CONTINGENT AND NONCONTINGENT ATTORNEYS' FEES IN PERSONAL INJURY CASES

CONTINGENT AND NONCONTINGENT ATTORNEYS’ FEES IN PERSONAL INJURY CASES

JOSEPH M. FISHER*

Fee structures determine the economic incentives for lawyer perfannance. A certain hourly fee promotes excessive legal work, while a contingent fee leads to insuflcient attomy effort. Com- petition among lawyers for enhanced reputation helps mitigate these effects, though client welfare still is not maximized. Clients’ monitoring of attorney conduct ofen is necessary, but the expense of such monitoring limits its usefulness. This study concludes that the contingent fee may be a second-best solution to the problem of regulating lawyer performance.

I . INTRODUCTION

In an overwhelming majority of personal injury cases, plaintiffs’ lawyers in the United States are compensated on a contingent basis.’ (See, for example, the studies in Danzon, 1985, p. 195; Franklin et al., 1961, p. 22; Mac- Kinnon, 1964, pp. 114-116.) A contingent fee usually is calculated as a percentage of the plaintiff‘s recovery to be paid to the plaintiff’s attorney if, and only if, the plaintiff prevails at trial or otherwise obtains a positive settlement of his claim?

The contingent fee traditionally has been unlawful under English com- mon law,3 but such fee arrangements received widespread approval in the

*Member, District of Columbia Bar. This article was prepared while the author was a Visit- ing Associate Professor at the Department of Economics, University of California, Santa Bar- bara. An earlier version of this paper was presented at the 62nd Annual Western Economic As- sociation International Conference, Vancouver, B.C., July 1987, in a session organized by John Ward, University of Missouri, Kansas City.

1. The analysis is limited to plaintiffs’ attorneys in cases where a single plaintif€ seeks to recover damages for personal injuries. The paper does not consider the use of contingent fee arrangements in other litigation contexts such as injunctive actions, class actions, and derivative lawsuits. See, e.g., Coffee (1986) and Leubsdorf (1981). Nor does the paper consider contingent payment of defense counsel (see Annotation, 1981).

2. The plaintiffs payment of court costs and other litigation expenses-such as expert wit- ness fees-might also be contingent, depending on whether the lawyer is willing to advance these amounts and thus risk reimbursement on the outcome of the case. (See rule 1.8(e) of the American Bar Association’s (ABA’s) Model Rules of Professional Conduct, 1983.) For simplicity, this paper ignores all litigation expenses other than attorneys’ fees.

3. The prohibitions against contingent fees arose from four traditional legal doctrines: (1) the doctrine of maintenance, prohibiting someone from supporting another person’s litigation; (2) the doctrine of champerty, prohibiting agreements to share in litigation proceeds; (3) the doctrine of barratry, prohibiting litigation from being promoted or stimulated; and (4) the doctrine of non-assignability, prohibiting interests in a cause of action from being purchased or sold (Mac- Kinnon, 1964, pp. 35-38; Radin, 1935).

108 Contemporary Policy Issues Vol. VI, July 1988

FISHER: ATTORNEYS’ FEES IN PERSONAL INJURY CASES 109

US. by the turn of the c e n t ~ r y . ~ Contingent fees are permitted in most Canadian provinces but generally remain unavailable throughout Europe.’

The contingent fee arrangement in the U.S. often is justified as a form of legal aid for poor claimants-opening up the doors of justice to those who otherwise could not afford to vindicate their legal rights (Rhein, 1982, pp. 156-158; Shrager, 1985). The contingent arrangements also is defended as a rational economic solution to the problem of portfolio diversification in a world where claimants are risk averse and where imperfect information and high transactions costs impede access to capital markets (Posner, 1986, p. 534). The contingent fee is further justified in that it creates incentives for lawyers to work diligently in their client’s interests since the magnitude of their fee and the probability of collecting it are determined directly by such lawyers’ success in advancing the claim. (See Schwartz and Mitchell, 1970, pp. 1125-1126. for a detailed review of these contentions.)

Critics, however, contend that contingent fees “induce lawyers to bring unwarranted lawsuits, to seek exaggerated damages, and not to settle claims for reasonable amounts” (Robinson, 1986, p. 22). Some argue that the prospect of obtaining a percentage of the jury award leads to attorney ex- cesses, and that these expose defendants and their insurance companies to unanticipated and perhaps unwarranted financial risks and to burdensome litigation. This, some argue, produces a crisis in insurance affordability and availability and a backlog in the court system. (See, for example, DuBois. 1985.)

