Opinions

Ethics Opinion 347

Reverse Contingent Fees


A reverse contingent fee is a fee that is based upon the difference between the amount a third party demands from a lawyer’s client, and the amount ultimately obtained from the client, whether by settlement or judgment. The Rules of Professional Conduct (“Rules”) do not prohibit reverse contingent fees, and a fee arrangement of this nature may align the lawyer’s and client’s interests more closely than hourly or fixed fee arrangements. Like all fees, reverse contingent fees must be reasonable. Beyond the requirement of reasonableness, entering into a reverse contingent fee arrangement places increased burdens of disclosure on the lawyer in order to obtain informed consent to such a fee arrangement. The lawyer is in a better position to assess the likely outcome of a dispute than a client is, and the lawyer must fully and fairly communicate that assessment to the client in any discussion concerning a reverse contingent fee. In addition, a lawyer should take particular care in setting the percentage of the reverse contingent fee, because unlike contingent fees based upon a client’s recovery, there is little established practice upon which a client and lawyer can rely. Finally, as with other Rule provisions, the degree and nature of the disclosure required of the lawyer and the ensuing scrutiny of the fee arrangement may vary based upon the experience and sophistication of the client.

Applicable Rules

  • Rule 1.5 (Fees)

Inquiry
The inquiry is whether, and under what circumstances, a reverse contingent fee, i.e., a fee computed based upon the savings to a client, rather than the client’s recovery, comports with the Rules of Professional Conduct.

Background and Discussion
Rule 1.5 governs the fees charged by lawyers. Rule 1.5(a) mandates that fees be reasonable and sets forth eight factors to be considered in assessing the reasonableness of a fee. Reasonableness is assessed based on the facts and circumstances of the representation, as they exist both at the beginning and the end of the representation. “A fee that looked to be reasonable at the outset of the representation may have become excessive as measured by the outcome of the client’s case.” Contingent Fees, ABA/BNA Lawyers’ Manual on Professional Conduct, 41:901, at 18 (2004).

Rule 1.5 discusses when contingent fees are and are not permissible, but it does not directly address “reverse contingent fees.” Rule 1.5(c) allows fees “contingent upon the outcome of the matter for which service is rendered.” Comment [6] to the Rule states that “[g]enerally, contingent fees are permissible in all civil cases.” Contingent fee agreements must be in writing and must “state the method by which the fee is to be determined, including the percentage or percentages that shall accrue to the lawyer.” Comment [7] to Rule 1.5 provides a caution with regard to domestic relations cases: “[c]ontingent fees in domestic relations cases, while rarely justified, are not prohibited by Rule 1.5.” Such fees in domestic relations matters are “permitted in order that lawyers may provide representation to clients who might not otherwise be able to afford to contract for the payment of fees on a noncontingent basis.” The only outright prohibition of contingent fees in Rule 1.5 is limited to representations of defendants in criminal cases.[1]

Rule 1.5 appears to contemplate only the standard contingent fee arrangement (i.e., where a recovery is generated for the client) rather than a reverse contingent fee. Rule 1.5(c) provides that a contingent fee agreement must address “expenses to be deducted from the recovery.” (emphasis added). Comment [8] requires a lawyer to “provide the client with a written statement at the conclusion of a contingent fee matter, stating the outcome of the matter and explaining the computation of any remittance made to the client.” (emphasis added).    

We have addressed contingent fees in a number of prior Opinions.[2] None of these prior Opinions discuss reverse contingent fees. Like Rule 1.5, these Opinions consider the typical contingent fee where the lawyer is “‘produc[ing] a res with which to pay the fee.’” D.C. Ethics Op. 262 (1995) (quoting Code of Professional Responsibility Ethical Consideration 2-20, which discussed the basis for prohibiting contingent fees in criminal representations).

