Committee on Professional Ethics and Conduct of Iowa State Bar Assn. v. Mershon

Brief Fact Summary.

Mershon (Defendant), an attorney, formed a corporation with a farmer client and an engineer to development the client’s farmland as a residential township, but failed to advise his client of his adverse interests in the deal

Synopsis of Rule of Law.

Prior to entering into a business transaction with a client, an attorney must obtain the client’s informed consent through full disclosure

Facts.

Mershon (Defendant) was an attorney who performed tax and property work for Miller, a farmer who owned 100 acres of vacant land near a Cedar Falls country club.  Miller decided to develop this land as a residential township.  He met with Mershon (Defendant) and Schenk, an engineer, to discuss the project.  The men decided to form a corporation that would develop the land continent upon their ability to borrow money based on the land as security.  Miller conveyed the land to the corporation at a capitalized value of $12,500 and received 400 shares of stock.  Schenk and Mershon (Defendant) both gave the corporation their promissory notes for $12,500 and $6,250 in return for 400 and 200 shares of stock, respectively.  The promissory notes were interest-free and due at the discretion of the corporation and were to represent the services provided by Schenk and Mershon (Defendant).  The deal fell through when the three were not able to secure financing unless they personally guaranteed the development loan, which they were reluctant to do.  Miller died afterwards, and the land was valued at $4,000/acre at his death.  Defendant, who believed the parties had an oral understanding that if the development did not occur they would reconvey their interests in the corporation to Miller, transferred his stock to the corporation and canceled his note.  However, Schenk refused to do the same.  Despite Schenk’s position, Defendant, as executor of Miller’s will, showed Miller as sole owner of the corporate stock in the initial probate inventory.  The Iowa State Bar Grievance Commission, after an investigation and hearing, decided to reprimand Defendant for failing to obtain Miller’s consent to his ownership in the development corporation after full disclosure.  Mershon (Defendant) appealed

Issue.

Prior to entering into a business transaction with a client, must an attorney obtain the client’s informed consent through full disclosure?

Held.

(McCormick, J.)  Yes.  Under DR 5-104 (A), an attorney shall not enter into business transaction with a client if they have differing interests therein unless the client has given consent after full disclosure.  Because of the fiduciary relationship between an attorney and his client, full disclosure in this context means active diligence to make sure the client was fully informed of the nature and effect of the transaction proposed and of his own rights and interests in the subject matter involved, and by seeing to it that his client either has independent advice in the matter or else receives from the attorney such advice as the latter would have been expected to give had the transaction been one between his client and a stranger.  In this case, Mershon (Defendant) and Miller obviously had differing interests.  Miller’s interests were aligned completely with the development corporation.  However, Defendant’s interests were potentially at odds with those of the corporation because his fee for legal services was tied to the value of his stock, and because he was obliged to provide such services because of his debt (promissory note) to it.  Although Defendant hid nothing from Miller and Miller was an active participant in the transaction, Defendant did not advise Miller to seek independent advice, nor did he give Miller the type of advice he would have if the transaction had been conducted with a stranger.  Defendant neither investigated the value of his legal services to determine if it was fairly represented by his stock ownership, nor did he advise Miller to make such an estimate.  There was no writing to assure that Miller would have his farm returned if the development did not proceed, or to protect him in the event Defendant or Schenk died.  In addition, the note provided by Defendant contained terms very favorable to Defendant.  Defendant also did not advise Miller of the effect of his differing interests on the exercise of his professional judgment.  Therefore, although Mershon (Defendant) did not act dishonestly or make a profit on the transaction, he failed to provide Miller with full disclosure, and his reprimand was proper.  Affirmed.

Dissent.

This case represents a judicial interpretation of what the broad and undefined requirement of “full disclosure†means under ABA Code of Professional Responsibility DR 5-104(A).  However, ABA Model Rule 1.8(a), which addresses the same issue, sets forth very detailed guidelines for disclosure.  Rule 1.8(a) requires the client-lawyer transaction overall to be “fair and reasonable,†with “fully disclosed terms,†“in writing,†and with client consent “in writing†obtained after a reasonable opportunity for advice from an outside attorney.  The Comment to Rule 1.8 also explains that the “full disclosure†rule does not apply to ordinary commercial transactions for products and services that the client routinely supplies to others.  The rationale for this exception is that when the attorney becomes one of the client’s regular customers, the attorney is in no position to exercise undue influence.