Jump to ContentJump to Main Navigation
Show Summary Details
More options …

Review of Law & Economics

Editor-in-Chief: Parisi, Francesco / Engel, Christoph

Ed. by Cooter, Robert D. / Gómez Pomar, Fernando / Kornhauser, Lewis A. / Parchomovsky, Gideon / Franzoni, Luigi

3 Issues per year


CiteScore 2017: 0.30

SCImago Journal Rank (SJR) 2017: 0.195
Source Normalized Impact per Paper (SNIP) 2017: 0.410

Online
ISSN
1555-5879
See all formats and pricing
More options …
Volume 9, Issue 3

Issues

Who Benefits from the Uniformity of Contingent Fee Rates?

Eyal Zamir / Barak Medina / Uzi Segal
Published Online: 2014-01-08 | DOI: https://doi.org/10.1515/rle-2013-0009

Abstract

Lawyers’ contingent fee (CF) rates are rather uniform, often one-third of the recovery. Arguably, this uniformity is a type of anti-competitive price-fixing, which results in clients paying supra-competitive fees. This paper challenges this argument. It shows that uniform CF rates provide clients with an important advantage, as such rates enable them to make a de facto “take-it-or-leave-it” offer. Consequently, lawyers cannot exploit their private information, and clients retain the transaction’s entire surplus and may hire the best lawyer among those who find it profitable to handle the case.

The paper also addresses the effect of uniformity of CF rates when lawyers refer cases to other lawyers. It shows that uniformity facilitates matching of clients and lawyers through the referral system. It also demonstrates that the fact that both direct clients and those obtained through paid-for referrals pay the same CF rate does not attest to cross-subsidization. The clients whose cases are transferred for a referral fee (paid by the handling lawyer) “pay” for the referral service by obtaining a less highly ranked lawyer.

Keywords: contingent fee; lawyers; uniform prices

References

  • Abel, R.L. 2006/2007. “How the Plaintiffs’ Bar Bars Plaintiffs,” 51 New York Law School Law Review 345–376.Google Scholar

  • Bar-Hillel, M., and E. Neter. 1996. “Why Are People Reluctant to Exchange Lottery Tickets?” 70 Journal of Personality and Social Psychology 17–27.CrossrefGoogle Scholar

  • Ben-Shahar, O., and J.A.E. Pottow. 2006. “On the Stickiness of Default Rules,” 33 Florida State University Law Review 651–682.Google Scholar

  • Bernstein, L. 1993. “Social Norms and Default Rules Analysis,” 3 Southern California Interdisciplinary Law Journal 59–90.Google Scholar

  • Bolton, P., and M. Dewatripont. 2005. Contract Theory. Cambridge, MA: MIT Press.Google Scholar

  • Brickman, L. 1989. “Contingent Fees without Contingencies: Hamlet without the Prince of Denmark?” 37 UCLA Law Review 29–137.Google Scholar

  • Brickman, L. 2003a. “Effective Hourly Rates of Contingency-Fee Lawyers: Competing Data and Non-Competitive Fees,” 81 Washington University Law Quarterly 653–736.Google Scholar

  • Brickman, L. 2003b. “The Market for Contingent Fee-Financed Tort Litigation: Is It Price Competitive?” 25 Cardozo Law Review 68–128.Google Scholar

  • Chen, H.-C., and J.R. Ritter. 2000. “The Seven Percent Solution,” 55 Journal of Finance 1105–1131.CrossrefGoogle Scholar

  • Cotten, S.J., and R. Santore. 2012. “The Effect of Contingent Fee Caps on the Quality of Legal Services,” 32 International Review of Law and Economics 317–328.CrossrefGoogle Scholar

  • Dai, N., H. Jo, and J.D. Schatzberg. 2010. “The Quality and Price of Investment Banks’ Services: Evidence from the PIPE Market,” 39 Financial Management 582–612.Google Scholar

  • DanaJr., J.D., and K.E. Spier. 1993. “Expertise and Contingent Fees: The Role of Asymmetric Information in Attorney Compensation,” 9 Journal of Law, Economics, and Organization 349–367.Google Scholar

