A lawyer who takes a case on an hourly basis expects to collect her lodestar — hours times hourly rate — no matter the outcome.

The same lawyer, when she works on contingent fee basis, plans to earn more than her lodestar if she wins.  The bonus rewards her for sharing the client's risk.

So why did the Second Circuit today uphold an award, in a contingent fee case, equal to the lodestar. McDaniel v. County of Schenectady, No. 07-5580-cv (2d Cir. Feb. 16, 2010) (affirming lodestar award representing 13 percent of common fund instead of 26 percent class counsel applied for).  Why didn't the panel insist on a risk premium for class counsel?

The court's 28 pages never mentions the fact that may explain the no-bonus result:  The class action lawyers who negotiated the settlement seldom, if ever, work on an hourly basis.  

Why does that matter?  Their hourly rates may not reflect how paying clients — who define the market for hourly lawyers — would value their work.

Blawgletter has noted the drawbacks of hourly fees.  But at least they reflect the judgment of actual clients.  

Does a similar mechanism peg the worth of a pure class action lawyer's hour?   Not really.  Judges award the fees in class actions.  Their after-the-fact evaluations may aim to mimic a real market, but their post hoc judgments must indulge a fiction.  No true market gives them useful guidance.  And so their thoughts about a reasonable hourly rate signify little more than a gestalt feeling of overall fairness. 

In McDaniel, class counsel got their nominal hourly rates.  We suspect the judges chose that measure because they felt it approximated what a pure class action lawyer should receive for an average result.  The lawyers' rates already built in a bump for risk.

You will notice that our example at the start of this post implies something different — that our hypothetical lawyer chooses between hourly and contingent fee work.  For her, the market for hourly lawyers does yield a decent indicator of her work's risk-free value per hour.  

Should courts take that into account in setting a fee award for her in a class action common fund case — by which we mean should she get a tip due to the fact that she traded the certainty of an hourly fee for the upside and downside risk of working on a contingent fee basis?  We think so.

The Second Circuit's discussion of the pros and cons of lodestar and percentage-of-recovery methods for awarding common fund fees glides over the difference:

The lodestar method is not perfect. It creates an incentive for attorneys to bill as many hours as possible, to do unnecessary work, and for these reasons also can create a disincentive to early settlement. Goldberger v. Integrated Resources, Inc., 209 F.3d 43,] 48-49 [(2d Cir. 2000)] (citing Savoie, 166 F.3d at 460-61). Under certain conditions, moreover, lodestar awards can create the near opposite incentive, encouraging attorneys to settle before trial even when it is not in their clients’ best interest. While under the lodestar method lawyers share the “downside” risk of trial (i.e., the possibility of an adverse judgment, and hence no fee), they do not share in the potential economic “upside” (i.e., fees as a percentage of a large common fund), especially since trial requires comparatively fewer hours than the process of trial preparation. Janet Cooper Alexander,Do the Merits Matter? A Study of Settlements in Securities Class Actions. Stan. L. Rev. 497, 543 (1991); John C. Coffee, Jr., Understanding the Plaintiff’s Attorney: Implications of Economic Theory for Private Enforcement of Law through Class and Derivative Actions, 86 C. L. R. 669, 717 (1986) (hereinafter Coffee, Understanding the Plaintiff’s Attorney). Although the district court is charged with ensuring the fairness of a proposed settlement, including any lodestar-based attorneys’ fee award, this task is often challenging in common fund cases, especially because – since the attorneys’ fees are drawn from a common fund rather than being paid separately by the defendants – there is little incentive for the defendants to contest the size of the fee. To the contrary, plaintiffs’ and defendants’ lawyers share an interest in the approval of an agreed upon settlement.Goldberger, 209 F.3d at 52-53. As a result, the district judge “los[es] the benefit of an adversarial process, which may . . . inform[] and sharpen[] the judicial inquiry.” Doe v. C.I.A., 576 F.3d 95, 107 (2d Cir. 2009); see also Baker v. Carr, 369 U.S. 186, 204 (1962); Goldberger, 209 F.3d at 53 (“It is not without significance that when [lead counsel for plaintiffs on appeal] stood up at oral argument to petition for a bigger slice of his clients’ recovery, no one sat adjacent to him at opposing counsel’s table.”).

But the percentage method has its limitations as well. As we indicated in Goldberger this Circuit’s adoption of the lodestar method was precipitated by the perception that percentage fees “tended to yield too little for the client-class, and an unjustified ‘golden harvest of fees’ for the lawyer.” 209 F.3d at 48 (quoting City of Detroit v. Grinnell Corp., 495 F.2d 448, 468, 469 (2d Cir. 1974) (“Grinnell I”), abrogated on other grounds by Goldberger, 209 F.3d at 43). Particularly in cases that result in a very large monetary award, the percentage method holds the potential to result in attorneys’ fees many times greater than those that would have been earned under the lodestar of hourly rate multiplied by hours worked. “The principal analytical flaw” in Appellants’ argument for a presumptive percentage award as a “benchmark” in common fund cases lies in the “assumption that there is substantial contingency risk in every common fund case” that would justify such a multiplier.  Id. at 52.

Moreover, although the percentage method has the advantage of aligning the interests of plaintiffs and their attorneys more fully by allowing the latter to share in both the upside and downside risk of litigation, it can create perverse incentives of its own, potentially encouraging counsel to settle a case prematurely once their opportunity costs begin to rise. Coffee, Understanding the Plaintiff’s Attorney at 687-90. And as in the case of the lodestar method, neither defense counsel nor the actual plaintiffs have much of an incentive under the percentage-of-fund approach to oppose an award of attorneys’ fees, the latter since “[t]hey have no real incentive to mount a challenge that would result in only a ‘minuscule’ pro rata gain from a fee reduction.” Goldberger, 209 F.3d at 53 (citing Cont’l Ill. Sec. Litig., 962 F.2d 566, 573 (7th Cir. 1992)).

In short, neither the lodestar nor the percentage-of-fund approach to awarding attorneys’ fees in common fund cases is without problems. It is for reasons such as those just discussed that Goldberger we declined to “junk” the lodestar method in favor of the presumptive or exclusive use of the percentage method, see id. at 47-53, and instead left the decision as to the appropriate method to “the district court, which is intimately familiar with the nuances of the case.” Id. at 48. While Appellants assert that there would be a benefit
in allowing “district judges . . . [to] step away from the business of analyzing and reviewing attorneys’ fee applications,” Appellants’ Reply Br. at 9, we underscore the importance of the district court’s duty “to act as a fiduciary who must serve as a guardian of the rights of absent class members,” City of Detroit v. Grinnell Corp., 560 F.2d 1093, 1099 (2d Cir. 1977) (“Grinnell II”) (internal quotation marks omitted), abrogated on other grounds, Goldberger, 209 F.3d at 43, and reaffirm the requirement of a “searching assessment” regarding attorneys’ fees “that should properly be performed in each case.” Goldberger, 209 F.3d at 52. Even were we not bound by Circuit precedent on the matter, we would decline to hold otherwise.

McDaniel, slip op. at 12-15.