Outside of the District of Columbia, reverse contingent fees have been addressed by a number of jurisdictions. In Formal Opinion 93-373 (1993), the ABA concluded that “[t]he Model Rules do not prohibit ‘reverse’ contingent fee agreements for representations of defendants in civil cases where the contingency rests on the amount of money, if any, saved the client, provided the amount saved is reasonably determinable, the fee is reasonable in amount under the circumstances, and the client’s agreement to the fee arrangement is fully informed.”

The ABA identified several significant differences between typical, recovery-based contingent fees and reverse contingent fees. First, while the setting of percentages in the typical contingent fee cases is susceptible to abuse or over-reaching by the lawyer, the “profession’s long experience with straight contingent fees and the active regulation by the courts and the legislatures” have “pretty well established” the “range of reasonable percentages.” For reverse contingent fees, reasonableness “will not be so readily determinable.” The legal profession “has not built up a long term common experience with the concept. The fact that straight contingent fees typically range from 25% to 33% does not necessarily mean that the same percentage is reasonably applied to the potential savings of a defendant.” Second, even if a fair percentage can be set, reverse contingency fees have the added complication of calculating the amount saved the client. A plaintiff’s demand may be overstated or not specifically enumerated; thus, “the amount demanded cannot automatically be the number from which saving resulting from a judgment or settlement can reasonably be calculated.” ABA Formal Op. 93-373 (1993).

While not leading it to conclude that reverse contingency fee arrangements were unethical, the ABA determined that the above considerations require that the lawyer exercise greater care and consultation than in the typical “straight” contingency fee case. A lawyer must “fairly evaluate the plaintiff’s claim and set a reasonable number as the amount from which the plaintiff’s recovery will be subtracted to determine the defendant’s savings.” The lawyer has the burden of “demonstrating fairness in this process,” a burden that is significantly greater when negotiating with an unsophisticated client than it is when dealing with, for instance, an organization represented by an experienced in-house counsel.

The cases and other authorities considering reverse contingency fees are generally consistent with the ABA’s approach. In Ethics Opinion E-359 (1993), the Kentucky Bar Association stated that it is permissible for a defense lawyer to charge a reverse contingent fee in a civil case but noted that the lawyer bears “the burden of proving that the method of computing the charge, and the amount of the fee, are reasonable and rational under the circumstances.” In Ethics Opinion 98-03 (1998), the Iowa Supreme Court Board of Professional Ethics and Conduct approved a reverse contingent fee because the damages sought from the lawyer’s client were liquidated and readily determinable. See also Pennsylvania Bar Association Committee on Legal Ethics and Professional Responsibility Informal Opinion 92-76 (1992) (approving use of reverse contingent fee in tax appeal). In Wunschel Law Firm v. Clabaugh, 291 N.W.2d 331 (Iowa 1980), the court invalidated a reverse contingent fee because it was based upon the plaintiff’s damages demand in a defamation suit. While noting “nothing in the nature of [a contingent fee] contract limits its use to employment by plaintiffs,” it rejected “a contingent defense fee predicated on a percentage of the amount saved under the prayer in defending an unliquidated tort claim.” Id. at 333.

The case of Brown & Sturm v. Frederick Road L.P., 768 A.2d 62 (Md. Ct. Spec. App. 2001) illustrates the potential for abuse in reverse contingent fee cases. In that case, the underlying representation concerned the value of a family farm. The clients requested an hourly fee arrangement but the lawyers insisted on a reverse contingency fee. The IRS assessed the property at $60 million. While negotiating the fee agreement with their clients (the individuals who had inherited the farm), the lawyers knew that the IRS assessment was inflated, “more than double any other contemporaneous appraisal of the property.” Id. at 76. The attorneys concealed from their clients appraisals that depicted “a more realistic worst-case market value” and entered into a reverse contingent fee contract with their clients based upon the inflated $60 million appraisal. The underlying litigation with the IRS was settled prior to trial, based on a $20 million valuation. Under the fee agreement, the attorneys claimed a $40 million “savings” and charged the clients $4.8 million in fees. The Court of Special Appeals upheld findings that the attorney’s failure to disclose to their clients what they knew about the property’s net worth made their fee agreement unenforceable. The Court also upheld a finding that the fee “was unreasonable because it bore little relation to time, labor, novelty and risk of the legal problem.” Id. at 81.

