FACTS[1]

The inquiring attorney has asked about the ethical propriety of a fee agreement in which a lawyer is compensated for his or her services by receiving the greater of a contingency fee (33% to 40% of gross proceeds) or the firm's hourly time charges.

QUESTION PRESENTED
 
Would a fee agreement violate the Arizona Rules of Professional Conduct if it provides that in return for the attorney's services, the attorney will receive the greater of a contingency fee (33% to 40% of gross proceeds) or the firm's hourly time charges?

RELEVANT ETHICAL RULES

ER 1.5     Fees

(a)     A lawyer's fee shall be reasonable.  The factors to be considered in determining the reasonableness of a fee include the following:

(1)     the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly;

(2)     the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;

(3)     the fee customarily charged in the locality for similar legal services;

(4)     the amount involved and the results obtained;

(5)     the time limitations imposed by the client or by the circumstances;

(6)     the nature and length of the professional relationship with the client;

(7)     the experience, reputation, and ability of the lawyer or lawyers performing the services; and

(8)     whether the fee is fixed or contingent.

* * * *

(c)     A fee may be contingent on the outcome of the matter, for which the service is rendered, except in a matter in which a contingent fee is prohibited by paragraph (d) or other law.  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 a settlement, trial or appeal, litigation and other expenses to be deducted from the recovery, and whether such expenses are to be deducted before or after the contingent fee is calculated.  Upon conclusion of a contingent fee matter, the lawyer shall provide the client with a written statement stating the outcome of the matter and, if there is a recovery, showing the remittance to the client and the method of its determination.

RELEVANT ARIZONA ETHICS OPINIONS

Ariz. Op. 94-15 (Dec. 12, 1994)

OPINION

The fee arrangement described by the inquiring attorney makes the client responsible for paying the greater of either a prescribed contingent fee or the firm's hourly time charges.  One obvious concern with this arrangement is that it takes the "contingency" out of the contingent fee component of the lawyer's fee.

The Arizona ethical rules expressly authorize lawyers to enter contingent fee arrangements in certain cases, subject to certain procedural safeguards.  ER 1.5(c).  The Arizona Supreme Court has recognized that the fee from such an arrangement ultimately "may be much larger than that attorney or others would have charged had they been retained and paid on a time basis."  In re Swartz, 141 Ariz. 266, 273, 686 P.2d 1236, 1243 (1984).  Such a result is justified mainly on the ground that under most contingent fee arrangements, the lawyer runs a risk of not being paid if he or she is unsuccessful in securing a recovery in a case.  REINSTATEMENT OF THE LAW GOVERNING LAWYERS § 35 cmt. c (2000) ("A contingent-fee lawyer bears the risk of receiving no pay if the client loses and is entitled to compensation for bearing that risk.")  That rationale, however, is inapplicable here because the fee arrangement guarantees that the lawyer will receive no less than his or her time charges for the matter.

Although the ethical propriety of the fee arrangement described by the inquiring attorney has never been addressed by an Arizona court or the Committee on the Rules of Professional Conduct, one New York court has held that such a fee structure is per se illegal and unenforceable.  In Beltzer v. Bollea, 571 N.Y.S.2d 365 (Sup. Ct. 1990), counsel for a settling plaintiff asked the trial court to approve an increase in his contingent fee from one-third to one-half of the recovery.  The court denied the application, limiting counsel to the one-third contingency set forth in his retainer agreement with his client.  During its discussion of the issue, the court noted that the fee agreement called for a contingent fee of one-third of the gross proceeds of the recovery "or whatever the Firm's straight time billing charges would have been, whichever is greater."  Id. at 366.  The court sharply condemned that provision in dictum because it potentially allowed counsel to recover more than the agreed-upon contingency:

If there is a contingency agreement, the attorney cannot exceed the permitted percentages by providing for alternatives, which would result in even higher compensation.  The contingent fee is permitted because the attorney takes the risk of recovering nothing at all.  If the agreement provides for the certainty of recovery in any event, the risk which justifies the contingency fee is removed, especially if there can be a recovery on a time billing basis should that turn out to be more remunerative.

