Contingency-Fee Con-Men

Suppose you believe you’ve been injured by the wrongful action of some individual or corporation and deserve compensation. You approach an attorney. She takes your case on a contingency fee.

Later on your attorney says she’s received a settlement offer of $150,000. You’re disappointed: You had hoped for more, and you’ll only get two-thirds of this lower amount. Then she tells you that she’s negotiated an entirely separate agreement for her fee with the defendant’s insurance company, which, she says, will not be subtracted from the settlement. “It’s all been taken care of,” she says. “There’s nothing for you to worry about.”

Clearly, you do have something to worry about: Was the settlement the best the attorney could get for you -- or for her?

If the attorney’s behavior troubles you, it should. It is unethical -- yet it is happening with increasing frequency. When lawyers negotiate their fees directly with a settling defendant, bypassing their client, they are at grave risk of violating a fundamental premise of the legal system: that lawyers owe clients their undivided loyalty and the obligation to always act in their clients’ best interests.

The paradigmatic example is the settlement between the tobacco companies, the private lawyers that the states hired on a contingency fee basis to sue them, and the states. The private attorneys worked out a side deal with the tobacco industry for the latter to separately pay them fees well in excess of $15 billion.

This money was obviously available to be paid to the states, had the lawyers not carved it out for their own benefit. Nevertheless, when a state judge challenged the $625 million fee to be paid to the lawyers in the New York settlement, then Attorney General (now Governor) Eliot Spitzer successfully argued against judicial review of the fees because it would jeopardize the payment to New York of its share of the settlement: The tobacco lawyers had included provisions making the settlements hostage to payment of their fees.

Plaintiffs’ attorneys are also negotiating separate fees in class actions, where the opportunities for self-interested behavior at the expense of the class of defendants appear boundless. Seventh Circuit Judge Richard Posner, for example, has stated that “inflated attorneys’ fees are an endemic problem in class-action litigation. . . .” Nevertheless, it’s become routine here for attorneys to include provisions in settlement agreements that inhibit judicial review of negotiated fees.

A typical fee provision appears in the recent settlement of a class action brought against the American Express Travel Related Service Company: “The amount of the attorneys’ fees and costs to be paid by American Express was negotiated separately after agreement on the terms of the class settlement and does not take from, or in any way reduce, the Settlement Fund. . . .” The point here is that any reduction of the fee will go to benefit the defendant -- not the clients.

The purpose of a provision such as this becomes clear when someone objects to the privately negotiated fee. The attorneys then argue to the court that the objection should be dismissed, because any reduction would only benefit the defendant -- not the class of plaintiffs. Courts, which already have little affinity for strictly scrutinizing fee requests, apparently find this argument persuasive.

Consider a recent class-action settlement involving UBS Financial Services. The announced value of the settlement was $45 million and the separately negotiated fee was $11.25 million. According to the terms of the settlement, any reduction in the fee (as well as any reduction in the amount actually claimed by the class) reverts to UBS. But thanks to restrictive terms written into the settlement by the attorneys, only $21 million was claimed by members of the plaintiff class. The U.S. district court nonetheless approved the full fee request -- a decision currently on appeal to the U.S. Court of Appeals for the Ninth Circuit.

It is beyond cavil that plaintiffs’ lawyers negotiating their fees directly with, and separately payable by, a defendant -- and which include provisions that strongly inhibit judicial scrutiny of the fee for excessiveness -- breach lawyers’ fiduciary obligations to clients. Nonetheless, to date, no court has declared the practice illegitimate. The failure of the legal profession to enforce its ethical rules and lawyers’ fiduciary obligations is an indelible indictment of the bar’s claim to self-regulation based on its acting in the public interest. The need for ethical guidance is thus clear and compelling, and the body that has the charge to issue such guidance is the American Bar Association’s Standing Committee on Ethics and Professional Responsibility.

Last week, 20 legal ethics scholars, including Deborah Rhode of Stanford and Thomas Morgan of George Washington University, sent a letter to the ABA committee requesting just such a declaration. Only a strong statement that these practices violate ethical rules can hold back the ultimate triumph of avarice over ethics.

This piece originally appeared in Wall Street Journal

This piece originally appeared in The Wall Street Journal