Conclusion
Consistent with ABA Formal Opinion 93-373 and other authorities discussed above, we conclude that reverse contingency fee agreements are not unethical. Indeed, in the appropriate instance, such arrangements “may be in the best interests of the clients.” ABA Formal Opinion 93-373 (1993). Unlike a typical fixed fee or hourly arrangement, under a reverse contingency arrangement, the lawyer could “receive no fee if not successful in saving the client money.” Id. Like any other fee, a reverse contingent fee must be reasonable, as judged both at the outset and the conclusion of the representation. A reverse contingent arrangement must also be reflected in a written fee agreement under Rule 1.5(c) and such fee agreement must state the “method by which the fee is to be determined.”

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

The percentage to be applied to the savings obtained by the lawyer must similarly be the product of full disclosure by the lawyer and informed consent by the client. Unlike the typical contingent fee arrangements, there are no established norms concerning the appropriate percentages for a lawyer to use. It is beyond the expertise of this Committee to opine about the percentages or range of percentages that might be appropriate. To support the reasonableness of a particular percentage, the lawyer should consider discussing with the client the likely range of fees under hourly or fixed fee arrangements as compared to the range of fees that might result from a reverse contingent fee arrangement.  

The lawyer should summarize for the client, preferably in writing, the analysis underlying the sum or amount from which a client’s savings are computed and the percentage to be applied to produce the lawyer’s fee. Particularly when it is the lawyer and not the client who suggests the reverse contingent fee, a prudent lawyer will recognize that a writing will facilitate review of the reasonableness of the fee and of the client’s informed consent to the fee arrangement. A lawyer may also find it advisable to document any offer to accept a fixed or hourly fee arrangement as an alternative to a reverse contingency fee arrangement.

The sophistication and experience of the client is an important factor to be considered by the lawyer in discussing and reaching a reverse contingent fee arrangement. The type of discussion and disclosure that are required when the client is a sophisticated in-house attorney for a large corporation is different from those required when the client is unsophisticated and is not being advised by independent counsel. See Comment [2] to Rule 1.0 (assessing adequacy of disclosure to obtain informed consent in light of client’s sophistication in legal matters). To the extent that a reverse contingent fee arrangement is with a sophisticated client, who has the benefit of independent legal advice and who provides the lawyer with suggested figures and percentages to base the fee arrangement upon, many of the above disclosures and discussions may not be necessary. On the other hand with respect to an unsophisticated client, the lawyer should be assured before proceeding with the representation that the client has a full understanding of the amount from which the client’s savings would be computed and the percentage to be applied to that amount to produce the lawyer’s fee.  

The partial dissent of our colleagues reflects a disagreement over the relatively narrow issue of whether a lawyer violates Rule 1.5 by failing to provide the client a writing that sets forth the lawyer’s analysis or explanation of the components of a reverse contingent fee. Our view is that such a writing is preferable but not required. The partial dissent concludes that Rule 1.5(c) mandates a writing containing such analysis or explanation. In reaching a different conclusion than our colleagues, we are mindful that our role is to interpret the Rules as we find them, not to revise them as if we were starting anew. 

We believe that a writing containing the lawyer’s analysis of the sum or amount from which the savings are to be computed and the percentage to be applied to such sum or amount is not required by Rule 1.5 for three reasons. First, as outlined previously in this opinion, Rule 1.5 was not drafted with reverse contingent fees in mind. The Rule speaks of “expenses to be deducted from the recovery” and “remittance[s] made to the client.” Rule 1.5(c) & Comment [8]. We find no indication that reverse contingent fees were contemplated by the drafters of Rule 1.5.