  • Daniels, S., and J. Martin. 1999. “It’s Darwinism – Survival of the Fittest:” How Markets and Reputations Shape the Ways in Which Plaintiffs’ Lawyers Obtain Clients,” 21 Law and Policy 377–399.CrossrefGoogle Scholar

  • Daniels, S., and J. Martin. 2002. “It Was the Best of Times, It Was the Worst of Times: The Precarious Nature of Plaintiffs’ Practice in Texas,” 80 Texas Law Review 1781–1828.Google Scholar

  • Daughety, A.E., and J.F. Reinganum. 2011. “Search, Bargaining, and Agency in the Market for Legal Services (March 2011).” Availabale at SSRN: http://ssrn.com/abstract=1650058.

  • DellaVigna, S. 2009. “Psychology and Economics: Evidence from the Field,” 47 Journal of Economic Literature 315–372.CrossrefGoogle Scholar

  • Drummonds, H.H. 1993. “The Law and Ethics of Percentage Contingent Fees in Oregon,” 72 Oregon Law Review 859–900.Google Scholar

  • Emons, W. 2006. “Playing It Safe with Low Conditional Fees Versus Being Insured by High Contingent Fees?” 8 American Law and Economics Review 261–274.Google Scholar

  • Engstrom, N.F. 2011. “Sunlight and Settlement Mills,” 86 New York University Law Review 805–886.Google Scholar

  • Epstein, R.A. 1992. “The Path to the T.J. Hooper: The Theory and History of Custom in the Law of Tort,” 21 Journal of Legal Studies 1–38.CrossrefGoogle Scholar

  • Fernando, C.S., V.A. Gatchev, and P.A. Spindt. 2005. “Wanna Dance? How Firms and Underwriters Choose Each Other,” 60 Journal of Finance 2437–2469.CrossrefGoogle Scholar

  • Fisch, J.E. 2002. “Lawyers on the Auction Block: Evaluating the Selection of Class Counsel by Auction,” 102 Columbia Law Review 650–728.CrossrefGoogle Scholar

  • Friehe, T., and F. Baumann. 2012. “Contingent Fees Meet the British Rule: An Exploratory Study,” 150 Public Choice 499–510.Google Scholar

  • Furgeson, R. 2009. “Civil Jury Trials R.I.P.? Can It Actually Happen in America?” 40 St. Mary’s Law Journal 795–890.Google Scholar

  • Garicano, L., and T. Santos. 2004. “Referrals,” 94 American Economic Review 499–525.CrossrefGoogle Scholar

  • Garoupa, N., and F. Gomez-Pomar. 2008. “Cashing by the Hour: Why Large Law Firms Prefer Hourly Fees Over Contingent Fees,” 24 Journal of Law, Economics and Organization 458–475.Google Scholar

  • Gilson, R.J. 1990. “The Devolution of the Legal Profession: A Demand Side Perspective,” 49 Maryland Law Review 869–916.Google Scholar

  • Gross, L. 2006. “Are Differences Among the Attorney Conflict of Interest Rules Consistent with Principles of Behavioral Economics?” 19 Georgetown Journal of Legal Ethics 111–154.Google Scholar

  • Gryphon, M. 2011. “Assessing the Effects of a “Loser Pays” Rule on the American Legal System: An Economic Analysis and Proposal for Reform,” 8 Rutgers Journal of Law and Public Policy 567–613.Google Scholar

  • Hada, M., R. Grewal, and G.L. Lilien. 2010. “Referral Equity and Referral Management: The Supplier Firm’s Perspective,” 7 Review of Marketing Research 93–144.CrossrefGoogle Scholar

  • Hadfield, G.K. 2000. “The Price of Law: How the Market for Lawyers Distorts the Justice System,” 98 Michigan Law Review 953–1006.CrossrefGoogle Scholar

  • Hyde, C.E. 2006. “Conditional Versus Contingent Fees: Litigation Expenditure Incentives,” 26 International Review of Law and Economics 180–194.CrossrefGoogle Scholar

  • Korobkin, R. 1998. “The Status Quo Bias and Contract Default Rules,” 83 Cornell Law Review 608–687.Google Scholar

  • Kritzer, H.M. 1990. The Justice Broker: Lawyers and Ordinary Litigation. New York: Oxford University Press.Google Scholar

  • Kritzer, H.M. 2002. “Seven Dogged Myths Concerning Contingency Fees,” 80 Washington University Law Quarterly 739–794.Google Scholar

  • Kritzer, H.M.. 2004. Risks, Reputations, and Rewards: Contingency Fee Legal Practice in the United States. Stanford, CA: Stanford University Press.Google Scholar

  • Lederer, P.J. 2010. “Uniform Spatial Pricing (March 23, 2010).” Available at SSRN: http://ssrn.com/abstract=1799470.

