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August 17, 2004

“Early Offers:” A Proposal To Counter Attorney Fee Gouging By Aligning The Contingent Fee System With Its Policy Roots And Ethical Mandates

By Lester Brickman

Over the past forty years, the scope of liability assessed under the aegis of the tort system has greatly expanded. This expansion has been driven by the substantially increasing yield from contingent fees realized by plaintiff lawyers. Since 1960, the effective hourly rates of tort lawyers have increased 1000% to 1400% (in inflation-adjusted dollars), while the overall risk of nonrecovery has remained essentially constant though it has decreased materially for such high end tort categories as products liability and medical malpractice.

These enormous increases in contingency fees have occurred despite the existence of regulatory regimes that ostensibly apply to such fees. Under both ethical codes and fiduciary principles, fees must be reasonable. Contingency fees are designed to and do yield higher effective hourly rates than do hourly rate fees to reflect the risks that lawyers bear. These higher rates of return, however, are justified under ethical codes and fiduciary principles only if they are commensurate with the risks assumed by lawyers of non-recovery or low recovery. The need for such doctrinal protection has long been manifest because clients being charged contingency fees in personal injury cases are highly susceptible to lawyers’ overreaching.

Ethical and fiducial protections for personal injury clients have failed to accomplish their essential purpose. By pursuing anticompetitive strategies including erecting barriers to competition from outside the profession and promulgating ethical rules restricting price competition within the profession, contingent fee lawyers have not only flouted ethical rules and fiducial protections but have imposed substantial rents on tort claimants as the price for tort claiming. These rents, which often translate into effective hourly rates of thousands and even tens of thousands of dollars an hour, are the product of lawyers’ collusive efforts in maintaining uniform pricing: standard contingent fees in virtually all personal injury litigation, ranging from 33 to 50% in various jurisdictions.

The hallmark of the gross overcharging that permeates contingency fee practice is the zero-based accounting system that plaintiff lawyers impose. When a client hires a lawyer to process a tort claim, the lawyer assigns the initial value of the claim as zero. Even if the case is a “no brainer” and a multi-million dollar settlement is a virtual absolute certainty as, for example, if a doctor amputates the wrong limb or operates on the wrong side of the patient’s brain, or engages in other equally impactuous acts of egregious medical malpractice, a standard contingency fee is charged and it applies not only to the value added to the claim by the lawyer but to the value of the entire claim, irrespective of the fact that the claim already had substantial value at the time the client hired the lawyer. As one leading ethics expert has explained:

We permit contingent fees to be larger than what would constitute a reasonable hourly fee because the lawyer takes the chance, if the contingency does not occur, of going uncompensated. But most personal injury cases have some value. Prospective defendants are often willing to pay something to resolve them. Why should the plaintiff’s lawyer get a full contingent fee for “recovering” this amount?

Stephen Gillers, REGULATION OF LAWYERS: PROBLEMS OF LAW AND ETHICS, 154 (4th ed. 1995). See also Kenseth v. Com’r of Int. Revenue, 114 U.S. Tax Ct. Rep. 399 (2000) (stating that the fact that a contingency fee attorney agrees to represent a client on a contingent basis indicates that the cause of action “had value in the very beginning.” Id. at 413).

The zero-sum accounting scam perpetrated by the contingency fee bar is on vivid display in the August 2004 edition of The American Lawyer. Professor Stephen Lubet describes the unfortunate encounter of a woman, Mary Corcoran, with the contingency fee system, nothing that “it begins in tragedy and ends in frustration.” Her husband has been struck and killed by a railroad train while working for the railroad. As reported by Professor Lubet:

Shortly after the accident, Mary was contacted by a representative of the railroad, who wanted her to settle out of court. Negotiating on her own behalf, Mary eventually obtained an offer of slightly more than $1.4 million, at which point she decided to see if any attorney could do better for her. That surely seemed like a sensible decision at the time, although it would end up backfiring badly.

A friend of Corcoran’s introduced her to a lawyer named Joseph Dowd, a solo practitioner in suburban Des Plaines, Illinois, who lists his practice areas as bankruptcy, divorce, and real estate. Dowd spoke to Corcoran about the accident and told her that she needed a personal injury lawyer. She replied that she was interested in retaining Corboy & Demetrio [one of the top personal injury firms in Chicago] because her father knew Philip Corboy from high school. Apparently impressed by her choice, Dowd arranged a meeting with Thomas Demetrio, and Corcoran eventually signed a contingent fee contract. She agreed to pay the firm “25 percent of any sum recovered from settlement or judgment,” and also consented to a referral fee for Dowd in the amount of “40 percent of the attorneys’ fees.”. . .

After nearly two years of litigation, the Corboy & Demetrio lawyers came to the conclusion that they could not improve on Union Pacific’s offer-so they recommended that Mary accept the $1.4 million, which had been held open by the railroad. Because they hadn’t gotten an increased offer, Corboy & Demetrio voluntarily waived any fee.

