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Recently in Attorneys' Fees and Ethics Category

Contingency fees: format, links down

August 17, 2004 10:52 AM

Our second Featured Discussion brings together two of the nation's leading experts on legal ethics, Lester Brickman and Richard Painter, to discuss potential ways to improve the legal system through reforming the way lawyers charge contingency fees. For a fuller introduction to their views, see my entry on the main forum page.

Also, in contrast to the usual weblog format, new entries in this Featured Discussion are posted at the bottom rather than the top of the page. So scroll down. Thanks!

Table of contents of the discussion: August 17 Brickman; August 18 Painter; August 19 Brickman; August 20 Painter; August 26 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.

On fees and markets

August 18, 2004 3:54 PM | No Comments

Professor Brickman makes several very good points, and his proposal to link contingent fees to the work that lawyers actually do for their clients to improve upon settlement offers, is theoretically sound. I am concerned, however, about how his proposal might work in practice, and more importantly that his proposal might never get implemented because voters and legislators believe it to be too complex and to interfere too much with lawyer and client autonomy. I thus suggest below that an alternative proposal, the so called �New American Rule�, be considered as well.

A few general observations:

1. We should not go overboard in our criticism of price gouging by the plaintiffs� bar. Personal injury lawyers serve a useful purpose when they loyally and competently represent their clients, as I believe most do. The vast majority of personal injury lawyers also do not earn outrageously high fees when their annual incomes are measured as a whole. In many communities, lawyers representing businesses and other defendants earn as much as, and sometimes more than, their counterparts in the plaintiffs� bar.

2. There is, however, considerable price gouging by some (by no means all) plaintiffs� lawyers. The tobacco lawyers who sought fees running into the billions of dollars from Texas, Florida, Massachusetts and other states because of �arm�s length� contingent fee contracts they entered into with state attorney general�s offices (or more accurately in some cases with their friends in state attorney general�s offices) are the most blatant example of price gouging at the public�s expense. Contingent fee lawyers who demand hundreds of thousands of dollars from individual plaintiffs for doing little or no work (e.g. attorney Dowd in the Corcoran case) are also abusing the public trust (as Corboy & Demetrio recognized when it voluntarily waived its fee in that case even though it did considerably more work for Corcoron than Dowd had done, but nonetheless without improving upon the settlement offer that Corcoron had before her attorneys got involved).

3. To the extent possible, the market should be allowed to solve the contingent-fee-abuse problem itself, free of regulatory interference. This is why I suggested in a 1995 law review article that the answer might be less regulation not more. See Richard W. Painter, Litigating on a Contingency: A Monopoly of Champions or a Market for Champerty?, 70 Chicago Kent Law Review 625 (1995) (Symposium on Fee Shifting). The contingent fee I argued is in essence a form of champerty that lawyers are allowed to provide for their clients, while traditional prohibitions on champerty prevent non-lawyers from funding and insuring lawsuits (with some exceptions). Allowing third-party insurers to offer the same champertous product that is embodied in the contingent fee (litigation insurance and financing) in return for a portion of any judgment might help some clients hire hourly rate lawyers and, where contingent fees are excessive, drive those fees down to more reasonable levels. There has since been some experimentation with such arrangements in jurisdictions that allow them, but for the most part only with advances against plaintiffs� awards on appeal. Furthermore, ethical standards in the litigation financing industry, and its reputation, will have to improve substantially before it becomes a realistic competitor with contingent fee arrangements offered by the plaintiff�s bar.

4. Even when lawyers still dominate the market for litigation financing and insurance (the essential services being offered with a contingent fee), existing market mechanisms work sometimes. This is exactly what happened with respect to 60% of the fee in the Corcoron case, which was waived. Corboy & Demetrio is one of the most well respected plaintiffs� law firms in the country and has far more to lose by way of reputation than it has to gain by taking fees from Ms. Corcoron on the basis of a dubious contractual claim. Other potential clients having more lucrative claims than hers might be deterred from going to Corboy & Demetrio if they heard that the firm had charged her a �contingent� fee without getting her a penny more than she had before she talked to her lawyers. The firm�s economic interests, and its partners� social and professional reputations, dictated that the firm should do the right thing, which it did.

5. The question in that case then is how to deal with the other 40% and Mr. Dowd. The market itself may help here as well. Enough publicity surrounding this incident could make this one of the most costly fees Mr. Dowd has ever earned (unless people in Des Plaines really enjoy the prospect of paying a lawyer for doing no work). Furthermore, contract law should have come to the aid of Ms. Corcoron. The Illinois courts simply got this one wrong, because fee reasonableness (required under Rule 1.6) is an implied-in-fact covenant in any contract between a lawyer and a client (as are other rules of professional ethics). In many jurisdictions, a lawyer who practice law unethically for a client has no right to be paid at all, and at a minimum a lawyer should be held to his end of the bargain when he contractually obligates himself to practice law according to rules of professional responsibility (including the rule that a fee must be �reasonable� in relation to, among other factors, the work done by the lawyer for the client). Finally, the Corcoron case illustrates a subset of abuses arising out of referral fees (which normally are paid to attorneys who do little or no work on a case) rather than out of contingent fees as a whole. This problem could be addressed with narrowly tailored measures, for example an amendment to state ethics rules providing that a referring lawyer shall not receive an amount in excess of the amount actually collected from the client by the lawyer doing the majority of the work on a case. Under such a rule, Corboy & Demetrio�s determination of its ethical obligations (and of its contractual rights) would have been binding on Dowd as well.

6. The �early offer� proposal designed by Lester Brickman, Michael Morowitz and Jeffrey O�Connell is a good one (so good as to receive praise from former Harvard President Derek Bok and Judge John T. Noonan, Jr. in forwards to the 1994 Manhattan Institute publication). The proposal is, however, complex in its procedural aspects because of the discovery rights that its authors rightly perceive to be a necessary precondition to an �early offer� being meaningful. Collateral litigation between plaintiff and defendant over pre-offer discovery could make the tort system more rather than less expensive for all concerned. The proposal also interferes with market mechanisms perhaps more than is necessary to address the underlying problem (excessive contingent fees charged by lawyers who do little or no work for a client). The proposal also does not address other related problems (such as the tobacco lawyers and other lawyers who do a lot of work but still charge an effective hourly rate far in excess of that which is reasonable � in some cases in excess of $20,000 per hour). Finally, the bulk of the �early offer� proposal�s rules are not triggered at all unless the defendant makes a settlement offer, which puts the defendant in the unique position of being able to determine through its own settlement strategy the ethical obligations of the plaintiff�s lawyer to the plaintiff. A proposal that was more independent of a triggering mechanism controlled by the defendant might better withstand political arguments that contingent-fee reform is more about protecting defendants from plaintiffs� lawyers than it is about protecting plaintiffs themselves.

I will now make a few observations about the alternative �New American Rule� for contingent fees that I drafted with Jim Wooton and then analyzed in a 2000 publication for the Manhattan Institution (see Richard W. Painter, The New American Rule: A First Amendment to the Client�s Bill of Rights, 2000 Civil Justice Report (Manhattan Institute 2000) ):

1. We call our proposal the �New American Rule� because we believe it would be a useful corollary to a unique aspect of the American justice system that supposedly improves access to the courts: the contingent fee. The contingent fee is banned in most other countries but helps ordinary plaintiffs sue without fear of being stuck with large lawyers� bills if they lose (another uniquely American rule that supposedly helps impecunious litigants is the rule that losing parties do not have to pay the other party�s legal fees, which contrasts with the �loser pays� approach followed in many other countries). Our intent with the New American Rule is to assure that, while plaintiffs lawyers are allowed to charge their clients a premium above a normal hourly rate for the risk they assume with a contingent fee instead of an hourly fee, this premium will be disclosed to the client in terms that the client can most easily compare with the hourly rate that they otherwise would have to pay if the fee were not contingent.

2. In essence, the New American rule requires the lawyer charging a contingent fee to say to the client in advance that �my fee will be X% of any judgment or settlement in this case but will be no higher than Y dollars per hour.� Under the proposal, the lawyer and client are free to agree on any numbers for X and Y that they want (subject of course to the existing provision in ethics rules and thus implied in the retainer agreement that a lawyer�s fees must ultimately be reasonable). X and Y have nothing to do with whether there is a settlement offer in the case or any other decision made by the defendant. Instead, these numbers are determined by what plaintiffs will pay in a market for legal services that is unregulated except for the requirement that the lawyer who chooses to charge on a contingency must specify both X and Y. After the case is over, the client has the option of paying the lower of X or Y.

3. Of course a lawyer can �evade� the rule by choosing a ridiculously high number for Y. Plaintiffs who are told by their lawyer that Y is $10,000 per hour (or higher), however, should know that something is wrong (they will know enough to look for another lawyer, even if they don�t� know the details -- for example that within minutes of their leaving a lawyer�s office their �complex case that will require a lot of hard work� may instead be settled with a quick call to the insurance company) . The purpose of the rule is to force the lawyer in fee negotiations to signal to the client something about the lawyer�s estimate of the strength of his own hand, thus leveling the information gap between lawyer and client concerning the admittedly uncertain factors that determine a reasonable contingent fee (the size of the client�s claim, the probability of success and the amount of lawyer work likely required). Instead of being told that X is 33% or 40% simply because that is the �industry standard�, the client will at least get a hint as to what the lawyer actually thinks about important aspects of the client�s case, and about what the lawyer will do for the client, when the lawyer names his number for Y.

4. The New American Rule imposes some regulation on the market for lawyer�s fees (it requires the lawyer to choose a number Y that, unless extraordinarily high, could in some cases cap his percentage fee X). The interference with market mechanisms, however, is minimal, particularly compared with the �early offer� proposal, which allows an agreed upon contingent fee percentage X to be applied only to a portion of the client�s judgment or settlement amount that is itself determined not by the autonomous decisions of the lawyer or client, but by the size of an early settlement offer from the defendant.

5. Finally, I will suggest two useful corollaries for the New American Rule. First, because contingent fees are designed for clients of limited means, large governmental entities (such a states seeking to sue tobacco companies or gun manufacturers) should not hire contingent-fee lawyers at all (they can self insure against the risk of losing by paying an hourly rate, just as governmental entities usually self insure against a host of other losses � including negligence lawsuits brought against them by plaintiffs� lawyers) . The game in which officials in some states passed contingent-fee business on to their friends, and lawyers sought billions of dollars in fees arguing that these arrangements constituted �freedom of contract� would, under this new restriction come to an end. Second, courts should take more seriously ethics rules requiring that a lawyer�s fee be �reasonable.� Courts should also recognize that clients like Ms. Corcoron, when they hire lawyers, do so with the understanding that, when their case is over, the fee charged will in fact be reasonable in view of such factors as the risk involved, the size of their recovery and the amount of lawyer work involved.

Professor Brickman responds

August 19, 2004 6:25 PM

Professor Painter expresses basic agreement with my core thesis but disagrees on a number of issues. Although our areas of agreement far outweigh our disagreements, in this response, I will focus on two areas of disagreement: contingency fee practices and the relative merits of the �early offer� proposal versus the �New American Rule.�

While Professor Painter agrees that there is considerable price gouging by some lawyers, he believes that this is not true for the �vast majority.� I disagree. Contingent fee lawyers routinely charge standard contingency fees even though there is already a settlement offer on the table at the time they begin representation as well as in other cases without meaningful risk. As I indicated in a recent article:

A frequent abuse in personal injury representation occurs when lawyers routinely charge standard contingency fees of one-third or more even though the insurance company has either already offered to pay policy limits to the injured party or claimant before the lawyer was retained or would have offered to do so, if approached, and, in fact did do so after the claimant retained counsel. For example, a former insurance adjuster in Missouri has stated under oath:
From 1962 until January 1, 2002, I was employed by State Farm Insurance Company . . . as an adjuster. . . [and] supervised other adjusters. Over the years I witnessed many examples of attorneys charging their clients (people with a claim against State Farm) a contingency fee of one-third or more when State Farm had already or would have offered to pay that client all that State Farm was obligated to pay under the policy of insurance in force.
Quoted in: Lester Brickman, Effective Hourly Rates of Contingency-Fee Lawyers: Competing Data and Non-Competitive Fees, 81 Wash. U.L.Q. 653, 660-61 (2003).