  • Levmore, S. 1993. “Commissions and Conflicts in Agency Arrangements: Lawyers, Real Estate Brokers, Underwriters, and Other Agents’ Rewards,” 36 Journal of Law and Economics 503–539.CrossrefGoogle Scholar

  • Madrian, B.C., and D.F. Shea. 2001. “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior,” 116 Quarterly Journal of Economics 1149–1187.CrossrefGoogle Scholar

  • McKee, M., R. Santore, and J. Shelton. 2007. “Contingency Fees, Moral Hazard, and Attorney Rents: A Laboratory Experiment,” 36 Journal of Legal Studies 253–273.CrossrefGoogle Scholar

  • Miller, G.P. 1987. “Some Agency Problems in Settlement,” 16 Journal of Legal Studies 189–215.CrossrefGoogle Scholar

  • Mnookin, R.H. 1998. “Commentary: Negotiation, Settlement, and the Contingent Fee,” 47 DePaul Law Review 363–370.Google Scholar

  • Painter, R.W. 1995. “Litigating on a Contingency: A Monopoly of Champions or a Market for Champerty?” 71 Chicago-Kent Law Review 625–697.Google Scholar

  • Parikh, S. 2001. Professionalism and Its Discontents: A Study of Social Networks in the Plaintiff’s Personal Injury Bar (unpublished Ph.D. dissertation, University of Illinois at Chicago, on file with authors).Google Scholar

  • Parikh, S. 2006/2007. “How the Spider Catches the Fly: Referral Networks in the Plaintiffs’ Personal Injury Bar,” 51 New York Law School Law Review 243–283.Google Scholar

  • Pauly, M.V. 1979. “The Ethics and Economics of Kickbacks and Fee Splitting,” 10 Bell Journal of Economics 344–352.CrossrefGoogle Scholar

  • Polinsky, A.M., and D.L. Rubinfeld. 2003. “Aligning the Interests of Lawyers and Clients,” 5 American Law and Economic Review 165–188.CrossrefGoogle Scholar

  • Posner, R.A. 2007. Economic Analysis of Law, 7th ed. New York: Aspen Publishers.Google Scholar

  • Rickman, N. 1994. “The Economics of Contingency Fees in Personal Injury Litigation,” 10 Oxford Review of Economic Policy 34–50.CrossrefGoogle Scholar

  • Rubinfeld, D.L., and S. Scotchmer. 1993. “Contingent Fees for Attorneys: An Economic Analysis,” 24 RAND Journal of Economics 343–356.CrossrefGoogle Scholar

  • Santore, R., and A.D. Viard. 2001. “Legal Fee Restrictions, Moral Hazard, and Attorney Rents,” 44 Journal of Law and Economics 549–572.CrossrefGoogle Scholar

  • Schelling, T.C. 1960. The Strategy of Conflict. Cambridge: Harvard University Press.Google Scholar

  • Schwartz, D.L. 2012. “The Rise of Contingent Fee Representation in Patent Litigation,” 64 Alabama Law Review 335–388.Google Scholar

  • Schwartz, M.L., and J.B.M. Daniel. 1970. “Economic Analysis of the Contingent Fee in Personal-Injury Litigation,” 22 Stanford Law Review 1125–1162.CrossrefGoogle Scholar

  • Silver, C. 2002. “Does Civil Justice Cost Too Much?” 80 Texas Law Review 2073–2113.Google Scholar

  • Spurr, S.J. 1987. “How the Market Solves an Assignment Problem: The Matching of Lawyers with Legal Claims,” 5 Journal of Labor Economics 502–532.CrossrefGoogle Scholar