Critics also contend that the contingent fee ill-serves plaintiffs, who sup- posedly are disadvantaged not only by court delays caused by excessive claims but also by conflicts of interest that develop between client and counsel when payment of fees is transformed into “joint ownership” of a claim. The lawyer’s profit-maximizing conduct regarding his share of the claim may not coincide with action that would maximize the client’s net expected return. (See Schwartz and Mitchell, 1970.) Differences may arise over such issues as settlement strategies and how lawyer time is utilized. Moreover, the client often has insufficient information (i) initially, to bargain effectively with his lawyer in arriving at an appropriate contingent fee arrangement, and (ii) after representation has commenced, to monitor the lawyer’s activity so as to ensure optimal performance. These conditions may lead to “extraordinary abuses where attorneys receive fees in the hundreds of thousands of dollars for limited work” (U.S. Department of Justice, 1986, p. 72).

4. The ABA sanctioned contingent fees by adopting canon 13 of the 1908 Code of Profes- sional Ethics. (See Comment, 1986, p. 535.)

5. Contingent fee arrangements are either illegal or considered unethical in most European countries (Pfennigstorf, 1984, pp. 59-60). Contingent fees are expressly permitted in all Canadian provinces except Ontario, and even in Ontario such arrangements exist defucto (Kritzer, 1984, pp. 129-133).

110 CONTEMPORARY POLICY ISSUES

This paper analyzes the incentive effects of attorney fee arrangements. Section I1 discusses some preliminary ethical issues as a backdrop to con- sidering lawyers’ economic motivations. Section 111 establishes the theoretical effects of noncontingent fee arrangements on legal conduct in a risk- neutral environment. Section IV explores the changes in legal incentives that arise under contingent fee arrangements, again under the assumption of risk neutrality. Section V considers the implications of alternative risk preferences. The paper concludes with policy implications for the continued use of contingent fees.

II. THE LAWYER AS PROFESSIONAL

Central to this paper’s analysis of fee arrangements is that lawyers are characterized as entrepreneurs motivated primarily, if not solely, by economic considerations. This view ignores the professional and public service aspects of law practice-dominaot features of the lawyers’ethical code. For example, rule 1.5 of the American Bar Association’s (ABA’s) Model Rules of Professional Conduct (1983) limits attorneys’ fees to a standard of “reasonableness,” rule 1.7 demands that the lawyer be loyal to the client and prohibits conflicts of interest, and rule 6.1 encourages lawyers to render pro bono public0 legal service. Lawyers clearly are influenced by considerations such as “altruism, a personal sense of integrity, an ideologically in- spired desire to right certain wrongs, [and] a shared sense of affinity to traditional professional role models honored within the legal profession” Wolfram (1984, p. 295).

But a law practice is also a business, in which economic self-interest can create incentives for departing from professional standards. As the ABA (1986, p. 9) observed, “[wlhile economic pressure cannot justify unprofessional behavior, it may help explain why some lawyers seem less selfless than before.” Lawyers may focus their efforts more on allocating their time optimally (Nagel, 1980) than on pursuing principles for which they may have to sacrifice their own personal wealth. Because case selection and manage- ment practices may be skewed in the direction of lawyer profit maximiza- tion, Wolfram (1984, p. 296) terms the concept of lawyers as professionals “a tapestry of professional mythology.”

Thus, an economic analysis of fee arrangements helps identify the various incentives that potentially could influence attorney conduct. But one should not mistake it for a complete assessment of lawyer behavior, nor should one deem it applicable to all lawyers’ activities.

111. EFFECTS OF CERTAIN HOURLY FEE ARRANGEMENTS ON PLAINTIFF AND COUNSEL

Consider a situation in which an accident victim is also a lawyer. For simplicity, assume that the victim is risk neutral and that the only cost as-


sociated with his pursuing the accident claim is the income foregone from devoting legal time to the case. Under the U.S. system for allocating legal costs, each side bears its own costs. Thus, a claim’s viability is limited by the litigation costs regardless of the plaintiff‘s chances of prevailing on the merits (Shavell, 1982). A rational victim-lawyer, acting as his own counsel, should pursue a claim if and only if its expected benefits exceed the costs of pursuing the claim! He will devote legal time to the case only up to the point at which the marginal product of an additional hour’s work equals the opportunity cost of his legal time?

A. Agency Costs of the Attornefllient Relationship: The Certain Hourly Fee and Risk Neutrality Suppose that the victim-lawyer believes that an attorney who represents

himself has a fool for a client, and thus engages outside counsel. The counsel, who will earn a certain hourly wage equal to the opportunity cost of legal time, is directed to maximize the victim’s expected return on the claim. If the victim can trust counsel to follow this direction exactly, then again counsel will pursue the claim if and only if the expected benefits exceed the costs. Also, counsel will devote only enough legal time to the case to equate the marginal product of an additional hour’s work with the wage rage for the case.

