The use of contingency fee arrangements has become increasingly commonplace–and not just among plaintiffs in slip-and-fall cases, but in corporate America as well. While surveys of in-house counsel show legal departments still overwhelmingly prefer flat or hourly fee arrangements, more and more companies are working with outside counsel on a contingency basis.

“From the point of view of the company, it cabins the litigation cost and insulates the company from huge out-of-pocket expenses that commercial litigation can entail,” says Lester Brickman, a professor at Cardozo School of Law who studies contingency fees.

Deborah House, vice president and deputy general counsel for ACC, says the increase in contingency fees comes in response to the increasingly high cost of litigation and the ensuing demand for value-based billing. “It makes the outside counsel much more invested in making determinations about what needs to be done and what doesn't,” she says.

Such comments seem to suggest that contingency arrangements are the perfect solution to ensuring outside counsel's interests are in line with those of their clients and that lawyers aren't filing needless motions just to pad their billings. But two recent court battles exemplify that the arrangements have their drawbacks.

In a D.C. Circuit case decided in October 2007, a law firm sued its client because the law firm lost out on its contingency fee when its client decided to drop the case. And in a case the Supreme Court of New York ruled on November 2007, a widow in an estate dispute challenged the fairness of a contingency arrangement that had her paying millions of dollars to her law firm.

“There are negatives to contingency fees in that the very dynamic that can be viewed as positive–that is, an aligned interest between lawyer and client–can highlight differences of interest,” says Mark Zauderer, a partner with Fleming Zulack Williamson Zauderer who represented the law firm in Lawrence v. Miller, the New York Supreme Court case.

Differing Interests
The D.C. Circuit case, King & King v. Harbert International, underscores that when a lawyer and a client wish to take different approaches, pre-existing contingency arrangements only complicate matters.

Harbert International Inc. had worked with King & King since the early 1980s on an hourly basis. In 1995 they began working under a blended contingency agreement: The firm would charge $150 an hour, and those hourly billings would later be deducted from contingent recovery of 20 percent of the first $2 million recovered and 25 percent of any greater recovery. Harbert was seeking a $12.8 million adjustment to a construction contract it held with the government.

King & King filed the claim on behalf of Harbert in 1994 before the Armed Services Board of Contract Appeals (ASBCA). Amid company restructuring as well as a DOJ criminal investigation into alleged fraud and bid rigging, the ASBCA in September 1998 dismissed the claim without prejudice–as long as the company refiled the claims by September 2001. When the deadline rolled around, King & King couldn't get in touch with Harbert's president, so it refiled on its client's behalf. Harbert refused to cooperate with the firm. As a result the ASBCA dismissed the claims with prejudice in 2002.

By that point, King & King had invested a lot of time and resources in the matter. It sued Harbert for $4.8 million–the amount it would have received under the contingency agreement if it had obtained a full recovery.

The D.C. Circuit upheld a lower court's dismissal of the claims, citing precedent that
“a client has the ultimate authority to control his affairs” and thus can withdraw
a claim even if the client promised its attorney otherwise.

The court added, “This rule is admittedly harsh to attorneys, especially to those who provide services under contingent fee arrangements, for they bear a substantial risk. An attorney's fees under such an agreement depend not only on the merits of the case, but also on the client's continued zeal for the cause and his willingness to continue retaining the attorney.”

And if the client's zeal for the case starts to wane, an attorney working on a contingency basis will be more likely to fight to push forward and collect on his or her investment. Similar disputes can arise if an attorney wants to settle against a client's wishes or if a client wishes to fire his attorney.

Cover the Bases
According to House, such disputes can be avoided with careful contract drafting. “You should plan for if you win big or small; if you decide to settle just as you go into the courthouse door or 30 days after you file the complaint; or if you decide to drop the case,” she says.

The key is to include provisions that cover all situations and are understandable and not open to debate. But that can be easier said than done.

“Some of the contingency fee agreements that I have reviewed that have been the subject of disputes have been 20 to 30 pages long and involve a number of complex computations that virtually invite subsequent litigation over the meaning of the various clauses,” Brickman says.

Furthermore, Brickman notes commercial contingency fee contracts tend to heavily favor the law firm because general counsel lack experience in negotiating these agreements. “I would urge in-house counsel negotiating contingency fee arrangements with a law firm to seek professional assistance either from other contingency fee lawyers or from experts who have experience in the pitfalls of such retainer agreements,” he says.

Familiarity with your lawyers also helps. “If you enter into this arrangement with an outside counsel, you really need to have a working relationship with them and know them,” House says.

