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Contingent fee ruling

A couple of months ago, the Fifth Circuit upheld a fee agreement that entitled the lawyers to full-price hourly fee plus a 15 percent contingent-fee on any recovery. An arbitration panel had ruled that the lawyers might never have received anything, including the hourly portion, in view of the fact that the contract said the clients could defer payment until “financially practicable”. The fact that the underlying case settled for $188 million meant that the lawyers would receive more than $28 million — now, with interest, north of $40 million — for less than $5 million worth of work.

I opined that the decision “enhances confidence in contingent-fee agreements and therefore lowers the collection risk that law firms face when entering into contingent-fee arrangements with clients.” That, I went on, “should save clients who live up to their contracts money” because the lawyers do not need to “build in an additional premium for the lawyer’s risk of enforcing the fee deal.”

But thinking about that case put me in mind of an article about a more basic notion — why clients choose the contingent-fee lawyers they do. With contingent-fee rates “uniform” or nearly so — running about a third of the recovery — how do clients get their money’s worth, the article asked.

Assortative matching of lawyer and client

The article answered like this:

The notion of assortative matching was introduced and analyzed from an economic perspective by Gary Becker (1973). Becker used it to model decisions regarding whether and whom to marry. Among other things, he showed that when the division of output from marriage is uniform and nonnegotiable, a positive assortative matching is expected. Applying this model to a legal-services market with nonnegotiable CF rates, plaintiffs with particularly strong cases, where the anticipated recovery is particularly large, are expected to match with lawyers of particularly high repute; plaintiffs with the second-most lucrative cases are expected to pair with second-best lawyers; and so forth. The high value of the case is likely to result in an especially large fee for the top lawyer, and the high quality of legal services is expected to result in a particularly large net recovery for the plaintiff with the lucrative case, without deviating from the standard CF rate. At the other end of the scale, low-quality cases are expected to match with low-quality lawyers, thus yielding small net recovery for the plaintiff and a minimal fee for the lawyer.

The hypothesis of positive assortative matching in the CF market is supported by a large-scale study of Texas plaintiff lawyers conducted by Stephen Daniels and Joanne Martin. Daniels and Martin (2002, pp. 1783-95) describe a hierarchical plaintiff bar. The “Bread and Butter” lawyers at the bottom of this hierarchy ordinarily deal with low-value cases, while the “Heavy Hitters” at the top handle very large ones. Sara Parikh (2001, pp. 59-61) provides a comparable description of the CF market in Chicago. The lawyers in these categories, as well as the intermediate ones, differ with regard to the mean value of the cases they handle, with the mean and median cases ranging from several thousand dollars to several million. These categories also differ with regard to the scope of the geographic market the lawyers serve (local, regional, or state/national) and the percentage of potential clients they turn away.

Eyal Zamir, Barak Medina, and Uzi Segal, The Puzzling Uniformity of Lawyers’ Contingent Fee Rates: An Assortative Matching Solution  at 6-7 (Jan. 16, 2012).

The authors propose that the best lawyers charge the same percentage but get a far better result for the client and therefore earn a larger fee than their less-capable colleagues would have.

Return on investment

You could also look at the phenomenon in terms of the return on the lawyers’ investment.

You can figure out the implicit value of what the lawyer invests if you have a proxy for the lawyers’ value. In the case of a lawyer who does work by the hour as well as on a contingent-fee basis, you can simply multiply his or her hourly rate by the number of hours he or she must spend to obtain the favorable outcome.

If the lawyer typically earns $1,000 per hour from clients who pay her by the hour and she works 1,000 hours on the case before it settles or she wins an award or judgment, her investment totals $1,000,000. A less able lawyer might charge $400 an hour but take more time to achieve the result, investing (say) 1,500 hours for an implicit investment of $600,000.

If the dispute settles for $10 million, the more expensive lawyer would receive $3.33 million — a 3.33 multiple on her time. But the less costly colleague would receive the same multiple in the event of a resolution totaling only $6 million. The client nets $6.67 million for a one-third fee to the pricier lawyer but only about $4 million for the one with the lower hourly rate.

You can use different numbers of course, but you will always find that the lawyer who has the higher rate — which presumably the competitive market has blessed — must get a better result for the client in order to obtain the same return on investment unless he can handle the case with far greater efficiency. And even if he does get to a resolution faster and with less brain damage, that also confers a net benefit on the client, other things remaining equal.

What do you think? Should clients prefer a contingent-fee lawyer who charges a top hourly rate?