Practice Management

16
Aug
2016

Practice Management:

Flat fees: Earned, unearned or both?

Alberto Bernabe
Chicago, IL

​Ohio's Rules of Professional Conduct pertaining to flat fees are confusing and contradictory, sometimes leaving lawyers in limbo.
 
In February the Board of Professional Conduct of the Ohio Supreme Court released an advisory ethics opinion on whether a lawyer may enter into an agreement requiring a client to pay a flat fee in advance of representation and on whether a lawyer must deposit such a fee into a client trust account.1 Because these questions are addressed in the applicable Rules of Professional Conduct or in their comments, the opinion does not actually add much to the current state of the law. Unfortunately, however, the state of the law is based on a confusing inherent contradiction within the applicable rule.

By simply repeating that confused doctrine without criticizing it, the board missed the opportunity to propose a much-needed change in the rules. As a result, the board's opinion merely reiterates a faulty analysis that leads to confusion and defeats the purpose of providing clear guidance to lawyers. Ohio lawyers need a better approach to help them understand the issues they face when handling flat fees paid in advance.

The current state of Ohio law

The comment to Ohio Rule of Professional Conduct 1.5 defines a flat fee as "a set amount [charged] for performance of agreed work, which may or may not be paid in advance but is not deemed earned until the work is performed."2 There are three important elements in this definition. The first one is that the amount of the fee is determined before the work is performed.3 Obviously, this is what defines the fee as "flat." Second, the fee may or may not be paid in advance. This is important because the issues addressed by the Board of Professional Conduct's opinion only present a problem if the fee is paid in advance.

Finally, the third element in the definition of flat fees is that they are not earned until the work is performed.4 This is important because if the fee is not earned until the work is performed and a client pays the lawyer in advance, the money still belongs to the client, and the lawyer has an obligation to keep the amount paid in a trust account until the fee is actually earned.5 This is to protect clients because if the lawyer does not complete the task the fee is supposed to pay for, the lawyer is obligated to refund the client the portion of the fee that was not earned.6 Otherwise a lawyer could claim that a fee is earned upon receipt and then abandon the representation, but retain the amount of the fee as if the work had been completed.

This definition is logical and straightforward, but, unfortunately, the doctrine in Ohio does not end there. Even though the comment to the rule states that flat fees paid in advance are not yet earned, according to Rule of Professional Conduct 1.5(d)(3), a lawyer can agree with a client to consider such a fee as "earned upon receipt" and non-refundable as long as the client is informed that the client may have a right to a refund.7 This notion of a non-refundable fee that must be guaranteed to be refundable is an illogical inherent contradiction in terms at the heart of the confusion created by the Ohio rules.

One would think that agreeing that the fee is "earned upon receipt" means that the fee is earned and that the money belongs to the attorney. Yet, in Ohio, a fee that is earned upon receipt is actually not really earned, and although the attorney can place it in the attorney's own bank account as if the money belonged to the attorney, the attorney can't touch that money since it is possible the attorney may have to refund it. This makes little sense.8

Opinion 2016-1

In Opinion 2016-1, the Board of Professional Conduct accurately describes and applies the elements of the rule that lead to this inevitable result but does not address the contradiction they create.9 The board points out correctly, for example, that if a fee is earned upon receipt, the money belongs to the lawyer and the lawyer can do with it as the lawyer pleases except leaving it in the trust account because leaving it in the trust account would result in commingling funds.10 However, the board does not consider what happens once the money is moved from the trust account to the lawyer's general account.

After moving the money, the lawyer has deposited in the lawyer's general account an amount of money the lawyer can't touch since it is possible it may have to be refunded to the client. At that point, the account contains client money (the unearned amount to be refunded) and attorney money at the same time. In other words, by allowing a lawyer to consider a fee paid in advance to be earned, even though it really hasn't been earned, to avoid commingling funds within the trust account, the rules force the lawyer to commingle funds within the lawyer's operating account.

