Can a North Carolina law firm outsource the employment of its lawyers and staff to a professional employer organization (PEO) for payroll and benefits?

Plain-English summary

A professional employer organization (PEO) becomes the employing unit of a client company's workers for payroll, payroll taxes, workers' compensation, benefits, and human-resource functions, while the client company keeps supervising and directing its core operations. The PEO is paid a percentage of payroll cost, not of the company's income or business outcomes. A prior opinion, 2001 FEO 2, approved a law firm using such a management company to employ its nonlawyers; the question here is whether the firm may also outsource the employment of its lawyers.

The opinion analyzes Rule 5.4, which (in subsection (a)) prohibits sharing legal fees with a nonlawyer and (in subsection (d)) prohibits practicing in a firm where a nonlawyer has the right to direct or control a lawyer's professional judgment. Comment [2] frames Rule 5.4 as expressing the traditional limits on letting a third party direct or regulate a lawyer's professional judgment.

The opinion concludes there is no specific prohibition on the described arrangement. So long as the PEO does not control, seek to influence, or interfere with the lawyers' exercise of professional judgment, and its compensation is a percentage of payroll costs rather than a percentage of the firm's legal fees, the arrangement does not violate Rule 5.4. If the firm retains complete control of the legal practice, the opinion sees no resulting problems with conflicts of interest, protecting entrusted client property, or maintaining client confidentiality, citing 2001 FEO 2.

In practice

Under the North Carolina rule as it stood at the time of the opinion, the analysis turns on two lines: whether the PEO can direct the lawyers' professional judgment and how the PEO is paid. The opinion holds the arrangement is permissible where the PEO performs only payroll and human-resource functions, takes its fee as a percentage of payroll rather than legal fees, and leaves control of the practice with the firm.

Per the opinion, the firm's retention of complete control over the legal practice is what keeps the arrangement clear of Rule 5.4(d)'s bar on nonlawyer control and of any fee-sharing problem under Rule 5.4(a).

Common questions

Q: Can a law firm move its lawyers' payroll and benefits to a PEO?

A: Yes. The opinion concludes outsourcing the employment of lawyers and nonlawyers to a PEO does not violate Rule 5.4 if the PEO does not control the lawyers' professional judgment and the firm keeps control of the practice.

Q: Is paying a PEO a form of prohibited fee sharing under Rule 5.4(a)?

A: Not as structured here. The opinion concludes that because the PEO is paid a percentage of payroll costs rather than a percentage of legal fees, the arrangement does not constitute prohibited fee sharing with a nonlawyer.

Q: What keeps the PEO from improperly controlling the firm?

A: The condition that the PEO not control, influence, or interfere with the lawyers' professional judgment, and that the firm retain complete control of the legal practice, consistent with Rule 5.4(d) and comment [2].

Background and rules framework

The opinion interprets Rule 5.4 (professional independence of a lawyer, corresponding to Model Rule 5.4), specifically Rule 5.4(a)'s bar on sharing legal fees with a nonlawyer and Rule 5.4(d)'s bar on practicing in a firm a nonlawyer may control, with comment [2] framing the rule's purpose. It builds on the prior North Carolina opinion 2001 FEO 2.

Citations and references

Rules of Professional Conduct:

• MR 5.4 / NC Rule 5.4(a) (no sharing of legal fees with a nonlawyer) and Rule 5.4(d) (no nonlawyer control of a lawyer's judgment), cmt. [2]

Statutes:

• N.C. Gen. Stat. §58-89-5(6), (8) (definition of a professional employer organization)

Other opinions cited:

• NC 2001 FEO 2: a law firm may contract with a management company to employ its nonlawyers if the lawyers keep their independent judgment and protect client property and confidences.

See also

• ABA Formal Op. 95-392: Sharing Legal Fees With a For-Profit Corporate Employer
• ABA Formal Op. 91-360: Prohibition of Partnerships With Nonlawyers
• NC State Bar 2013 FEO 7: Sharing a Fee From a Tax Appeal With a Nonlawyer

Source

• Landing page: https://www.ncbar.gov/for-lawyers/ethics-and-governing-rules/ethics-opinions/opinions/2003-formal-ethics-opinion-6/

Original opinion text

Reproduced from the official source for research purposes. The linked source is authoritative.

Inquiry:

A professional employer organization (PEO), as described in N.C. Gen. Stat. §58-89-5(6) and (8), provides a small business with an alternative to the traditional employment relationship between a company and its workers. An employer that enters into a service agreement with a PEO agrees that human resource, payroll, and other non-operational employment functions will be "outsourced" to the PEO. The PEO becomes the employing unit of the client company's workers. The service agreement typically obligates the PEO to pay the employees, pay and withhold payroll taxes, maintain workers' compensation coverage, provide employee benefit programs, establish protocols for consistent administration of human resource complaints, and provide worksite safety guidance. However, the worksite employees continue to be employees of the client company for all operational purposes. The client company continues to supervise and direct its core business operations and the employees who are operating the company. The PEO does not assume responsibility for the client company's business, does not direct or supervise the work, and does not participate in the profit and losses of the client company. The PEO's compensation is calculated as a percentage of payroll cost. The compensation is not related to the client company's operational income or the outcome of a client company's business transactions.

Formal Ethics Opinion 2001-2 ruled that there is no prohibition on a law firm entering into a contract with a management company to employ the nonlawyers in the firm, in the same manner as a PEO, provided the lawyers in the law firm can continue to fulfill their ethical duties, including the duty to exercise independent professional judgment, the duty to protect client property, and the duty to maintain client confidences. The opinion did not consider whether such an arrangement would be permissible if the employment of the firm's lawyers, as well as its nonlawyers, is outsourced.

To maximize efficiency and the economic benefit to a law firm, the entire employment function, including the employment of lawyers and nonlawyers, should be outsourced to the PEO. The PEO would not supervise or interfere with the law practice of the lawyers. The lawyers would be employees of the PEO only for payroll, tax reporting, benefit plans, workers' compensation, and other human resource-related functions. The compensation paid to the lawyers in the firm would be determined by the agreement between the lawyers who own or manage the firm. Is this arrangement prohibited by the Revised Rules of Professional Conduct (2003)?

Opinion:

Rule 5.4(a) of the Revised Rules of Professional Conduct (2003) prohibits sharing legal fees with a nonlawyer and Rule 5.4(d) prohibits a lawyer from practicing in a professional corporation or association if a nonlawyer has the right to direct or control the professional judgment of a lawyer. As noted in comment [2], Rule 5.4 expresses the "traditional limitations on permitting a third party to direct or regulate the lawyer's professional judgment in rendering legal services to another."

There is no specific prohibition in the Rules on the arrangement described in this inquiry. Provided the PEO does not control, seek to influence, or interfere with the lawyers' exercise of professional judgment and the compensation paid to the PEO is a percentage of the payroll costs and not a percentage of the legal fees earned by the firm, the employment outsourcing arrangement described in this inquiry does not violate Rule 5.4. Moreover, if the law firm retains complete control of the legal practice, there should be no problems with conflicts of interest, protecting client property that is entrusted to the firm, or maintaining client confidentiality. See, e.g. , 2001 FEO 2.