Not so Joe Dowd. He demanded payment of the referral fee-$140,000-even though the litigation firm had waived its fee. By his own admission, Dowd was not an experienced personal injury lawyer, and he had not actively participated in the litigation on Mary Corcoran behalf. Nonetheless, he insisted, a contract is a contract and he wanted his 140 grand. . . .

Most people, including most lawyers, might suppose that $140,000 is an unreasonable amount for attending several meetings, reading a file, and making some phone calls-which pretty much describes Joe Dowd’s work for Mary Corcoran. Incredibly, however, the judge agreed with Dowd. The fee agreement would be enforced as written, end of discussion.

Mary Corcoran appealed, represented by a Chicago lawyer named Christopher Hurley. Once again, the judicial system disappointed her. The appellate court ruled that Dowd had a contractual right to payment, even though neither he nor Corboy & Demetrio had obtained an increase in the railroad’s offer. If Mary wanted an “improvement” clause, the court held, she should have asked for one. But that ignored the fact that she was depending on the lawyers to draft the contract and protect her interests. Still, the Illinois Supreme Court refused to hear the case, so Joe Dowd got his money.

Mary Corcoran’s unfortunate experience with the contingency fee system is the rule not the exception. As a rule, contingency fee lawyers not only charge fees against settlement offers previously obtained, but also routinely charge standard contingency fees in cases where they know at the outset that there is no meaningful litigation risk and that little work will need to be required to produce a settlement. Each year, I receive a few dozen phone calls from clients in circumstances similar to Corcoran’s who have been mulcted by their lawyers. [For an account of these telephone calls, see 81 Wash. Un. L.Q. 653 at 660 n. 14 (2003).] They are further dismayed to learn, like Mary Corcoran, that they have no recourse (though Mary at least found a lawyer to litigate her claim against her lawyer – a rarity). These clients have been cheated by their lawyers and the legal system.

Responding to this need for consumer protection, Professor Jeffrey O’Connell of the University of Virginia Law School, Michael Horowitz, then with the Manhattan Institute and currently with the Hudson Institute and myself designed the “early offer” proposal, to protect Mary Corcoran and others from fee-gouging lawyers. It emulates the market bargain that Mary Corcoran would have attained if she were a sophisticated user of legal services or if her lawyer had not breached his fiduciary obligation to his client by failing to advise her what a second lawyer would have advised Mary if she had gone to that lawyer for legal assistance in negotiating a fee contract with Dowd: to negotiate a contract in which Dowd and others would receive a percentage of what they obtained for Mary over and above the $140,000 offer that she had in hand; that is, to confine their fee percentage to the value that they added to the claim. The proposal, which is designed to be self-effectuating, require no additional bureaucracy for its enforcement, and impose no significant transaction costs, has received extensive coverage in both the media and professional responsibility casebooks. It provides:

1. Contingency fees may not be charged against settlement offers made prior to plaintiffs’ retention of counsel.

2. All defendants are given an opportunity to make settlement offers covered by the proposal, but no later than 60 days from the receipt of a notice of claim from plaintiffs’ counsel. If the offer is accepted by the plaintiff, counsel fees are limited to hourly rate charges and are capped at 10% of the first $100,000 of the offer and 5% of any greater amounts.

3. Notices of claim submitted by plaintiffs’ counsel are required to include basic, routinely discoverable information designed to assist defendants in evaluating plaintiff claims. In turn, to assist plaintiffs in evaluating defendants’ offers, discoverable material in the defendant’s possession concerning the alleged injury upon which the defendant relied in making his offer of settlement must be made available to plaintiffs for a settlement offer to be effective.

4. When plaintiffs reject defendants’ early offers, contingency fees may only be charged against net recoveries in excess of such offers.

5. If no offer is made within the 60 day period, contingency fee contracts are unaffected by the proposal.

Thus, the proposal would prohibit plaintiff lawyers in personal injury cases from charging standard contingency fees where alleged responsible parties made early settlement offers before the lawyer added any significant value to the claim. Instead, the lawyer would be restricted to charging an hourly rate fee for the effort required to assemble and notify the allegedly responsible party of the relevant details of the claim. If an early settlement offer were rejected and a subsequent settlement or judgment was obtained, the lawyer would apply a contingent percentage to the amount in excess of the early offer. Critics of the proposal, who have frequently mischaracterized it, have failed to comprehend how it counteracts the ethically challenged if not outright fraudulent zero-based accounting system used by contingent-fee lawyers. In fact, by confining application of the contingent fee to the value that a lawyer has added to a claim, the proposal implements the ethical requirements set forth in Rule 1.5(a)(8) of the Model Rules of Professional Conduct and DR2-106 (B)(8) of the Model Rules of Professional Responsibility requiring that contingent fees be commensurate with risk.

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Attorneys' Fees and Ethics, Politics



Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.