How Are States Limiting PE Investment in Law Firms (and What’s Next)?
While private equity buzz continues to swirl about the legal sector, three state legislatures set out to limit outside investment in law firms – in three different ways.
And while California, Colorado and Illinois were the first to restrict outside investment in this year’s legislative session, more could follow in 2027. Legislative sessions for another 36 states should start in January, and most will have gaveled in by the end of Q1.
What do these new regulations address, and what do they suggest for future regulation?
First: Background
Most U.S. states prohibit non-lawyers (e.g. investors) from owning or controlling law firms through their state’s Rules of Professional Conduct, regulated by the state supreme court. These rules vary from state to state, but most adhere rather closely to the American Bar Association’s Model Rules of Professional Conduct.
ABA’s Model Rule 5.4 addresses non-lawyer ownership specifically, saying in part: “A lawyer or law firm shall not share legal fees with a non-lawyer” except for certain specific conditions, and “A lawyer shall not form a partnership with a nonlawyer if any of the activities of the partnership consist of the practice of law.”
Pretty straightforward.
But in 2020, Arizona struck its version of ABA Rule 5.4, and now has more than 100 law firms open to outside investors, including enterprises owned outright by major corporations like KPMG. In the same year, Utah opened a “regulatory sandbox” to oversee law firms owned by outside investors.
As of now, Puerto Rico, North Carolina and Washington state are allowing some degree of non-lawyer investment. Washington D.C. has a plan under consideration.
Even outside these states, there can be workarounds for outside investors, the most common being the Management Services Organization (MSO) model, where a non-lawyer-owned entity contracts with a law firm to provide non-legal services (accounting, marketing, IT). This allows outside capital to support the business functions of the law firm while the lawyers maintain control over the practice.
Each of these three new laws – California, Colorado and Illinois – set boundaries for these MSO models, and one introduces a new avenue of litigation for traditionally structured firms.
California: Taking Effect January 1
In August 2026, the California state legislature passed AB2305, a bill that would introduce new limitations on “corporate legal funders.” It was signed into law by Governor Gavin Newsom on September 20.
The bill centers on litigation, working to keep investors out of it by designating their influence as an unauthorized practice of law if they engage in any of the following “substantive litigation decisions”:
- Determining which clients to represent;
- Determining the scope of representation of any client;
- Determining the financial terms of any client representation;
- Determining the legal strategy or theory of a case;
- Deciding whether to file, continue or dismiss a claim or defense;
- Making decisions about a settlement offer, negotiation position or acceptance of proposed resolution;
- Determining what evidence to present or how to conduct discovery; or
- Advising on appeals, procedural tactics or litigation timing.
In addition, outside investors are forbidden to have control “or be delegated authority” for selecting counsel based on profit maximization rather than client interest; setting financial incentives tied to litigation outcomes; making decisions about litigation funding allocations or budgeting that affect case strategy; and requiring litigation decisions to be based on investor return metrics.
The bill’s authors – including a former public defender, a former prosecutor and a former partner at Latham & Watkins – state in the bill its intent is to “safeguard the integrity of the judicial process, ensure advocacy remains ethically sound and in the best interest of the individual, and prohibit corporations from controlling or improperly influencing litigation decisions or outcomes.”
This follows AB 931, which passed in 2025 and restricted fee-sharing with out-of-state alternative business structures.
Under the bill, violating attorneys will be referred to the state bar for discipline, and clients can bring actions for $10,000 per violation (or three times the actual damages, whichever is greater).
If adopted, the measure will apply to contracts entered into on or after January 1, 2027 – so we may see a gold rush of a different sort hitting California in Q4.
Key point: AB2305 focuses on litigation, leaving other areas of the law (e.g. estate planning) ready for PE.
Colorado: Took Effect on August 12
On June 3, Colorado Governor Jared Polis signed the Colorado Legal Practice Integrity and Fee-Sharing Prohibition Act, a considerably more far-reaching statute. The bill’s preamble gets right to the point, declaring that “even minimal nonlawyer ownership or profit participation in law firms compromises public trust in the legal profession.”
