f/k/a . . . the archives

April 8, 2006

contingency fees (pt. 1 of 4): market failures

Filed under: — David Giacalone @ 1:59 pm

 

SlicingThePie This is Part I of a four-part series on the use of Contingency Fees (also called “contingent fees”) in personal injury (“p/i”) cases.   With a contingency fee, there is no fee unless the lawyer obtains money for the client, with the lawyer taking a portion of the proceeds. When properly used, contingency fees can be a beneficial option for the client.  However, this series focuses on the ethical and competitive issues raised by the common practice of charging a “standard” contingency fee (often one-third or 40% of moneys received) for virtually all clients — without regard to the risk the lawyer is taking in each particular case of doing the work without receiving adequate compensation, and thus without regard to how likely the client is to win or how much effort the lawyer is likely to expend on the client’s behalf.  The standard contingency fee results in many clients paying unfairly high fees that are not warranted by either the work performed or the risk taken by the lawyer.

-  In addition to this section on Market Failures, click for Part II (risk matters)Part III (do “standard” fees still exist?); and Part IV (ethical duties) -

 

 

Ted Frank of Overlawyered and Point of Law usually approaches contingency fee issues a bit differently than I do. He is far more steeped in economics than I, and he brings the perspective of a “tort reformer.” As ethicalEsq said in July 2003, tort reform is a matter of political and social policy, not legal ethics, and it is not my fight. My perspective — by temperament, and after a dozen years practicing antitrust law at the FTC — is that of a consumer and competition advocate. I want legal clients to receive the benefits of both professional responsibility rules (with related fiducial rights) and competition, and I believe that a well-informed client can protect his or her interests far better than one treated like a mushroom (viz., kept in the dark and covered with manure).

ATLA: at least one third gray bar association

Personal injury lawyers, however, seem to get just as upset with me as they do with tort reformers, even though I have never advocated limiting the right to sue (except when a claim is truly frivolous — that is, without a colorable basis in fact or law), nor capping the amount paid out in damages. However, my wanting clients to get all that they deserve means having their lawyers take only the fees that they deserve. That’s what has gotten me in hot water with the personal injury bar from the very first time I questioned whether application of a “standard” or customary contingency fee to virtually every client is ethical — before I had ever heard of a tort reform movement.

 

What does this have to do with the title of today’s post? Well, this week, Ted Frank wrote at Overlawyered (”Search Engine Index,” March 27, 2006) about the interesting (but not surprising) fact that:

“Six of the eight most expensive Google AdSense search terms are for attorneys . . . with “mesothelioma lawyers” topping the charts.” [per CyberWyre]

In addition, at Inside Opinions,, Robert Ambrogi pointed to Ted and pointed out that: Other chart-topping search terms include “tax attorney,” “car accident lawyer” and “auto accident attorney.” Ted concluded that the lawyers were willing to pay very high click-through rates for AdSense “because there is a lot of easy profit to be made.” He then asks:

“The interesting question is what market failure has occurred such that this gigantic profit is not being competed away by, say, offering clients a smaller attorneys’ fee. This is surplus that should be going to clients, not to Google.”

That’s where the tort-reforming economist in Ted starts sounding an awful lot like the ethicist-trustbustin’ consumer advocate in me. For instance, in September 2003, I posted “Contingency Fees Inspire Ever More Lawyer Advertising – Auto Accidents to Product Recalls,” which reported how much lawyers were spending on those very expensive television commercials. In the post, I noted:

While I agree that class action recall specialists are quite different than fender-bender/slip-and-fall lawyers, there is still one general characteristic that fits virtually all lawyer tv advertising: The firms use contingency fees exclusively (and they never mention the percentage amount of the fee).

What can we make of the fact that tv advertising is very expensive, and that only lawyers who charge contingency fees use the medium regularly? Are the p/i firms acting irrationally? Are they extremely altruistic? If not, we have to assume that contingency fee cases are so rewarding financially that they are worth the investment — the risk — in large tv advertising campaigns, while hourly fee [and flat fee] matters are not.

What does that tell us about contingency fee cases in general? curiousEsq wants to know.