However, creating an agency relationship between victim and counsel af- fects participants’ economic incentives in ways that can distort the ideal outcome described above. One problem concerns the quantity of legal time devoted to the case. A lawyer receiving a certain hourly wage from a client will profit by working as many hours as possible, particularly if the wage rate for the case is greater than such lawyer’s opportunity cost of time (Nagel, 1980, pp. 429-441). Moreover, given that the outcome of litigation is uncertain and that counsel cannot specify exactly how hours worked will affect the probability and magnitude of success, a nonzero chance of malpractice exposure will always exist if counsel devotes insufficient time and effort to the case. Counsel can reduce this exposure, at the client’s expense, by work-

6. Let p denote the probability of plaintiff success. B the dollar value of the benefit of success, w the opportunity cost of an attorney hour, and L the number of hours to be worked on the case by the plaintifF‘s attorney. A claim is viable when the expected return is at least as great as the costs of pursuing the claim, ie., when pB 2 wL.

7. Both the probability @) and the value (B) of success for the plaintiff increase as the plaintiffs attorney devotes more time (L) to the claim, although they do so with decreasing marginal returns. Similarly, the plaintiffs expected success decreases as the defendant’s attorney devotes more time to the claim For convenience, assume the Coumot-Nash outcome of each side optimizing against the optimal investment of his opponent (Danzon, 1983, p. 214). In such case, the victim-lawyer’s net profit is the difference between the expected recovery and the legal costs. The profit function is f(L) - p(L)B(L) - wL, which is maximized when the marginal product of legal time equals the opportunity cost:

d@B)ldL - W.


ing additional hours. Finally litigation success sometimes offers counsel additional rewards, such as enhanced reputation and prestige, which are of little or no value to the client but which translate into future income for the attorney. Because of these potential reputational benefits, the lawyer may work additional hours above and beyond the level that would be optimal in promoting the client’s best interests.

A second problem concerns the quality of legal time devoted to the case. Counsel receiving a certain hourly wage will have a reduced incentive to operate at peak efficiency when he has idle time to fill. Or, as Clermont and Currivan (1978, p. 568) point out, counsel will have an increased incentive to overstate the number of hours worked. With a certain hourly fee, the lawyer’s payment is based on hours billed and not on performance. Whether an attorney is working at one-half efficiency or is working at maximum efficiency and inflating his reports of hours worked, the effect of attorney slack on client welfare is the same: It increases the cost of lawyer hours and thus results in the victim’s securing a lower net recovery.’

B . Market Monitoring Competitive forces in the legal services marketplace alleviate these quan-

tity and quality problems to some e ~ t e n t . ~ A lawyer’s ability to attract and retain clients should be related directly to his ability to maximize clients’ net recoveries. Knowledgeable clients adjust their willingness to pay for a lawyer’s time based on both his reputation and his actual performance. In the ideal legal market, lawyers bid for cases in terms of promised expected net returns to the client (Danzon, 1983, p. 216). This includes commitments of both quantity and quality of legal time.

However, lawyers generally do not make explicit bids for work in terms of promised expected net returns. Making either expressed or implied war- ranties about the outcome of uncertain future litigation would be considered

8. In the case of attorney inefficiency and accurate time reports, the number of hours that the plaintiffs attorney works, L, can be transformed into efficiency units of time, E. The relationship is E - sL, where s is the “slack” factor, 0 < s < 1. Probability and magnitude of litigation success actually are determined by E. Thus, the victim’s expected net recovery is

With attorney efficiency and inflated time reports. the number of hours billed to the client, Lb, is a multiple of the true number of hours worked. In this case, the multiple is the inverse of the “slack” factor: Lb - L/s. The victim’s expected net recovery becomes f2(L) - p(L)B(L) - wUs. Both fi and fz are maximized when

d@B)ldL. - wls. For a given s < 1, client welfare is optknized4ough at lower levels of gross and net

recovery-when the lawyer works fewer hours relative to the no-slack situation (s - 1). If lawyer work levels are not reduced, the client’s gross recovery may be unchanged but the net recovery decreases further.

9. Not only market forces but also legal ethics address the issue of attorney effort. For ex- amples, ruIes 1.1 and 1.3 of the ABA’s Model Rules of Professional Conduct (1983) require lawyers to practice with competence and diligence.

fl(L) - P(sL)B(sL) - wL.

FISHER: A’lTORNEYS’ FEES lN PERSONAL INJURY CASES 113

unprofessional. (See rule 1.8 of the ABA’s Model Rules of Professional Con- duct (1983) prohibiting transfers of interest in a claim, and ABA rule 1.4 procribing the unethical inducement of client reliance.) Moreover, using explicit bids would openly invite malpractice actions against lawyers in unsuc- cessful cases-a prospect that legal malpractice insurance providers would discourage. In practice, then, a lawyer’s reputation for good performance is the marketplace substitute for explicit bids.