Price gouging is thus the norm, not the exception. Price gouging and price fixing largely account for the 1400% inflation-adjusted increase in the effective hourly rates of contingency fee lawyers over the past 40 years. See id. at 707. Corboy & Demetrio�s declination to apply their contingency fee to the pre-representation settlement offer was both ethical and honorable--and extremely rare. Mr. Dowd�s action in taking a percentage of the offer that he did nothing to generate is both commonplace and well within the standards that courts and disciplinary agencies apply to contingencies fees. Therein lies the problem. Professor Painter�s observation that the Dowd case is a referral fee problem and not a contingency fee problem is off the mark. Mr. Dowd�s action in taking a percentage of a settlement that he did little or nothing to generate is replicated every day by hundreds of contingency fee lawyers. Professor Painter is certainly correct that what is different about the Dowd matter is that it has attracted some publicity and may yet attract more. Beyond that, however, it is a run-of-the-mill commonplace occurrence � and an indictment of these contingent fee practices.

Of course, I agree with Professor Painter that the Illinois courts� decisions are at best regrettable. To be sure, Illinois courts have been in the forefront of the movement to depreciate clients� fiducial and co-relative ethical rights in favor of the rights of lawyers. See Lester Brickman, The Continuing Assault On the Citadel of Fiduciary Protection: Ethics 2000�s Revision of Model Rule 1.5, 2003 Ill. L. Rev. 1181 (2003). Even so, the Illinois courts� treatment of Mr. Dowd�s claim is consistent with the practices of other courts in other jurisdictions.

�Early Offer� vs. the �New American Rule�

Professor Painter�s proposal is a commendable effort to deal with contingency fee lawyers� price gouging. It is a variant of a proposal I set forth 15 years ago. See Lester Brickman, Contingent Fees Without Contingencies: Hamlet Without The Prince of Denmark?, 37 UCLA L. Rev. 29, 115 (1989). There, I also attempted to empower clients to bargain with contingency fee lawyers over fees. Over the years, however, I came to realize that the impediments to price competition erected by the bar, including ethical rules designed to preclude price competition, were simply too formidable to overcome without more direct intervention. See Lester Brickman, The Market For Contingent Fee-Financed Tort Litigation: Is It Price Competitive?, 25 Cardozo L. Rev. 65 (2003). A summary version of this article is set forth in 27 Regulation 30 (Summer 2004). In light of that insight, I set out, with others, to devise the �early offer� proposal.

Professor Painter criticizes the proposal because it �interferes with market mechanisms more than is necessary.� In my view, the �early offer� proposal replicates the market bargain that would be concluded if consumers of legal services were able to do what businesses and corporations do when they hire lawyers on a contingent fee basis in commercial litigation. In these instances, corporations bargain out terms that identify the underlying value of the claim, agree to a set fee for the legal effort to assert the claim and agree to pay a percentage of any recovery in excess of the agreed upon underlying value of the claim. This is precisely the market bargain that the �early offer� proposal seeks to extend to consumers of legal services.

Professor Painter also identifies as a defect in the �early offer� proposal that it is only triggered if the defendant makes a settlement offer. The latter is true but is this a defect?

Consider the ethical substructure upon which the proposal is constructed. We both agree that lawyers are charging standard contingency fees in cases devoid of meaningful risk and that this is or should be considering unethical. That is, such conduct violates the ethical rule that fees be limited to �reasonable� amounts. In the contingency fee context, I previously established that risk is the ethical underpinning of the ethical validity of contingency fees and that such fees must be commensurate with the risk being undertaken by the lawyer. See Contingent Fees Without Contingencies, id. A contingent fee includes a risk premium for assuming risk. When lawyers charge standard and substantial contingency fees in cases without meaningful risk, they are charging risk premiums though not assuming risk. That is price gouging. But how then to breath life into the dormant ethical rule that lawyers cannot charge risk premiums if they are not assuming any remotely commensurate risk?

The practical problem this poses is how to measure the existence of risk without creating a bureaucratic structure or imposing new burdens on judges who already shirk their responsibility to apply ethical rules to lawyer�s fees. The �early offer� proposal presents an elegant solution to this conundrum. It identifies as a marker of the absence of risk, the amount, if any, offered by an allegedly responsible party to settle a tort claim, before any substantial value adding efforts have been contributed by the lawyer. Against such amounts offered in settlement, the lawyer may not charge a risk premium.

Thus, the �early offer� proposal depends upon a marketplace assessment of the underlying value of a tort claim by an allegedly responsible party putting its money on the line. That decision, however, is guided by the same invisible hand that �regulates� competitive markets: self-interest. Consider the financial incentives that motivate an allegedly responsible party to make an early offer of settlement.

Allegedly responsible parties will only make early settlement offers if they believe that they will likely be found liable for an injury suffered by the claimant. Currently, because of the time value of money and for other reasons, such parties have financial incentives to delay paying claims until the last possible moment. This raises transaction costs and lowers efficiency.

The �early offer� proposal changes those incentives as follows:

1) It allows allegedly responsible parties to offer settlements in dollars worth 90-95 cents versus the current value of such settlement offers to claimants of 66 2/3 cent dollars. They will allow both lower settlement costs and higher in-pocket receipts for claimants.

2) It allows allegedly responsible parties to save on defense costs which consume a formidable 14% of the total amounts spent by defendants and their insurers for tort claim costs.

3) It allows allegedly responsible parties to avoid medical costs �build-up� which amounts to tens of billions of dollars a year in inflated and fraudulent medical care costs incurred by tort claimants. Under contingency fee �math,� each $1 in medical care costs incurred by a claimant generates $1 in legal fees for the contingent fee lawyer. (For an explanation of this process, see Effective Hourly Rates, id. at 673-74). It is because of contingency fee �math� that someone who suffers a weight-bearing bone break in an automobile accident will incur $14,165, mostly in medical care costs, compared to $5,228 in such costs incurred by someone identically injured, who does not hire a lawyer to press her claim.

To avoid such medical care cost �build up,� and to realize the other savings identified, allegedly responsible parties have an financial incentive to make early settlement offers that are sufficiently substantial to gain acceptance. This will lead to earlier settlements and considerably lowered transaction costs.

To be sure, the �early offer� proposal will prove costly to constituencies that own shares in Litigation, Inc., including: plaintiff lawyers, defense lawyers, doctors, chiropractors, expert witnesses, court reporters and process servers. Indeed, the only group that will benefit is consumers through lowered insurance and product costs.

One final point is Professor Painter�s assertion that political arguments weigh in favor of the �New American Rule� over the �early offer� proposal.

Unlike most tort reform proposals, �early offer� is not susceptible to the sound bite-sized criticism that the proposal takes away victims� rights to seek redress from the courts for their injuries. �Early offer,� instead of playing the �take away� game, is designed to protect consumers of legal services from price gouging by lawyers. It is for this reason that Ralph Nader, in referring to a variant of the �early offer� proposal that was on the California ballot, termed the proposal �diabolical.�

The essence of the �New American Rule� is that consumers of legal services get to choose, at the conclusion of their representation, whether to pay a contingency fee or an hourly rate fee instead. Lawyers will claim that the proposal is a Trojan Horse designed to do away with contingency fees � the poor man�s �key to the court house.�

I will leave it to readers of this discussion to determine which proposal wins the �political� debate.

Less complexity, more information

August 24, 2004 9:30 AM

Professor Brickman once again makes cogent and well reasoned arguments in favor of the �early offer� proposal. While I am not opposed to that proposal, I am concerned that it will continue to run into political obstacles not just because it is opposed by the plaintiffs� bar, but because other features undermine its appeal to voters and legislators normally predisposed to favor contingent fee reform. Chief among my concerns are:

* Early offers under the proposal are preceded by a moderately complex early discovery procedure that could itself be the subject of disputes between the parties. Disputes over �early offer� discovery could bog down settlement negotiations and make resolution of tort claims more difficult. These early discovery provisions also make the proposal more difficult for legislators and voters to understand, and make it vulnerable to �what if� questions in which opponents of the proposal demand that its supporters describe what would happen under various scenarios in which early discovery rules are not complied with in letter or spirit. It is important to recognize that the existing system in which many tort claims are settled early, without much discovery or dispute over discovery, saves time and expense. This system arguably should not be changed simply because early discovery allows parties to negotiate settlement on a more informed basis. In any event, the timing of discovery is a separate issue from the reasonableness of legal fees, and the two issues arguably should not be entangled as they are in the early offer proposal.

* Professor Brickman makes compelling arguments that the risk assumed by a plaintiff�s lawyer in litigating a contingency case is directly linked to the amount the defendant is willing to pay to settle the case early on (the higher that amount, the lower the lawyer�s risk). Professor Brickman�s answer is to tie the lawyer�s fee to improvement on this amount as the case moves along after a settlement offer is rejected. While theoretically sound, the problem with this approach is that it allows defendants, by making or not making settlement offers within the framework of the proposal, to determine the size of plaintiffs� lawyers� fees. This gives rise to possible collusion between defendants and plaintiffs� lawyers (e.g. defendants who do not make early settlement offers that trigger the proposal, or who make very low offers, and plaintiffs� lawyers who return the favor by recommending that their clients accept low settlement offers later on). Linkage between contingent fees and defendants� settlement posture also makes the proposal politically vulnerable because it injects defendants into plaintiffs� relationships with their lawyers (opponents will run political ads saying that �when you are injured, under this proposal the other driver�s insurance company, not you, gets to decide how much your lawyer gets paid�). This bolsters claims of those who argue that contingent-fee reform is really about helping defendants rather than helping plaintiffs avoid paying too much to their lawyers.

A few more general observations:

* Contingent fee abuse could be pervasive throughout the plaintiffs� bar, as Professor Brickman argues, or, as I believe, a serious problem that arises in a relatively small portion of cases and that unfairly inflates the incomes of a relatively small portion of plaintiffs� lawyers. This debate largely turns on statistics, and I have seen statistics that support each side. I should only point out that most statistics on median incomes of plaintiffs� lawyers (which I cite in my report for the Manhattan Institute on the New American Rule) do not reveal figures that are particularly shocking or that plaintiffs� lawyers as a whole are overpaid for the role they perform in our civil justice system. It is, however, telling that some statistics (also cited in my report) show mean incomes for plaintiffs� lawyers that are significantly higher than the median, meaning that there is a lot of money being made by relatively few lawyers on the high end. Some of this mean/median differential is because some very good lawyers earn a lot (e.g. Corboy & Demetrio), but the mean is also driven up when contingent fees are excessive in a small but significant number of cases, unfairly enriching some lawyers (e.g. Dowd). Regardless of our disagreement over the breadth of the contingent fee abuse problem, Professor Brickman and I agree about its depth and the injury that it does to the reputation of the legal profession.

* If most plaintiffs� lawyers do in fact make relatively modest incomes, or legislators and voters perceive most plaintiffs� lawyers to make relatively modest incomes, contingent fee reform will be difficult to accomplish if cast as part of a general attack on plaintiffs� lawyers� fees. This is particularly true in today�s environment where corporate lawyers, not plaintiffs� lawyers, have been characterized as enriching themselves at the public�s expense, and plaintiffs� lawyers argue that their work is necessary to protect the public. Whether true or not, such arguments have political resonance. My own view is that contingent fee reform does not require a general attack on levels of compensation for the plaintiffs� bar, and if carefully implemented would not drive down the annual incomes of most plaintiffs� lawyers. The target is instead a select one: unfair practices that allow some lawyers to take too much money from their clients in some cases. These relatively few lawyers who are unjustly enriched may be politically powerful if they also make large campaign contributions, but they are not necessarily popular. Once it is understood that contingent fee reform would benefit not only plaintiffs but also most lawyers by improving the reputation of their profession, opposition to reform should be easier to overcome.

* Professor Brickman points to a number of factors that may impede fair pricing of contingent fees, but in my view the most salient factor is information asymmetry. Plaintiffs� lawyers know more than their clients do about the admittedly uncertain factors that determine the reasonableness of a contingent fee: the size of a likely judgment or settlement if a case is successful, the chances of success and the amount of lawyer time likely to be required. The New American Rule addresses this information asymmetry by requiring lawyers to disclose an hourly rate above which their fee will not go. This rule applies regardless of whether the defendant offers to settle the case, keeping the defendant away from the outcome of lawyer-client fee negotiations. The proposal instead allows the plaintiff to decide, after hearing how high the lawyer�s fee could go on a per hour basis, whether to hire that lawyer or a different one. Finally, the proposal cannot possibly be characterized as doing away with contingent fees, except of course those charged by a lawyer who wants fees that would translate into an extraordinarily high amount of money per hour and cannot justify this amount to his client. That lawyer should not be representing the client to begin with.

