YourABA: March 2012 | Reverse contingent fees

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Reverse contingent fees

By Peter H. Geraghty
Director, ETHICSearch

You are defending a client in a contract dispute where the opposing party claims he is owed $10,000 for services rendered. The client likely will not be able to pay your hourly rate to handle the matter. Can you enter into a “reverse contingent fee” agreement whereby you will be entitled to a percentage of the money that you save the client?

For example, if you are able to convince the opposing party to settle the matter for $5,000, can you ask your client to agree to pay you a percentage of the $5,000 that the client might otherwise have had to pay the opposing party?

In 1993, the ABA Standing Committee on Ethics and Professional Responsibility issued Formal Opinion 93-373, Contingent Fees in Civil Cases Based on the Amount of Money Saved for the Client. The committee began with an analysis of the provisions of Model Rule 1.5 Fees that deal with contingent fees. (For a general discussion of the ethical issues relating to contingent fees, See ABA Formal Opinion 94-389 Contingent Fees (1994)) The committee noted that Subpart (d) of the rule lists the only two circumstances under which contingent fees are prohibited: matters involving domestic relations, because of public policy concerns that a lawyer should not have an interest in the dissolution of a marriage, and criminal defense, out of concerns that it would encourage unscrupulous representation and discourage plea bargaining.

Assuming that the amount in dispute was reasonably determinable, the fee is reasonable and the client gives his informed consent, the committee could discern no public policy rationale that would prohibit a reverse contingent fee.

Model Rule 1.5(a) lists a number of factors that can be taken into consideration as to whether a fee is reasonable. These include but are not limited to the time and labor involved, the amount involved and the results obtained and whether the fee is fixed or continent. The committee cited to ABA Informal Opinion 86-1521 Offering Alternatives to Contingent Fees (1986), which provided a framework for determining the reasonableness of a contingent fee:

…Contingent fees are subject to the "reasonableness" and "clearly excessive" tests of the Model Rules and the Model Code. Whether a contingent fee is reasonable and whether it is in the best interest of the client may be dependent on many factors, including the estimated amount of a reasonable fixed fee, the degree of contingency in fact involved and the probable size of the recovery, factors which the client normally has the right to consider before agreeing to a fee arrangement. – ABA Informal Opinion 86-1521 at page 3.

As the committee noted, Opinion 86-1521 addressed a “straight” contingent fee, that is to say, a fee that is based on the amount recovered for the client. The reasonableness of a reverse contingent fee is far more difficult to assess, since it is much more difficult to assess the benefit to the client in this context. A client may be sued for $100,000, but this may not in fact be an accurate representation of the amount in dispute, since it could be an exaggeration by plaintiff’s counsel to gain a tactical advantage in the litigation. Also, the committee noted that in some jurisdictions, a plaintiff is not permitted to name a specific amount in the pleadings filed in a matter, and is required to state that the prayer for relief is, e.g. “in excess of $50,000.” The committee stated that a lawyer who wants to enter into a reverse contingent fee agreement with his client would have to negotiate with the client in order to determine a fair amount representing the value of the plaintiff’s claim. This can be a sensitive task, particularly in those situations where the plaintiff’s lawyer has exaggerated the plaintiff’s claim. The committee stated:

Whether or not a specific ad damnum figure is mentioned, for an unliquidated claim, it is incumbent on the defendant's lawyer fairly to evaluate the plaintiff's claim and set a reasonable number as the amount from which the plaintiff's recovery will be subtracted to determine defendant's savings. The sensitivity of this exercise becomes apparent when it is recognized that to the extent defendant's lawyer exaggerates the value of plaintiff's claim, defendant's lawyer enhances his or her prospect of recovering on the contingent arrangement. Needless to say, the lawyer negotiating with the unsophisticated client will have a significantly greater burden of demonstrating fairness in this process than the lawyer, for example, who negotiates a reverse contingent agreement with an experienced in-house counsel. – ABA Formal Opinion 93-373 at page 5.

The committee took note of Wunschel Law Firm, P.C. v. Clabaugh 291 N.W. 2d 331 (1980) in which the Iowa Supreme Court addressed the ethical issues involved in the reverse contingent fee scenario. In the Wunschel case, the plaintiff sued for $17,500, and the jury awarded $1,750. Under the terms of the fee agreement, the lawyer representing the defendant would have been entitled to $5,250, or one-third of the $15,750 “saved” the client. Relying in part on and quoting at length from an amicus brief filed by the Committee on Professional Ethics and Conduct of the Iowa State Bar Association, the court found the fee agreement to be unreasonable and void as against public policy, stating that the amount demanded in a tort claim was too speculative an amount upon which to base a contingent fee. Excerpts from the Iowa committee’s brief state as follows:

…The Committee believes that the guiding principle for any fee or an agreement for a fee is that it is, under all of the circumstances known at the time, reasonable. Both parties must have sufficient information upon which to make an informed decision; this includes the client. The lawyer knows that a jury verdict for the prayer for unliquidated damages is rare. The client does not. The lawyer knows that even if a default is entered, damages must be proved and again, it is rare, in all cases claiming unliquidated damages, for a judgment entry upon default to be for the amount of the prayer. The client may not. Many times the client believes that if he or she loses the case, the prayer will be the judgment entered. The lawyer knows that this is not the case. The opposite probably is true if the claim is liquidated; however, if it is unliquidated, the client simply does not have sufficient knowledge or information upon which to make an informed decision.
… The Committee therefore believes that since these critical factors are missing from a defense-contingent fee arrangement in an unliquidated tort action, that such fee is based upon pure speculation. A fee based purely upon speculation cannot be reasonable as required by the Code. The Committee is unanimous in its decision that in a tort action claiming unliquidated damages, a defense contingent fee based upon a percentage of the difference between the prayer in the plaintiff's petition and the jury's verdict is improper. Its decision is the same even if the actual amount of the prayer is written into the contingent fee contract (as in the case at bar) so that the fee would not increase if the prayer is increased.