The impact of competition as a disciplinary force regarding lawyers’ conduct depends critically on the availability of an enforcement mechanism. Lawyers’ suboptimal activity must be detected if and when it occurs. But un- less the client continually monitors the attorney’s activities, such detection may be impossible.” Unfortunately, it often is difficult to observe or measure the lawyer’s “product.” For example, the effectiveness of attorney hours reportedly spent increasing the probability of success-say, from 20 to 40 percent-cannot readily be observed.

To the extent that the value of his output can be observed, a lawyer’s concern for his reputation promotes some self-monitoring-particularly if the client is a public figure or if the case was referred by another lawyer who is following its progress with interest. Typically, however, the dissemination of information about any particular case is likely to be severely limited if no established market for such information exists. The problem is especially acute for clients who have not played the litigation game before. Indeed, if the cost of rating lawyers accurately before employing them is excessive, rational clients will select lawyers on an almost random basis-e.g., by using a telephone book or local bar association referral service. This type of demand for lawyer services is highly inelastic with respect to past attorney performance.

C. Client Monitoring Clients have an interest in monitoring the quantity and quality of their

attorneys’ activities to ensure that those attorneys are handling their cases properly and that the fees charged are reasonable. However, because obtaining and processing relevant data concerning the lawyer’s “product” is difficult, such monitoring can be only approximate. This imprecision is likely to be even more pronounced if such monitoring is performed by nonlawyer clients lacking legal expertise in the relevant substantive and procedural aspects of their cases.

10. The possibility also exists that suboptimal activity by one lawyer may be detected by other lawyers. Traditionally, however, lawyers are prohibited from communicating with a person known to be represented by another lawyer without first securing the consent of the lauer lawyer. (See rule 4.2 of the ABA’s Model Rules of Professional Conduct, 1983.) Leubsdorf (1979) describes the disadvantages arising when communications in the legal market are restricted.


Moreover, monitoring is not a costless activity. Its costs are determined by the amount and type of lawyer time being monitored and by the amount and opportunity cost of client’s time (and perhaps that of an outside expert) devoted to such monitoring. These “agency costs” can affect the economics of the attorney-client relationship in one of two ways. First, if the costs of client monitoring exceed the expected amount of reduction in net claim value with no monitoring, then no monitoring occurs and uncon- strained lawyers may engage in the nonoptimal conduct described above. Alternatively, if monitoring is justified economically, its costs are added to the client’s other legal expenses up to the point at which the marginal gains due to monitoring equal the marginal costs of monitoring. Both situations result in reduced client welfare.

The net effect of agency costs on litigation is predictable. Victims pursue fewer claims and hire fewer lawyer hours per claim.”

IV. EFFECTS OF CONTINGENT FEE ARRANGEMENTS ON PLAINTIFF AND COUNSEL

An alternative to the certain hourly wage arrangement is the contingent fee. Under this arrangement, the accident victim hires an attorney who is paid a percentage of the award if and only if the claim succeeds. Otherwise, the attorney receives no compensation.

The rational, risk-neutral victim clearly prefers the contingent fee when he cannot afford to pay the lawyer’s fee upfront.12 In these circumstances, the contingent fee is best characterized as a form of legal aid. Posner (1986, p. 534) describes the arrangement as a “loan” of legal services, whereby the contingent percentage compensates the lawyer for both the value of his services and the implicit interest rate on the ‘‘loan.’’

The accident victim also prefers the contingent fee when the expected value of the claim is less than the total projected hourly legal expenses. The claim may not be viable on a certain hourly wage basisPven assuming costless and perfect monitoring of legal activity-if the victim an- ticipates relatively high litigation costs, a low probability of prevailing on

11. Consider the simple case in which client monitoring always is cost justified. Monitoring costs (m) increase at a decreasing rate when the attorney works additional hours (L): m - m(L). A claim is viable when expected returns exceed costs. including monitoring costs4.e.. when pB Z WL + m. The client’s net profit function is f(L) - p(L)B(L) - WL - m(L), which is maximized when

d@B)ldL - w + dmldL. Thus, fewer claims will be viable and lawyer time will be employed only up to the point at which the marginal product of an hour’s work equals the wage rate for the case plus the marginal cost of monitoring.

12. Clearly, if legal fees (wL) exceed the victim’s budget constraint regardless of how many lawyer hours ace involved (L), the victim always prefers a contingent arrangement to an hourly fee arrangement. More often, litigation requires at least a minimum commitment of lawyer time (see Schwartz and Mitchell, 1970, p. 1128). For values of L at or above this level, WL exceeds the victim’s budget constraint.