Similarly, in February 2004, we described “a major new law review article” where legal ethics professor Lester Brickman marshals evidence and arguments to demonstrate that contingency fee levels are generally far greater than the risk assumed by p/i lawyers, and are therefore unreasonably high. “Effective Hourly Rates of Contingency-Fee Lawyers: Competing Data and Non-Competitive Fees,” 81 Wash.U.L.Q. 653 (2003). In that article, Prof. Brickman points to both the market failures noted by Ted Frank and their results.

tiny check For example, Brickman argues that “contingent-fee pricing is not competitive. The use of a uniform pricing structure is a “heads-I-win-tails-you-lose” fee-setting practice. If a case is too risky, it is rejected. If it is lucrative, it is accepted, and a standard contingency fee is charged irrespective of whether there is any meaningful litigation risk and even though the cost of production of the service in no way justifies the enormous projected return on investment.”

tiny check [There is a study by Prof. Herbert M. Kritzer,"Seven Dogged Myths Concerning Contingency Fees," that is often cited by those who support the contingency fee status quo. See our post debunking the Kritzer Study, which discusses some of the failures of the system, as it is practiced in the USA today, as does our discussion of the continued existence of the ”standard” contingency fee in Part III of this series.]

As Your Editor has described elsewhere: Despite rabid advertising rivalry by hordes of lawyers, p/i clients who are not sophisticated enough to know their rights and assert them strongly will continue to be denied price competition.The existence of a monolithic “standard” contingency fee in each state has always seemed an economic (and ethical) impossibility, absent some kind of agreement or pressure not to compete on pricing terms. How, for example, can the fee level be the same — and just happen to be the maximum fee allowed by law — when law firms have such different costs and experience levels, and face such a wide spectrum of risk among the cases presented by prospective clients?

HeavyHittersCoverG Former Harvard Law School Dean Derek Bok also described the strange market failure in the p/i litigation field in his landmark 1993 book The Cost of Talent: How Executive and Professional Are Paid and How It Affects America (1993),at 139 to 140:

“The world of plaintiffs’ litigation would seem competitive enough to satisfy the most zealous free market economists. [with yellow pages and billboards filled with smiling lawyers willing to take your p/i case] . . . Curiously, however, the crowded market for legal services turns out to work quite differently from anything described in an economics textbook.

“Under the classic conditions of perfect competition, . . . Attorneys would not be able to insist on a standard percentage of all moneys gained from taking such cases. Instead, they would bargain with potential clients and arrive at a percentage arrangement that would vary with the strength of the complaint and the potential settlement or court award. Claimants with a powerful case for winning a large amount of money would demand that a lawyer accept a small percentage of the award, while plaintiffs with weaker claims would have to share more equally.”

”This is not what occurs in real life. . . . There is little bargaining over the terms of the contingent fee. Most plaintiffs do not know whether they have a strong case, and rare is the lawyer who will inform them (and agree to a lower percentage of the take) when they happen to have an extremely high probability of winning. In most instances, therefore, the contingent fee is a standard rate that seldom varies with the size of the likely settlement or the odds of prevailing in court.”

“. . . Instead of perfect competition, then, the world of plaintiffs’ litigation is a much more haphazard place where ignorance and luck play prominent roles in shaping the fortunes of attorneys.”

Pick up your local Yellow Pages. Check out all of the many full-page and block ads by p/i lawyers. Can you find even one that mentions a willingness (a) to charge less than the local customary percentage or (b) to negotiate the fee? If you do, please let me know. In years of looking, I’ve found only one law firm in the New York Capital Region, or in the Western end of the State (the Rochester, Buffalo, Syracuse areas) that advertised a willingness to tailor the contingency fee to the client’s actual case. To my dismay, however, that firm — Pennock, Breedlove & Noll which we praised in July 2004 after seeing its new tv ads, has removed its Fair Fee Promise from its ads and website. [the URL http://www.fairfeepromise.com/ now redirects you to http://www.pbnlawyers.com/ ]