Second, we do not believe that Rule 1.5(c)’s requirement that the “method” by which a contingent fee is to be determined be set forth in writing mandates anything more than providing the arithmetic components of the reverse contingent fee. “Method” is a “means” or a “manner of procedure,” especially, according to one dictionary, “a regular and systematic way of accomplishing anything.”[3] The term does not mean an explanation of how or why one decided to employ that particular method or process. The method used to calculate the relationship between the sides of a right triangle and its hypotenuse is the Pythagorean theorem. How Pythagoras arrived at that method is another matter.

Finally, Rule 1.5(c) speaks of the method “by which the fee is to be determined…” (emphasis added). In other words, the phrase refers to something that is going to happen in the future, i.e., how the fee will be calculated in the future when the case is resolved. Future-looking language does not encompass something that has already occurred. It cannot include the analysis that the lawyer went through in the past in order to propose a particular fee arrangement.

Partially Dissenting Opinion:
While we agree with most of the Committee's opinion, we disagree on one small but significant point, namely what must go into the written fee agreement establishing a reverse contingent fee (RCF). On this point we dissent, because we believe that the Committee’s opinion does not adequately protect unsophisticated clients. Adequate protection requires that the written agreement state not only the percentage the lawyer will receive of the amount saved, and the baseline value against which savings are calculated, but also the lawyer’s analysis of how he or she came up with the baseline. The opinion correctly notes that typically the baseline cannot simply be the amount demanded in the adversary’s complaint, which is likely to be inflated. Rather, it represents an analysis and estimate of the client’s exposure.[4] We believe that Rule 1.5(c) requires a written explanation, however brief, of how lawyer and client have arrived at that estimate. By contrast, the Committee’s opinion requires an oral explanation to the client, but makes the writing optional.

First let us note common ground with the Committee’s opinion. A reverse contingency fee may be to the client’s advantage, and we agree with the Committee that the Rules of Professional Conduct permit reverse contingency fees. We also agree that the Rules require the lawyer to explain the RCF thoroughly enough to obtain the client’s informed consent to the arrangement. As the opinion notes, this oral explanation must include both a discussion of the applicable percentage used to compute the fee, and the lawyer’s analysis of the baseline value of the case against which savings are calculated. The point of contention lies in a single sentence, and in fact a single word. The opinion states, “The lawyer should summarize for the client, preferably in writing, the analysis underlying the sum or amount from which a client’s savings are computed and the percentage to be applied to produce the lawyer’s fee.” (emphasis added). The word “preferably” means that the lawyer is not strictly required to put his or her oral analysis of the baseline value into writing. We disagree, and would not weaken Rule 1.5(c)’s writing requirement by making this analysis optional.

In a “straight” contingent fee, there is no uncertainty about the amount to which the percentage is applied: the res is what it is. In the RCF, however, the baseline value is inherently indeterminate. We do not mean merely that it can never be better than a rough ballpark estimate of the client’s exposure, which might turn out to be completely wrong. The inevitable uncertainty of the estimate should be clear—if not, it is the lawyer’s job to make it clear—and it is a risk that both lawyer and client assume when they agree to a RCF.[5] The additional problem is knowing what the lawyer is trying to estimate. Is the lawyer estimating the settlement value of the case, or the unlikely worst-case scenario if it goes to trial and they lose badly, or the most likely trial outcome? These may be many thousands of dollars apart. The Committee’s opinion correctly notes that the lawyer has to explain to the client, at least orally, “the analysis underlying … the sum or amount from which a client’s savings are computed.” Surely that includes explaining the measure of exposure the lawyer is using. At the bare minimum, therefore, the lawyer has to tell the client whether the proposed baseline value represents an estimate of the worst-case scenario, the most likely outcome, or something entirely different. Otherwise, the client might agree to a high baseline that really represents an unlikely worst case, without understanding how unlikely it is. A lawyer who withholds that information has not met the minimum disclosure requirement under Rule 1.4(b). The client might wind up paying an inflated fee under a misapprehension that an improbable million-dollar judgment against him is really a significant risk.

