by Fred L. Wilks
Typical contingency fee agreements provide that the fee a lawyer receives will be a percentage of any money the client recovers, if and when there is a recovery. Civil litigation is an expensive and risky endeavor. Contingency fee agreements reallocate many of the inherent risks involved by shifting to the lawyer the risk of receiving little or no fee. By waiting until a recovery is obtained before receiving a fee, and often waiting for reimbursement of costs, the lawyer effectively finances the litigation. These features are appealing to clients. The lawyer accepts these terms in exchange for the potential of receiving a greater fee than might be earned under an hourly fee arrangement. The client bears the risk of paying a higher fee, hoping that the percentage fee incentivizes the lawyer to obtain a greater recovery.
Contingency fee agreements serve an important purpose for clients who lack the means to pay hourly legal fees as they are incurred, eliminating a barrier to legal representation. Even clients who can afford to pay an hourly fee may prefer to shift litigation risk to their lawyers.
The tradeoffs of a contingency fee arrangement are based on an important premise: that the lawyer will have a full opportunity to obtain the desired recovery. When a client terminates the representation before a recovery is obtained, the cost-benefit calculation of the contingency fee arrangement is upset. Lawyers may be tempted to address this problem with a “conversion clause” providing that, if the client discharges the lawyer, the percentage fee converts to an alternate fee. Such clauses must be carefully drafted with ethical issues in mind. This article presents the view that, where the client has received full disclosure at the inception of the engagement, the parties negotiated the terms of the fee agreement at arm’s length, and the client freely accepted the terms of the agreement, a lawyer may ethically include a conversion clause in the agreement providing that when the client discharges the lawyer the agreement converts to an hourly fee arrangement.
THE DEFAULT RULE: QUANTUM MERUIT A client’s right to discharge a lawyer, with or without cause, is absolute. Fracasse v. Brent, 6 Cal. 3d 784, 790 (1972). California Rule of Professional Conduct 1.16 provides that a lawyer shall withdraw from the representation if the client discharges the lawyer. In the absence of a conversion clause, a discharged contingency fee lawyer is entitled to quantum meruit recovery for the reasonable value of the lawyer’s services. Fracasse, 6 Cal. 3d at 791. This rule “preserve[s] the client’s right to discharge his attorney without undue restriction, and yet acknowledge[s] the attorney’s right to fair compensation for work performed.” Id.
The subject is more complex when a contingency fee lawyer voluntarily withdraws. Generally, a contingency lawyer who voluntarily withdraws is only entitled to quantum meruit recovery if the lawyer establishes “justifiable cause” for withdrawal based on five requirements demonstrating an ethical compulsion to withdraw, including most significantly: (1) the withdrawal is mandatory under statute or state bar rules, and (2) the “overwhelming and primary” motivation for withdrawal was the obligation to adhere to these ethical imperatives. See Estate of Falco, 188 Cal. App. 3d 1004, 1016 (1987). A court has discretion to award recovery of fees where the lawyer’s withdrawal was merely permissive, but such recovery is subject to “heightened scrutiny.” See Rus, Miliband & Smith v. Conkle & Olesten, 113 Cal. App. 4th 656, 676 (2003), as modified (Dec. 19, 2003). Recovery of a fee following permissive withdrawal should be rare, as courts frown upon contingency-fee lawyers engaging in “bet hedging” by abandoning a client when the case appears less valuable than originally believed. This article addresses the ethics of conversion clauses triggered by a client’s discharge of the lawyer, not the lawyer’s withdrawal, which is a more complex question. However, the analysis should be similar where a conversion clause is triggered by a lawyer’s mandatory obligation to withdraw.
Where a client discharges a contingency fee lawyer, payment of the fee ordinarily remains dependent on the client’s recovery: the client does not have “an absolute obligation to pay his former attorney regardless of the outcome of the litigation.” Fracasse, 6 Cal. 3d at 792. In other words, if the client recovers nothing, then the lawyer receives no fee. This rule, Fracasse reasoned, was consistent with the parties’ reasonable expectations: (1) the client “should not be held to have incurred an absolute obligation to compensate his former attorney,” and (2) “the attorney agreed initially to take his chances on recovering any fee whatever . . . .” Id.