  • Spurr, S.J. 1988. “Referral Practices Among Lawyers: A Theoretical and Empirical Analysis,” 13 Law and Social Inquiry 87–109.CrossrefGoogle Scholar

  • Spurr, S.J. 1990. “The Impact of Advertising and Other Factors on Referral Practices, with Special Reference to Lawyers,” 21 RAND Journal of Economics 235–246.CrossrefGoogle Scholar

  • Swett, Jeffrey J. 2010. “Determining a Reasonable Percentage in Establishing a Contingency Fee: A New Tool to Remedy an Old Problem,” 77 Tennessee Law Review 653–683.Google Scholar

  • Sykes, A.O. 1993. “Some Thoughts on the Real Estate Puzzle: Comment on Levmore, “Commissions and Conflicts in Agency Arrangements: Lawyers, Real Estate Brokers, Underwriters, and Other Agents’ Rewards,” 36 Journal of Law and Economics 541–551.CrossrefGoogle Scholar

  • Thomason, T. 1991. “Are Attorneys Paid What They’re Worth? Contingent Fees and the Process of Settlement,” 20 Journal of Legal Studies 187–223.CrossrefGoogle Scholar

  • Wang, G.H. 1998. “Bargaining Over a Menu of Wage Contracts,” 65 Review of Economic Studies 295–305.CrossrefGoogle Scholar

  • Zamir, E. 1997. “The Inverted Hierarchy of Contract Interpretation and Supplementation,” 97 Columbia Law Review 1710–1803.CrossrefGoogle Scholar

  • Zamir, E., and I. Ritov. 2008. “Neither Saints nor Devils: A Behavioral Analysis of Attorneys’ Contingent Fees (January 22, 2008).” Available at SSRN: http://ssrn.com/abstract=1085985.

  • Zamir, E., and I. Ritov. 2010. “Revisiting the Debate Over Attorneys’ Contingent Fees: A Behavioral Analysis,” 39 Journal of Legal Studies 245–288.CrossrefGoogle Scholar

  • Zamir, E., and I. Ritov. 2011. “Notions of Fairness and Contingent Fees,” 74 Law and Contemporary Problems 1–32.Google Scholar

About the article

Published Online: 2014-01-08


Note that the ranking of lawyers may – and usually does – depend on the type of claim. Thus, Lawyer A may be ranked higher than Lawyer B in medical-malpractice cases while B is ranked higher in car-accident cases. It follows that reciprocal referrals between two lawyers may both be to a higher-ranking lawyer (Parikh, 2001:156–158). See also Section 5.2

In fact, the expected recovery is determined by the distribution of the possible sums of recovery. In a discrete setting, it is an aggregation of the products of each sum and the likelihood of its recovery, and in a continuance setting, it is the integral over the probability density function.

In the next section, we discuss the plausibility of this assumption, which is shared by others. See, e.g., Dana and Spier (1993); Brickman (2003b:94–95); Daughety and Reinganum (2011).

This is a very plausible assumption, because the lawyer’s reservation hourly fee is not exogenous, but determined according to the demand for her services. If the demand for the services of a certain lawyer exceeds her capacity, one would expect her reservation hourly fee to increase accordingly.

A comparable claim can be made regarding any sub-market in which lawyers charge other uniform CF rates, such as a non-negotiable variable fee depending on how the case is resolved (e.g. 25% if it is settled without trial, 33% if it goes to trial, and 40% if there is an appeal), provided that the probability of settling/trial/appeal is uniform for all attorneys.

Note that this result differs from the standard result in the literature regarding two-party negotiation under asymmetric information. According to the standard result, efficiency requires that the informed, rather than the uninformed, party would make the contract offer (e.g. Wang, 1998; Bolton and Dewatripont, 2005:243).

This insight, originally offered by Zamir and Ritov (2008), was endorsed by Furgeson (2009:824) and Gryphon (2011).

The same tendency is manifest in variable-percentage CF rates, where the common pattern is a scale of rates of 1/4, 1/3, and 2/5 or 1/2, depending on the stage to which the case gets. It is also manifest in the common referral fees, where, according to one study, some 80% of the negotiated referral fee rates are either one-third or one-half of the handling lawyer’s fee (Spurr, 1988:100–102).