FightingForYou pb&n

The PB&N masthead logo has replaced “Fair Fee Promise” with the innocuous, uninformative, and non-threatening (to other lawyers) ”Fighting for You.” Although the site’s “personal injury” page still has the caption “IT’S OUR JOB TO GET YOU MORE, FOR LESS,” there is currently not one word about fees on that page, nor any other, beyond saying they only take a fee if you win. I would love to know what prompted this change — and, especially whether there have been hints (subtle or not) from their p/i colleagues that price competition is not acceptable in their guild.

fence painter Many market failures can be addressed by giving the buyers of services more or better information. That seems especially appropriate in the arena of legal services, because lawyers have a fiduciary and ethical duty to keep their clients well-informed. It is even more appropriate regarding contingency fees, because the p/i bar has itself made the market fail by creating, over several decades, the fiction of a “standard” contingency fee that would be offered to and mutely accepted by virtually all injury victims. The public was lulled into believing that the customary or standard percentage fee in their community was sacrosanct — perhaps even required by law — and a fait accompli.

 

Sadly, but not surprisingly, attempts at informing the consumer have not made any significant leeway — basically, because p/i lawyers have en masse refused to do so.

tiny check The most important attempt to correct the ethical failures that have led to this massive market failure was probably the American Bar Association’s Formal Ethics Opinion 94-389:Contingent Fees (not available free online; $$ dowload from ABA; quoted and discussed at length in Pt. IV of this series; summarized here). The 1994 Opinion is the most comprehensive treatment that I have found on when contingency fees are appropriate, and how agreements should be presented and entered into by lawyers to avoid ethics violations, while fulfilling fiducial duties. Like any ethics opinion, Op. 94-389 gets its authority from its persuasiveness in the context of the history and purposes of the rules of professional conduct, and the prime directive to put the client’s interests ahead of the lawyer’s financial interests.

The f/k/a The Injured Consumers’ Bill of Rights for Contingency Fees sets forth the informational requirements promulgated in the Opinion. If they were followed, consumers would be given enough information to negotiate for fair and reasonable contingency fee percentages [by helping to set a fee that corresponds with the likelihood of success, the likely award or settlement figure, and the complexity of the case] — or (keep dreaming) lawyers will start out offering such risk-related rates, based on their best, professional good faith assessment of each case. This would have undoubtedly stimulated price competition.

Indeed, Op. 94-389 basically declared the fee practices of 90% of all p/i lawyers to be ethically inadequate. It called for “redoubled efforts” to assure that the bar understood its ethical and fiduciary obligations related to contingency fees and started applying them in practice, rather than honoring them in the breach. Instead, Op. 94-389 has been all but forgotten by the masses of p/i lawyers, while being buried alive by their leaders in the organized bar.

 

erasingS Thus, in a discussion within Comments to a recent post, we learned that even very conscientious p/i lawyers have never heard of Ethics Opinion 94-389 (or, more important, the principles it espouses). What other legal specialty could have its pricing mechanism totally rebuked by a distinguished national association without mounting CLE seminars and articles and other mechanisms to correct the problem — or, at least, to debate the issues? Apparently, the p/i bar didn’t want to take its fight public, because – gasp! – consumers might somehow find out that they can bargain over contingency fees, and the rest of the Bar might actually get embarrassed by the p/i greedfest.

However, although Op. 94-389 was ignored. it was certainly not forgotten. Within the ABA Ethics 2000 Commission, for example, it is clear that the p/i bar flexed its muscles to keep the Opinion from interfering with their standard fee racket. For example, the final version of the New Model Rules eliminates from the then-current version (which is still in effect in many jurisdictions) all phrases that directly support the reasoning of the 1994 Opinion — despite their historical basis in prior rules of professional ethics (e.g., EC-20 and EC-5-7).

erasingSF For example, the new Model Rules deletes from the official Comments to Rule 1.5 (fees) the statement that:

“When there is doubt whether a contingent fee is consistent with the client’s best interest, the lawyer should offer the client alternative bases for the fee and explain their implications.”

