5 Ethics Considerations for Alternative Fee Arrangements

Alternative fee arrangements are fashionable at the moment.  Clients, at least, appear keen to structure outside counsel fees based on a variety of arrangements, some that share risks, some that create incentives for certain outcomes, and others that encourage efficiency.  Many attorneys are less than enthused about alternative fee arrangements, perhaps viewing them as new methods for the old practice of reducing outside counsel fees.  It turns out that both attorneys and clients have reason to be cautious when entering alternative fee arrangements, given the potential ethical issues that may be implicated.

1. Are the fees illegal or unconscionable?  Start with the obvious question.  Regardless of how creative or well-designed an alternative fee arrangement may be, it does not obviate the overarching general requirement that attorneys’ fees must no be illegal or unconscionable under the circumstances of the representation.  This includes, among other things, consideration of whether the amount of the fee is proportional to the services provided and to the value of the matter, the amount of work actually performed, and the results obtained.  For example, the rules likely would not permit an alternative fee agreement that led to a windfall for an attorney who did little or no work on a matter, regardless of the provisions of an alternative fee arrangement.

2. Does the fee structure improperly limit an attorney’s professional judgment? Similarly, alternative fee agreements should not override an attorney’s exercise of independent professional judgment.  Alternative fee arrangements that mandate early resolution efforts, for example, regardless of whether the attorney believes that such efforts are advisable or advantageous, could create a potentially problematic limitation on an attorney’s independent judgment.  Clients hire attorneys for their independent professional judgment.  In general, avoid any structural limitations on that judgment.

3. Does the fee structure create conflicts of interest? A primary criticism of hourly billing fee structures is that lawyers are incentivized to work as much as possible when they are being paid by the hour, with little or no incentive to be efficient in that work.  Many alternative fee arrangements are designed to correct, or at least to address, this issue.  But beware the potential to create conflicting incentives.  An alternative fee arrangement that provides for a flat fee, for example, could incentivize an attorney to work as little as possible on the matter, or to staff the matter with the least experienced attorneys or staff, or to settle the matter as quickly as possible before substantial work on the case.  So-called success bonuses can incentivize attorneys to swing for the fences regardless of whether that is appropriate or prudent, or to alter their risk analysis to seek a higher return even if it involves a higher risk.  Of course, attorneys have independent ethical obligations not to do these things, but it is generally best to avoid testing the power of these negative incentives.

4. Does the fee structure improperly limit the client’s right to terminate? Alternative fee arrangements may not limit a client’s unqualified right to terminate an attorney and to seek new counsel.  But alternative fee arrangements can set up a system where an attorney will be substantially financially disadvantaged by being replaced.  If the agreement provides for a substantial success bonus, for example, an attorney who positions the case for a trial win may not get that big bonus if he or she is replaced right before, during, or after trial, even if they did the work that leads to the win.  So attorneys may try to draft alternative fee agreements that explicitly or implicitly limit a client’s right to pull the plug on them.  Beware: alternative fee arrangements that improperly limit, qualify, restrict, or impair a client’s right to choose counsel, and to terminate an attorney at any time for any reason, are problematic.

5. Does the fee structure entwine attorneys in the client’s business? Alternative fee arrangements that provide for compensation based on the client’s business are not necessarily unethical.  It may be permissible, for example, to receive payment in the form of stock in the client’s company, assuming you comply with other ethical requirements.  However, with only narrow and limited exceptions, attorneys are prohibited from acquiring a proprietary interest in a client’s cause of action or the subject of litigation.  Moreover, depending on the nature of the client’s business, there are inherent risks in accepting compensation that may connect you with that business.  If the business fails, you probably won’t get paid at all.  The receipt of stock or other property may have negative tax implications.  And if there is a shareholder dispute, whose side are you on?  Alternative fee arrangements that provide for payment that is too closely connected to the client’s business, or connected to the subject matter of the representation, are a red flag.