Once again, the early offer proposal is in many ways a good one, despite its disadvantages. The New American Rule, however, is less complex in its procedural aspects, is not contingent on discovery, involves bilateral negotiations between the plaintiff and the lawyer alone rather than triggering mechanisms controlled by the defendant, and limits contingent fees in all cases, not just those in which a settlement offer is made. For these reasons, the New American Rule also is worthy of serious consideration.

A brief rejoinder

August 26, 2004 11:39 AM

I think Professor Painter and I have covered most of the salient points. I offer only a brief rejoinder to three of Professor Painter�s arguments in his latest response.

1. Professor Painter identifies as a defect of the �early offer� proposal that alleged responsible parties (�ARPs�) may make �very low [settlement] offers.� The fact is true but not the characterization. The �early offer� proposal has a built-in self-effectuating mechanism to discourage defendants from gaming the system by making a �very low� settlement offer. If an ARP makes a derisorily low settlement offer in order to reduce the fee that the plaintiff lawyer will ultimately receive, this will deprive the ARP of the financial benefits made available by the proposal. Self-interest dictates that when ARPs believe that they will ultimately have to compensate the plaintiff, they will make settlement offers that are calculated to be sufficient (but not more) to deprive the plaintiff�s attorney of the incentive to go forward and continue the litigation through trial if necessary. If the ARP fails to make a sufficient early offer and it is turned down, it loses most of the benefits that the �early offer� proposal offers, including substantial savings on medical care cost �build up� and defense costs. To be sure, the sufficiency incentive already exists in tort litigation where the dominant determinant of whether a plaintiff will accept a settlement offer is usually plaintiff lawyer�s self-interest. What the �early offer� proposal does is move up the timing of such a settlement offer from much later to near the very beginning of the claiming process because of the benefits that an ARP can realize for doing so. The effect is to significantly reduce transaction costs.

2. Professor Painter again cites to statistics on tort lawyers� income which he says belies the level of windfall fees that I indicate are commonplace. I have devoted an entire article to the subject. See Effectively Hourly Rates of Contingency Fee Lawyers: Competing Data And Non-Competitive Fees, 81 Wash. U.L.Q. 653 (2003). In that article, I conclude that the leading data on tort lawyers� earnings ranges from the trivial to the unreliable to the unrepresentative. The Manhattan Institute has published a study, Trial Lawyers, Inc., concluding that tort lawyers� gross $40 billion a year in revenues. A significant percentage of this revenue is in the form of windfall fees as I have explained previously. Effective hourly rates of tort lawyers range from $350 in auto tort claiming to multiples of that in product liability, medical malpractice and other specialty areas. A top echelon of tort lawyers commands effective hourly rates of $5,000 - $10,000.

3. With regard to the political context, it is interesting to note that in survey after survey, the American public, by wide margins, believes that lawyers charge too much. If the political merits of the respective proposals are compared, there is compelling reason to believe that a proposal that seeks to curb unethical price gouging by lawyers would be overwhelming endorsed by the electorate.

A final note. The �early offer� proposal has been widely reported in the media and is discussed in most legal ethics casebooks. Professor Painter�s New American Rule is also worthy of serious consideration and hopefully will also come to gain such attention.

I'm very happy to welcome our friend Alex Tabarrok back to Point of Law this week to talk with me a bit about his and Eric Helland's empirical research on contingency fees. Our readers may remember Alex's interesting discussion last year with David Rottman of the National Center on State Courts on judicial selection and election mechanisms.

Alex and Eric's work in that area, along with invaluable work looking at juries, is summarized nicely in a new book, Judge and Jury: American Tort Law on Trial. I highly recommend this book for all our readers. It�s accessible to a lay audience without extensive legal training or a deep econometric background, and it covers some of the best recent empirical work done in the area of tort law. In a field where good data are sparse and empirical evidence is sometimes lacking (though it's far more plentiful than the plaintiffs' bar likes to pretend), Alex and Eric have led a new batch of empirical scholars who creatively use what data is out there to reach some very interesting conclusions.

While Alex and I largely agree on the need for tort reform�-both think that litigation in America is significantly more costly and more inefficient than it could be�-we part ways in our enthusiasm for the contingent fee. Based on their empirical findings as well as their preference for permitting private contracts, Alex and Eric give "two cheers" for contingency fees in the final chapter of their book. (Readers who have yet to buy the full book and want an accessible version of their paper should look at the AEI Liability Project's publication here.)

Why Contingency Fees?

At the outset, let me stipulate that I do not support wholesale elimination of the contingency fee. As Alex and Eric ably argue, there are some valid reasons for permitting plaintiffs to contractually shift the financing and risk of their case to their attorneys. Eliminating the contingency fee entirely would either lead to the evolution of less efficient financing alternatives or reduced access to courts for less sophisticated and financially well-off claimants, neither of which is a very defensible option.

Why do contingency fees make sense? Alex and Eric give the pro-contingency rationale in more detail, but in a nutshell, contingency fees are a mechanism for reducing information asymmetries and liquidity constraints. Taking the latter, simpler point first, a lot of individuals in the society are unable to afford to pay lawyers' high fees by the hour, but they may well have valid legal claims. Having legal costs assumed by the plaintiffs' attorneys in exchange for a piece of the ultimate verdict or settlement is one way in which such individuals can fund their prospective litigation.

The other major problem for most plaintiffs�-at least individuals without legal training and resources�-is that they lack the ability to value their potential case as well as the ability to monitor their lawyers' pursuit of the case. The hourly fee arrangement places the burden for such unsophisticated plaintiffs on the ethical scruples of their attorneys. An unethical lawyer might agree to take a case without merit, rack up legal fees, and later drop the case, profiting from the unknowing plaintiff's lack of sophistication. Or, the lawyer might encourage the plaintiff to go on litigating in the face of a perfectly good settlement offer, because the lawyer keeps getting paid regardless of whether it's worth the additional expense from the plaintiffs' perspective.

Big companies or sophisticated parties can more effectively monitor their lawyers, but the threat of lawyers bilking their run-of-the-mill clients is very real. This hypothesis�-that with contingency fee limitations, you see lawyers taking on more bad cases and taking longer to settle them, on hourly fee arrangements�-underlies Alex and Eric's interpretation of their findings, which I'll leave to Alex to explain in more detail. I'll get into my specific objections to that interpretation tomorrow, but for now I want to lay out the basic economic case for limiting contingency fees.

Why Limit Contingency Fees?

In essence, the contingency fee restrictions Alex and Eric examine are of the following sort: the state mandates a fee percentage above which attorneys cannot charge. Some states have outright limitations on fees for all cases, some for only certain types of cases (e.g., medical malpractice), and some have fee limits that kick in, or shrink, as payouts get larger. I think that there's a strong case that such contingency fee limits do make some theoretical sense.

Using the simplifying assumption that all cases go to trial (of course, only a fraction do, but settled cases are going to be a function of expected trial outcomes), the plaintiffs' lawyer on a contingency fee approaches the case with the following expected return:

EV = F*Pr*D � C

Where

EV = expected value of case to plaintiffs� attorney,
F = contingency fee ratio,
Pr = probability of success at trial,
D = expected damages at trial, and
C = cost of pursuing and trying case.

Under these assumptions, then, the lawyer takes any case in which his expected return is positive, i.e.,

F*Pr*D > C

What becomes immediately apparent is that under a contingency fee arrangement, plaintiffs' lawyers accept not only cases that are likely to succeed but long-shot cases with high potential damage payouts. A risk-neutral plaintiffs' lawyer with a diversified portfolio of cases is just as happy to take a case with a 1 percent chance of paying out $20 million as a case with an 80 percent chance of paying out $250,000.

But as a society, do we really want to be flooded with high-dollar, low-probability claims? The contingency fee creates a very real incentive to play the "lawsuit lottery"�a lottery with positive expected returns for the plaintiff and client, but substantial social costs. At a very basic level, the contingency cap, while a crude mechanism, ameliorates this problem. If a lawyer's take in a case goes down�-especially for high-dollar cases-�the incentive to take shoot-the-moon cases falls proportionately.

In chapter 2 of The Litigation Explosion, my colleague Walter Olson compares the contingency fee to analogous arrangements we find odious: traffic cops having an incentive to give more tickets (through, e.g., monthly "quotas"), IRS agents being given financial incentives to find more problematic tax returns, and soldiers in conquering armies getting to keep some of the "spoils" of the conquered peoples. What's crucial to recognize in each of these examples is that they involve using the heavy hand of government force to redistribute wealth�-which is no less true of tort lawyers and their clients. They may reach private arrangements, but make no mistake that plaintiffs and their lawyers are using the government's monopoly over legitimate force to take money from unwilling parties.

In some instances, is this redistribution through tort law warranted? Of course, just as in some instances traffic tickets, IRS audits and prosecutions, and military actions are warranted. But those of us committed to limited government should be ever watchful for keeping the scope of such government interventions appropriate.

I have lots more to say. Specifically, my simplifying equation for how a plaintiffs' lawyer approaches a case ignores two very basic points: (1) that the probability of success, and likely damages, are a range rather than a fixed level for any case; and (2) that the such ranges�-as well as legal costs-�are not constant across the entire time litigation is pursued. Relaxing those core assumptions forms the heart of my critique of the conclusions you and Eric draw from your results. I'll get to that tomorrow.

Until then,
Jim

The Contingent Fee Distraction

April 10, 2006 11:47 AM

Jim, we agree about a lot in Judge and Jury: American Tort law on Trial but agreement is boring so I'm glad that we will focus on one area of disagreement, contingent fees (or, as you say, contingency fees. See, we can't even agree on what to call them!)

Briefly, I think that contingent fees are not a driving force behind problems in the tort system and capping them could have serious unintended consequences.

First, contingent fees have been around for well over a hundred years - thus they cannot be responsible for problems in the tort system that have developed over the past several decades.

Second, tort reformers are usually respectful of markets and private contracts. Indeed, they rightly point to the death of contract (some say it was murder!) as a cause of current problems. Yet when it comes to private contracting between a lawyer and her client, regulation is now in order. That inconsistency bothers me.

If a lawyer and her client want to contract in Lira what business is it of the state to interfere? If the lawyer and client agree on an incentive plan, why should that be regulated? Do we want to regulate contingent fees in other areas? A money-back guarantee, for example, is a contingent fee - you pay only if the product is a winner. A tip is a contingent fee - you pay only if the service was good.

True, not all contracts should be respected - we don't enforce contracts against the public interest - nevertheless, my spider-sense starts to tingle whenever reformers of any stripe try to abrogate private contracting.

It should now be clear that I am not against regulating fees, contingent or otherwise, in class action suits. In class action suits there is no private contract between a lawyer and client. It's all lawyer and that is a recipe for abuse. The type of contingent fee restrictions that have been passed and that Helland and I analyze in Judge and Jury, however, are not restricted to class action cases.

Contingent fees have some good qualities, some of which you have already mentioned. Contingent fees allow injured but cash-poor individuals access to the legal system, they spread risk from plaintiffs to lawyers, and they act as an incentive system for lawyers who would otherwise be difficult for clients to monitor.

It's the last point which explains why restrictions on contingent fees can actually increase the number of frivolous lawsuits. A lawyer paid by the hour is paid regardless of whether the case has merit. But a lawyer paid by contingent fee is paid only if the legal system agrees that the case has merit. As a result, lawyers paid by contingent fee will screen cases more closely than those who are paid by the hour - thus doing the legal system a favor. More on that later.

You are correct that a lawyer on contingent fee may have an incentive to take on some cases that have a low probability of winning but high damages if they do win. But the lawyer's client has exactly the same incentives (indeed, given a contingent fee of 1/3rd, twice as strong incentives!) Thus the argument must be that these cases will go to court with contingent fees but not without them. But why would this happen? Only because clients wouldn't have the cash to take these cases to court - thus we are asking liquidity constraints to do our tort reform for us. I don't like tort reform by the back door.