Id. at 366-67.

While the court in Belzer had good grounds for questioning the fee at issue, it does not appear to have been justified in suggesting that it is never ethically appropriate to combine elements of a contingent fee arrangement with hourly billing.  Although the structure of a fee arrangement can have important ethical consequences, the key issue under ER 1.5(a) is not how a fee is structured, but whether the fee amount is "reasonable."  The rule lists eight factors that should be considered in making that determination, only one of which is whether the representation is undertaken on a contingent fee basis.  Assuming that the resulting fee is "reasonable," nothing in ER 1.5 expressly precludes combining hourly rates with a contingency component in a fee arrangement, so long as the client agrees and the arrangement is otherwise consistent with the procedural requirements of ER 1.5.[2]

Such a fee structure is sometimes called a "modified contingent fee" or a "hybrid fee."  It is not difficult to envision circumstances in which a "hybrid fee" arrangement would not produce an excessive fee.  For example, In Boston & Maine v. Sheehan, Phinney, Bass & Green, P.A., 778 F.2d 890 (1st Cir. 1985), the First Circuit approved a "hybrid fee" arrangement in which a law firm in an eminent domain case received not only its hourly charges, but also 15 percent of any recovery greater than the amount initially offered by the defendant.  It was stipulated that lawyers typically received a 50 percent of the recovery in handling such matters on a contingent fee basis, which would have produced a much larger fee than the firm's "hybrid fee" arrangement.  Id. at 897.  Also, the client was in bankruptcy, which made it more difficult for it to secure representation by a specialist in the field.  Id. at 895 & 898 n.9.  The court also noted that the trial court had acknowledged that the firm had responded: "imaginatively to two difficult legal challenges, both of which were vital to obtaining a high damages award."  Id. at 899.  In light of those factors, the First Circuit held that the lower court abused its discretion in not awarding the firm a fee consistent with the "hybrid fee" arrangement. Id.

Especially significant to the court was that in exchange for having the security of hourly fees, the firm had agreed to a reduced contingency percentage:

In return for the lowered risk, Sheehan accepted a much lower contingency fee - 15%.  Thus, Sheehan assumed the risk, indeed the likelihood, of receiving considerable less compensation that it might normally have received.  And the [client] could believe that the 15% being contingent upon the amount of additional moneys the attorneys brought in, would spur them to greater efforts that would ultimately benefit the [client] and its creditors.  We do not think the arrangement was unreasonable in the circumstances simply because it combined two different forms of fee calculation.

Id. at 897.

Ethics committees in other states also have approved of "hybrid fee" arrangements, subject to the requirement that they not produce "excessive" fees.  In one leading opinion, the New York State Bar Association concluded that a "hybrid fee" arrangement combining a contingent bonus with hourly fee charges was not prohibited under the Model Code so long as the resulting fee was not excessive.  New York State Bar Ass'n , Committee on Professional Ethics, Op. 697 (12/30/97). The key factor for the committee was whether "the contingency percentage will be lower than it would be if the fee were based on a pure contingency."  Id.  In such circumstances, "[a]lthough the lawyer who charges a modified contingent fee does not assume the full risk of no recovery (since he or she is receiving an hourly fee), the lower risk to the lawyer is balanced by the lower 'bonus' if the representation yields a significant recovery." Id.

The opinion also noted that if the lawyer agreed to reduce his or her hourly rate as part of the arrangement, it would serve the central purpose in allowing contingency fees in the first place: making legal services available to clients who otherwise may not be able to afford them.[3]  There may be cases that are so risky or difficult that a reasonable lawyer might be willing to work on them solely on a contingent fee basis.  At the same time, the lawyer might be willing to work on such a matter for a reduced hourly rate if the client agrees to pay the lawyer a reduced percentage of the recovery.  A "hybrid fee" arrangement in such circumstances might allow the client to secure legal representation when other types of fee arrangements would not.  Id. ("[I]f the hourly fee is reduced, it is likely to make counsel available to clients whose cases do not have such a high probability of success that a straight contingency fee would be attractive to prospective counsel."); see also Nevada Formal Op. 4 (1987) (fee arrangement not unethical where lawyer gave a client 20% discount on hourly fee rate and received a 50% contingency on any punitive damage recovery).

