FACTS

Inquiring lawyers wish to know whether a lawyer may charge a “non-refundable fee” for a set number of hours of work, which may or may not result in completion of a specific task.  The lawyers propose, by way of example, that a lawyer whose billing rate is $200 an hour offers to charge a non-refundable fee of $2,000 that would pay for 10 hours of legal work or completion of the matter, whichever occurs first.  In other words, the client is told in the fee agreement that the lawyer either will complete the matter for the $2,000 non-refundable fee, or the lawyer will provide 10 hours of work toward completion of that matter.  The agreement would further provide that, if facts or circumstances change that require additional time, the lawyer may then bill for the additional time at his or her specified hourly rate.

QUESTIONS PRESENTED

1.  May a lawyer charge a minimum, non-refundable fee for a certain specified number of hours, or through completion of a matter (if less than the specified number of hours), as opposed to charging a non-refundable fee for a specific task?

2.  May such a fee agreement combine a minimum, non-refundable fee, and, as facts or circumstances dictate, further services at an hourly rate?

APPLICABLE ARIZONA RULES OF PROFESSIONAL CONDUCT (“ER __”)

ER 1.4  Communication

. . .

(b)  A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.

. . . .

ER 1.5  Fees

(a)  A lawyer shall not make an agreement for, charge, or collect an unreasonable fee...

(b)  The scope of the representation and the basis or rate of the fee and expenses for which the client will be responsible shall be communicated to the client in writing, before or within a reasonable time after commencing the representation….

. . .

(d)  A lawyer shall not enter into an arrangement for, charge, or collect:

. . .

(3)  a fee denominated as “earned upon receipt,” “nonrefundable” or in similar terms unless the client is simultaneously advised in writing that the client may nevertheless discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee based upon the value of the representation pursuant to paragraph (a).

. . . .

ER 1.16  Declining or Terminating Representation

. . .

(b)  Except as stated in paragraph (c), a lawyer may withdraw from representing a client if:

. . .

(5)  the client fails substantially to fulfill an obligation to the lawyer regarding the lawyer’s services and has been given reasonable warning that the lawyer will withdraw unless the obligation is fulfilled;

. . .

(c)  A lawyer shall comply with applicable law requiring notice to or permission of a tribunal when terminating a representation.  When ordered to do so by a tribunal, a lawyer shall continue representation notwithstanding good cause for terminating the representation.

. . . .

RELEVANT ETHICS OPINIONS

Ariz. Ethics Ops. 99-02, 03-06

OPINION

Ariz. Ethics Op. 99-02 addressed the ethical propriety of “non-refundable” or “earned on receipt” fees and the ethical way of handling such funds.  Opinion 99-02 made clear that a non-refundable fee is ethically permissible if it is reasonable under ER 1.5, and the client is fully informed about and expressly agrees to such a fee, “preferably in writing” (as ER 1.5 provided then). [1]

Opinion 99-02 explained that a “non-refundable fee” is not synonymous with a “flat fee.”  A “flat fee” describes an agreement whereby the lawyer renders a specific legal service for an amount that is fixed at the start of the representation.  Typically, the specified legal service is a self-contained task that can be described from start to finish, such as drafting a will, obtaining a divorce decree, documenting a real estate transaction, or handling a litigation from complaint to judgment.  According to Opinion 99-02, in setting the amount of the flat fee, the lawyer assumes the risk of accurately estimating the probable time required to complete the service.  In that respect, a flat fee is analogous to a contingency fee.  Like a contingency fee (as with all fees), a flat fee is always subject to the reasonableness analysis.

A flat fee may or may not be paid in advance and be non-refundable.  The agreement between the lawyer and the client determines these additional matters.  The agreement could provide, for example, that the fee would be paid in advance and then “earned” at an hourly rate until exhausted.  When treated in that fashion, the amount tendered is no different from an advance fee drawn on at an hourly rate, except that the fee establishes an upper limit on the client’s liability.  A flat fee also may be paid in advance and then deemed earned in part upon the completion of specified portions of the task or the occurrence of specified events in the representation.  The fee could be paid and earned in installments triggered by the specified events or task.  Or, the fee could be paid in advance and treated as “earned on receipt” or non-refundable.  Id. at 4.  Opinion 99-02 continues by explaining that, in addition, a non-refundable flat-fee agreement may appropriately reflect a negotiated element of risk sharing between lawyer and client.  The lawyer takes the risk that he or she will do more work than planned, without additional compensation, and the client, in return, agrees that the lawyer will earn the agreed-upon amount, even if that amount would exceed the lawyer’s usual hourly rate, assuming the total fee is reasonable.