Not all low-probability, high damages cases lack merit. Nor will capping contingent fees prevent all low-probability, high-damages cases from accessing the courts - only the low-probability, high damages cases where the client can't fund the case in some other way will be stopped. Can we be so sure that clients with little cash are the real danger?

Capping contingent fees is a blunt weapon and I am not at all confident that it hits the right people or hits enough of them to justify the hits that others must take.

Tort reform should aim more directly at the true source of problems in our current system namely judges, juries, and the law.

Alex,

Your comments are typically thoughtful and lucid. I have so much to say, so I'm going to start with a very basic reaction to your post. I'll then post later today with more detailed thoughts about the empirical evidence you and Eric put together on this issue.

First, again, I'd like to emphasize where we do agree: that fee regulation is not inappropriate for class actions. That concession is actually a major step in the right direction. Class actions are a particular problem in that low probability claims very regularly have fairly high expected returns for the plaintiffs' attorneys working on a contingency fee merely due to the size of the class. As you note, in no way can we say that class members are actually able to negotiate at arms' length for fee contracts, since they're automatically in the class unless they choose to opt out. The lawyers drive the process. Securities class action lawyer Bill Lerach has noted that his legal practice is "the best" since it has "no clients."

I wonder if you'd also extend that position to mass tort claims? There, plaintiffs aren't automatically in the class, so you could say there's (in theory) some fee negotiation. But plaintiffs' attorneys advertise aggressively to pull together thousands of claims. Often, such claims wind up being manufactured. Courts are flooded. Again, the contingent fee is the primary driver in these cases because the aggregate nature of the claims makes speculative cases much more valuable. Television, internet, and radio advertisements trolling for clients wouldn't be nearly so effective if the clients weren't told "you pay nothing unless you win."

Taking television advertising as an entry point, let's look at why I don't buy your argument that contingency fees "have been around for well over a hundred years -- thus they cannot be responsible for problems in the tort system that have developed over the past several decades." Yes, contingent fees -- like the "American rule," like civil juries, like elected judges, like so many other features of American law -- are deeply rooted. But it simply does not follow that such entrenched features of our legal system are not related to the litigation explosion merely because they've been around a long time; it only follows that such features are not solely responsible. 100 years ago, there were no aggregate claims like today's class actions and mass torts; tort claims were much more restricted by substance and procedure (indeed, there wasn't any products liability law to speak of -- see Richard Epstein's discussion of the evolution of products liability law here); federal courts weren't bound to apply state law under Erie v. Tompkins; transportation costs were much higher (making forum shopping much more difficult); there was no television, radio, and internet; and attorneys were not permitted to advertise.

The real question is whether any of these changes, interacting with deeply rooted features of American law (like the contingency fee, no fee-shifting, elected judges, civil juries, federalism, etc.), have contributed to the increase in litigation costs. My claim is yes. And it's not because the changes are necessarily all bad; rather, we may need to look at the long-standing rules as well. For instance, a free speech purist like myself agrees with the Supreme Court that attorneys have the right to advertise commercially. But there's no question that such a right changes attorney behavior. When attorneys can aggregate mass tort claims on a contingent fee, the payoffs are huge. Folks who may or may not be sick are happy to sign up when there are "no fees unless we win."

Private Contracts and Contingent Fees

I, like you, am generally a big fan of private contracting. But "spider-sense" isn't infallible, at least in those of us who can't climb walls. So, here too, I want to take issue with a couple of points.

I think it's important to remember that contingency plaintiffs, in general, are not only liquidity constrained but relatively unsophisticated. Yes, that's one reason contingency fees can be useful: when lawyers are only paid if they win, it pays them to be careful about the cases they take and to be cautious about rejecting settlement and proceeding to trial. But the "screening function" in which the lawyer evaluates the merits of the case cuts both ways. Because an unsophisticated plaintiff is unable to evaluate the merits of his case, he has no idea if, for instance, it's a "slam dunk" that the insurance company is certain to settle for the policy limit. The lawyer does typically know that and is happy to take the case, on a standard contingency fee of 33 percent, to score a windfall at the plaintiff's expense. This potential for abuse is at the root of the contingency fee reforms that are focused on plaintiff protection -- admittedly different from the "blunt instrument" caps we're discussing. (Yes, I agree with you that percentile fee caps are a crude reform measure, as I said before. So are damage caps. But that doesn't mean they can't be effective.)

What we have when it comes to contingency fees is a market failure. Unsophisticated plaintiffs can't value their cases and therefore can't bargain with their attorneys over price. They can't shop on price -- they're too unsophisticated to know a good attorney from a bad one, and might indeed be suspicious that a "cheaper" attorney isn't as good, whether that's the case or not. Thus, as Lester Brickman has shown, there isn't really any price competition over contingency fees. Now I disagree with Lester's claim that the lack of price competition is likely due to collusion; as those of us with training in economics are well aware, collusive arrangements are very difficult to maintain and would be virtually impossible to maintain for a group as broad and varied as contingency fee lawyers. It's the very fact that plaintiffs in contingency fee cases have too little information and understanding to shop and negotiate on price that leads contingency fees to be set at a standard level.

So, there are ethical reasons to question the contingency fee, from the plaintiff's perspective. Unlike Professor Brickman, I tend to approach most of these questions from a law and economics rather than an ethical perspective, but the above-normal windfall from noncompetitively priced contingency fees almost certainly helps drive excess litigation.

Why is that? Well, let's start with Lester's seminal study concluding that contingency fee lawyers, on average, make above normal profits relative to their hourly brethren, even after adjusting for risk. I view that paper similarly to yours and Eric's on contingency fees: very useful work, but the wrong analysis. (I know I haven't yet laid out in detail why I think that is for your paper, but I will in my next post, as I said at the outset. I just want to get the main theoretical debate on the table first.) I find it hard to believe that contingency fee plaintiffs' lawyers, on average, make a risk-adjusted return higher than hourly attorneys, because if that were the case, hourly attorneys would switch to contingency work.

And that, I think, is just what has happened. Lester's study, importantly, looks at the top quartile of contingency fee lawyers. Some of those lawyers are indeed getting paid handsomely for risk, luck, or performance. Others are exploiting the information imbalance between plaintiffs and lawyers to get extra cash based on the absence of price competition over fees. But among the lawyers not in the top quartile, a lot are doing worse than hourly lawyers. They're often less skilled, in courtroom work, in preparation, in case screening, or even in advertising strategy. Still, they stick around chasing the big payoffs, at least as long as they can. The absence of price competition over contingency fees leads directly to more contingency fee lawyers -- and more lawsuits and cost to society.

Of course, the mere fact that there's a market failure need not imply a regulatory response. Far too often, those with too little respect for limited government ignore the cautions of public choice theory and the law of unintended consequences and rush to "correct" market imperfections with cures that are worse than the disease.

But so too is it the case that merely because we generally respect the law of contracts -- and indeed think that the substitution of the law of tort for that of contracts over time is a major underpinning of overlitigation -- we need accept every contractual arrangement. You admit as much in saying "we don't enforce contracts against the public interest." My argument is that contingent fee contracts, at least in some cases, can be just that, as I'll explain further in my next post.

Jim,

We both favor fee regulation where there is no bargaining between lawyer and client but we favor this for different reasons. I think fee regulation could modestly reduce some heavily padded lawyer fees. You think that fee regulation would substantively improve the tort system.

Movie stars also work on contingent fee (they get paid a share of the gross). Using your argument this causes them to go for films with a low probability of a high payoff � the potential blockbuster that alas is usually a dud. If we regulated fees so that movie stars could be paid only a straight salary that would certainly change how movies are financed. The studios (big law firms), for example, would become more important. A few actors (lawyers) would make less money but the average actor would make more (if you don�t give people a lottery ticket you have to increase their average salary). But would changing how actors are paid really improve the quality of the movies? I doubt it.

If you want better movies there�s only one solid method, attack the source of the problem, and raise the taste level of the public. If the public demands Armageddon that is what they will get. The same is true of improving the tort system � fiddling around with fees won�t do it � we need to address the substantive issues that give judges and juries a taste for bad law.

The unsophisticated plaintiff abused by the sharp lawyer is a classic rhetorical device. I�m sure it happens but there is a real tension in claiming on the one hand that contingent fees are so powerful they motivate lawyers to flood the courts with thousands of manufactured cases (and the plaintiffs are �happy to sign up�) and on the other hand argue that contingent fees are a form of plaintiff abuse.

If contingent fees really were a form of plaintiff abuse then we would expect sophisticated plaintiffs not to use contingent fees but in fact both the rich and poor, corporations and individuals, repeat players and one-time suers use contingent fees. In fact the trend today is to structure defense contracts on a contingent basis.

I agree that Lester Brickman has done very interesting work on contingent fees but, as you note, it is hard to believe his theory that there is collusion in the market for lawyers.

Brickman is also wrong about some of the facts. He likes to say, for example, that the return to contingent fee lawyers has increased by 1400 percent since 1960. As I showed in my paper �The Problem of Contingent Fees for Waiters� (The Green Bag, Summer 2005) this is implausible.

Brickman does not calculate lawyer income and its growth directly but reasons that �increases in average verdicts, adjusted for inflation, translate into proportionately higher annual incomes.�

A growth rate of 1400 percent since 1960, however, appears to be inconsistent with what we know about lawyer income today. The Bureau of Labor Statistics estimates median lawyer income in 2002 of $90,290. If lawyer income had grown by 1400 percent since 1960 this would imply a real ($2002) income in 1960 of just $6019. But GDP per-capita in 1960 was $15,075. Thus Brickman�s growth estimate implies (implausibly) that lawyers in 1960 were earning substantially less than the average person.

In contrast, Wolff (1976) estimated that income for �Deans, Lawyers, and Judges� in 1960 was $56,680 (in $2002 dollars) nearly ten times the figure implied by Brickman�s calculation. Using Wolff�s more realistic estimate I calculate that real income for lawyers has increased by 59 percent since 1960. Substantial, but a far cry from 1400 percent.

Let me end this part of our debate by quoting your wise comment:

Far too often, those with too little respect for limited government ignore the cautions of public choice theory and the law of unintended consequences and rush to "correct" market imperfections with cures that are worse than the disease.

Alex,

My intention today was to get fully into my critique of your article with Eric Helland, but after your most recent post, I again wanted to clarify some theoretical issues. To keep this entry at a readable length, I'm posting it first. I'll follow up tonight or in the morning with an analysis of your empirical findings.

In your most recent post, you draw an analogy between contingency fee arrangements and arrangements in which "superstar" actors and actresses -- like Julia Roberts -- get a piece of the eventual revenues from their movies. You then suggest that such forms of actor compensation are a major reason why we have bad, dumbed down "blockbuster" movies -- and argue that nevertheless we shouldn't regulate actors' movie contracts (that's an easy point of agreement!).

I don't think your analogy works on a number of levels. Studios, not actors, are the main drivers behind the "blockbuster" business model. They may be coming into question of late, but summer blockbusters have been the industry's staple since Jaws and Star Wars hit it big some 30 years ago. The blockbuster movie model predated actors' ability to get a slice of movie revenues, not the other way around.

Now, a limited group of actors has proven its ability to "draw" audiences based on reputation alone, and has thus gathered a piece of the pie (not on a true "contingency" basis but rather on top of a multimillion dollar guaranteed fee). But this group is a very limited one, and includes only the "top draw" actors like Tom Cruise, Julia Roberts, Reese Witherspoon, Will Smith, and a handful or two others. These artists get a stake in blockbuster movies' outcomes because they have negotiating leverage based on their unique human capital, a proven brand name that virtually guarantees ticket sales. But the run-of-the-mill actor doesn't get a percentage of the movie's profit. The "superstar actor" model, then, is very different from what we observe with contingency fee arrangements for lawyers, in which the vast majority of plaintiffs' lawyers in personal injury/ products liability/ medical malpractice cases work on a contingency fee -- at essentially the same standard 33% level.

Studios, unlike the vast majority of contingency fee plaintiffs, have no liquidity constraints when it comes to paying actors. They may get some improved performance out of superstar actors when they give them a piece of the pie, by inducing them to be more enthusiastic about promotional movie junkets. But that incentive effect is much more analogous to incentives offered to top corporate executives in the form of stock options than lawyer contingency fees; and with the exception of employers trying to wring union concessions via ESOP plans, stock options only go to key personnel.