FISHm ATI’ORNEYS’ FEES IN PERSONAL INJURY CASES 115

the merits, or a small magnitude of recoverable damages. If the victim’s assessment is accurate, however, no rational lawyer will agree to work on a contingent basis since the lawyer’s expected return on time invested in the case will be negati~e.’~

Claims viable under a certain hourly wage arrangement may or may not be desirable candidates for a contingent fee, depending on whether the client can increase his expected net recovery. Assume that a high degree of competition exists in the market for legal services: Competitive forces monitor lawyers’ performances perfectly, and attorneys’ fees in both contingent and certain hourly wage arrangements are just equal to the opportunity cost of legal time. Danzon (1983) has shown that under these conditions, the attorney works to maximize the client’s expected net recovery regardless of the fee arrangement. The client’s expected recovery and the lawyer’s expected fee are identical under either contingent or certain hourly fee arrangement^.'^

The relative desirability of the two fee arrangements changes, however, if the market fails to monitor lawyer activity. First, consider the consequences when the market monitors the quality of lawyer time inadequately. Under a certain hourly fee arrangement, inefficient or improper time utili- zation rewards the lawyer at the expense of the client. But under a contingent fee arrangement, the lawyer gains nothing from low-quality activity. In fact, such inefficiency imposes an opportunity cost on the lawyer, who has no billable hours to inflate. Thus, a contingent fee lawyer has a personal and profit-maximizing incentive to monitor and improve his own quality.

Next, consider the consequences when the market monitors the quantity of lawyer time inadequately. Under a certain hourly fee arrangement, the lawyer has an incentive to work extra hours whenever the wage rate for the case exceeds his opportunity costs or whenever the lawyer obtains extra benefits, such as enhanced prestige of reputation, from working on the case.

The quantity incentives that the contingent fee creates are somewhat dif- ferent. The attorney’s expected profit from a case equals his contingent percentage share of the client’s gross recovery minus the opportunity cost of legal time that he devotes to the case. The lawyer maximizes this profit by putting in just enough effort to equate his opportunity cost of legal time with

13. A claim is not viable with a certain hourly fee when pB < wL. Under a contingent fee arrangement, the plaintms lawyer receives a fraction, a < 1, of the award if and only if he prevails. The lawyer’s expected fee. is apB < pB. Under competitive conditions, wL represents the opportunity cost of the lawyer’s time, which exceeds his expected fee: apB < pB < wL. Only a risk-prefeming lawyer would voluntarily accept such a case.

14. The expected contingent fee, apB, is the same as the certain hourly fee, wL. Danzon (1983, p. 216) points out that when the plaintiff prevails in a case, the amount of the contingent fee that is actually paid (a) will exceed the competitive certain hourly fee by a factor in- versely proportional to the optimized ex ante probability of winning @*). Under these conditions and assuming risk neutrality, winning plaintiffs always are worse off for having agreed to a contingent fee.


his share of the gross marginal product of legal work performed. (This falls short of the time commitment that would maximize the clienr’s net recovery.) Thus, economic incentives induce the contingent fee lawyer to put in fewer hours per case.

The incentive to underwork is offset at least partially, however, whenever the attorney believes that successfully prosecuting a claim-particularly one with a potentially large recovery-wilI enhance his legal reputation and thus promote higher future income. Such auxiliary benefits inuring to the lawyer encourage additional legal work.16 Because of such expected reputational benefits, contingent fee lawyers may even work too many hours and seek excessive recoveries.

Lawyers’ incentives to work additional hours benefit plaintiffs when such incentives improve lawyer performance and induce higher recoveries. Such incentives are detrimental to plaintiffs’ interest, however, when the lawyer starts ignoring client welfare. This can occur, for example, when the lawyer urges the client to reject a reasonable settlement offer in the hope of a more glamorous award and the case ultimately is concluded on terms less favorable to the plaintiff (see Reder, 1978, p. 229).

15

17

A. Market Monitoring Given the numerous economic incentives affecting the contingent fee

lawyer, monitoring of his activities by competitive forces seems highly desirable. Market monitoring likely has its greatest impact on lawyers when they compete for cases. Competition can occur when lawyers offer lower

15. The lawyer’s profit function is f(L) - ap(L)B(L) - wL. which is maximized when d@B)ldL. - wla > w.

With the contingent percentage less than 100 percent (Q < l), maximum profit occurs at a greater marginal product. ?his results in fewer lawyer hours (L) and a smaller expected litigation benefit @B) compared with the respective levels that optimize client welfare.

16. Suppose that larger awards or settlements create reputational value for the attorney. The profit function for a contingent fee lawyer would be f(L) - ap(L)B(L) + p(L)R(B(L)) - wL, where R(B) represents the dollar value of an enhanced legal reputation resulting from an award or settlement of magnitude B.