Fracasse does not address what happens where the lawyer agrees with the client, at the outset of the engagement, to set different expectations. “A lawyer legitimately may bargain with a prospective client and deal at arm’s length in entering into a contract of employment.” Baron v. Mare, 47 Cal. App. 3d 304, 311 (1975). Absent “duress, unconscionability, or the like,” a client has no cause to complain that the terms the lawyer negotiated were favorable to the lawyer. Ramirez v. Sturdevant, 21 Cal. App. 4th 904, 913 (1994).
This article considers a conversion clause, triggered by a client’s discharge of the lawyer, that: (1) establishes an hourly rate for work performed, (2) entitles the lawyer to the hourly fee immediately and regardless of whether the client obtains any recovery, and (3) permits the lawyer to receive an uncapped fee even if it exceeds the contingency fee the lawyer would have recovered. In other words, this article considers conversion to a traditional hourly fee agreement, fully unwinding the risk allocation of the contingency fee arrangement.
ETHICAL RULES IMPLICATED BY CONVERSION CLAUSES As discussed above, the client has an absolute right to discharge the lawyer, and the lawyer must withdraw from the representation. Cal. R. of Prof’l Conduct (CRPC), rule 1.16. Of course, a client should expect that discharging a lawyer will have consequences, even negative consequences. The question is: at what point does a fee agreement, by imposing obligations on a client triggered by discharge of the lawyer, unduly restrict the client’s right to do so? California case law does not fully answer this question. What we know is permissible, as Fracasse and other cases informs us, is a requirement that clients who discharge their lawyer must pay the “reasonable value” of services performed by the lawyer.
Conversion clauses may also implicate CRPC 1.5, which provides that a lawyer may not charge an unconscionable fee. The rule provides thirteen factors to be considered in determining the unconscionability of a fee, not the least of which is whether the lawyer engaged in “fraud or overreaching” in negotiating the fee. Procedural unconscionability is an important aspect of the analysis. See Cotchett, Pitre & McCarthy v. Universal Paragon Corp., 187 Cal. App. 4th 1405, 1420 (2010). With respect to substance, fees are not unethical or prohibited “simply because they are substantial in amount.” Baron, 47 Cal. App. 3d at 311. Even a fee that “is in fact high is not the same as an unconscionable fee.” Aronin v. State Bar, 52 Cal. 3d 276, 285 (1990). The ultimate test of unconscionability is “whether the [lawyer’s] fee is ‘so exorbitant and wholly disproportionate to the services performed as to shock the conscience.’” Tarver v. State Bar, 37 Cal. 3d 122, 134 (1984) (quoting Herrscher v. State Bar, 4 Cal. 2d 399, 401-02 (1935)). Importantly, the determination of unconscionability “must be viewed as of the time the arrangement was made,” Cetenko v. United Cal. Bank, 30 Cal. 3d 528, 532 (1982), except where the parties contemplate the fee will be affected by later events. CRPC, rule 1.5(b).
In 2022, the State Bar’s Committee on Professional Responsibility and Conduct released an interim opinion for public comment that addressed whether conversion clauses are ethically permissible. See Cal. State Bar Proposed Formal Opn. Interim No. 20-0005 (Conversion Clauses in Contingency Fee Agreements). The preliminary view expressed in the interim opinion is that conversion clauses are not ethically prohibited per se, but the committee also expressed skepticism that such clauses are ethically permissible in most circumstances, including fee agreements with features discussed in this article.
Other state bar committees have also issued formal opinions addressing conversion clauses, but those opinions are of limited value in California to the extent they rely on versions of ABA Model Rule of Professional Conduct 1.5. The ABA model rule prohibits lawyers from charging “unreasonable” fees, whereas CRPC 1.5 only prohibits lawyers from charging “unconscionable” fees. “[U]nconscionability and unreasonableness are two different standards,” and “the State Bar has no power to regulate the amount of fees charged by its members unless such fees are so ‘outlandish’ as to merit discipline” because they are unconscionable. Cotchett, Pitre & McCarthy, 187 Cal. App. 4th at 1420.
CONVERSION TO AN OTHERWISE ETHICALLY PERMISSIBLE HOURLY FEE ARRANGEMENT Few would question the ethics of an agreement establishing only a fee payable based on an hourly rate, payable as the work is performed, payable regardless of what percentage of the client’s recovery that fee represents, and payable even if the client obtains no recovery. The conversion clause discussed in this article raises concerns not because it is unethical to charge an hourly fee, but because the hourly fee is triggered by a client’s exercise of an absolute right, and it may result in a fee that is greater than the contingency fee would have been.