So when it comes to clever but misleading rhetorical devices, I think the "actor superstar" analogy fits the bill. And, most importantly, it conveniently sidesteps the crucial difference between employee incentive arrangements in the free market and contingency fee arrangements in the legal market: litigation involves using government force to redistribute wealth, whereas movie sales involve willing consumers. If I pay for a movie, then I presumably value the experience more than the ticket price. I may sometimes be disappointed, ex post, just as I might be for a meal, a bottle of wine, or a basketball game. But going in, I expect to prefer the experience to the cash. The social planning instinct that underlies wanting "better movies" through contract regulations is of course silly to those of us with libertarian instincts -- and after all, in this day and age we can watch classic movies via Netflix or AMC; visit art house cinemas; or take in opera, theater, and the like.

But litigation is a different beast entirely. What the plaintiff and lawyer are contracting for is to take money from someone else. While it isn't quite the same as Tony Soprano paying a henchman to shake down a local business owner for "protection," it isn't always so different. Yes, in an ideal world, our legal system would be the perfect black box that only spit out awards to deserving plaintiffs, quickly and at low cost. But it isn't.

There are a couple key points that bear emphasis:

First, litigation costs society. Lawsuits are not just market transactions in which two parties both benefit, helping society apart from any negative externalities. Plaintiffs may be perfectly happy to give up one-third of their ultimate winnings to obtain financing and reduce attorney-client agency costs. But let's not forget that defendants and companies insuring defendants end up paying over one-third of all litigation costs. Moreover, market incentives are significantly distorted by the prospects of litigation. If you believe, a la Calabresi, that the courts are on average creating distortions that drive decision makers in the economy to reduce true "accidents" or social costs, at an efficient level, you're just fine with that (as long as the social costs reduced exceed the dead weight loss of the system). But if you agree with Peter Huber that such distortions are actually welfare and safety reducing (as the recent study by Paul Rubin and Joanna Shepherd tends to suggest), you've got an even bigger reason to worry about litigation's effects on our society.

Second, contingency fees increase the quantity and decrease the quality of litigation. I've suggested a couple of mechanisms through which this effect happens, which you consider to be in "real tension." Well, let's see. First of all, most contingency fee plaintiffs are unsophisticated, creating a market failure because there's no price competition over the fee. Apart from the Brickman studies previously cited, I think that the fact that fee percentages are not varied based on case risk (or in most instances attorney quality) is extremely evident to anyone with much familiarity with the legal system. As Walter Olson pointed out on Overlawyered yesterday, David Giacolone recently wrote extensively about this market failure on his blog, in much more detail than I have here. (I don't agree with everything he says, but it's very interesting.) In my view, the fact that there are a lot of cases in which attorneys on a contingency fee get high returns for little risk leads a lot more attorneys -- filing a lot more lawsuits, often dubious -- to enter the field. The latter attorneys do worse than their hourly fee brethren, but the end result is more lawyering, and more money for lawyers on both sides.

The second mechanism I suggest to explain how contingency fees drive up the quantity and reduce the quality of litigation is the very fact that contingency fee lawyers have a big incentive to file low probability, high value cases because they have a stake in the outcome. In your initial post you attacked this line of thinking in a couple of ways. First, you note that "the lawyer's client has exactly the same incentives (indeed, given a contingent fee of 1/3rd, twice as strong incentives!)." But that isn't really very compelling to me: remember, the plaintiff, just like Tony Soprano, may have lots of incentive to shake down a business, but that doesn't mean that society is better off if he does. It doesn't really trouble me that some plaintiffs who aren't liquidity constrained (and who are capable of assessing and monitoring their cases) might still find ways to file low probability cases. To begin with, the contingency fee from the outset was a mechanism for giving the poor access to the legal system. That the non-liquidity-constrained might prefer it, too -- because it reduces monitoring costs but also because it gives attorneys incentives to cut ethical corners -- doesn't in my view add much to the debate. And it isn't really in tension with the fact that some plaintiffs are abused, either: the corporations and rich folks who want contingency fee lawyers are almost certainly better able to protect themselves from their own attorneys' potential abuse.

Your second argument against my point that contingency fees encourage "low probability, high value" lawsuits is that "[n]ot all low-probability, high damages cases lack merit." Well, sometimes that's true (though I'd say that on average we witness the opposite effect -- that cases that really lack merit are high probability due to bad laws or rules, or judges' or juries' prejudices). But you wouldn't really argue that in our legal system good cases are on average very unlikely to win, would you? Even accounting for selection bias, that's hard to believe when over 50 percent of civil jury trials result in a plaintiff verdict. In reality, most low probability cases are low probability for a reason: the plaintiff shouldn't win (but might given a bad judge or jury). Recognizing that litigation costs society due to huge administrative costs and substantial distorting effects, as I explained in point 1, we really don't want those cases in court.

Finally, the fact that contingency fees create a direct and very powerful incentive for attorneys to bend the rules is a crucial point. Attorneys having a stake in the outcome gives them a strong inducement to generate fraudulent claims, fabricate evidence, and suborn perjury. Hourly fee attorneys are zealous advocates, for sure, but without a stake in the outcome of the case, their advocacy typically has real limits. If you don't believe that the contingency fee has an extremely powerful effect on attorneys trolling for clients, consider what Ted Frank reported on Overlawyered a couple weeks back: "Six of the eight most expensive Google AdSense search terms are for attorneys (the other two are for mortgage and loan refinancing), with 'mesothelioma lawyers' topping the charts at $54.33." And if you don't think that contingency fee lawyers haven't been manufacturing false claims on a grand scale, take a look at Janis Graham Jack's findings in the silicosis litigation (along with our commentaries), or what Judge Harvey Bartle found in the fen-phen litigation (summarized nicely in a recent Forbes article). I haven't heard of any silicosis or fen-phen lawyers working on hourly fees. But one thing's for sure: these cases are extremely costly to society.

In sum, I think the contingency fee is a primary cause of the litigation explosion. The contingency fee caps you and Eric study are a crude mechanism to be sure, but their problem isn't that they infringe on the right to contract but that they don't go far enough. Your empirical analysis, as you interpret it, directly undermines the arguments I've made above: you conclude that contingency fees on average improve case quality and lower the time it takes cases to settle -- presumably increasing the social welfare. I think you misinterpret your data, though, as I'll explain in full later tonight or in the morning.

Drop by Drop

April 13, 2006 3:19 PM

Alex,

OK, at long last I want to start getting at the substantive meat of your article with Eric Helland. Your article makes two key findings that lead you to conclude that in states with contingency fee caps, plaintiffs' lawyers switch to hourly fees and exploit their clients:


  1. You observe that in states with contingency fee caps, lawyers are more likely to drop cases they've filed; you interpret this finding as evidence that in those states more plaintiffs are suing using hourly fees, and -- being unsophisticated -- are duped by their lawyers into filing bad cases.

  2. You observe that in states with contingency fee caps the average time it takes a case to settle is longer; again, you interpret that finding as evidence that those states have more suits filed using an hourly fee, in which lawyers are stretching out their cases to rack up bills on their unwitting clients.

In this post, I'll set out my initial objection to your theory itself and offer an alternative explanation for your first result. I'll get to your second finding in my next posting.

In my view, your results are consistent with your theory that contingency fee caps cause lawyers to switch to more hourly work and thereby rip off their clients; but your theory is not the only -- or the most persuasive -- explanation of your results. The big problem I have with your theory (and its application to your empirical results) is that it doesn't match reality. Yes, some contingency fee litigation involves businesses that would switch to hourly rates on the margin when fee caps are imposed. But the overwhelming majority of contingency fee plaintiff cases exist in the American system solely due to the contingency fee itself; by definition, the clients lack sufficient liquidity and sophistication to hire hourly lawyers. Lester Brickman raised this essential critique in an AEI conference on your paper in 2004:

Alex Tabarrok's paper has several false assumptions. His assumption that contingency fee caps are a surrogate for hourly rates does not reflect the real world. Attorneys do not combine hourly rates with contingency fees -- they do in commercial litigation, but not in tort cases. Instead, caps are a practical way of lowering the effective hourly rate of return to attorneys, thereby reducing the overall volume of litigation.

Contrary to Tabarrok's assertion that there is no reason to think fee caps will decrease effective hourly compensation, there is no reason not to think that caps will decrease effective hourly compensation. Fee caps will move the threshold of risk such that attorneys working on contingency fees will take lower-risk, lower-return cases and pass on the higher risk cases of questionable merit.

In reaching his conclusions, Tabarrok assumes that a variety of fee agreements are available to plaintiffs, including agreements that waive fees. Empirically, the market for legal fees is not competitive, and so the kinds of flexible agreements which the paper presumes possible simply are not observed.

Tabbarok's critique of fee caps rests heavily on unwarranted assumptions. If society deems it a worthy goal, fee caps will reduce the volume of litigation by reducing the effective compensation to attorneys.


I think Lester's right here. You basically pooh-pooh the point, arguing that it's "trivial economics": "Imagine that tips for waiters were banned. What would happen to wages? They would increase. No big surprise but apply the same idea to lawyer contingent fees and we get lots of objections."

But I think what you're going after here is a straw man. Of course substitution effects exist. Of course contingency fee lawyers would shift on the margin to hourly work if caps were imposed. The real question, though, is whether that hourly work would involve the same type of work the lawyers performed with the contingent fee. And on that question, I'd say no; rather, I'd say that on the margin you'd have fewer of the products liability, medical malpractice, and personal injury cases the contingency fee reform was designed to reduce. Lawyers couldn't afford to pursue as many of those cases, of the shoot-the-moon variety, with contingency fee caps. Nor would they have those very same plaintiffs lining up to pay them hourly rates for the same types of cases. I think what you'd see is lawyers substituting hourly work of a different variety -- trusts and estates, family law, real estate, transactional. The increase in labor supply in those fields of law would push hourly rates down over time, and ultimately on the margin induce some lawyers to substitute nonlegal for legal work, in essence giving up the sunk cost that was their legal education and experience.

If you can come up with contrary evidence here -- even anecdotal -- I'd love to hear it. Can you show that there are a lot of medical malpractice cases being filed using hourly fees in states with contingency fee caps, like New York, Illinois, and California? Since that supposition is the linchpin of your theory, it would be nice to see even a quantum of evidence that lawyers are behaving consistent with your theory in the real world.

With that said, I'll move on to interpret your analysis of case drops.

Dropping the Ball: An Alternative Interpretation of Higher Case Drop Rates in States with Contingency Fee Caps

Chapter 5 of Judge and Jury, and the AEI paper on which it's based, are laymen's versions of a 2003 article you and Eric published in the Journal of Law, Economics, and Organization, available at 19 J.L. Econ. & Org. 517 ($). Your first major observation is that among medical malpractice cases filed in states in which contingency fees are capped, "18.3% of medical malpractice cases are dropped, but only 4.9% are dropped" in states without contingency fee caps. 19 J.L. Econ. & Org. at 531. You also look at what happened in the state of Florida before and after contingency fee caps were imposed and observe "a 15% increase in drops" after the caps were put in place.

I should note to our readers that your technical paper includes much more sophisticated analyses than the laymen's version in Judge and Jury. Specifically, you and Eric run two more sophisticated tests -- econometric regressions -- to see if the observed increase in drop rates still holds once you control for other factors. (Your methodology for analyzing your data across states is quite ingenious, I might add: you control for variation across states by observing differences between medical malpractice cases, in which fees are capped, and auto accident cases, in which they're not.) On one of your two cross-state tests, and on your Florida test, you find again that drop rates are significantly higher when contingency fee caps are in place.

Well, at first blush, this doesn't look too good for Copland's theory, does it? I mean, I hypothesized that by reducing the effective rate of return for attorneys who file low probability, high dollar claims, you'd improve overall case quality. On the surface, then, it doesn't make much sense that you'd see more dropped cases when states had caps on fees.

But let's step back a minute. As I noted in my first post, a rational plaintiffs' lawyer (risk neutral, with a diversified portfolio of cases) will accept a contingency fee case if and only if:

F*Pr*D > C


Where

F = contingency fee ratio,
Pr = probability of success at trial,
D = expected damages at trial, and
C = cost of pursuing and trying case.

As I noted then, however, it's crucial to realize that the probability of success at trial and expected damages at trial are best viewed as ranges, not certainties, and that in any event they are not constant over time. Herein, I think, lies the most plausible explanation of your findings.

