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October 2014 - Plaintiffs’ Lawyers Beware: Structured Settlements Can Sour the Attorney-Client Relationship

by Mary A. Dannelley

After negotiating a successful settlement for a client, the last thing either the lawyer or client wants to face is yet another potential litigation over how the attorney’s fee is to be paid. If not contemplated by an appropriate written contingency fee agreement, structured settlements can present fertile ground for a dispute to erupt between a plaintiff’s lawyer and his or her client over when and how the attorney’s fee should be paid. Indeed, if a contingency fee agreement is silent as to how the attorney will be paid in the event of a structured settlement,

the attorney-client relationship [is] subject to the general rule in California that, ‘absent other agreement, a contingency fee is payable only as the client obtains recovery. Thus, where the settlement calls for future payments on a periodic basis, the attorney’s fee is payable pro rata, i.e., the attorney is entitled to the agreed percentage of each periodic payment when, as and if actually received by the client.’
Knight v. Aqui, 966 F. Supp. 2d 989, 998 (N.D. Cal. 2013) (citations omitted). However, a written contingency fee agreement between a lawyer and client that provides for payment of the entire fee at the time of settlement may be lawful, notwithstanding a structured settlement that calls for installment payments to the client over time, provided that it comports with statutory and ethical requirements set forth in California Business & Professions Code section 6147 and Rules 3-300, 3-500 and 4-200 of the Rules of Professional Conduct. See also Cal. State Bar Form. Opn. 1994-135.

 

In Knight, a former client sued his attorneys for malpractice and breach of the written contingency fee agreement. The parties’ contingency fee agreement provided that the attorneys would receive a contingency fee of forty percent (40%) of “the total amount realized by way of settlement and/or litigation” if the case resolved after the court set a trial date. Knight, 966 F. Supp. 2d at 993. The agreement did not address when the attorneys would receive their payment in relation to the client’s receipt of settlement funds and did not include provisions related to how the fee would be paid in the event of installment payments. Id. On the attorneys’ advice, the client settled his underlying case for $550,000.00, with $150,000.00 to be paid upfront jointly to the client and the attorneys’ trust account, and the remainder to be paid in the same manner in eight installments of $33,333.33. Id. The defendant paid only $254,999.99 and then became insolvent and suspended payments. Id. at 994. The attorneys paid themselves $204,300.78, almost their full contingency fee from the settlement amounts received, and disbursed only $50,699.81 to the client as a “compromise.” Id.

The client’s subsequent lawsuit against the attorneys included claims for breach of fiduciary duty, misappropriation of funds, and breach of contract. The United States District Court for the Northern District of California granted partial summary judgment in favor of the client on his claims for breach of fiduciary duty and breach of the fee agreement, noting that “[a]n attorney who misapplies the law of attorney’s fees to the client’s financial detriment breaches the duty of care to the client.” Id. at 997. The court found that the attorneys had misappropriated funds due to their client by taking the entire contingency fee upfront, rather than as the client received his installments. Id. at 1000. The court further concluded that the attorneys’ conduct “breached the terms of the retainer agreement, which required her to distribute to Knight his pro rata share of settlement funds as they were collected.” Id.

Relying heavily on Formal Opinion No. 1994-135 of the California State Bar Standing Committee on Professional Responsibility and Conduct and the opinion of the California Court of Appeal in Sayble v. Feinman, 76 Cal. App. 3d 509 (1978), the Knight court provided guidance for attorneys in regards to the requirements that must be met for an attorney to be paid the entire contingency fee upfront in the event of a structured settlement for the client.

Any Contingency Fee Agreement Must Comply With Section 6147 of the California Business & Professions Code
The Knight court found that, as a threshold matter, the contingency fee agreement at issue did not comply with California Business & Professions Code section 6147. Knight, 966 F. Supp. 2d at 997. Section 6147 provides that a contingency fee agreement must be in writing and signed by both the attorney and the client. Cal. Bus. & Prof. Code § 6147(a). In addition, the written fee agreement must include all of the following: (1) a statement of the contingency fee rate that the client and attorney have agreed upon; (2) a statement as to how disbursements and costs incurred in connection with the prosecution or settlement of the claim will affect the contingency fee and the client’s recovery; (3) a statement as to what extent, if any, the client could be required to pay any compensation to the attorney for related matters that arise out of their relationship not covered by their contingency fee contract, including amounts collected for the plaintiff by the attorney; (4) a statement that the fee is not set by law but is negotiable between the attorney and client, unless the claim is subject to section 6146; and (5) if the claim is subject to the provisions of section 6146, a statement that the rates set forth in that section are the maximum limits for the contingency fee agreement, and that the attorney and client may negotiate a lower rate. Id. To comply with section 6147(a), a fee agreement providing that the attorney will be “cashed out” upfront in the event of a structured settlement “must specify how paying all of [the] attorney’s fees at settlement could affect [the] client’s recovery.” Cal. State Bar Form. Opn. 1994-135. The agreement at issue in Knight did not include a statement as to how disbursements and costs would affect the contingency fee and the client’s recovery, or a statement that the fees were not set by law and were negotiable between the attorney and the client. Knight, 966 F. Supp. 2d at 997. Since the agreement did not comport with these statutory requirements, the court held it was “voidable at the option of the plaintiff” pursuant to California Business & Professions Code section 6147(b). Id.; Cal. Bus. & Prof. Code § 6147(b).

