Contingent Fees

Contingent Fees

Description

A contingent fee is a contractual arrangement between a client and an attorney in which the attorney’s fee depends on the outcome of the case. Such fee arrangements can take many different forms, each of which creates a different type of risk-sharing arrangement. Perhaps the most common is the linear fee schedule, in which the client agrees to pay the attorney a fixed percentage of any monetary benefit (either settlement or trial judgment) that the client receives or is awarded. In many such fee arrangements, the attorney pays the client’s expenses during the legal process, with the knowledge that these funds are not likely to be reimbursed if the client is unsuccessful; as a result, the linear arrangement may be seen as a fixed initial payment plus a percentage of the monetary benefit that is received subsequently. Nonlinear fee arrangements are also quite common, typically appearing in the form of a schedule in which the contingency percentage decreases with the magnitude of the monetary benefit. Other forms of ‘nonlinearities’ may also be seen as contingent fee arrangements, as when the percentage received by the attorney depends on whether the case is settled or tried (Hay 1977), or on the amount of effort (hours billed) that the attorney makes (Miller 1987). Finally, it is not uncommon for clients to agree to pay certain expenses and hourly fees for law firm associates, while offering a contingency arrangement in exchange for an agreement by the partners not to bill their time. Contingent fees have been controversial throughout legal history. In the United States they are commonly used by the plaintiff’s bar and occasionally by the defence bar. Kakalik and Pace (1986) report a US survey in which 96 percent of individual plaintiffs’ attorneys in tort litigation brought the cases on contingency, but 95 percent of defendants’ attorneys work for an hourly wage. Contingent fees are prohibited or substantially restricted, however, in many other common law and civil law legal systems. Until recently, West Germany and Spain were the only civil law systems with contingent fees. However, in 1995 a variant of a contingent fees system was instituted in England. Under the English conditional fee arrangement, if a case is lost the attorney pays all the plaintiff’s costs. If the case is won (or there is a settlement) the attorney receives her hourly fees plus a mark up which cannot exceed 100 percent (see CONDITIONAL FEES IN BRITAIN). The historical reluctance of England to institute contingency fees gives a flavour of the concerns that have historically supported such market restrictions elsewhere. Dover (1986) traces the roots of the English prohibition to the medieval era in which citizens’ legal disputes became instruments of a power struggle between the feudal nobility and the crown. He interprets the long-standing English disallowance of contingent fees as arising from a desire to discourage litigation. Others see the prohibition as a means of protecting uninformed clients with poor bargaining power from the grips of unethical or economically unscrupulous attorneys. In the United States, where litigation is widespread, contingent fees are seen by many as not only benign but also as a necessary means to provide all citizens, especially those with limited means, with access to the legal system. From a free market perspective, a compelling argument is needed to justify a restriction on contractual arrangements between principals (clients) and agents (attorneys). Yet many countries have such restrictions, and numerous attempts (some successful) have been made in various states in the US to limit the use of contingent fees. This essay focuses on the normative question of whether the restriction of fee arrangements in economically efficient. We seek, therefore, to evaluate the arguments for prohibition, and to sketch out the circumstances under which the gains from prohibition outweigh the benefits that the freedom to contract is likely to bring to both parties. The law and economics literature on contingency arrangements is almost entirely directed to the positive question of what fee arrangements are best from the point of view of the parties in litigation: the client and the attorney. Disturbingly, a question that is left almost untouched is the one that motivates the social interest in fee arrangements: the effect of such arrangements on ‘social welfare’, broadly defined to incorporate deterrence, litigation costs and the interests of other potential plaintiffs, defendants and attorneys. A related question is how fee arrangements between clients and attorneys affect the adjudication process, with a view toward the ultimate objective of how they affect the probability that offenders are convicted or determined to be liable, and nonoffenders acquitted or found not liable. And, of course, the social calculus must also account for the social resources spent on litigation. In addition to evaluating these normative questions we will attempt to find economic explanations for some empirical regularities: why do plaintiffs’ attorneys work most frequently on a contingency basis, while defendants’ attorneys do not? Why are contingency fees more common in some types of tort litigation than others? In focusing on economic efficiency, we realize, of course, that we are deemphasizing important non-economic perspective such as equity and justice. Besides being concerned about deterrence and the minimization of litigation costs, courts care about the ability of potential plaintiffs to file suit and to be fairly reimbursed for any harm they have suffered (see, for example, Birnholz 1990). In Section I, we outline the nature of actual fee arrangements. In Section II, we discuss positive issues, focusing primarily on the moral hazard implications of various fee structures. Section III treats other positive issues – adverse selection and other behaviour that result when there is asymmetric information between attorneys and clients. In Section IV, we return to the larger normative question of whether restrictions on fee arrangements are warranted. Section V conclude with a brief summary.

Source Publication

The New Palgrave Dictionary of Economics and the Law

Source Editors/Authors

Peter Newman

Publication Date

1998

Volume Number

1

Contingent Fees

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