Why is that? Well, the probability of a case's success, from the perspective of the plaintiff's lawyer, varies over time. Litigation involves various stages:


  1. Pleading. In the United States today, the dominant rule is "notice pleading," in which "the plaintiff is required to state in their initial complaint only a short and plain statement of their cause of action. The idea is that a plaintiff and their attorney who have a reasonable but not perfect case can file a complaint first, put the other side on notice of the lawsuit, and then strengthen their case by compelling the defendant to produce evidence during the discovery phase."

  2. Discovery. Here the parties exchange information in "the pre-trial phase in a lawsuit in which each party through the law of civil procedure can request documents and other evidence from other parties or can compel the production of evidence by using a subpoena or through other discovery devices, such as requests for production and depositions. In American law, discovery is wide-ranging and can involve any material which is relevant to the case excepting information which is privileged or information which is the work product of the other side."

  3. Summary Judgment, Settlement, or Trial. The parties look for the judge to rule for one side or the other as a matter of law, they try to settle the case, and if all else fails they go to trial.


Viewing cases in this light -- how they actually occur in practice -- helps us to see what I think is actually going on here. Notice pleading is very, very cheap for the plaintiffs' lawyer. All a plaintiffs' lawyer has to do is pull up his template on Microsoft Word, alter a few names, dates, and phrases, and -- voila! -- notice is served. The plaintiffs' lawyer can then demand that the defendant produce documents, attend depositions, and the like.

And herein lies our answer. When a plaintiff first walks into the lawyers' office -- having seen that ad telling him he only need pay if he wins -- all the lawyer can observe is the plaintiff's level of injury. He cannot determine with any certainty whatsoever how likely he is to win at trial: that involves proving causation, i.e., that the plaintiff's injuries were caused by the doctor or hospital; and fault, i.e., that the doctor or hospital was negligent in causing those injuries. At the outset, when he signs up the plaintiff and assumes the minimal expense of filing the case, he only has his perception of the plaintiff's credibility to go on.

But once the defendant files a reply and discovery starts, it's a whole new game. Now the plaintiffs' lawyer starts to get a lot more information about what went on from the defendant's point of view. He starts to figure out just what the defense is probably going to look like at trial. So he readjusts his probability range, upwards or downwards, in a narrower band, based upon the information he has received.

Once we view the problem this way, it should come as little surprise that we see higher drop rates in cases in which we have contingency fee caps. At the outset, whether a state has contingency fee caps or not, lawyers sign up cases if the damages are sufficient that it might be worth their while to go to trial. Once the lawyers get more information as the legal process continues, they have a better estimate of the cases' real value. For any case, if the new expected value based on better information is below the expected cost to try the case, the lawyer drops the case. If the damages are really great, some low probability cases might still survive -- consistent with your strong empirical finding using the Florida data that cases with "permanent and grave" injuries were much less likely to be dropped. But for a significant subset of low probability cases, the expected value, once you have good information, is too low to justify pursuing when you have a cap on contingency fees but still worth taking a shot at if you have unlimited contingency fees. So you have more dropped cases in states with contingency fee caps precisely because the caps work as expected: once information emerges that refines the probability assessment for the plaintiffs' lawyer, he's more likely to drop the weaker cases.

In my interpretation of your results, then, contingency fee caps do work to eliminate bad claims. Because my interpretation is much more consistent with what we actually observe on the ground -- namely, that the relative merits of a case only emerge with any precision for the plaintiffs' lawyer after the claim is filed, and that we simply don't see lawyers pursuing med-mal cases on an hourly basis in states with contingency fee caps -- I think it's far more compelling than the explanation you give.

The legal profession is necessarily detail-oriented, and lawyers quite regularly miss the forest for the trees. But economics is necessarily a simplifying profession, and we must be vigilant to ensure that those simplifications make sense. When the assumptions of our economic models don't match reality, we can reach bad results.

Putting Two Theories to the Test

April 14, 2006 1:42 AM

Jim,

Your last post does a really impressive job of explaining both the theory and results of my Journal of Law and Economics paper (19 J.L. Econ. & Org. 517) with Eric Helland. Thanks!

Lawyers do find our proposition that restricting contingency fees will cause lawyers to turn towards hourly compensation difficult to accept. Part of the problem, however, is that Helland and I should have spelled out more clearly that by "hourly compensation" we simply mean non-contingent compensation. Hourly compensation doesn't have to be literal payment by the hour, instead it can be cost-sharing. In legal cases of all kinds there are costs (deposition costs, discovery costs, witness cost etc.) Lawyers paid on contingent fee sometimes bear these costs but they need not do so and there is quite a bit of flexibility in how these costs are assigned. (This is another reason, by the way, why the apparent inflexibility of the nominal contingency fee near 1/3rd can actually mask fairly flexible total payments.) Is it so hard to believe that when contingent fees are restricted there will be greater cost sharing? I don't think so.

Now let's turn to your alternative theory. Once again, I am impressed. Your comments are the most sophisticated that we have received on this paper. I found especially useful how you laid out the order of pleading, discovery, judgement, this all makes a lot of sense. Indeed, I agree that the theory you outline can explain the same results that we presented in our paper.

Thus, we have two theories that can explain the same set of results. What do we do now? I am tempted to say that at this stage a lawyer rests but an economist gets to work! The two theories have the same implication for drops but what else do they predict? Can we find some other testable proposition that the theories disagree upon?

Here is one answer. Our theory says that when contingent fees are restricted lawyers take on bum cases that they would not have taken on under contingent fees (these cases are then dropped as plaintiffs figure out that they are wasting their money). Our theory, therefore, implies that expected awards should decrease when contingent fees are restricted. More bum cases under c. fees thus lower expected awards (lawyer income doesn't necessarily fall since they get more hourly compensation but there are more bum cases so expected awards will be lower.)

Your theory says that when c. fees are restricted lawyers take on the same initial set of cases but then they drop weak cases that they would not have dropped under c. fees. Thus, your theory implies that expected awards should increase when contingent fees are restricted. That may surprise you but I think the reasoning is right. Since it's the weak cases which are being dropped the cases that remain must have higher expected value.

Ok, so what do we find? I went back to our data from Florida but instead of looking at drops I ran the same regression (with all the control variables) on awards. I had not previously run this regression or if I had I did not remember the results.

The regression says that after limits are put into place expected awards decrease by about 30-50 thousand dollars. The decrease is statistically significant.

Well, it's 2:30 in the morning so take the results with a grain of salt but as for me I think I can now sleep peacefully.

Time Warp

April 14, 2006 6:13 AM

Alex,

First of all, thank you for your gracious response to my last posting. This type of give-and-take is exactly what we hope for in our Point of Law featured discussions. And I must say I'm flattered by your reaction to my thoughts -- not only your words of praise but also you actions, i.e., that an economist of your stature would actually run a new regression at 2:30 in the morning to generate an immediate response.

Since we do have two competing theories, the answer is ultimately empirical. And I don't know that we'll be able to come to a clear answer this week; I expect that this discussion could have some useful offshoots going forward. I'm pulling together this response quickly myself at 6:30 in the morning -- before heading to the airport, and I'm not generally a morning person -- so don't hold me to this snapshot reaction as if I'd given the matter extended thought; but here's my immediate take on your new regression results.

I agree with you that your theory does match the assumption that after a contingency fee cap is imposed, expected awards would decrease -- given that you postulate that plaintiffs' lawyers switch to hourly fees and exploit their clients by milking them through more bad cases being filed and more billing, i.e., time spent, per case.

I'm not sure though that in my view of the world, I'd expect average awards over all cases to increase. For any given case picked up, I'd expect that to be true after the drop decision, holding attorney behavior and other legal rules constant. The first clause there -- "for any given case picked up" -- is important: because although the screening mechanisms for lawyers pre-discovery are crude (the very foundation of my theory vis-a-vis the drop results), they're not non-existent. Lawyers, or at least good lawyers, certainly know on average how likely various types of cases are to win or lose, and how big an award they're likely to generate, based on certain characteristics. Although you pick up a lot of these characteristics as independent variables in your Florida regression (i.e., the basic severity of injury, the type of practice, and the type of defendant), there are undoubtedly factors missing. And in any event, there are significant factors to consider for the Florida data that could be affecting those results.

Crucially, as you and Eric notice, there was a "rush to file" in Florida prior to the November 1985 filing deadline, before the contingency fee caps went into place. Florida lawyers certainly seemed to think that the fee caps made a difference. Given the structure of the fee caps in Florida, which only kick in at $1 million (more on that later), it's very likely that these cases rushed to the courthouse were of the really-high-dollar variety. Today, those would be infant birth defect cases and the like; I'm not sure what they be in Florida in 1985, but it wouldn't surprise me at all that attorneys' rush to file such cases before the fee caps kicked in would overwhelm the discovery screening effects.

Perhaps even more important than this rush to the courthouse effect, it's important to consider the other "confounding problem" you and Eric note about the Florida data:

Florida enacted another series of reforms in 1986, the first of which took effect in 1987. These reforms included limiting contingency fees in nonmedical malpractice cases, eliminating joint and several liability, capping non-economic damages, instituting a period payment schedule for large awards, implementing a collateral sources offset rule which reduces the amount of the award by payments from other sources, and capping punitive damages.


19 J.L. Econ. & Org. at 531-32. Given that damage caps certainly could effect award outcomes, these changes might be a significant explanatory factor for the fall in awards, assuming that the damage caps kicking in starting in 1987 would affect a larger subset of the cases filed in the 10 months after the November 1985 deadline than those filed in the 10 months before. Without your full dataset and without a lot of time to consider the issue -- I've only just reread your section with the Florida data specifics -- I'm going to stress again that this reaction is tentative. But I do think that there could be other reasons for a fall in average awards in the Florida dataset other than the contingency fee cap itself.

Time to Settlement: Theoretical Issues

Now I want to look at the second major empirical finding in your contingency fee paper, namely that in states with contingency fee caps, we see an increase in the time it takes to settle a case. You and Eric conclude that this phenomenon is explainable through your hourly-fee theory, i.e., that in states with contingency fee caps, plaintiffs' lawyers switch to the same types of cases on an hourly basis -- and stretch out the time to settle so that they can charge more billable hours to their poor unknowing clients.

Having observed hourly-fee attorneys in action, I'd be the first to concede that each marginal hour of work billed isn't necessarily in the client's self-interest in terms of the value added to the case. I'd also admit, as I did at the outset, that contingency fees help mitigate this incentive misalignment; the incentives for contingency fees on average tend to run in the opposite direction -- the attorney wants to get as much as possible, yes, but for as little work as he can.

But just because I agree with you that hourly-fee lawyers have an incentive to string out cases when they shouldn't, and contingency fee lawyers have an incentive to settle on the cheap and move on to the next case, doesn't mean I buy the theory you and Eric advance. Again, I know of no evidence that lawyers in New York, Illinois, or California are doing significant amounts of medical malpractice litigation on an hourly basis. In your most recent post, you acknowledge that rather than switching to a pure hourly fee, lawyers might shift from a pure contingency fee to other forms of cost-shifting. That's slightly more persuasive to me, but I'd still want to see some real evidence that we see this in practice -- for the med-mal cases you're analyzing -- before I bought into it very much.

Before I get into the specifics of your empirical analysis, let me delve a bit into what we'd expect to see if we accept my alternative view of the world. I don't think that there's a clear theoretical prediction about the effects of contingency fee caps on settlement time. On the one hand, by giving lawyers an incentive to weed out bad cases, contingency fee caps increase the number of dropped claims, as you observe. That trend would directly reduce the time to settlement. Moreover, lawyers working on an unlimited contingency fee, the expected return is higher all else being equal. Thus, it's worth it to invest more time in any given case -- and we'd expect contingency fee caps to lead to quicker settlements.

But other factors would seem to cut the other way. Specifically, the very incentives that cause plaintiffs' lawyers to be more cautious about taking weak cases in states with contingency fee caps, due to the reduced upside, are also likely to encourage lawyers to be more careful about discovery in general -- thus spending more time on the average case. Also, while contingency fee lawyers should be more risk neutral than their clients, they aren't generally going to approach pure risk neutrality except for megafirms with broad portfolios of cases, like the Milberg Weiss securities firm. So if I'm right that contingency fee caps increase the average probability of case success, then we'd expect to see an increase in settlement time; with uncapped contingency fees, risk averse attorneys with more long-shot claims are more likely to cut and run for the cheap settlement.