An Attorney May Only Receive a Contingency Fee Upfront if Expressly Contemplated by the Fee Agreement
The Knight court concluded that a contingency fee is payable only as the client obtains recovery unless the fee agreement expressly provides otherwise. Knight, 966 F. Supp. 2d at 998. The court relied upon Sayble, 76 Cal. App. 3d 509, in which the court rejected the contention that attorneys were entitled to be paid their entire contingency fee based on the present value of a structured settlement that included an annuity to be paid over the client’s lifetime. In Sayble, the court applied general rules of contract construction and interpretation and concluded: “If anything prevented the immediate payment of all attorneys’ fees as soon as the settlement became final, it was appellants’ failure specifically to express that intention in the contract.” Id. at 515. Noting an attorney’s duty to communicate with the client regarding any information that materially affects the client’s interest, the California State Bar Standing Committee on Professional Responsibility and Conduct reiterated this requirement in Formal Opinion No. 1994-135, stating:

[I]f it is Attorney’s intent to receive her entire fee at settlement, this is a significant fact relating to her employment which must be disclosed to the client. If this arrangement is not set forth in the fee agreement, the agreement will properly be strictly construed against Attorney, who wrote the agreement.
Cal. State Bar Form. Opn. 1994-135 (citing Cal. R. Prof. Conduct 3-500).

 

The Client Must Give Informed Written Consent to a Front-Loaded Fee Agreement in Compliance With Rule 3-300
The Knight court cautioned that, regardless of whether a contingency fee agreement provides for payment of the entire contingency fee upfront, such an agreement may still be unlawful if it does not comply with the Rules of Professional Conduct, including Rule 3-300 of the Rules of Professional Conduct. Knight, 966 F. Supp. 2d at 999. In California State Bar Formal Opinion No. 1987-94, the Standing Committee on Professional Responsibility and Conduct noted that “in California, our legislature has decreed that contingency fee agreements, which otherwise involve inherent conflicts of interest (as do other forms of attorney compensation) are exempt from the effect of conflict of interest rules because of public policy.” Cal. State Bar Form. Opn. 1987-94. However, in its subsequent opinion specifically analyzing front-loaded fee agreements in the context of structured settlements, the Committee clarified that “Attorneys should be cognizant of Rule 3-300, concerning the acquiring of a pecuniary interest adverse to a client, and be aware that a court of competent jurisdiction could conclude that rule 3-300 does apply at least in these limited circumstances.” Cal. State Bar Form. Opn. 1994-135.

Under Rule 3-300, the fee agreement providing for upfront payment to the attorney: (a) must be “fair and reasonable” to the client and properly disclosed in writing; (b) must include a written provision that the client may seek independent counsel (and the client must be given a reasonable opportunity to do so); and (c) requires the client’s written consent. Cal. R. Prof. Conduct 3-300. As set forth above, informed written consent under these circumstances means that a client is fully informed in regards to how the upfront payment of the contingency fee may affect his recovery at the end of the day, which means a lawyer should take reasonable steps to advise the client in writing as to any possibility of future non-payment or insolvency.

Rule 4-200 Provides the Ultimate Test for Whether a Front-Loaded Contingency Fee Arrangement Is Lawful
Perhaps driving the court’s conclusion in Knight was the inequitable result to the client in the event the attorneys were permitted to keep the entirety of the contingency fee. While the attorneys advised the client to accept a settlement that included payment of a significant portion of the fees in installments over time, they never advised the client of what that settlement could mean to him if they took the entirety of their fee upfront and the debtor ultimately became insolvent. The attorneys paid themselves almost their entire fee while the client stood to receive nothing, but for the “compromise” that the attorneys made in paying him a fraction of the settlement to which he agreed. The court held that, to pass muster, an agreement to “cash out” the attorney upfront must not provide for an “unconscionable fee” in violation of Rule 4-200 of the Rules of Professional Conduct, “for example, an unconscionable percentage of the amount actually recovered.” Knight, 966 F. Supp. 2d at 999. The Standing Committee on Professional Responsibility and Conduct has noted that an attorney who stands to receive an upfront contingency fee must evaluate whether application of such a provision would create an unconscionable result and, under such circumstances, “alter her receipt of fees to avoid an unconscionable result.” Cal. State Bar Form. Opn. 1994-135; see also Cal. State Bar Form. Opn. 1987-94 (“A member should employ independent consultants or resources in a good faith effort to calculate the present cash value of a proposed structured settlement.”). The bottom line is that, if receipt of the entire contingency fee upfront results in a payment “so exorbitant and wholly disproportionate ... as to shock the conscience,” it will not pass muster. Id. (citing Cal. R. Prof. Conduct 4-200(b)(5) and Bushman v. State Bar, 11 Cal. 3d 558, 563 (1974)).

Mary A. Dannelley is a sole practitioner in Newport Beach, California. Ms. Dannelley practices in the areas of commercial and employment litigation. She also provides employment counseling to employers and conducts independent workplace investigations. Ms. Dannelley can be reached at mary@dannelleylaw.com.

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