What Are Creative Fee Agreements and Why Do Clients Want Them?
Creative fee agreements depart from the typical all-hourly or all-contingent models. In the former, the client typically bears the financial risk of litigation, as the payment of legal fees is untethered to the ultimate outcome of the case. In the latter, the economic risk is shifted largely to the lawyer, as payment of fees is entirely contingent upon a successful outcome for the client. Creative fee agreements blend aspects of the hourly and contingent models to re-allocate the risk of litigation based upon client needs and goals, and the lawyer’s tolerance for risk.
Commercial litigation clients increasingly desire creative fee agreements because they can be tailored to a client’s particular financial reality. A client, for instance, may have a large complex case worth $20,000,000, which would take $100,000 in legal fees per month to properly fund, but a stream of only $20,000 per month to allocate toward legal expenses. A creative fee agreement under these circumstances might consist of an agreement to cap monthly fees at $20,000 per month, with a 15% contingent interest in the client’s recovery. Such an arrangement would take into account the client’s ongoing ability to pay legal expenses as well as align client and lawyer interests in achieving a significant recovery.
Formation of Creative Fee Agreements
In addition to potential benefits to the client’s and lawyer’s bottom line, the process of forming creative fee agreements will often lead to increased client satisfaction with the litigation process.
There are three steps that typically lead to the formation of a good creative fee agreement. First, the client establishes the goals of the litigation, including a quantification of the importance of each goal. Put another way, the client always decides what the win is, and how much the win is worth. Second, for each identified goal, the lawyer should evaluate the costs, risks and length of time to completion. As discussed more fully below, this step is why many firms are unwilling or unable to embrace creative fee agreements. After analysis of the client’s goals, the third and final step is the creative process of merging the client’s interests and lawyer’s interests so that both parties are benefitted (or harmed) in similar ways based on the outcome of the matter – with the client’s goals being the yardstick for measuring “outcome.”
To give you an idea of how this looks in practice, we discuss seven examples of different types of creative fee agreements that the authors’ firm has entered into with clients over the years.
Examples of Creative Fee Agreements
A standard blended fee option with a contingent interest is the most prevalent creative fee agreement. Such an agreement allows the client to convert a standard hourly fee arrangement into a reduced fee arrangement, with a contingent interest to the firm based upon a successful recovery.
As an example, the client would have the option to convert a standard hourly arrangement into a blended fee deal whereby the client would receive a 33% discount off the firm’s regular hourly rates in exchange for the firm receiving a contingent fee of 15% of any gross economic recovery. Accordingly, once the client invokes this option, the client would receive a 33% discount off the firm’s hourly rates for the life of the case. If, for example, the client was awarded $4,500,000 in damages related to the dispute, the firm would be entitled to a contingent fee of 15% of $4,500,000 or $675,000 as part of the deal.
As a variation on the theme above, the blended fee option may also contain a floor – so that a certain gross recovery threshold would have to be met in order for the firm’s contingent interest to be triggered. Using the numbers from the example above, the client and firm might agree that the client would receive a 50% discount off the firm’s regular hourly rates in exchange for the firm earning a 25% contingent fee on any gross economic recovery above $500,000.
Creative fee agreements can also be structured to take into account the risk created by jurisdictional issues. For instance, a threshold jurisdictional issue may exist that could result in a matter being dismissed from a United States court and litigated in Japan or Europe. Accordingly, the client and firm might agree that the client would receive a 33% discount off the firm’s regular hourly rates in exchange for the firm receiving a 15% contingent fee on the client’s gross economic recovery. The parties might further agree, however, that if the case was dismissed in the U.S. and continued in Japan or Europe, then the firm would release its right to the contingent fee at the election of the client in exchange for a predetermined payment.
Creative fee agreements are not only for the plaintiff’s bar. The firm and client may agree that the firm will have a contingent interest based upon a successful defense verdict. Assume the client agrees to pay the firm 75% of its regular hourly rates. In exchange for the 25% discount off the firm’s regular hourly rates, the client agrees to pay the firm a contingent fee of 25% on the amount a settlement or final judgment is below $1.1 million. So, under this agreement, if the parties settled and the plaintiff received $1 million, the firm would receive a contingent fee of $25,000 (25% of $100,000). Or, if the plaintiff obtained a final judgment of $500,000 then the firm would receive a contingent fee of $150,000 (25% of $600,000). If the plaintiff received no monetary award, then the firm would receive a contingent fee of $275,000 (25% of $1.1 million).