Complicated information like this is hard for an unsophisticated client to take in. If the lawyer does not put it in writing, unsophisticated clients will have to trust their memory of a conversation about something out of their ordinary experience. Six months or two years later, a client with doubts about the bill will have nothing to talk over with the lawyer except that memory. If worst comes to worst and the client wants to challenge the reasonableness of the fee, he has nothing beyond his memory, and his possibly garbled understanding of what the lawyer told him many moons ago, to go on. That is unfair to the unsophisticated client. It puts that client at a disadvantage.

We believe that both the letter and the policy of Rule 1.5(c) require putting the analysis leading to the baseline in writing.

The text of Rule 1.5(c) is clear:
A contingent fee agreement shall be in writing and shall state the method by which the fee is to be determined, including the percentage or percentages that shall accrue to the lawyer in the event of settlement, trial, or appeal, litigation, other expenses to be deducted from the recovery, whether such expenses are to be deducted before or after the contingent fee is calculated, and whether the client will be liable for expenses regardless of the outcome of the matter.” (emphasis added).

In a straight contingent fee, the rule is traditionally understood to require only that the terms of the agreement be in writing. But the rule does not actually say that. It says to put the “method by which the fee is to be determined” in writing. In a straight contingent fee, which has a hundred-year-old tradition, the “method” does not need more explanation than specifying the percentages and how the expenses are handled. That is not true with the RCF. The RCF is a relatively unfamiliar device. It has two variables that are both “soft” and unsettled by tradition: the percentage and the baseline.

If Rule 1.5(c) really meant that the percentage and expense arrangements are the only things that have to go in the fee agreement, it would have omitted the words “…the method by which the fee is to be determined, including…”We take it that those words are not surplus. The plain meaning of the Rule is that the written agreement must include the percentage and the expense arrangements, but not that those are the only items needed to state the method by which the fee is to be determined. An unfamiliar fee arrangement calls for more information in writing. The question is what this “more” includes, in a species of contingent fee that the Rule’s drafters never thought about.

The Committee relies on the dictionary definition of “method” and the grammar of the phrase “method by which the fee is to be determined.” We are skeptical that any substantive conclusions can be derived this way.[6] From the dictionary we learn that a “method” involves regularity. We agree. The first step of this regular method consists in estimating (or guesstimating) the client’s exposure, either at trial or in the settlement process, in order to set the baseline. Whether or not that first step must go in the written agreement cannot be learned from the dictionary.

Neither does anything come from noticing that “is to be determined” is in the future tense. To be sure, if an RCF specifies that “the fee will be X% of the money saved under $2 million,” that is indeed a method by which the fee is to be determined. But so is “the fee will be X% of the money saved under $2 million, which represents Attorney’s estimate of likely settlement” or “…which represents Attorney’s estimate of potential liability in a jury trial.” Grammar alone does not make the latter sentences any less a statement of the “method by which the fee is to be determined” than the first sentence. The issue dividing us from the Committee is not a verbal one.

In our view, when semantics and custom do not settle the scope of an ambiguous rule, it helps to look at the practical point of the rule. The practical point of imposing a writing requirement on lawyers is to protect clients by creating something objective that an impartial reviewer can examine to settle disagreements between the lawyer and the client.[7] Such a disagreement can be over the numerical terms of the agreement (“Forty percent? You told me thirty-three!”). But it can also be over the reasonableness of the agreement. In a straight contingency fee that specifies only the percentage and the handling of expenses, custom will enable prudent lawyers to evaluate whether the fee is reasonable.[8] A reviewing body knows that 33% is a reasonable contingency fee for many typical cases, and it knows that 80% is not.

In the RCF, however, simply seeing a number like “$2 million” is not enough to know if the lawyer has proposed a reasonable baseline. Cases of this sort may typically settle for a quarter that amount. But $2 million could be a reasonable worst-case estimate of the client’s exposure in the unlikely event that settlement fails and the case goes to trial. Neither way of arriving at the baseline is inherently unreasonable. The same number—$2 million in this example—can be a reasonable guesstimate of worst-case exposure to liability at trial and an absurdly inflated guesstimate of the settlement range. Without knowing what the number represents, a reviewing body would be unable to declare that the agreement has violated Rule 1.5(a)’s requirement that the fee “shall be reasonable.” Ergo, the client loses.