&ldB > 0, &I& - (&/dB)(dBldL) > 0 If, at some point, diminishing returns to reputation occur, the lawyer’s profit is maximized when

d@B)ldL - (WlQ) - {[llal[d@R)/dLl). This new equilibrium occurs at higher levels of legal input than those in the ordinary contingency situation. The lawyer’s reputational benefits act as a subsidy to induce additional legal work.

17. Considerations of legal reputation may generate excessive litigation by the plaintiffs lawyer when he works more hours than the amount that an optimizing. risk-neutral, client of sufficient wealth would be willing to pay under a certain hourly fee arrangement. This occurs whenever the equilibrium value of the reputational marginal product exceeds a certain fraction of the lawyer’s opportunity cost of time:

d@R)ldL (in equilibrium) > w(1-a). The likelihood of excessive litigation increases along with the size of reputational benefits of the case. The latter is directly and positively determined by the magnitude of the possible recovery.

FISHER: A’ITORNEYS’FEES IN PERSONAL INJURY CASES 117

contingent percentages. Brown (1987, p. 798) observes, however, that vir- tually all members of the plaintiff‘s bar demonstrate “remarkable pricing in- flexibility” by charging a constant 33 percent contingent fee.18 As Danzon (1983, p. 216) suggests, competition also occurs when lawyers bid implic- itly for cases in terms of such immeasurables as the probability of winning and the expected gross recovery. As discussed previously, reputation plays a vital role in establishing the lawyer’s credibility for performance. The value of reputation as a market signal is limited, of course, by the constraints that costly and imperfect information create.

Once the lawyer has been retained to handle a case, however, the disciplinary effects of competitive pressures diminish. Concern for maintaining or improving reputation likely promotes some self-monitoring. But this form of monitoring is far from precise since the incentives associated with enhancing reputation vary widely from case to case and from client to client, and since only the lawyers involved in a case may know all the relevant legal circumstances.

B . Client Monitoring

Clients monitor, or at least consider monitoring, the performance of contingent fee lawyers to ensure that their claims are handled properly. Initially, clients must guard against selecting a contingent fee arrangement when a certain hourly fee arrangement would be preferred and vice versa. Obtaining reliable legal advice in this regard may be difficult, since lawyers’ financial interests are directly opposed to clients’ interests during fee negotiations.

The ease and the costs of monitoring also bear directly on how a fee arrangement is selected. Monitoring attorney performance generally is easier when the lawyer files weekly or monthly billing statements detailing the nature and extent of effort expended. A certain hourly fee arrangement directly empowers the client to redirect attorney hours, to purchase additional

19

18. Numerous statutes impose limitations on contingent fees. For example, attorneys’ fees under the Federal Tort Claims Act ace limited by the Judicial Code (1948, as amended, 28 U.S.C. 5 2678) to no more than 25 percent in cases after suit is filed and to no more than 20 percent for administmtive settlements. California Business and F’rofessions Code 3 6146 (West, 1988) limits the amount of contingent fees that an attorney may obtain in a medical malpractice action to no more than 40 percent of the first $SO,000 recovered, 33.3 percent of the next $50,000 recovered, 25 percent of the next $500,000 recovered, and 15 percent of any amount for which the recovery exceeds $600,000. New York Judiciary Law 5 474-a (McKinney, 1988) limits contingent fees in medical malpractice cases-except in extraordinary circumstances--to no more than 30 percent of the first $250,000 recovered, 25 percent of the next $250,000 recovered. 20 percent of the next $SOO,000 recovered, 15 percent of the next $250,000 recovered, and 10 percent of any amount over $1,250,000 of the sum recovered.

19. The risk-neutral victim prefers a contingent fee whenever the associated expected net return exceeds the expected return with a certain hourly fee. Assuming the same quantity and quality of lawyer time under either arrangement, the victim is better off with a contingent fee when (1-a)pB > pB - wL. This condition is satisfied if and only if the certain hourly fee exceeds the corresponding contingent fee: wL > apB. The risk-neutral lawyer prefers exactly the opposite. He prefers a contingent fee whenever his expected net fee exceeds his certain hourly fee: apB > wL.


hours, or to demand that all work be ceased. Exerting the same kind of control over a contingent fee lawyer is more difficult, since the power of the purse is attenuated greatly.20 When the legal work is unsatisfactory, sometimes the client’s only recourse is to discharge one lawyer and retain another. (See the discussion in Annotation, 1979.)

Monitoring the activity of contingent fee lawyers may be more difficult than monitoring that of certain hourly fee lawyers, but the former tends to be less necessary. For example, in situations where quality of lawyer time is suspect or is difficult to appraise, the contingent arrangement puts the onus of performance on the lawyer. Doing so ensures at least some self- monitoring by the rational lawyer and thus reduces the burden and costs of client monitoring.

