When Lawyers Collect More Than Clients Receive

When lawyers collect more money in legal fees than the value of property recovered by the client, the result may appear unreasonable, or it may be the product of a fee agreement, which itself must be unconscionable or violate public policy. Yet a recent California Court of Appeals case confirms that transactional lawyers can legally and ethically receive more in legal fees than the value of property recovered by the client. This is true even if the fee recovered is more than what the lawyers would have received if they had charged by the hour. Of course to achieve this feat it helps to have a "sophisticated client," a "stupendous" outcome, and a well crafted contingent fee agreement negotiated amongst parties of equal bargaining strength.

This is exactly what occurred in connection with the purchase of contaminated real property in Cotchett, Pitre & McCarthy v. Universal Paragon Corp. et al (2010) Cal. App. Lexis 1644, No. A126149. The case reaffirms many traditional principles governing fee agreements and also offers some useful practice pointers in crafting such agreements.

Universal Paragon Corp. (UPC), purchased a parcel of real property adjacent to property owned by Ingersoll-Rand Corp. The Ingersoll property was contaminated by acid used in the manufacture of Schlage locks and by fuel from Southern Pacific Railroad operations. The contamination was migrating to UPC's property. UPC wished to acquire the Schlage site so it could control the environmental clean up and develop both parcels as part of a larger project.

UPC wanted to avoid up front attorney fees with a contingency fee agreement, but the Cotchett firm was concerned that a contingency fee based upon the value of contaminated property would be too low. UPC hired outside counsel to negotiate the fee agreement with the Cotchett firm. After several months, the parties reached an agreement based on an alternate contingency formula with certain allowances: the Cotchett firm would receive a percentage of either the fair market value of the property at its highest and best use or the total amount of UPC's estimated damages based on remediation costs, clean-up insurance, demolition, diminution in value, etc., whichever was greater.

The case settled and total damages far exceeded the value of the property. UPC claimed its legal fees should be based only on the value of the property obtained and that the agreement was unconscionable and unenforceable due to lack of mutual assent, mistake and misrepresentation.

The Court of Appeals disagreed and deemed the nearly $8 million in legal fees not unconscionable, even though the value of the property received in its unremediated state plus cash was only $7.8 million. The standard for legal fees in California is whether they are "unconscionable" (Note that this is not the same standard as "unreasonable" employed by the ABA Model Rules.) Attorney fees are unconscionable if they are "so exorbitant and wholly disproportionate to the services performed as to shock the conscience." Traver v. State Bar (1984) 37 Cal. 3d 122, 134.

In Cotchett the parties, both equally matched and sophisticated, agreed to share the risk of complicated litigation. The arbitrator deemed the result obtained by the lawyers "stupendous." UPC hired outside counsel to negotiate the agreement, and the retainer agreement itself included a "Hypothetical Example of Alternative Contingency" describing how legal fees would be calculated.

Cotchett suggests several valuable practice pointers that increase the likelihood of a fee agreement withstanding complaints that the client didn't understand the agreement or that its terms are unconscionable.

Not all clients are created equal. There is an emerging trend among courts to recognize that a personal injury victim is generally not as sophisticated as a well-heeled corporate client. The less sophisticated the client, the more the lawyer is required to show that the fee agreement is not the product of over reaching or unequal bargaining power. When a fee agreement produces overly harsh or one-sided results, lacks mutuality of remedy, or seeks to restrict statutory rights; the onus is on the attorney to show informed consent by the client.

Use a hypothetical to demonstrate how the fee agreement would work. This is particularly important with unsophisticated clients and contingent or hybrid agreements. Using an example or hypothetical in your fee agreement eliminates claims the client was confused by the contingent fee formula or didn't understand that fees were calculated on the gross rather than the net recovery.

Use a separate Rule 3-300 notice, acknowledgment and consent if you are taking an interest in specific client property or entering into a business transaction with a client and abide by the three-day rule. Say a client offers you 1000 shares of common stock in his corporation that you have been hired to incorporate as partial compensation for your efforts, or perhaps the client offers you a lien on a commercial property as collateral to secure your legal fees, Rule 3-300 of the Rules of Professional Conduct requires a separate "notice, acknowledgment and consent" that contains notification of the client's right to seek independent legal counsel, recites the foreseeable consequences of the transaction (inability to sell or refinance the property), and allows the client time to seek out such counsel. As a rule of thumb, give the client at least three business days to seek such advice before asking them to sign the Acknowledgment even if they do not wish to avail themselves of the opportunity.

Offer to pay for a consultation with outside counsel. If you have an unsophisticated client, and the stakes are high, you may actually want to offer to pay for an hour of time by an independent counsel of the client's choosing. Where the client lacks business and legal experience, a little money invested up front in an objective review by an outside lawyer means the client cannot later be heard to complain they didn't understand the terms of the agreement or that the terms were unfair or unreasonable.

Send a notice of right to arbitrate to the client as soon as a client threatens to complain to the State Bar. Clients will often use a complaint as a strong-arm tactic in a fee dispute. The complaint to the State Bar will often try to portray a fee dispute as a failure to perform competently. Always send the client a notice of right to fee arbitration (Business & Professions Code Section 6200 et seq.), because the State Bar will usually not pursue an investigation where the matter is solely a fee dispute. If you can frame the issue as a fee dispute and not a pattern of failing to perform competently, you are immune from State Bar inquiry unless the fee itself or your conduct is unconscionable.

"The State Bar has no power to regulate the amount of fees charged by its members unless such fees are so "outlandish" as to merit discipline or the conduct [of] the attorney in negotiating for or attempting to collect a fee merit discipline" Cotchett, page 15.

Business transactions with a client or taking an interest in specifically identified real property must be fair and reasonable. This requires you to obtain the client's informed written consent after advising the client of their right to seek the advice of independent legal counsel, and actually giving the client time to do so. The less sophisticated the client the more detail you will need to disclose as to the effect of the transaction. The less sophisticated the client, the greater the reason to actually pay for the consultation with independent counsel. Use a hypothetical or example to show how the transaction is likely to play out. Give the client at least three business days to seek outside counsel before they sign the acknowledgment. At the first sign of a fee dispute, give your client a notice of right to fee arbitration to keep the dispute from becoming a disciplinary matter. These small acts on your part will help protect you from clients who claim they were taken advantage of, or didn't understand the terms of your fee agreement.