It may well be that RCFs will mostly be proposed by sophisticated clients who understand quite well—maybe better than the lawyer—how to value cases. An insurer, for example, has extensive data on the settlement value of automobile collision cases. That insurer might well propose a flat fee with an RCF “bonus” to defense counsel who can beat the averages. In such cases, we agree with the Committee’s opinion: when the client proposes the terms of a RCF, the written agreement need say nothing beyond noting that fact. That satisfies the letter of the rule. But when the lawyer proposes a RCF and a baseline for calculating it, a written agreement that includes the baseline value but not even a hint of the method the lawyer used to arrive at that baseline violates the rule and under-protects clients. The Brown & Sturm case that the opinion discusses shows that lawyer overreaching in a RCF is not merely a hypothetical danger to clients.[9]

Joseph Brent, PhD
Steven Ebbin, PhD
David Luban, PhD

  1. [Return to text] Substantive law may restrict those matters in which a reverse contingency fee is permitted. See, e.g., 31 C.F.R. § 10.27 (IRS regulation prohibiting reverse contingent fee for preparation of a tax return but permitting such fee under other circumstances). This opinion does not purport to address any additional conditions or restrictions imposed by substantive law on reverse contingent fees. 
  2. [Return to text] D.C. Ethics Ops. 29 (1977) (Change in Contingent Fee Arrangement In Course of Representation); 37 (1977) (Provisions of Contingent Fee Retainer Agreements With Respect to Payment of a Fee in the Event of Discharge or Withdrawal of the Attorney); 42 (1977) (Written Retainer Agreement Based on Combination of Contingent Fee Plus Time Charges); 115 (1982) (Propriety of Contingent Fees In Non-Litigation Matters); 161 (1985) (Contingency Fees in Child Support Cases); 208 (1989) (Calculation of Attorneys Fees in Structured Settlements); 262 (1995) (Application of Rule 1.5(d) to Receipt of a Contingent Fee in a Writ of Error Coram Nobis Proceeding).
  3. [Return to text] The American Heritage Dictionary of the English Language 857 (3d ed. 1993).
  4. [Return to text] It is possible that the proposed baseline does not represent an estimate of potential exposure at all, but is simply an arbitrary number. In effect, the lawyer makes a sporting proposition to the client: “If I can save you money below $X, I get Y% of it; if I cannot, you owe me nothing.” Whether a fee agreement that, in effect, sets the lawyer’s fee by a game of chance can be “reasonable” under Rule 1.5(a) is a question that we do not address here. We simply assume that the baseline value of the case represents a ballpark estimate of the client’s exposure.
  5. [Return to text] The lawyer’s risk is that the case is shakier and more difficult than she had anticipated, so that she puts in many hours for a small fee because she is unable to save much money below the agreed-on baseline. The client’s risk is the opposite: the case turns out to be unexpectedly easy, it settles for a small amount of money, and the client pays a large fee for very few lawyer hours.
  6. [Return to text] The dictionary definition of “method” is especially unhelpful. A method is a “manner” or “procedure.” The same dictionary defines a “procedure” as a “manner” or “set of…methods.” The American Heritage College Dictionary 1090 (1993). It likewise defines a “manner” as “a way of doing something,” noting that in this sense the word is a synonym for “method.” Id. at 825. The word “way,” unsurprisingly, is defined as a “manner or method.” Id. at 1527. A closed circle of synonyms chasing each other’s tails tells us nothing.
  7. [Return to text] Obviously, written agreements protect lawyers too. Presumably, the Court of Appeals does not impose enforceable disciplinary rules to make sure that lawyers protect themselves.
  8. [Return to text] Rule 1.5(a)(3) makes “the fee customarily charged in the locality for similar legal services” a criterion of reasonableness.
  9. [Return to text] Brown & Sturm v. Frederick Road L.P., 768 A.2d 62 (Md. Ct. Spec. App. 2001).

March 2009