs to do. Always remember the KBA Ethics Hotline if you are in doubt about any aspect of cryptocurrencies. The Hotline has demonstrated its great value for Kentucky lawyers for a number of years. It is an ideal source for guidance on this new development in the practice of law.