Those aren't the only arguments out there, but it's obvious that it's not wholly clear to me in which direction we'd expect contingency fee caps to influence settlement time in my view of the world.

Time to Settlement: The Florida Data

You and Eric observe that the time it took to resolve a case increased in Florida after contingency fee caps went into place in November 1985. In your regression analysis, you control for the stock of cases -- thus holding constant court "congestion effects" that may have occurred due to the "rush to file" before the caps took effect. With that control, the increase in time to settlement remains statistically significant.

Rather than reflecting attorneys' switching to hourly fees starting in November 1985, and bilking their clients, I'd guess that this effect has much more to do with the way the Florida reform was actually structured. The main Florida caps only kick in at $1 million. That's around the median jury verdict today, but well above it in 1985. Indeed, Lester Brickman observes that in 1984 the mean med-mal jury verdict nationally was just over $900,000 in 2001 dollars (at p. 710). The median is certainly a good bit lower than that (means are driven upward by large outliers in tort cases), the inflationary effects from 1984 to 2001 are substantial (but not worth my while to calculate since it's not central to my argument), and Florida may well have had lower verdicts on most cases than the rest of the country (since its cases are disproportionately brought by seniors, who have lower economic damages than cases brought by earners in their prime). The point here is that Florida's capping of contingency fees above $1 million is not likely a good explanatory factor for the increase in time to settlement you observe.

What may well be a good explanatory factor is the way Florida structured its fee limitations below $1 million. Fees were capped at one-third for recoveries through the time of filing an answer or a demand for arbitration; but fees were only capped at 40 percent from that point through the trial of the case. Assuming lawyers in Florida took advantage of this statutory cap and structured it into their fee arrangements after November 1985 when the law went into effect, contingency fee lawyers in Florida faced a direct inducement to string out cases beyond the filing of an answer or arbitration demand because they'd take home a bigger piece of the pie. That perverse incentive probably goes a long way toward explaining the results you observe.

Time to Settlement: The Cross-State Data

Like your time-series analysis in Florida, your cross-state analysis also finds that the time to settlement increases in states that have contingency fee caps. Again, though, I'm not convinced that this observation results from attorneys in those states bilking their clients using hourly fees, rather than other factors.

Specifically, I think your observed results are a function of anomalies in your data set. You draw from the 1992 sample of data from 75 large metropolitan counties in a Bureau of Justice Statistics report. When looking at Appendix table 2 (p. 8) of the report, I immediately notice the very long processing time in 2 of the 3 largest counties in your "contingency fee cap" states, namely New York, NY, and Cook, IL (Chicago). Cook County is a notorious "judicial hellhole," and a prominent left-wing litigator has called the Bronx civil jury "the greatest tool of wealth redistribution since the Red Army."

On a hunch, I looked at the summary data for civil jury results in the 1992 survey, presented in this BJS report. I looked at the 4 counties in your "cap states" with 200 or more civil jury trials in the sample -- the two aforementioned MSAs plus Los Angeles and Orange counties in California. I then examined the 7 counties in the "non-cap states" with 200 or more civil jury trials: Hennepin, MN; St. Louis, MO; Cuyahoga, OH; Philadelphia, PA; Bexar, TX; Dallas, TX; and Houston, TX. What I found confirmed my suspicions. The large counties in the "cap" sample had juries more likely to award for the plaintiff (54 percent to 50 percent), thus reducing risk to the attorneys (and reducing the incentive for attorneys to "cut and run" through early settlement). The "cap" counties had higher average verdicts ($834,000 to $697,000), thus increasing the expected return to attorneys (and increasing the amount of time a reasonable attorney would spend working on a case). And, significantly, the "cap" counties had a higher percentage of plaintiff winners getting a verdict of $1 million or more (14 percent to 8 percent) -- again, increasing the percentage of cases for which contingency fee attorneys would be willing to work more hours on a case, caps notwithstanding.

Of course, these data differences also show up in your summary data showing that the "cap" counties have higher average awards than "non cap" counties -- and indeed, that the differential is greater in med-mal cases than in auto cases (unsurprisingly, since the high-end med-mal verdicts bumping up the mean will be relatively larger than the biggest auto cases). But all that tells us is that contingency fee caps -- or more precisely, the caps imposed in these states -- are not sufficient to ameliorate the tort system's problems entirely. I don't think any reasonable person would claim otherwise.

But what your analysis tells us is that even these caps can have a significant effect in screening undesirable cases, to the tune of inducing a higher drop rate of around 15 percent. That's nothing to sneeze at.

Agreeing to Agree

April 14, 2006 12:35 PM

Jim,

Are you sure that you are not an economist? (Only an economist would intend that question as a compliment but that is my intention!). Empirical researchers and graduate students should take note of your last post because you have given them plenty of grist for the mill.

I often tell my students to evaluate literatures not papers because no single paper is definitive. Truth emerges more slowly through the give and take of the scientific process. I think we have seen some of that process in action with this week's debate. I've certainly learned a lot and am always delighted to come away with more ideas for future papers. Thanks!

Thanks Alex!

April 17, 2006 12:01 AM

Alex,

Believe me: I definitely take your asking me if I'm an economist as a compliment. (It's when people ask me if I'm a lawyer that I sometimes take offense!)

It's been a pleasure having you at Point of Law over the last week for this featured discussion. I'm sure our readers found it interesting and gained new perspectives on contingency fees and empirical research in law and economics. As I said at the outset, the work you and Eric Helland have done is extremely thoughtful and offers a great deal of leadership to the debate over legal reform. I hope our readers will check out Judge and Jury and get a picture of the entirety of your outstanding research to date.

Thanks -- and I look forward to continuing these discussions going forward.

Jim

Jonathan Wilson says that licensing protects the public and the courts from incompetent and immoral lawyers. Although I have proposed a limited and tentative defense of licensing based on motivating lawyers to participate in law reform, I question licensing laws designed to address the broad goals Jonathan articulates. Although licensing doubtless contributes to these goals, my questions are: how much, at what cost, and compared to what?

As for protecting clients, the problem with legal representation is that it's hard for the client to judge the lawyer, so the client needs some assurance of the lawyer�s quality. But how much assurance does a license provide? As a law professor it would be hard for me to deny that three years of law school do say something about legal competence. But passing a bar exam doesn't guarantee the lawyer�s willingness and ability years later to attend to clients' problems. A fitness investigation at the outset of a lawyer�s career is likely to reveal more about youthful indiscretions than about how the lawyer will face up to the temptations of an adult career. And keep in mind that, unlike a physician, a lawyer need not have any hands-on experience to be licensed.

Yet while a license arguably communicates little useful information, in many respects licensing sets too high a bar. How much legal history, philosophy and economics, to name a few of the subjects students learn in law school, does a lawyer need to handle a real estate conveyance, to name one of the subjects few students learn in law school?

Because all this costly learning reduces the availability and raises the costs of legal advice, licensing hurts the poor and lower income people licensing it is supposed to help. Their only recourse may be self-help. I�m reminded here of a study showing that regulation of electricians increased electric shocks to do-it-yourselfers.

And remember that lawyer licensing turns regulation of the legal profession over to, guess who, the legal profession. In other words, it creates a legalized cartel. How likely is it that lawyers themselves will come up with precisely the regulation that protects the public and no more?

There are better ways to protect clients. Big law firms provide a strong reputational "bond" (see my article, Ethical Rules, Agency Costs and Law Firm Structure, 84 Virginia Law Review 1707 (1998)). Lawyers can be certified by private organizations, including existing bar associations, which can compete with each other by earning reputations for reliability. These are market-oriented, consumer-friendly, ways of dealing with information asymmetry. Private organizations could accommodate a variety of standards, suitable for the range of clients' needs. The main regulation that would be necessary in this market regime is protection against practitioners misrepresenting their level of certification.

What about protecting the courts from the unskilled? Here�s where the anti-litigation folks like Jonathan and the free marketers like me really seem to divide on lawyer licensing. Again I�m skeptical about how much help licensing can provide. After all, abusive litigation has been brought to us by licensed attorneys. Jonathan asks how �an unlicensed attorney, perhaps with no legal training [could] distinguish between those arguments that are valid and those that are not?� The answer is common sense. Only trained lawyers could come up with, and vigorously defend in court, the legal theories and clever tactics that litigation critics deplore. We're not going to get more ethics and common sense from beginning-of-career character and fitness exams. Licensing, which turns regulation over to the very people who got us into this mess, is not likely to be the best way out of it.

There are better ways to deal with excessive litigation. We could have stricter pleading rules, or require losers to pay winners� fees. Or how about this: let anybody into court, but adopt a loser pays rule for parties that come into court represented by anything less than a lawyer with the highest possible trial certificate.

Even if only licensing would effectively deal with this problem, the licensing scheme should be designed specifically to protect the courts. Instead of requiring the same all-purpose license to handle a real estate transaction and to prosecute a billion-dollar class action, we could have a special licensing law for courtroom practice, backed by tight regulation of trial lawyers� conduct � something like the traditional barrister/solicitor distinction in the UK.

As I noted above, I don�t propose completely eliminating lawyer licensing. My limited licensing proposal would not impose high legal representation costs on those who can least afford them. Moreover, even without a broad licensing requirement, there would (I certainly hope!) be a significant demand for trained legal professionals. The difference is that the market, and not the legal profession itself, would determine the extent of that demand.

As Jonathan pointed out, the pro-licensing folks won the WSJ poll on lawyer licensing by around 60-40. That�s not an impressive win given all the lawyers and other professionals who read the WSJ. There�s a lot of discontent with lawyers. The masses are ready to storm the citadel. The time has come to contemplate the end of the lawyers' cartel.

In responding to Jonathan Wilson's latest post, I think it's useful to discuss the defects of lawyer licensing in terms of its distinct objectives.

1. Protecting clients from dishonest and incompetent lawyers.

As I said in my initial post, licensing communicates little useful information to the client and serves mainly as an entry barrier. Indeed, the exhaustive research that I did for Lawyers as Lawmakers: A Theory of Lawyer Licensing, 69 Mo. L. Rev. 299 (2004) revealed no credible arguments or data in support of the client protection rationale for lawyer licensing. Of course legal training provides important skills, as Jonathan argues in his recent post, and as I said in my post. But that doesn�t support licensing. Clients could be protected by markets, including certification by private organizations.

The challenge in defending lawyer licensing is that it's not enough to argue that licensing addresses the problem of incompetent and immoral lawyers. This is true. The question is whether legally enforcing the lawyer cartel does a better job than markets alone would � a much more dubious proposition.

Jonathan says the poor and middle class will be hurt if they can hire unlicensed practitioners. But, again, there�s no evidence that licensing is a cost-effective remedy for this problem.

I can�t guarantee that the legal profession and journalists won�t demand regulation when the inevitable horror stories occur. But that�s an argument for appropriate skepticism about such demands, not for regulation.

2. Protecting against abusive and irresponsible litigation.

As I argued Monday, there is no reason to believe that our current licensing system protects against excessive litigation. Anybody with a grievance can find somebody to argue it. I suggested some possible reforms, but whether they would work or are politically feasible is tangential to the present debate.

3. Enforcing ethical rules.

The legal profession has been notoriously lax at disciplining itself. Bribing litigants, as alleged in the Milberg case, is serious misconduct (though I don�t think the nuclear option against the firm is appropriate). Where was the state bar? Where, indeed, is Eliot Spitzer? Even with lawyer licensing we had to rely on federal criminal prosecutors. Moreover, as I�ve argued in Ethical Rules, Agency Costs and Law Firm Structure, 84 Virginia Law Review 1707 (1998), ethical rules often disable the very market mechanisms that could provide real protections.

4. Ensuring that lawyers fulfill their obligations to the public, as by monitoring corporate clients.

The appropriate extent of such obligations is an open question, in my view. In any event, since the bar has refused to impose meaningful obligations in this regard, we now have SOX 307.

5. Giving lawyers incentives to engage in lawmaking.

This is the argument I made in my lawyer licensing article. Some would say that if licensing encourages lawyers to make law, that�s a reason not to have licensing, given lawyers� perverse effects on the law. I agree that this argument for licensing is a close call. In any event, even if I�m right, this argument supports only a limited licensing requirement for high-end law practice, mainly for transactional lawyers. It would not impose significant constraints on the availability of legal services for the poor and middle class.