This sentence had been specifically quoted by Opinion 94-389 and earlier opinions (such as ABA Informal Opinion 86-1521, Oct. 26, 1986), that came to the conclusion that contingency fees could be inconsistent with the client’s best interests when, for example, there was little risk of non-payment; therefore, potential clients needed to be given enough information to decide whether alternative fee arrangements were preferable, and lawyers were expected to offer such fee options (e.g., hourly fees, as used by most other lawyers for most services).

Thank you p/i bar!

(Feb. 20002, ETHICS 2000)

RULE 1.5: FEES

Comment

Reasonableness of Fee and Expenses

[3] [5] An agreement may not be made whose terms might induce the lawyer improperly to curtail services for the client or perform them in a way contrary to the client’s interest. . . . A lawyer should not exploit a fee arrangement based primarily on hourly charges by using wasteful procedures. When there is doubt whether a contingent fee is consistent with the client’s best interest, the lawyer should offer the client alternative bases for the fee and explain their implications. Applicable law may impose limitations on contingent fees, such as a ceiling on the percentage.

In addition, the Ethics 2000 final Report (after receiving “outside” comment and input) removed from its own earlier versions, a clause explaining that “the degree of risk assumed by the lawyer at the outset of the representation,” is relevant to the reasonableness of contingency fees. As will be discussed in detail at this weblog later this week, this clarification of the role of risk in the reasonableness of contingency fees was attacked by supporters of the contingency fee staus quo — despite the adoption in 1986 by the Board of Governors of American Trail Lawyers Association of the following statement [see ATLA's 1994 "Keys to the Courthouse," which has been adopted by many state trial lawyer groups]:

“Attorneys should exercise sound judgment and use a percentage in the contingent fee contract that is commensurate with the risk, cost, and effort required. . . . Attorneys should discuss alternative fee arrangements with their clients.”

In 2003, ATLA reaffirmed, in a submission to the Utah Supreme Court (to show there was no need to adopt the Common Good Early Settlement proposals), that “This resolution continues to be ATLA’s policy regarding the ethical obligations of its members.”

tiny check It is such inconsistency between reality and ethics that has led ATLA’s ally Public Citizen to tell the same Utah proceeding that “It is widely accepted that contingency fees should vary depending on the riskiness and complexity of the individual case; indeed, that is what the ethical rules currently require (even though almost universally honored in the breach).”

The Ethics 2000 final Report also eliminated a phrase that echoed Opinion 94-389, stating that “all” of the traditional factors relevant to the reasonableness of a fee are applicable to contingent fees (e.g., “the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly”). Of course, Rule 1.5 (a) has always had an “and” connecting the 7th and 8th of the eight “reasonableness factors” for attorneys’ fees. So, Op. 94-389 was merely stating the obvious. [It should be noted, though, that a "final" posted version of new Model Rule 1.5(a) substituted an "or" for the "and." It may have been the outcry by this weblog, plus Prof. Brickman, that caused the "or" to be replaced by the intended "and." The culprit who tried to sneak the "or" into the ethics books has never been identified. I bet I know what kind of law he or she practices.]

honest In sum, while publicly stating that p/i lawyers should “use a percentage in the contingent fee contract that is commensurate with the risk, cost, and effort required,” personal injury lawyers have tried to use Ethics 2000 to re-write ethical history and the lawyers’ code, and stymie calls that traditional ethical and fiduciary rules be enforced, in the contingency fee context, so that the client’s interests will in fact be placed above the lawyer’s financial interests. They have forgotten, of course, that the Model Rules and Model Code set forth general principles for attorney-client interactions, especially in fee matters, that cannot be erased merely by taking a sentence out of a Comment or two, or by preventing the adoption of clarifying clauses, which were only proposed to counteract the p/i lawyers’ own misinformation campaign.

tiny check They have also forgotten that lawyers and judges in some states will stand up for the rights of injured consumers, as they enter into contingency fee arrangements. For an excellent example, see our discussion of the new Arizona Rule 1.5, adopted in 2003 by the Arizona courts. Among other improvements, Rule 1.5(a)(8) no longer has the cryptic phrase “whether the fee is fixed or contingent.” As of Dec. 1, 2003, the factor to be considered is “the degree of risk assumed by the lawyer.”