These considerations lead to the conclusion that ER 1.5 does not prohibit "hybrid fee" arrangements if the resulting fee is not "excessive" and the other requirements of ER 1.5 are satisfied.  It also bears emphasizing that a fee's reasonableness ultimately must be determined after the services are rendered, as "[e]ither a fixed or contingent fee, proper when contracted for, may later turn out to be excessive."  In re Swartz, 141 Ariz. At 273, 686 P.2d at 1243.

That leaves the question whether the fee arrangement described by the inquiring attorney would produce an "excessive" fee.  It certainly is suspect.  Unlike Boston & Maine and the facts considered by the New York State Bar Association in Op. 697, the contingency (33% to 40%) does not appear to be any smaller than the percentage typically charged in many types of contingent fee matters.  The hourly fee rate also does not appear to have been discounted, reflecting instead what appears to be standard "hourly rate charges."

Unfortunately, the inquiring attorney has not provided sufficient facts to determine definitively whether this fee structure would produce an "excessive" fee.  Consistent with the factors listed in ER 1.5(a), fee arrangements that initially may appear excessive may nonetheless be justifiable (and, in light of the rendered services, justified) because of factors such as the difficulty or risk of the matter, the contingent fee rates typically charged for similar matters, the size of the expected or actual recovery, the time constraints involved, the unique skills of counsel, and the competing demands for counsel's services.  The facts provided by the inquiring attorney do not shed light on any of these issues.  However, unless one or more of these factors provide substantial support for the reasonableness of the fee, the fee structure described by the inquiring attorney appears likely to yield an "excessive" fee and therefore would be prohibited under ER 1.5(a).

CONCLUSION

Although ER 1.5 does not prohibit "hybrid fee" structures that combine aspects of contingency fee and hourly billing arrangements, the resulting fee must not be "excessive."  The fee structure described by the inquiring attorney - requiring the client to pay the greater of 33% to 40% of the gross proceeds of a prospective recovery or the firm's standard time charges-is likely to result in an excessive fee, unless other factors listed in ER 1.5(a) are sufficiently compelling to justify the size of the fee.

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[1] Formal Opinions of the Committee on the Rules of Professional Conduct are advisory in nature only and are not binding in any disciplinary or other legal proceedings.  © State Bar of Arizona 2003

[2] Indeed, subject to the requirements in the rule, ER 1.5 affords lawyers and clients considerable flexibility in structuring fee arrangements.  Billing on an hourly or flat-fee basis is permissible, and ER 1.5(c) authorizes proceeding on a contingent fee basis in certain types of cases and if certain procedural requirements are satisfied.  The comments to ER 1.5 also state that in lieu of a monetary fee, a lawyer may ethically accept an interest in property in payment for services so long as the lawyer does not "involve acquisition of a proprietary interest in the cause of action or subject matter of the litigation" contrary to ER 1.8(j).  The Committee on the Rules of Professional Conduct also has concluded that an attorney may accept a partial assignment of a patent in return for rendering legal services in preparing and prosecuting the patent.  Ariz. Op. 94-15 (Dec. 12, 1994).

[3] See also In re Swartz, 141 Ariz. 266, 272, 686 P.2d 1236, 1242 (1984) ("Whatever the dangers, it is now generally accepted that the contingent fee is proper and has substantial social utility because such arrangements are 'often the only method by which a person of ordinary means may prosecute a just claim to judgment.'" (quoting Note, Lawyer's Tight Rope - Use and Abuse of Fees, 41 CORNELL L.Q. 683,689 (1956)).