While the ABA ethics committee agreed with the court that the prayer for relief should not have served as the basis for the contingent fee, it went on to state that the reasonableness of a reverse contingent does not necessarily depend on whether the claim is based on a liquidated amount. The reasonableness of the fee must be determined on a case-by-case basis. Both the reasonableness of the percentage as well as the amount in dispute that forms the basis of the contingency must be taken into account at the time the fee agreement was set.

Referring back to Informal Opinion 86-1521, the committee also provided guidance as to the substance of the consultation the lawyer should have with his client about the appropriateness of a reverse contingent fee in a given matter.

"[W]hen there is any doubt whether a contingent fee is consistent with the client's best interest, which can normally be determined only in light of all the facts and circumstances after consultation with the client, the lawyer must offer the client the opportunity to engage counsel on a reasonable fixed fee basis before entering into a contingent fee arrangement." – ABA Informal Opinion 86-1521

State and local bar association ethics opinions

There have been some state bar ethics opinions that have been issued on this topic, most of which are in agreement with Opinion 93-373. See, District of Columbia Bar Opinion 347 (2009) in which the D.C. ethics committee stated that a lawyer may charge a reverse contingent fee so long as the fee agreement is reasonable both at the outset and at the conclusion of the proceeding, and the client gives his fully informed consent. In a dissenting opinion, three members of the D.C. committee stated that the client should give his consent in writing. The committee listed the following as “key components” of a reverse contingent fee agreement:

…The key components of a reverse contingency fee arrangement are (a) the selection of the sum or amount from which a client’s savings are computed and (b) the percentage to be applied to such savings to produce the lawyer’s fee. The selection of the former should be the product of full disclosure by the lawyer and informed consent from the client. The lawyer may not suggest a number based upon an assessment of the matter or experience in the particular type of dispute that is not disclosed to the client. A lawyer whose experience and knowledge provide insight into the range of results that are typically achieved in a particular type of matter must share such insight with the client. The amount demanded by an adversary may not be taken alone as the basis for a reverse contingent fee. Following such a course would be highly problematic. Instead, to the extent a demand is used by an attorney as the basis for a contingent fee, the lawyer should perform his or her own independent analysis and thoroughly discuss the matter with the client.

See also Kentucky Bar Opinion E-359 (1993), which stated that a lawyer defending against a civil claim can charge a reverse contingent fee so long as the fee is reasonable and the client gives his written consent:

…[W]e stress that the lawyer who would charge a contingent fee or bonus for result should also expect to bear the burden of proving that the method of computing the charge, and the amount of the fee, are reasonable and rational under the circumstances and are settled in writing at the outset of the representation. – Kentucky Bar Opinion E-359.

Iowa state bar opinion 98-3 stated that a reverse contingent fee is permissible under circumstances where the lawyer defends a client against a claim by a creditor; the specific facts of the inquiry involved a lawyer who was defending his client against the Social Security Administration’s claim of overpayment.

Pennsylvania state bar opinion 87-182 (98) stated that a reverse contingent fee agreement may violate the then in effect Pennsylvania Code of Professional Responsibility. A later Pennsylvania state bar opinion 92-76 (1992) stated that a lawyer may charge a reverse contingent fee in a tax appeals case.

Other resources

See Also , Brown & Sturm v. Frederick Rd. Ltd. P'ship , 768 A.2d 62, 17, in which the lawyer represented a group of defendants in a tax liability-real estate valuation dispute with the IRS. The court, citing to Opinion 93-373 denied the lawyer’s $4.8 million fee, stating that the lawyer did not inform the client that the IRS’s assessment of the subject matter property was unrealistic. It also found that the amount claimed bore no relationship to the time, labor, novelty, and risk involved in the representation. The court stated:

…In negotiating the fee agreement, appellants not only took advantage of their dominant position vis-a-vis the King children, but they also failed to make full disclosure of all information and advice that the siblings would have required under the existing confidential relationship... “Consequently, if the attorney relies on a special fee arrangement in defense of a ... complaint that a clearly excessive fee has been charged, the attorney must demonstrate that the arrangement was made ‘after disclosures appropriate to the existing confidential relationship....’ ” Id. (quoting Wright, 306 Md. at 106, 507 A.2d 618). The undisputed evidence here shows that the reverse contingency fee was based on a reduction in the tax liability claimed by the IRS, which in turn, was premised upon the farm having a fair market value of $60 million, an inflated sum of more than double any other contemporaneous appraisal of the property. The court below found, based on the evidence presented at the trial, that Brown & Sturm failed to disclose to the family at the time of the agreement a more realistic worst-case market value of the farm for the purposes of federal taxation-and that information would have significantly reduced the amount agreed upon as a benchmark for tax liability in the retainer agreement. – Brown & Sturm at page 76.

For further information on reverse contingent fees, See Stuckey, “Reverse Contingency Fees: A Potentially Profitable and Professional Solution to the Billable Hour Trap,” 17 Prof. Law, no 3 at 25 (2005).

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