Another example of personal injury lawyers frustrating attempts to better-inform clients of their rights can be seen in the Florida and California requirement that potential clients be told in writing of their right to negotiate or bargain for the percentage used in a contingency fee arrangement. Lawyers in both states have decided that the client’s right to negotiate does not mean that they have to engage in any negotiation or bargaining with the client, nor that they have to give the client information that would assist such negotiation.

priceReducedN not

Florida was the first state in the nation to require that every client be told in writing that contingency fees are negotiable. Nonetheless, I have been able to locate only one Florida law firm that might be willing to negotiate such fees [I am not sure that they are still advertising their phone number 866-FAIR-FEE]. Meanwhile, a Florida resident, with what looks like a very good multi-million-dollar lawsuit against a deep-pocket defendant, has corresponded with me this year, saying that no firm has been willing to budge from the statutory maximums; indeed, they won’t even discuss why they won’t negotiate.

tiny check Imagine any of the other “rights” that various states have enumerated for law clients (e.g., in New York State) — from written fee agreements, to competent handling of your matter, to being treated with courtesy. Now, imagine a lawyer saying — as I’ve heard from p/i lawyers with regard to the right to negotiate — “oh, that’s just a general right; it doesn’t mean that I have to grant the client that right; they can just keep looking until they find a lawyer who is willing to do so.”

Similarly, several p/i lawyers have told me they do not have to discuss “alternative fee options” with clients, because they do not offer such options in cases where they use contingency fees.

mushroomsF So, yes, Ted Frank is absolutely correct: there is massive market failure in the setting of contingent fees, despite the armies of lawyers hoping to cash in on the personal injury Lawyer Lottery.

tiny check Here are some of the reasons, many of which were suggested above:

1) P/I lawyers — especially when dealing in non-class-action situations, where there is virtually no likelihood of court review — have worked hard to make sure the public is neither aware of the right to bargain for those rates, nor of the yardstick that should be applied in arriving at a fair contingency fee.

2) After making darn sure that virtually everybody knows there is a “standard,” “customary,” or “prevailing” percentage rate in each locality or jurisdiction, they have all in unison started to deny that any such thing exists. [more on this later this week; for now, see this prior post]

3) They have an Advertising Law of Omerta on Fee Levels — without which it would be extremely difficult for a cartel with so many (and such varied) members to sustain a price floor (which is also the ceiling). Here, where advertising is such an imporant aspect of attracting clients, lawyers would need to “cheat” in public on their guild’s no-fee-compeition tradition to be effective. Clearly, individual p/i lawyers or firms have not been willing to take such a public stance.

4) They have quickly condemned any client advocate as a tool of the insurance industry and tort reform movement, in order to discredit attempts to make the standard contingency fee obsolete.

5) They have ignored and/or maimed ethical standards, whenever possible, while claiming the purest of intentions, and using some of the lamest arguments in the annals of legal reasoning.

wolf dude neg 6) They have co-opted the very politicians and nonprofit consumer groups that would normally be fighting the standard contingency fee, with massive donations. (Thus, for example, the Clinton Administration came out against legislation that would merely have informed clients of their right to bargain over contingency fees.)

7) They have lulled/scared bar counsel into ignoring the issue of unreasonable contingency fees. (See our post Blame Bar Counsel for the Capoccia Scandal. We learned recently, that the same grievance committee that refused to investigate the much-advertised, immorally excessive, reverse contingency fees of the felonious Andrew Capoccia, contacted good-guy Warren Redlich, because he listed himself as “Abogado Warren Redlich,” to assist clients needing a Spanish-speaking lawyer.)

8) While touting that ”a court always possesses the power to review attorneys’ fees in personal injury cases,” they have helped establish court regulations and customs whereby fees that do not exceed the local “standard” are accepted as reasonable on their face.

Finally, p/i lawyers make Adam Smith look naive. His oft-repeated axiom

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

works in spades for the clubby personal injury bar, which often finds itself huddled against outside forces, or hanging out at the local courthouse’s lawyers’ lounge, trying to figure out how to keep their little racket going, and their halos glowing. [I wonder when the Hate Mail will start.]

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