A creative fee agreement that we can discuss in some detail – because it is public information – is the fee agreement that the authors’ firm entered into with the City of Albany over litigation the City had with PepsiCo.
This fee agreement was unique in several ways. First, the parties agreed to cap the monthly fees paid by the City. Pursuant to the agreement, the City received a 50% discount on the firm’s standard hourly rate. However, because it was important to the City’s budget to have a fixed monthly amount in litigation costs, the parties agreed that the City’s monthly fees would be capped at $20,000 each month, with any fees in excess of $20,000 per month rolled over to the following month until all the fees incurred were paid in full.
Second, in exchange for the discount to the City, the firm received a contingent fee of 15% of gross economic recovery in excess of $10 million. However, the firm agreed to deduct from the contingent fee all prior payments by the City to the firm (the $20,000 a month in fees).
Additionally, the firm included a “put our money where our mouth is” clause in the fee agreement. It was apparent that the City might have obtained a settlement with PepsiCo for $10 million pre-litigation. Accordingly, the firm agreed that if it tried the case and obtained a judgment for less than $10 million, then the firm would repay the City all of the discounted monthly fees the City had paid to the firm (the $20,000 a month in fees).
Happily, the case settled for $25 million, which also is a matter of public record.
Creative fee agreements can also contain a contingent interest that is driven by events in the litigation – not just economic outcomes. For example, the client may have a main goal of defeating a request for a preliminary injunction. The parties may agree that the client would receive a 25% discount off the firm’s standard hourly rates. The discounted money would then be placed into a bonus pool, with the firm’s contingent fee based on the success or failure of certain events, with a multiplier applied to the amount of money contained in the bonus pool.
Accordingly, if the firm obtained victory at the preliminary injunction hearing (i.e., if no injunction entered), then the firm would receive 200% of the bonus pool money. If no victory was obtained at the preliminary injunction hearing, then the bonus pool reset (i.e., the client kept the discount) and the timing and amount of settlement would determine the contingent fee. If no settlement was achieved, then the contingent fee would be based upon the final result.
As a final example, one of the earliest and arguably best contingent fee agreements entered into by the authors’ firm was one in which the firm’s contingent interest depended upon multiple issues – but primarily, the speed of resolution of the case. The parties agreed the client would pay a monthly flat fee in exchange for the firm having a contingent interest. However, the firm’s contingent interest was reduced monthly by the amount of the flat fee paid by the client. The longer it took the firm to resolve the case, the less money it could make as a contingent fee. This creative fee agreement aligned the client’s primary goal of speed of resolution with the firm’s goal of obtaining a contingent fee upon resolution of the case.
Given Their Benefits, Why Do Many Firms Avoid Creative Fee Agreements?
The benefits of creative fee agreements extend beyond simply providing some potential upside for a firm in the event of a successful outcome. The real benefit is that they lead to an individualized approach to client needs and goals that help the creative firm to land the client in the first place, and increases overall satisfaction with the litigation experience. This increased client satisfaction will often lead to repeat business and additional referrals.
Given these benefits, most firms would probably want to utilize creative fee agreements but for the one thing most lawyers seem genetically programmed to avoid: risk. Analyzing the litigation costs and fees, risks of success or failure, and expected length of time to achieve goals not only requires experience – it also requires the firm to be willing to take on risk. Many firms are risk adverse when it comes to putting their own skin in the game because they do not have the experience necessary to accurately assess costs, risks and length of time for completion of complex goals and cases. To the extent practitioners can get over their aversion to risk, and take steps to mitigate it by informed analysis and preparation, then a world of work that is currently out of reach could become available.
As hourly legal fees continue to rise, clients – even large institutional clients – are increasingly looking for ways to minimize costs and risk. Naturally, firms that are in a position to offer creative fee agreements that align the expense and timing of litigation with client goals will be at a competitive advantage in obtaining and retaining clients. If a firm is good at analyzing litigation timing, cost and probable outcomes, then creative fee agreements are worth the risk.
This article appeared in the Spring 2013 issue of the Oregon State Bar's Litigation Journal.