* * *

Having said all that, I�m hardly sanguine about the prospects for meaningful reform of our current system, supported as it is by our most powerful interest group. Nevertheless, I support Jonathan�s recommendation of a blue ribbon commission. However, I would argue that we need a commission focused on problems in the market for legal services, not just one for abusive litigation. The commission I have in mind would be explicitly tasked with analyzing the functions of lawyer licensing, and whether it is fulfilling its goals. The case for such a commission is made, in my view, by concerns about excessive litigation and by significant changes in the markets for legal services and the functions of lawyers. These changes should prompt a reexamination of our more than 100-year-old system that the profession, on its own, would be unlikely to undertake.

This is the final post in the featured discussion. Thanks to Jonathan and the folks at the Manhattan Institute for making it all possible.

In my last post, I listed supposed problems in the legal marketplace that lawyer licensing is supposed to deal with, and summarized why it is at best a flawed response to these problems.

Jonathan persists in his claims that mandatory licensing would work better than the market, but has no support for those claims other than repetition. I can only again point to my lengthy article on the subject cited in early posts and repeat that the absence of mandatory regulation does NOT mean that there would be no mechanisms for dealing with these problems, but only that they would be dealt with through a competitive market rather than by the lawyer�s cartel.

Jonathan asserts in response to my argument that licensing inflates the price of legal services that, in fact, lawyers charge a wide variety of prices, and it�s not clear lawyers are �overpriced;� that legal services �don�t seem to be that expensive;� that �I often see a line at the counter at McDonald�s. I�ve never seen a line outside a lawyer�s office. I would be interested to see alternative data but my experience tells me there is no shortage of legal services in the marketplace and therefore no effective cartel created by lawyer licensing;� and that �I can see no evidence that lawyer licensing is driving up the cost of legal services. Legal services of the kind often purchased by the poor and the middle-class seem to be readily available at more-or-less reasonable prices.�

I would prefer a more scientific approach to the problem. I don't know what the �right� price for lawyers is. We have markets for that. What is the �length of line� test supposed to prove? Those who can�t afford a lawyer are not waiting at the lawyer�s office � they�re doing without the advice.

I do know that reducing the supply of something usually raises the price. Ideally this would invite more supply, unless it�s restricted by a licensing law. The law of supply and demand suggests that the price is higher given licensing than it would be without regulation. I suspect that an unregulated market would look very different at the lower end, maybe not so different at the higher end. The big question is whether the higher prices are worth it, which gets back to the value of licensing.

As for evidence, the best measure of the economic effect of lawyer licensing that I�m aware of is Dean Lueck et al., Market and Regulatory Forces in the Pricing of Legal Services, 7 J. Reg. Econ. 63 (1995). They show no correlation between barriers to entry (e.g., bar passage rates) and the price of legal services, but they do show a correlation between sets of regulatory barriers and lawyer earnings. A detailed analysis of this paper is in my article.

There is a lot of analysis of the discriminatory effects of licensing laws: Milton Friedman, Occupational Licensure, in Capitalism and Freedom 137, 150-51 (1962); S. David Young, The Rule of Experts: Occupational Licensing in America, 75-80 (1987); Richard B. Freeman, The Effect of Occupational Licensure on Black Occupational Attainment, in Occupational Licensure and Regulation 1 (Simon Rottenberg ed., 1980) at 165; Benjamin Hoorn Barton, Why Do We Regulate Lawyers?: An Economic Analysis of the Justifications for Entry and Conduct Regulation, 33 Ariz. St. L.J. 429, 444 (2001); Walter Gellhorn, The Abuse of Occupational Licensing, 44 U. Chi. L. Rev. 6, 18 (1976).

Josh Wright, over at Truth on the Market asks:

"I am curious as to the state of the empirical evidence with respect to lawyer licensing and its impact on consumers. If I recall, the Federal Trade Commission has recently been involved in some advocacy efforts in favor of limiting the scope of unauthorized practice of law statutes. My sense is that a number of states must have relaxed unauthorized practice of law restrictions (I think Arizona is one), or similarly relaxed restrictions on lawyer licensing, such that one could directly test the impact of these restrictions on consumers in terms of prices and quality of service. There must be work on this somewhere. My quick Google search did not return anything right away, but does anybody know of empirical work in this area?�

Good questions. Joyce Palomar, The War Between Attorneys and Lay Conveyancers�Empirical Evidence Says �Cease Fire!�, 31 Conn. L. Rev. 423 (1999) found little evidence of risk to the public from lay providers of real estate settlement services. But there�s obviously a lot more work to be done. Fred. S. McChesney & Timothy I. Muris, The Effect of Advertising on the Quality of Legal Services, 65 A.B.A. J. 1503 (1979) and Advertising and the Price and Quality of Legal Services: The Case for Legal Clinics, 1979 Am. B. Found. Res. J. 179 found that a legal clinic using advertising in high-volume practice reduced costs without compromising quality.

There�s obviously a lot more empirical work to be done.

This gets to Jonathan�s question about �transition� to a market regime. Actually, it would be a fairly simple matter for states to simply decide to allow people to do what they previously couldn�t do. Most of the adjustment would be for the previously protected class of lawyers.

But that doesn�t mean we shouldn�t proceed carefully, and our federal system allows us to do just that. Jonathan decries the fact that �With 50 separate state regimes to manage, policy-makers would either have to endure a decades-long transition in which some states deregulated and others didn�t or there would have to be some kind of nationwide, federally-mandated deregulation that trumped state law. How would that work? How could it work?�

In fact, these separate regimes are a blessing, not a curse. With 50 (actually, 51) different regulators we have an opportunity to test how reforms actually work, as Josh Wright suggests. This sort of test doesn�t have to wait � and indeed shouldn�t wait � for some �blue ribbon commission� to complete its work. I don�t see a problem with such a commission, as I said before, but the best possible commission is the formidable laboratory enabled by our federal system. The time to start is now.

Tallying fees

April 20, 2012 8:22 AM

Ted Frank

(As an initial matter, I just want to say that I wrote my first two posts before I saw the debate framing asking "rife with abuse or an important legal safeguard?" I'd answer "both": class actions are an important legal safeguard and they're rife with abuse.)

When Professor Fitzpatrick says his study didn't find a single class action in two years where the fee percentage was over 47%, I have to question the methodology of the study. I could double the number of lawyers working for CCAF, and we'd still have to turn away class actions where consumers come to us complaining that the attorneys are collecting more than 47%. In the first thirty cases where we filed objections, twenty-six of them involved cases where the attorneys intended to receive more than their putative clients and, like I said, we're confronted with more unfair class actions than we have the opportunity to object to. Sometimes it's much more, in the 90-100% range of total recovery: I have cases on appeal in the Second, Sixth, and Ninth Circuits where judges rubber-stamped settlements where attorneys ended up with over 90% of the recovery.

I suspect the problem is that Professor Fitzpatrick is not collecting accurate data. Most class actions don't report how much class members are actually collecting in settlements; settling parties suffer no consequences when they exaggerate recovery in their papers. Thus, in the first Classmates.com settlement, it was widely reported in the press that the class would receive $9.5 million; the actual number would have been $0.1 million if the court had not honored our objection. In the pending Brazil v. Dell, the parties reported in preliminary settlement papers that the settlement made $18 million available to the class, justifying a $7 million payout to the attorneys; in fact, enough barriers were placed in the claims-made settlement that the class will receive only $0.5 million, a figure that never would have been made public if we hadn't objected. In McDonough v. Toys R Us, the number that the class is to receive still isn't public after final judgment, other than that we can tell mathematically from what little has been disclosed that it will almost certainly be less than half of what the attorneys are getting. Settling parties suffer no consequences for exaggerating settlement value to courts, and those exaggerated values end up in Fitzpatrick's study's denominators; the real values remain known only to settlement administrators (who will not disclose them if asked) and rarely end up public. Professor Lester Brickman writes about this, too.

Returning to the Bank of America overdraft case, we see right away the difference between reality and study denominators. Professor Fitzpatrick characterizes the settlement as for $410 million; in fact, terms of the settlement call for as much as $60 million of this amount to go to third parties, rather than class members. The $123 million award to the attorneys is not only more than twice the typical percentage for a settlement larger than $150 million (a fact that the district court fails to acknowledge in its opinion), but works out to thousands of dollars an hour for a case that was barely litigated and immediately settled for nine cents on the dollar—and where nearly all of the legal research has application in numerous other cookie-cutter cases. (The main risk the attorneys identify was that the majority of their claims had been waived by previous class action attorneys who had accepted an $8 million payoff.) I have no objection to attorneys getting a multiple of lodestar when they take on risk, but settling a multi-billion dollar lawsuit for pennies on the dollar is the essence of a relatively riskless proposition. (The fact that the attorneys were not even willing to admit to a lodestar amount to demonstrate the fairness of the award in a cross-check is a fairly strong negative pregnant that the lodestar multiplier was in the double-digits.) That's not rewarding attorneys for success, it's rewarding them for going after big defendants. To add insult to injury, the MDL court signed off on the parties' agreement to make it nearly impossible for class members to object to this ripoff, demonstrating class counsel's fear of scrutiny—which is ironic, given their propensity for objecting to other overdraft settlements (and accepting a buyout in the Trombley v. National Bank case, where the victorious class attorneys collected a 28% fee after settling on Docket Entry #6, with class counsel being compensated for paralegals' work at about $3000/hour).

Because the Overdraft MDL was not subjected to a market test by, say, putting out the lucrative litigation for bid, there was a wealth transfer of tens of millions of dollars from consumers below median incomes to very wealthy trial lawyers, who would have been excited to litigate the case for, say, three times their lodestar, even though that would be a fraction of what they actually received. And by all accounts, the settlement would have been even higher if previous class counsel hadn't walked away with $8 million by agreeing to an even more unfair class action settlement. It's hard to see how that's good for anyone.

The final word on fees

April 23, 2012 8:20 AM | No Comments

Brian T. Fitzpatrick

Mr. Frank criticized the methodology in my study because it is based on settlement amounts approved by district courts rather than settlement amounts actually distributed to class members. He's right about that, but, again, it turns out not to make much of a difference to the portion that attorney's take from settlements. The vast majority of the money approved by courts is distributed pro rata--meaning it is all distributed, and how much each class member gets depends on how many others submit claims. Thus, even if we were to ask what portion of distributed money goes to class action lawyers, the answer would be about the same.

This is not to say that there aren't isolated examples where the only ones defendants end up paying are the lawyers. But it is to say that these cases are not representative. It is almost unheard of for undistributed settlements to revert back to defendants these days. If they cannot be distributed to class members, they at least go to third parties like charities; either way, the deterrence gained is the same.

Mr. Frank returned to the Bank of America settlement, but, again, I do not understand why. In one breath, he says the lawyers there did not take on any risk, but in the next he acknowledges that Bank of America had already settled the same claims for a fraction of a cent on the dollar. The fact that the new lawyers managed to persuade Back of America to resettle the case for over ten times the original amount is not just good lawyering, it is remarkable lawyering. They deserved to be paid handsomely. So what if they made a multiple of their hourly rate? The lodestar method fell into disfavor in class action litigation previously because it rewarded lawyers for dragging things out rather than getting results. The percentage method rewards results, and remarkable results should be rewarded with remarkable fees.

I will close on one point on which Mr. Frank and I agree. The optimal method for awarding fees is not to do so ex post by trying to divide some fair percentage of the settlement. It is to do so ex ante by auction. But until courts warm up to that, we will continue with the second best. And that is the percentage method, not the lodestar

 

 

 

FEATURED DISCUSSION ARCHIVE:


Obamacare Decision: Reactions, July 2012
Law School Faculty Diversity, May-June 2012
Class Actions, May 2012
Constitutionality of Individual Mandate, March 2012
Human Rights and International Law, February-March 2012
The constitutionality of President Obama's recess appointments, January 2012
Do caps on medical malpractice damages hurt consumers?, December 2011
Trial Lawyers Inc.: State Attorneys General, October 2011
Wal-Mart v. Dukes, April 2011
Kagan Supreme Court nomination, May-June 2010
Election roundtable, November-December 2006
Who's the boss, September 2006
Medical judgement, July 2006
Lawyer Licensing, May 2006
Contingent claims, April 2006
Smoking guns, July 2004

Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

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The Manhattan Insitute's Center for Legal Policy.