A critical question in this context is whether the conversion clause unduly restricts the client’s absolute right to discharge the lawyer. Stating a pre-agreed hourly rate establishing the value of the lawyer’s services, standing alone, is likely permissible. By default, under Fracasse, the client must pay the reasonable value of the lawyer’s services when and if there is recovery. While it is true that the pre-agreed rate might result in a higher fee than a court might award on a quantum meruit basis, the hourly rate also might result in a lower fee. The quantum meruit analysis is subjective and uncertain, and each side equally bears the risk of missing the mark. If anything, the pre-agreed hourly rate provides the client with more transparency when deciding how to proceed.
Where the hourly fee is uncapped, it poses the risk that the fee might be higher than the contingency percentage, but it also might be lower so again the parties bear that risk equally. The mere risk of a marginally higher fee—a comparison that typically cannot be made until the recovery is known—does not seem so severe that it unduly restricts the right to discharge the lawyer. Indeed, it seems unfair to conclude that a lawyer violates an ethical rule based on an outcome not known at the time of contracting. If anything, a lawyer may reasonably assume there is a low risk the hourly fee will exceed the contingency fee because the lawyer has little incentive to overwork a matter taken on a contingency basis.
The more difficult question is whether imposing an obligation to pay the hourly fee immediately, and regardless of whether the client obtains any recovery, unduly restricts a client’s right to discharge. In many cases, the risk of paying out of pocket might very well cause a client to think twice before discharging the lawyer, and may fully dissuade a client with limited financial means from discharging the lawyer. Again, however, there is no decisional authority establishing what level of impediment to discharge constitutes an ethical violation. Deeming it an ethical violation to reach agreement on an absolute obligation to pay hourly fees necessarily means limiting a client’s options. After all, a lawyer is not obligated to accept a contingency fee arrangement. One could argue a client should be free, at the outset and with eyes wide open, to weigh the risk of paying out of pocket in the event of discharge, if that is what is necessary to secure the client’s desired choice of lawyer.
With respect to the question of whether a fee agreement violates the rule against charging an unconscionable fee, the element of procedural unconscionability is critical and should include consideration of factors such as: whether the lawyer made full disclosure, whether the client had alternatives, whether the parties negotiated the terms of the conversion clause at arm’s length, and whether the client freely accepted the terms of the agreement without overreaching or coercion by the lawyer. Once the lawyer is discharged, the reasons for discharge may lead to a dispute about the lawyer’s legal entitlement to a fee, and the amount, based on subsequent events. At that point, questions may arise concerning whether the fee ultimately charged is reasonable and/or unconscionable. To avoid questions about the ethical propriety of the conversion clause itself—viewed as of the time the parties entered the agreement—consideration should be given to addressing in the fee agreement the client’s reasons for discharging the lawyer and how those reasons may impact the fee conversion.
Absent elements of overreaching by the lawyer, and viewing the contract as of the time it was made, a standard hourly fee arrangement should not be deemed “outlandish” or “exorbitant” merely because the agreement began as a contingency arrangement. An hourly fee agreement entered into at the outset of the engagement is permissible, and the fact that the parties began the representation with a reallocation of risks through a contingency arrangement—a risk tradeoff upset by the client—should not prohibit a lawyer from seeking a fair, agreed-upon fee. So long as the hourly rate does not “shock the conscience,” the lawyer should be permitted to negotiate payment of a fee due regardless of outcome. To the extent a client objects to the amount of hours billed at the time of discharge, a client remains free to challenge the lawyer’s legal entitlement to the amount billed as unreasonable. But even a successful legal challenge would not necessarily mean there has been an ethical violation.
CONCLUSION Contingency fee agreements with conversion clauses are likely to face ethical scrutiny. To ensure compliance with ethical standards, a lawyer should evaluate the client’s level of sophistication and ability to pay, and fully disclose and explain the terms of the agreement. Careful consideration should be given to the necessity of immediate payment and payment due regardless of whether the client obtains any recovery, as those elements seem most likely to impermissibly restrict a client’s right to discharge the lawyer.
Fred L. Wilks is a business litigation partner at Hodel Wilks LLP in Irvine, California, and can be reached at fwilks@hodelwilks.com.