Under the Act, lawyers and law firms may not:
- Share any portion of legal revenue to any alternative business structure or nonlawyer, aside from salaries or bonus paid to law firm staff as a part of ordinary business operations;
- Enter into any financial, contractual, ownership, management, marketing, co-counsel, referral or fee-allocation arrangement with an alternative business structure;
- Form a partnership, LLC, corporation or other entity with a nonlawyer if any of the entity’s activities include providing legal services; or
- Practice with or in the form of a professional company authorized to provide legal services if a nonlawyer owns any interest or a nonlawyer has the right to direct or control the professional judgment of a lawyer.
With regard to MSOs, lawyers and law firms cannot engage with one unless their compensation is not tied to a percentage of legal fees, revenues or profits and not determined by case outcomes.
According to Clark Hill analysis, this rule is the direct hit on private equity: “…the most common way investor capital reaches a firm’s economics is a management services organization that handles back-office functions and takes its fee as a percentage of firm revenue or profit. HB26-1421 permits the MSO but bans the percentage, collapsing the standard workaround while leaving genuine fixed-fee and hourly administrative support alone.”
The Act took effect August 12 and applies to “conduct occurring and contracts and agreements entered into or renewed on or after” the effective date.
The bill had a large team of 27 sponsors, including nine lawyers.
Key point: The Act provides for economic damages and attorneys’ fees for clients whose law firms have violated these rules, and in an interesting addition, law firms that “suffered or may suffer” loss in revenue due to offending competitors can seek injunctive or declaratory relief.
As one commentator wrote in LawWeek Colorado, “This means that competitors and perhaps even opposing counsel have an incentive to bring lawsuits collateral to the underlying suit if it gives them an upper hand. Far from deterring excessive lawsuits, this provision seems designed to incur a new spate of litigation between law firms.”
Illinois: Took Effect on August 7
On May 31, just three days before Colorado approved its measure, both houses of the Illinois General Assembly passed HB5487, and Governor JB Pritzker signed it into law on August 7.
Applying to all firms with annual global revenue of less than $300 million and all firms that “regularly represent clients on a contingent fee basis,” it also takes direct aim at the MSO structure, requiring disclosure of any MSO arrangements on all attorney-client contracts.
Further, it puts specific limits on the MSOs, forbidding them to:
- Interfere with lawyers’ professional judgment;
- Reveal, own or determine the content of client records, or to disclose any attorney-client communications;
- Hire or fire attorneys or professional staff;
- Set “competency, productivity or proficiency parameters”;
- Charge any fee directly or indirectly based on attorney fees, revenues or profits; and
- Restrict an attorney or staff member from competing with the law firm after a termination or resignation (i.e., no non-competes or non-disparagement clauses).
It also establishes new guidelines for fee-sharing with alternative business structure entities outside Illinois.
Similar to California, violations may result in discipline from the state bar, and statutory damages of $10,000 per violation or three times the actual damages incurred by the client, whichever is greater.
Unlike Colorado, there is no clear path to litigation for competing law firms.
The bill had 12 sponsors, seven of whom are attorneys.
Key point: This law exempts law firms with annual global revenue of $300 million or more – essentially carving out Big Law. This year’s AmLaw 100 – the annual compilation of the highest-grossing law firms – stopped at $567.9 million.
A quick review shows about two-thirds of these highest-grossing law firms operate offices in Chicago…and remain outside this law’s reach.
Other Developments
The American Lawyer reports that South Carolina is working to limit PE influence through its state ethical standards as opposed to legislation. In March 2026, its Ethics Advisory Committee issued an opinion stating that South Carolina lawyers should not serve as local counsel with an alternative business structure law firm with outside investors or fee-sharing.
It’s another avenue for regulation less open to lobbying and other legislative hijinks, and one that may be replicated outside The Palmetto State.
Meanwhile, the U.S. Chamber of Commerce’s Institute for Legal Reform – which exerts influence in state capitals through coordination with local organizations – makes its position relatively clear in the title of its position paper against nonattorney investment in law firms: “Selling Out.”
It concludes: “Allowing nonattorney ownership of law firms will allow large, well-capitalized, profit-seeking investment funds to supplant the professional judgment of lawyers who are obligated to serve their clients’ best interests. This development would be a detriment to clients, lawyers, judges, and the public at large.”
In The American Lawyer, Chris Batz, a legal industry adviser, said law firms and outside investors should take these new restrictive actions as a warning for anti-PE blowback.
“I think it has some implications that are things people should not ignore,” he said, “and supposedly some other states might look at this.”
