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Spurred by the explosion of e-commerce, lawyers who represent Internet startup companies are warming to the idea of accepting equity in lieu of legal fees. In New Jersey as elsewhere, the financial deals cut with clients are many and varied. They range from equity alone, to equity with upfront or deferred payments, to caps on the proportion of equity to fee. Some firms work for “warrants” — a type of security that entitles the holder to buy a certain amount of common stock at a specified price in the future. “It’s usually when the clients are very small and … are looking for creative compensation,” says Morristown, N.J.’s Leonard Nuara, who since 1995 has been accepting equity in companies he represents in software licensing and distribution, multimedia development and information security. Larger firms also are coming to terms with clients who want to barter. For instance, Florham Park’s Drinker, Biddle & Shanley, a firm that shies away from equity arrangements except in rare circumstances, is considering changing its policy to make it a regular option when dealing with emerging companies, says John Michel, chairman of the business and finance department at the firm’s Philadelphia headquarters. “We would expect that it would change within the next month,” Michel says. “It’s principally a marketing device. Clients expect it.” Drinker Biddle represents about 40 companies, some in New Jersey, with which it has an option to take an equity interest or in which it has deferred payments, relying on future financing. All the cases have hourly rates. In addition, the firm may get an equity interest, a portion of financing proceeds or a percentage of accrued fees, Michel says. Payment deferments are usually for about six months. But for every lawyer who finds the arrangement satisfactory, there are others who find the practices too risky — both financially and ethically. “Economically, the vast majority of these startups do fail and are not necessarily going to give a return that justifies an economic loss,” says technology lawyer Dennis Deutsch, a partner at Ferrara, Turitz, Harraka & Goldberg of Hackensack, N.J. Deutsch, also an adjunct professor of computer law at Rutgers Law School-Newark and Fordham University School of Law, says there’s nothing inherently wrong with a firm having an economic interest in a client. It’s the appearance of impropriety that he’s worried about. Although Rule of Professional Conduct 1.8(a) allows a lawyer to enter a business relationship with a client under prescribed conditions, New Jersey remains the only state in the nation to retain the appearance of impropriety standard, codified at RPC 1.7(c)(2). Although an ad hoc commission recommended that the state Supreme Court eliminate the rule altogether in the private sector, the Court in February delayed a decision until it reviews recommendations by the American Bar Association’s Ethics 2000 Commission, expected in October. John Leubsdorf, who teaches professional responsibility at Rutgers Law School-Newark, says conflicts might arise if, for example, the client asks for legal advice on whether to make certain public financial disclosures that may adversely affect its stock’s value. Or, the client may inquire about whether to go into bankruptcy, he says. And there is always the possibility and temptation of insider trading. On the other hand, some clients prefer having their legal counsel as a part owner because the firm would have a vested interest in the company’s success. “They see it as basically aligning the incentives of the client with the incentives of the firm,” says Leubsdorf. “It’s not exactly an ethical problem, as long as you comply with the rules,” he says. But Deutsch, for one, feels that more light needs to be shed. For example, what happens if the client later wants to repudiate the agreement on the grounds that he or she didn’t understand its implications? “I’m just not comfortable with it,” says Deutsch, who represents six Internet companies. “I’d just as soon represent them and be paid for my time.” But if equity is an acquired taste, it does seem to grow on those who partake. The Princeton, N.J., office of Philadelphia’s Buchanan Ingersoll started allowing equity agreements about two years ago after seeing that it was an accepted practice elsewhere, says David Sorin, the firm’s managing partner in its Princeton and New York offices. The firm will agree to equity in select situations in which it believes the client is likely to succeed, Sorin says. And in any case, the value of the equity can be no more than 25 percent of the legal fee. While Sorin concedes that there is financial risk involved, he is confident that the practice is ethically sound. “The potential conflict is exactly the same type of conflict as when a receivable builds up,” he says. New Jersey’s largest firm, Newark’s McCarter & English, has two high-tech clients in which it has some equity. But partner William Heller says the firm is approaching equity substitutes cautiously, scrutinizing a potential client’s business plan, prior successes, ability to raise capital, investors and other indicators before agreeing to accept equity in lieu of some payment. McCarter is not likely to agree to an arrangement for equity alone and no upfront payment, he adds. Finally, there’s the question of insurance coverage. Woodbury, N.J., sole practitioner Allan Richardson says he considered taking equity when a potential client approached him about it, but then he checked with his malpractice insurance carrier, which declined to cover any work arising out of such an attorney-client relationship. So he abandoned the option. On the other hand, Richard Catalina, a Long Branch solo, says his carrier agreed to cover this type of work so long as the firm’s interest in the client is no more than 5 percent of the value of a public company or 10 percent of a private business. Catalina left Woodbridge’s Wilentz, Goldman & Spitzer in December, where he had worked for 10 years, to practice intellectual property, patent, Internet and computer law on his own. He now represents two Internet companies in which he has agreed to accept stock options in lieu of partial payment. Under Catalina’s hybrid retainer agreements, he receives an hourly or flat fee for filing the application with the U.S. Patent and Trademark Office. The stock options cover the subsequent work in the application process, which can take years. The dot-com companies — a financial management consulting service and an Internet-based network for the health care industry — are only a few months old and have not begun operation yet. “Capital is limited, but they’re both on the verge of obtaining public placement,” Catalina says. “It’s exciting, and I want to be a part of it,” says Catalina. “If it does grow the way they all hope it will happen, I get to share in that.”

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