The Indiana Supreme Court recently issued a comprehensive opinion on the ethics of various types of attorney fee arrangements. Matter of O’Farrell, 942 N.E.2d 799 (Ind. Feb. 11, 2010). The three common types of arrangements discussed were: fixed or flat fees; advance fee payments to secure payment of future hourly fees, sometimes called “special” or “security” retainers; and general or engagement retainers. Excluded from the Court’s consideration were contingent fees and non-traditional fee arrangements.
This opinion is essential reading for all Indiana lawyers, who will ignore it at their peril. The Court did an excellent job of synthesizing the law in this area in a way that harmonizes it with the majority view nationally. What follows is a broad discussion of the principles laid out in the opinion, mixed in with some personal views.
An important aspect of this case is the Court’s attention to the substance of fee arrangements without regard to what they happen to be called. The Court will look beyond labels when assessing the ethical propriety of particular fee arrangements.
While this case arises out of a specific and rather complicated set of facts, the importance of it lies in its general discussion of the ethics of fee arrangements that goes well beyond the facts of the case.
Types of Client Fee Payments
The Court started out by identifying the three main categories of fee arrangements. The first is a fixed fee. By whatever name, a fixed fee is a stated dollar amount for a defined scope of representation. Lawyers often handle criminal cases on a fixed fee basis. A fixed fee can apply to the entire case or to successive stages of service. So, for example, a lawyer might charge a fixed fee in a criminal case if the case is resolved by plea, and an additional fixed fee if it will be tried—perhaps one fee if it is tried to the bench and another if it is tried to a jury.
The second category is an advance fee. An advance fee is simply a payment of money by the client in advance of the lawyer’s activities that will earn that fee by some agreed method of calculation. The payment really has nothing to do with the ultimate value of the lawyer’s services. Advance fees provide the security of knowing that at least some amount of client money will be available to pay fees as they are earned. An advance fee is not really a fee type, but merely a method for receiving client payment—in advance rather than after services are rendered.
The third category is the general retainer. A general retainer is a payment from client to lawyer to secure the lawyer’s availability to serve the client in the future. It purchases availability, not specific legal services. The general retainer creates an attorney-client relationship even though the client has not yet entrusted any particular matter to the lawyer. Because of that attorney-client relationship, the concurrent conflict of interest rule, Rule of Professional Conduct 1.7, precludes the lawyer from accepting any new matter that is adverse to that client (absent informed client consent). One way to think about a general retainer is that it is payment of a sum of money to purchase a lawyer’s loyalty. Payment of a general retainer will also entitle the client to other consideration, such as the lawyer’s agreement to keep time available to serve the client’s needs on short notice, or even the value of simply being able to say to others, “I am represented by Lawyer X.”
When Fees Are Earned
An overriding question in the O’Farrell case was when a lawyer may consider these various types of fee payments earned and assert full control over them. Under pre-existing Indiana precedent (not affected by the Court’s decision), a fixed fee is earned when paid, and the lawyer may assert control over those funds at the time the client pays them. Because a fixed fee is the lawyer’s when received, the lawyer need not deposit it into trust. Indeed, because the lawyer has earned the fee from the outset, placing it in trust would constitute improper commingling with client funds. While Indiana may be in a majority on this point, there is a significant minority of jurisdictions that require fixed fees to be deposited into trust and removed only after the lawyer has provided services that warrant removing some or all of the fixed fee from trust.
An advance payment can best be conceptualized as a deposit to secure the future payment of fees as they are earned. Because the funds will not be earned until some time in the future, the lawyer holds them, but does not own them. If the client pays the lawyer only after the lawyer does the work, there would be no question of ownership—the lawyer has already earned the fee at the time of payment. But lawyers often ask for advance payments typically because they are unsure the client will pay when billed. Unlike the fixed fee and the general retainer, the advance fee must be held in trust until it has been earned by whatever means of measurement the lawyer and client have agreed upon. When earned in part or in whole, the earned funds should be promptly removed from the trust account. There are many variations on how advance fees are handled. For example, the fee agreement may call upon the lawyer to bill against it on a periodic basis, and even have the client replenish it from time-to-time, or alternatively, to hold it in trust throughout the representation as a security buffer with the client paying current charges as billed.
A general retainer is also treated as earned when paid. By promising to be available to the client for a defined period of time in the future, the lawyer gives up the possibility of taking on matters adverse to that client and possibly forgoes other opportunities in order to be immediately available to serve that client’s representational needs. The opportunity costs associated with taking on that client, even in the absence of specific work, justifies the lawyer’s treatment of the general retainer as earned when paid. Because the general retainer only purchases availability, payment for actual legal services by the lawyer in the future will be governed by other fee arrangements. Because it is earned when paid, a general retainer should not be deposited into trust.
Nonrefundable Versus Earned
Related to the question of whether the lawyer has earned a fee when the client pays it is the question of whether the lawyer has an obligation under any circumstances to make a fee refund to the client. Let’s take the fee categories in the same order as discussed previously.