In Kritzer’s survey, 25% of the individual clients and 33% of the organizational ones reported that fees were not discussed at all with the lawyer prior to receiving the bill (Kritzer, 1990:57).

See Section 5.1. In Section 5.5., we will explain why this naïve assumption is problematic.

To see why, suppose that the expected returns to the client from the two lawyers are the same. Specifically, denote by k the CF rate, p the probability of success, and d the amount of recovery. The client’s expected return from the better lawyer is (1–k)pd while the expected return from the lower-ranked lawyer who charges a lower CF rate is (1–k’)p’d’, where k > k’, p> p’, and d > d’. Assuming, without loss of generality, u(0) = 0, we obtain that the expected utilities of the two returns are pu((1–k)d) and p’u((1–k’)d’). We assume that (1–k)pd = (1–k’)p’d’. It follows that p’ = (1–k)pd/(1–k’)d’, and the expected utility of hiring the lower-ranked lawyer becomes (1–k)pdu((1–k’)d’)/(1–k’)d’. The expected utility from the better lawyer is higher than that from the other lawyer iff This inequality holds because by (1–k)pd = (1–k’)p’d’, together with p > p’, we obtain that (1–k)d < (1–k’)d’, and since u is concave and u(0) = 0, the ratio u(x)/x decreases with x.

For instance, hiring a particular lawyer may yield a relatively low p and high d, whereas hiring a less-qualified lawyer would yield a lower expected value p’d’ < pd, but may result in higher probability of winning the case (p’ > p), which might be sufficient to compensate the risk-averse client for the lower expected value. In addition, a risk-averse plaintiff may be more interested in establishing the defendant’s liability than in the scope of damages awarded, and if a particular lawyer is better at attaining high damages once liability is determined, but not in proving liability, the client may be better off with someone else.

The actual scope of work required ex post may of course differ from the scope expected ex ante, but since there is no difference in this respect between negotiated and uniform CF rates, the model assumes away this possibility.

Conceivably, the ranking would have been different had the pricing scheme, and thus the incentives it provides, been different.

This is especially true if the lawyer’s input includes not only hours of work but also other aspects of her “production function,” which are often unobservable.

If both cases are expected to yield an effective hourly rate that is not lower than the attorney’s reservation price, then it may reasonably be assumed that she will accept both. See supra note 4 and accompanying text.

At least in theory, the incentive created by the ongoing relationship between the referring and the handling lawyers may outweigh the reduction in incentives due to fee splitting – in which case finding an appropriate lawyer through a referral may be advisable even if the client is knowledgeable about lawyers’ ranking.

As detailed in Section 5.1, while top lawyers obtain most of their cases through referrals, the majority of lawyers, who handle the lion’s share of the CF cases, obtain most of their cases directly.

Charging direct and transferred clients the same CF rate is analogous to a policy of uniform spatial pricing, where a seller charges a uniform delivered price for its goods regardless of the differences in transportation costs to customers in different locations. Such policy may be profit-maximizing under certain assumptions regarding demand functions (Lederer, 2010). For instance, if transferred clients are ordinarily poorer than direct ones – a plausible assumption given that their recourse to the referral system indicates that they are less sophisticated and knowledgeable – then the uniform pricing of the two populations may be a profit-maximizing strategy.

Take, for example, a case whose expected value, pidi, is $270,000 and the number of hours it requires, h, is 100. The expected fee under the standard one-third CF rate is $90,000. A client who finds her own legal representation would hire an attorney whose reservation hourly fee, wi, is $900. In contrast, a client with the same case, who approaches an unsuitable lawyer who then transfers her case, can only expect a handling lawyer whose reservation hourly fee is $600, as two-ninths of $270,000 is $60,000.

Contrary to the prediction of his theoretical model, Spurr (1988:102–107) found no statistically significant correlation between the referral fee and gross recovery.


Citation Information: Review of Law & Economics, Volume 9, Issue 3, Pages 357–387, ISSN (Online) 1555-5879, ISSN (Print) 2194-6000, DOI: https://doi.org/10.1515/rle-2013-0009.

Export Citation

©2013 by Walter de Gruyter Berlin / Boston.Get Permission

Comments (0)

Please log in or register to comment.
Log in