But that is no guarantee. In the D.C. Circuit case King & King had represented Harbert for nearly two decades when their dispute arose. “You're gambling; you're doing a straight business mathematical analysis, and then you spin the roulette wheel,” House says. “The risk for the client is that the law firm ends up getting more than you'd pay them hourly. And so you've just paid them a real premium.”

That was the case for Alice Lawrence, who hired Graubard Miller in 1983 to represent her in a dispute with her brother-in-law Seymour Cohn over the estate of his brother and Lawrence's late husband, the real-estate developer Sylvan Lawrence. Lawrence retained the firm on an hourly basis, but by late 2004, with the dispute still unresolved, she realized her legal fees were edging up to $1 million per quarter and requested a new fee arrangement. Graubard Miller came up with a modified retainer agreement that capped at $1.2 million the hourly fees Lawrence had to pay annually.

But the agreement also provided that the firm would be entitled to 40 percent of Lawrence's eventual takings. In May 2005, less than five months after the revised agreement had taken effect, Lawrence settled the case for $104.8 million. At that point she had already paid King & King an estimated $18 million in hourly fees as well as $5 million in “gifts.”

Lawrence refused to pay the firm an additional $42 million. Graubard Miller took Lawrence to surrogate's court, and Lawrence responded by suing the firm in New York Supreme Court. She charged that the firm's 40 percent contingency fee arrangement was unconscionable. The court disagreed.

Shared Risk
But in his dissent, Justice James Catterson said some facts of the case warranted a closer look at the retainer agreement, such as the fact that it was made when the firm should have been aware a settlement was imminent. In a letter commending Catterson's dissent, Brickman wrote that the law firm took virtually no risk.

“[A contingency arrangement is about] sharing the risk, sharing the reward,” says Bill Jawitz, principal of Jawitz Legal Consulting, which advises law firms and coaches lawyers.

If that's not possible under the circumstances, a contingency fee arrangement probably won't work. “The arrangement works best for clients when there is balance between the risk and reward,” Zauderer says.

Increasingly, though, general counsel believe that outside counsel will provide more value when working under a contingency arrangement. “More and more, folks are looking at ways to move away from that straight dollars-for-time paradigm and are looking at compensation for value delivered,” Jawitz says.

The use of contingency fee arrangements has become increasingly commonplace–and not just among plaintiffs in slip-and-fall cases, but in corporate America as well. While surveys of in-house counsel show legal departments still overwhelmingly prefer flat or hourly fee arrangements, more and more companies are working with outside counsel on a contingency basis.

“From the point of view of the company, it cabins the litigation cost and insulates the company from huge out-of-pocket expenses that commercial litigation can entail,” says Lester Brickman, a professor at Cardozo School of Law who studies contingency fees.

Deborah House, vice president and deputy general counsel for ACC, says the increase in contingency fees comes in response to the increasingly high cost of litigation and the ensuing demand for value-based billing. “It makes the outside counsel much more invested in making determinations about what needs to be done and what doesn't,” she says.

Such comments seem to suggest that contingency arrangements are the perfect solution to ensuring outside counsel's interests are in line with those of their clients and that lawyers aren't filing needless motions just to pad their billings. But two recent court battles exemplify that the arrangements have their drawbacks.

In a D.C. Circuit case decided in October 2007, a law firm sued its client because the law firm lost out on its contingency fee when its client decided to drop the case. And in a case the Supreme Court of New York ruled on November 2007, a widow in an estate dispute challenged the fairness of a contingency arrangement that had her paying millions of dollars to her law firm.

“There are negatives to contingency fees in that the very dynamic that can be viewed as positive–that is, an aligned interest between lawyer and client–can highlight differences of interest,” says Mark Zauderer, a partner with Fleming Zulack Williamson Zauderer who represented the law firm in Lawrence v. Miller, the New York Supreme Court case.

Differing Interests
The D.C. Circuit case, King & King v. Harbert International, underscores that when a lawyer and a client wish to take different approaches, pre-existing contingency arrangements only complicate matters.

Harbert International Inc. had worked with King & King since the early 1980s on an hourly basis. In 1995 they began working under a blended contingency agreement: The firm would charge $150 an hour, and those hourly billings would later be deducted from contingent recovery of 20 percent of the first $2 million recovered and 25 percent of any greater recovery. Harbert was seeking a $12.8 million adjustment to a construction contract it held with the government.