A non-refundable fee becomes the property of the lawyer when paid.  Such funds should not be placed in a trust account where they will commingle with client funds.  ER 1.15(a).  On the other hand, the client retains ownership of, or at least an equitable claim to, funds representing an advance payment of fees.  Accordingly, those funds must be deposited in the lawyer’s trust account.  ER 1.15(c).  The lawyer may withdraw the advanced fee from the trust account only when, and to the extent that, he or she earns the fee by the criteria specified in the fee agreement.  In the case of the type of “hybrid” fee at issue here – in part non-refundable, and in part earned on an hourly or other basis – prepaid funds advanced to secure the hourly fee would go into the trust account, but funds earned on receipt would not.

Opinion 99-02 implicitly suggests that a “hybrid” fee is ethically permissible, provided, of course, that the overall fee is “reasonable” under the eight factors set forth in ER 1.5(a).  Opinion 03-06 dealt with a hybrid agreement that combined aspects of a contingency fee agreement with an hourly fee agreement.  Such a combination was deemed ethical provided that the overall fee charged was reasonable.

Historically, the term “flat fee” has been associated with the notion that the client pays one amount for all legal services necessary to complete the legal matter.  Approval of the type of proposed minimum, non-refundable fee at issue here would require an expansion of what has become the accepted description of a flat fee.  This fee would not be a fee for all work necessary to complete the legal matter.  Rather, the fee paid would entitle the client to a specified number of hours of legal work, or completion of the matter if the work can be completed in the number of hours specified or less.  This fee arrangement differs from a traditional flat-fee arrangement. In essence, the fee arrangement that is proposed is a minimum fee, required by the lawyer in order to agree to undertake the representation, rather than a flat fee.

ER 1.5(a) requires that a fee must be reasonable.  The Committee is concerned that use of this type of fee arrangement, and its designation as a “flat fee” for a specified number of hours, would unjustly benefit the lawyer.  The lawyer would be assuming no real risk under these circumstances because, if the legal work takes more than a specified number of hours, the lawyer can then revert to charging the client by the hour.  One of the justifications for allowing lawyers to charge a flat fee has been that both the lawyer and the client assume risk.  The lawyer assumes the risk that the work may become unduly time intensive; the client assumes the risk that the lawyer will expend less time on the matter than if the lawyer charged an hourly rate.

The Committee is also concerned that, by denominating the minimum fee portion “earned on receipt,” this type of arrangement is an attempt to bypass holding client fees in the lawyer’s trust account until earned.  The concern is that the minimum fee paid for a specific number of hours is really an advance-fee deposit rather than a flat fee, because the lawyer must keep track of the time spent on the matter according to the terms of the agreement.

The Committee believes that the fee arrangement at issue is not on its face unethical, if the total fee is reasonable.  The Committee’s concern centers around use of the term “flat fee” for the proposed arrangement, because of the traditional understanding by clients of what the term “flat fee” entails.  The proposed arrangement would not pose this problem of confusion if the fee paid for the specified number of hours was termed a “minimum fee.” In reality, the proposed fee arrangement is calling for the payment of a minimum fee, not what has been traditionally termed a “flat fee.” 

This minimum fee could be designated as “earned on receipt” and “non-refundable,” [2] in which case the funds should be placed in the lawyer’s operating account.  If the minimum fee is not so designated, the funds should be placed in the trust account and transferred to the operating account when the funds have been earned.

If circumstances require that the minimum-fee arrangement shift to an hourly rate, ER 1.4  requires that the lawyer discuss that matter with the client so that the client understands what circumstances have arisen that justify the hourly charges thereafter.  While the Committee does not believe that the lawyer will have to enter into a new hourly fee agreement with the client, as a better practice, the lawyer should memorialize the changed circumstances that justify converting to an hourly rate from that point forward so there is no misunderstanding on the part of the client.

Should the circumstances of the representation change so that the lawyer begins to charge at the hourly rate, and the client at that point demurs to the continued representation at an hourly rate, the lawyer must comply with ER 1.16 before withdrawing from the representation.  If the matter is being litigated in court, pursuant to ER 1.16(c), the lawyer is reminded that he or she remains counsel of record unless and until the court allows withdrawal.

CONCLUSION

Provided that the overall fee is reasonable, it is ethically permissible to charge a minimum fee that may be designated “earned on receipt” or “non-refundable” with the language required by ER 1.5(d), for a specified number of hours or through completion of the matter, whichever occurs first, and also to include a provision that, under certain reasonably defined changed circumstances, the lawyer reserves the right to charge the client on an hourly basis for the remainder of the matter.

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. This opinion is based on the Ethical Rules in effect on the date the opinion was published. If the rule changes, a different conclusion may be appropriate. © State Bar of Arizona 2010

_______

[1] Effective December 1, 2003, ER 1.5 was amended to require that lawyers memorialize the rate and basis of the fee and scope of representation in writing.  Furthermore, ER 1.5(d)(3) was added to specify the certain minimum disclosures that must be included in the written fee agreement if the fee is denominated as “earned upon receipt,” or “nonrefundable”:  those being, that the client is simultaneously advised in writing that the client may nevertheless discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee based upon the value of the representation.

[2] ER 1.5(d) requires certain corresponding language be included in the fee agreement if those terms are used.