In some respects, the effect of contingent fees on aggregate litigation activity is unambiguous: More lawsuits are brought when contingent financing is available. However, the diligence with which lawsuits are prosecuted varies depending on the case characteristics, the monitoring costs, and the degree of competition among lawyers.

V. ATTORNEY AND CLIENT RISK PREFERENCES

The conclusions reached thus far have ignored victim and attorney at- titudes toward risk. During the litigation process, however, litigants make choices under conditions of uncertainty. Contingent fees offer several benefits to plaintiffs in such a risky environment.

The usual presumption is that lawyers handling contingent fee cases are less risk averse than are their clients (Clennont and Currivan, 1978, p. 565). This is particularly likely when the client possesses a single risky claim while the lawyer holds a portfolio of numerous risky cases. As Schwartz and Mitchell (1970, p. 1150) explain, the lawyer’s position is “analogous to an insurance company.”

The risk-averse client’s welfare can be improved in two respects when he employs a contingent fee lawyer rather than paying an attorney a certain hourly wage. First, the risk of nonreimbursed legal payments shifts from the client to the lawyer. This improves the client’s expected economic position provided that he retains a sufficient percentage interest in any possible recovery and that the lawyer works sufficient hours.21 Second, controlling

20. See (1984, p. 491) observes that “if the [contingent fee] attorney is compelled to yield to the client’s wishes, the client’s interest in requiring work from the attorney is likely to discourage the attorney from accepting a contingent fee arrangement, thereby damaging the legal system by denying representation to some potential clients.”

21. Let U($) represent the utility of money for a risk-averse plaintiff. &suing a claim under a certain hourly fee arrangement changes the plaintiffs expected utility by pU(B-wL)+(l-p)(-wL). This change is either positive or negative. Under a contingent fee arrangement, the plaintiffs expected utility increases by pU[(l-a)B], which is never negative. The magnitudes of the changes in utility function are determined by the equilibrium values of p . B, and L for a given legal wage rate (w) and by the contingent percentage (a).

FISHER: A’ITORNEYS’ FEES IN PERSONAL INJURY CASES 119

the number of legal hours worked is solely in the hands of the lawyer and not of the client. This improves the client’s gross recovery-though not neces- sarily his net recovery or utility-whenever the number of hours worked by the contingent fee lawyer exceeds the lawyer time that a risk-averse client would purchase voluntarily?2

On the other hand, two more dangers of the contingent fee arise when clients employ less risk-averse attorneys. First, as Reder (1978, p. 229) points out, the lawyer might refuse to settle cases on terms the client would accept, This subjects the client to undesirable risks, diminishing the client’s expected utility. This situation is particularly likely to occur when a lawsuit holds great prestige value for the lawyer. A second problem, identified by Danzon (1983, p. 220). is that less risk-averse contingent fee lawyers may stir up lawsuits not justified economically (see note 13). Lawyers then are participat- ing in litigation not to advance client or societal interests but for the joy of playing the game and enhancing their careers.

VI. CONCLUSION

Significant social interest exists in promoting efficient attorney-client arrangements. Paramount among the legal community’s concerns are that justice be administered fairly and equitably and that effective legal representation be available to those who need it. The economic goal is minimiz- ing the costs of erroneous legal outcomes and of operating the civil justice system (Posner, 1986, p. 517).

Fee arrangements should be reexamined constantly to assess their impact on the attorney4ient relationship, the number and composition of lawsuits, and the size and frequency of claim settlements. In addition to the certain hourly fee and the contingent fee, other arrangements have been proposed- e.g., a contingent hourly percentage fee (Clermont and Currivan, 1978), a risk-adjusted fee (See, 1984), and outright sale of the claim from victim to lawyer (Schwartz and Mitchell, 1970; Reder, 1978). More alternatives should be explored since the operation of attorney fee arrangements ultimately af- fects incentives to take care, allocation of accident risks, costs of civil ad- ministration, and popular faith in courts and lawyers.

22. Assuming perfect competition in the legal market, Danzon (1983, pp. 218-219) has shown that the expected utility of a risk-averse plaintiff is higher if he employs a risk-neutral lawyer on a contingent fee basis rather than doing so under a certain hourly fee arrangement. If competition among lawyers is less than perfect, the client’s expected net utility, pU[(I-a)B], may or may not be higher.


REFERENCES

American Bar Association, Model Rules of Professional Conduct, Chicago, 1983. , Commission on Professionalism, “In the Spirit of Public Service”: A Blueprint for

Annotation, “Limitation to Quantum Meruit Recovery, Where Attorney Employed Under

the Rekindling of Lawyer Professionalism, Chicago, 1986.