King & King filed the claim on behalf of Harbert in 1994 before the Armed Services Board of Contract Appeals (ASBCA). Amid company restructuring as well as a DOJ criminal investigation into alleged fraud and bid rigging, the ASBCA in September 1998 dismissed the claim without prejudice–as long as the company refiled the claims by September 2001. When the deadline rolled around, King & King couldn't get in touch with Harbert's president, so it refiled on its client's behalf. Harbert refused to cooperate with the firm. As a result the ASBCA dismissed the claims with prejudice in 2002.

By that point, King & King had invested a lot of time and resources in the matter. It sued Harbert for $4.8 million–the amount it would have received under the contingency agreement if it had obtained a full recovery.

The D.C. Circuit upheld a lower court's dismissal of the claims, citing precedent that
“a client has the ultimate authority to control his affairs” and thus can withdraw
a claim even if the client promised its attorney otherwise.

The court added, “This rule is admittedly harsh to attorneys, especially to those who provide services under contingent fee arrangements, for they bear a substantial risk. An attorney's fees under such an agreement depend not only on the merits of the case, but also on the client's continued zeal for the cause and his willingness to continue retaining the attorney.”

And if the client's zeal for the case starts to wane, an attorney working on a contingency basis will be more likely to fight to push forward and collect on his or her investment. Similar disputes can arise if an attorney wants to settle against a client's wishes or if a client wishes to fire his attorney.

Cover the Bases
According to House, such disputes can be avoided with careful contract drafting. “You should plan for if you win big or small; if you decide to settle just as you go into the courthouse door or 30 days after you file the complaint; or if you decide to drop the case,” she says.

The key is to include provisions that cover all situations and are understandable and not open to debate. But that can be easier said than done.

“Some of the contingency fee agreements that I have reviewed that have been the subject of disputes have been 20 to 30 pages long and involve a number of complex computations that virtually invite subsequent litigation over the meaning of the various clauses,” Brickman says.

Furthermore, Brickman notes commercial contingency fee contracts tend to heavily favor the law firm because general counsel lack experience in negotiating these agreements. “I would urge in-house counsel negotiating contingency fee arrangements with a law firm to seek professional assistance either from other contingency fee lawyers or from experts who have experience in the pitfalls of such retainer agreements,” he says.

Familiarity with your lawyers also helps. “If you enter into this arrangement with an outside counsel, you really need to have a working relationship with them and know them,” House says.

But that is no guarantee. In the D.C. Circuit case King & King had represented Harbert for nearly two decades when their dispute arose. “You're gambling; you're doing a straight business mathematical analysis, and then you spin the roulette wheel,” House says. “The risk for the client is that the law firm ends up getting more than you'd pay them hourly. And so you've just paid them a real premium.”

That was the case for Alice Lawrence, who hired Graubard Miller in 1983 to represent her in a dispute with her brother-in-law Seymour Cohn over the estate of his brother and Lawrence's late husband, the real-estate developer Sylvan Lawrence. Lawrence retained the firm on an hourly basis, but by late 2004, with the dispute still unresolved, she realized her legal fees were edging up to $1 million per quarter and requested a new fee arrangement. Graubard Miller came up with a modified retainer agreement that capped at $1.2 million the hourly fees Lawrence had to pay annually.

But the agreement also provided that the firm would be entitled to 40 percent of Lawrence's eventual takings. In May 2005, less than five months after the revised agreement had taken effect, Lawrence settled the case for $104.8 million. At that point she had already paid King & King an estimated $18 million in hourly fees as well as $5 million in “gifts.”

Lawrence refused to pay the firm an additional $42 million. Graubard Miller took Lawrence to surrogate's court, and Lawrence responded by suing the firm in New York Supreme Court. She charged that the firm's 40 percent contingency fee arrangement was unconscionable. The court disagreed.

Shared Risk
But in his dissent, Justice James Catterson said some facts of the case warranted a closer look at the retainer agreement, such as the fact that it was made when the firm should have been aware a settlement was imminent. In a letter commending Catterson's dissent, Brickman wrote that the law firm took virtually no risk.

“[A contingency arrangement is about] sharing the risk, sharing the reward,” says Bill Jawitz, principal of Jawitz Legal Consulting, which advises law firms and coaches lawyers.

If that's not possible under the circumstances, a contingency fee arrangement probably won't work. “The arrangement works best for clients when there is balance between the risk and reward,” Zauderer says.

Increasingly, though, general counsel believe that outside counsel will provide more value when working under a contingency arrangement. “More and more, folks are looking at ways to move away from that straight dollars-for-time paradigm and are looking at compensation for value delivered,” Jawitz says.