With a fixed fee, if a lawyer completes the contemplated work (and the total fee is otherwise reasonable), the lawyer owes the client nothing. If the job is done efficiently, the lawyer has still earned the full fee and owes no refund to the client; and if the lawyer has been required to do more work than anticipated at the outset, the client owes no further fee. A deal is a deal. One might thereby think of a flat fee as non-refundable—and it is, in the sense that the lawyer need not generally refund any money at the conclusion of the representation merely because the matter went more smoothly than anticipated. But it is not nonrefundable in all events. If the attorney-client relationship ends by action of either lawyer or client before the contemplated representation is complete, the lawyer will generally owe the client some form of refund based on equitable considerations underlying the doctrines of quantum meruit and unjust enrichment. I say “generally” because the Court noted that in some circumstances, equity may require no refund. If the client is owed a refund of a fixed fee, that refund will have to come from the lawyer’s own funds, not from the trust account where they should not have been deposited in the first instance. Rule of Professional Conduct 1.16(d) requires that fee refunds to clients be made promptly. Matter of Towell, 699 N.E.2d 1138 (Ind. 1998).
The refundability of advance fee payments is straight forward. When the attorney-client relationship has concluded, whether prematurely or at the end of the contemplated representation, the lawyer must refund whatever portion of the advance has not been earned. The refund will be made from the trust account because the funds should still be in that account if they have not been earned at the time the representation ends.
General retainers are ordinarily not refundable to a similar extent as fixed fees—if the lawyer remains available as contemplated, the fee is earned even though no particular legal work is assigned by the client. While there is little case law discussing the point, the generally retained lawyer might owe the client a refund if the lawyer’s continuing availability during the retainer period is terminated early—more clearly if it is terminated by the lawyer, rather than the client. This is not inevitably so, as illustrated by the interesting and unusual case of Ryan v. Butera, Beausang, Cohen & Brennan, 193 F.3d 210 (3d Cir. 1999), in which it was held that a law firm owed no refund of a $1 million general retainer when the client discharged the firm shortly after paying the retainer.
Talking Refundability With Clients
Fee agreements, whether written or oral, must be consistent with the Court’s guidance in the O’Farrell opinion. A fee agreement that claims a nonrefundable entitlement to a fee is improper even if the lawyer intends to pay a refund in the event the representation is terminated. If the client is led to believe that the decision to terminate a lawyer’s representation will entail a forfeiture of unearned funds, it might chill the client’s exercise of the right to discharge the lawyer. A fee agreement involving an advance fee should never refer to that payment as nonrefundable. In the case of a fixed fee, so long as the representation is concluded as contemplated, it will be nonrefundable. But the fee agreement should stop short of inducing a client to believe that the entire fee will necessarily be forfeited if the client decides to terminate the representation early. In the case of general retainers, the client is also entitled to know that the retainer will not be subject to refund, even if the client assigns no work to the lawyer during the term of the agreement.
It was suggested by the respondent in the O’Farrell case that minimum, nonrefundable fees should be permitted. The Court rejected that view and accepted the majority position that if the client makes a substantial fee advance, the client should be able to expect a refund if the work done by the lawyer did not earn the entire payment. Indeed, it was the respondent’s insistence on structuring fee agreements so as to be able to keep funds that had not been earned that the Court found to be so troubling. Nonetheless, in concept, the Court seemed open to the idea that the administrative costs of opening up a new client matter could justify some additional, but undoubtedly modest, payment up front to compensate for the premium costs of the first hour of legal representation.
What about a hybrid fee arrangement where a substantial payment is identified as a general (and nonrefundable) retainer, but the client gets credit against the retainer for the lawyer’s work on the assigned matter at an hourly rate? This is a variation on the minimum fee dressed up in general retainer clothing. The Court did not specifically address this option, but I believe the Court would consider it to be an advance fee payment, not a general retainer. It presents the same policy concerns that the client should not forfeit money for exercising the unqualified right to discharge the lawyer. The general retainer language would probably be viewed as pretextual, since even without a general retainer, the lawyer’s actual representation on the particular matter will preclude the lawyer from accepting adverse representations, will compel the lawyer to be accessible to serve the client’s legal needs as required by ethical duty of diligence, and will allow the client to hold out the existence of the attorney-client relationship to third parties.
The Supreme Court’s opinion assumes that nonrefundable fees are always advantageous to the lawyer and disadvantageous to the client. This is not always the case, as recognized by the Illinois Supreme Court in Dowling v. Chicago Options Associates, Inc., 226 Ill.2d 277, 875 N.E.2d 1012 (2007). Dowling found that there are circumstances when the client’s interests are served by making the equivalent of an advance payment to a lawyer, but to consider it fully the lawyer’s property and earned when paid. That is so even though the lawyer is expected to provide services to the client to be debited against the advance payment credit at an hourly rate.
Why would that be so? In order to secure the availability of the lawyer to represent the client who is at risk of losing assets to third parties. If the lawyer merely held the advance payment as security in the lawyer’s trust account, the client’s funds would still be subject to attachment by judgment creditors. The lawyer’s willingness or ability to continue representing the client might evaporate if the advance payment to secure future legal services were to disappear into the hands of the client’s creditors. Under those circumstances, the client might be very happy to pay an advance fee that is earned on receipt as a means of securing the on-going availability of crucial legal representation.
The O’Farrell case brings clarity to how lawyers must treat client money that comes under their control. There is no one-size fits all answer, but the core notion is that lawyers should not be able to use rhetorical flummery to turn unearned client money into the lawyer property.