Contingent Fee ContractIs Discharged Without Cause,” American Zhv Rkports 3d, 92, 1979, 690-718.

, “Validity, Construction, and Effect of Contract Providing for Contingent Fee to Defendant’s Attorney,” American Law Reports 4th, 9, 1981, 191-206.

Brown, J. P., “Book Review of Medical Malpractice: Theory, Evidence and Public Policy, by P. M. Danzon,” Journal of Economic Literature, June 1987, 797-798.

Clermont, K. M., and J. D. Currivan, “Improving on the Contingent Fee,” Cornell Law Review, April 1978, 529-639.

Coffee, J. C., Jr.. “Understanding the Plaintiffs Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions,” Columbia Law Review, May 1986, 669-727.

Comment, “Contingent Percentage Fees: An Economic Analysis,” Journal of Air Law and Commerce, Winter 1986, 531-566.

Danzon, P. A., “Contingent Fees for Personal Injury Litigation,” Bell Journal of Economics, Spring 1983, 213-224.

, Medical Malpractice: Theory, Evidence, and Public Policy, Harvard University Press, Cambridge, Mass., 1985.

DuBois, G. P., “Modify the Contingent Fee System,” American Bar Association Journal, December

Franklin, M. A., R. H. Chanin, and I. Mark, “Accidents, Money, and the Law: A Study of the Economics of Personal Injury Litigation,” Columbia Law Review, January 1961, 1-37.

Judicial Code and Judiciary Act of 1948, Federal Tort Claims Procedure-Attorney Fees Provision, Public Law 80-773, 62 Stat. 984 (1948), as amended by Public Law 89-506, 80 Stat. 307 (1966), 28 U.S.C. 9 2678 (1983).

Kritzer, H. M., “Fee Arrangements and Fee Shifting: Lessons from the Experience in Ontario,” Law and Contemporary Problems, Winter 1984, 125-138.

Leubsdorf, J., “Communicating with Another Lawyer’s Client: The Lawyer’s Veto and the Client’s Interests,” University of Pennsylvania Low Review, January 1979, 683-710.

, “The Contingency Factor in Attorney Fee Awards,” Yale Law Journal, January 1981, 473-513.

1985, 38-40.

MacKinnon, F. B., Contingent Fees for Legal Services, Aldine, Chicago, 1964. McKinney’s Consolidated Laws of New York Annotated, cumulative supplement, West, St. Paul,

Nagel, S. S., “Attorney Time per Case: Finding an Optimum Level,” University of Florida Law

Pfennigstorf, W., “The European Experience with Attorney Fee Shifting,” Law and Contemporary

Posner, R. A., Economic Analysis of Law, 3rd ed., Little, Brown, Boston, 1986. Radin, M., “The Maintenance of Champerty,” California Law Review, November 1935, 49-78.

Reder, M. W.. “Contingent Fees in Litigation with Special Reference to Medical Malpractice,” in S. Rottenberg, ed., The Economics of Medical Malpractice, American Enterprise Institute, Washington, D.C., 1978, 211-231.

Rhein, E. M., “Judicial Regulation of Contingent Fee Contracts,” Journal of Air Law and Commerce, Fall 1982, 151-178.

Minn., 1988.

Review, Spring 1980, 424-441.

Problems, Winter 1984, 37-124.


Robinson, G. O., “The Medical Malpractice Crisis of the 1970’s: A Retrospective,” h w and Contemporary Problems, Spring 1986, 5-36.

Schwartz, M. L., and D. J. B. Mitchell, “An Economic Analysis of the Contingent Fee in Personal-Injury Litigation,” Stanford Law Review, June 1970, 1125-1 162.

See, H., “An Alternative to the Contingent Fee.” Utah LAW Review, 1984, 485-509.

Shavell, S., “Suit, Settlement, and Trial: A Theoretical Analysis Under Alternative Methods for the Allocation of Legal Costs,” Journal Of Legal Studies, January 1982, 55-81.

Shrager, D. S., “The Hammer for the Public Interest,” American Bar Association Journal, December 1985, 38-40.

US. Department of Justice, Report of the Tort Policy Working Group on the Cause, Extent and Policy Implications of the Current Crisis in Insurance Availability and Affordubility, U.S. Government Printing Office, Washington, D.C., February 1986.

West’s Annotated CUlifornh Codes, cumulative supplement, West, St. Paul, M h . . 1988.

Wolfram, C. W.. T h e Second Set of Players: Lawyers, Fee Shifting, and the Limits of Professional Discipline,” Law and Contemporary Problems, Winter 1984, 293-320.

Documents

CONTINGENT AND NONCONTINGENT ATTORNEYS' FEES IN PERSONAL INJURY CASES