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A study that Blawgletter mentioned earlier this week concluded that clients prefer contingent fee arrangements even if the deals require them to pay their lawyers more than double their hourly rates.  What prompts such seemingly irrational behavior?  The researchers give a simple answer:  "mixed gambling".

For those who don’t regularly play five card stud and its like, what could mixed gambling mean in the context of a lawsuit?  The study tells us.  It signifies the reality that litigation involves risk and that different fee deals allocate the risk, well, differently.

An hourly fee, for instance, puts almost all the upside and downside on the client.  The lawyer earns money regardless of how the case comes out, while the client pays pretty much no matter what.  The lawyer has a reputational incentive to perform well, but with well north of 90 percent of cases settling before trial the likelihood of an empirically poor outcome approaches zero.  Relationships, in such situations, likely matter more than how effectively or efficiently the hourly lawyer does his work.

The contingent fee, by contrast, shares the risk of a bad result between client and lawyer.  The litigant may or may not pay litigation expenses but never comes out of pocket for fees.  Any payment to the lawyer for her effort depends solely on the case outcome, whether by judgment or settlement.  Client and lawyer thus both desire to maximize the benefits of prosecuting the client’s claims and will suffer or profit according to how well the litigation fares.

So, again:  why do clients choose contingent fees over hourly ones?  Simply because — in general and aside from considerations of inability to pay hourly fees — people dislike the prospect of losing more than they like the chance of winning.  The hourly fee compounds the risk that clients will lose with the certainty that they’ll pay for representation regardless, offsetting the gain from a positive recovery.  A contingent fee arrangement at least assures them that losing the case won’t also make their investment in lawyering services worthless.  Clients thus prefer the "pure positive gamble" of a contingent fee to the "mixed gamble" of paying hourly.

The study doesn’t say so, but we infer that contingent fee plaintiffs internalize the possibility of paying a premium fee as a reasonable price for guarding against a doubly negative outcome.  Agreeing to an arrangement that the lawyer expects will yield a premium on her time thus represents the premium for buying insurance against the loss of hourly fees.

The analysis, according to the study, does not apply to defendants.  Next time, therefore, we’ll look at why we see few negative contigent fee contracts.

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