Thus, the board's conclusion (which is based on the text of the rules) inevitably leads to a violation of the rules. If the fee is considered earned, but some of it has to be refunded, it means that some part of the fee was technically not earned and the lawyer commingled by placing the full amount in the general account. On the other hand, if the fee is deemed earned, but the lawyer leaves even part of the amount in the trust account just in case a portion of the fee will have to be refunded, the lawyer has also commingled.

Moreover, in addition to the obvious violation of the principle against commingling, by allowing the client to agree with the lawyer to move what is in reality client money to the lawyer's account, the rules are in effect allowing the client and lawyer to hide money from the client's creditors, while making the client's funds vulnerable to the lawyer's creditors.

The idea behind the current approach is inadequate for a few reasons. First, it is based on the sophistry that the full fee has been earned when in reality it has not. Perhaps it can be argued that an initial portion of the fee is earned when agreed upon, but certainly not the full fee. Second, allowing lawyers to pretend the fees have been earned creates the opportunity for unscrupulous lawyers to trick unsuspecting clients to give up their rights.11 Third, it does nothing to prevent the violations of the duty not to commingle funds. Finally, although it recognizes that the client might have a right to seek a refund, the client's right to compensation would depend on the client pursuing a civil action or a disciplinary action against the lawyer, both of which are options many clients will not know how to, or will prefer not to, pursue, and which may take a long time to complete.12

Is there a better approach?

Flat fee agreements offer both lawyers and clients certain advantages. For the client, a flat fee provides an attractive alternative to an hourly fee agreement because the client knows up-front exactly how much the attorney's services are going to cost, and once paid, the client does not have to worry about any more payments. The client also gets the benefit of the lawyer's efficiency because the lawyer knows that the value of the fee will diminish if the attorney is not efficient in providing the services. Thus, flat fees reward efficiency, enable clients to better control their budgets, eliminate conflicts with clients over bills and provide certainty of payment.13

On the other hand, when flat fees are paid in advance, they raise some ethical concerns; however, these concerns can be addressed in several different ways. One solution is to ban lawyers from asking clients to pay in advance. Another solution might be to stop requiring that lawyers use client trust accounts.14 Yet, many reasons justify allowing the practice of asking for payment in advance and of requiring lawyers to keep separate trust accounts. The problems can be avoided without having to go that far.

A better alternative is to eliminate the possibility of "deeming" a fee "earned upon receipt," which is just a way to pretend that the amount of the fee belongs to the lawyer even though the work it is supposed to pay for has not been performed.15 Instead of allowing this "legal fiction,"16 lawyers and clients should agree on how (or when) portions of the flat fee are actually earned so that ownership of that portion of the money can be transferred to the attorney.17 This way, the flat fee amount paid in advance is kept in the trust account, but the attorney can withdraw funds before the end of the representation.​

Accordingly, the Ohio Rules of Professional Conduct should be amended to eliminate Rule 1.5(d)(3) and to rewrite paragraph 6A of the Comment to Rule 1.5 to read something like this:

Advance fee payments are of at least four types. The "true" or "classic" retainer is a fee paid in advance solely to ensure the lawyer's availability to represent the client and precludes the lawyer from taking adverse representation. What is often called a In contrast, a security retainer is in fact an advance payment to ensure that fees are paid when they are subsequently earned, on either a flat fee or hourly fee basis. A flat fee is a fee of a set amount for performance of agreed work, which may or may not be paid in advance but is not deemed earned until the work is performed. An earned upon receipt fee is a flat fee paid in advance that is deemed earned upon payment regardless of the amount of future work performed. If paid in advance, the amount of the flat fee is not yet earned and should be placed in a trust account, in accordance with Rule 1.15. The fee is earned when the work for which the fee was paid is performed, at which point it should be placed in the attorney's general account. When a fee is earned affects whether it must be placed in the attorney's trust account, see Rule 1.15, and may have significance under other laws such as tax and bankruptcy. If the work is not performed, or if it is performed only partially, the The reasonableness requirement and the application of the factors in division (a) may mean that a client is entitled to a refund of an advance fee payment even though it has been denominated "nonrefundable," "earned upon receipt," or in similar terms that imply the client would never receive a refund. So that a client is not misled by the use of such terms, division (d)(3) requires certain minimum disclosures that must be included in the written fee agreement. This does not mean the client will always be entitled to a refund upon early termination of the representation [e.g., factor (a)(2) might justify the entire fee], nor does it determine how any refund should be calculated (e.g., hours worked times a reasonable hourly rate, quantum meruit, percentage of the work completed, etc.), but merely requires that the client must be advised of the possibility of a refund based upon application of the factors set forth in division (a). In order to be able to demonstrate the reasonableness of the fee in the event of early termination of the representation, it is advisable that lawyers and clients agree to set milestones at which point certain portions of the fee are to be considered earned, or, at least, to maintain contemporaneous time records for any representation undertaken on a flat fee basis.

This new language ensures that, un​like at present, a fee cannot be earned and unearned at the same time, and provides both clients and lawyers the protection and flexibility they need.

Endnotes


1 Board of Professional Conduct of the Supreme Court of Ohio, Opinion 2016-1 (Feb. 12, 2016), available at www.supremecourt.ohio.gov/Boards/BOC/Advisory_Opinions/2016/Op_16-001.pdf.

2 Ohio Prof. Cond. R. 1.5, Cmt. [6A].

3 Opinion 2016-1, supra note 1, at 3 (flat fees are based on factors independent of the actual number of hours involved in a representation).

4 Ohio Prof. Cond. R. 1.5, Cmt. [6A].

5 Opinion 2016-1, supra note 1, at 4.

6 Ohio Prof. Cond. R. 1.16(e) (a lawyer who withdraws from employment shall refund promptly any part of a fee paid in advance that has not been earned).

7 Ohio Prof. Cond. R. 1.5(d)(3); Opinion 2016-1, supra note 1, at 4.

8 Alec Rothrock, The Forgotten Flat Fee: Whose Money is it and Where Should it be Deposited?, 1 Fla. Coastal L. J. 293, 347 (1999) ("It simply makes no sense to permit lawyers to enter into fee agreements with clients stating that an advance payment such as a flat fee is earned upon receipt, when such payments are subject to being refunded to the extent unearned.").

9 The opinion concludes that lawyers are allowed to charge flat fees in advance but they must deposit those fees in a trust account unless the fees have been designated "earned upon receipt." If designated as such, clients must be advised that they may be entitled to a refund. Opinion 2016-1, supra note 1, at 5.

10 See Ohio Prof. Cond. R. 1.15(a); Opinion 2016-1, supra note 1, at 4 (earned fees should not be placed in a trust account because it is impermissible to commingle a lawyer's own funds with those of a client).

11 Rothrock, supra note 8 at 347 (many clients, believing that their flat fee is non-refundable and unaware of the ethical obligation to the contrary, will not ask for a refund even if they are entitled to one).

12 Id.

13 Rothrock, supra note 8 at 354; Tyler Moore, "Flat Fee Fundamentals: An Introduction to the Ethical Issues Surrounding the Flat Fee After In Re Mance," 23 Geo. J. Legal Ethics 701, 701-702 (2010); Douglas R. Richmond, "Understanding Retainers and Flat Fees," 34 J. Legal Prof. 113, 114 (2009).

14 See, for example, Carolyn Elefant, "Want to Lower the Cost of Legal Services? Let's Ditch Trust Accounts," My Shingle, May 27, 2014, myshingle.com/2014/05/articles/setting-and-collecting-fees/want-lower-cost-legal-services-lets-ditch-trust-accounts/; Carolyn Elefant, "If Lawyer Trust Accounts Don't Keep Clients' Money Safe, Isn't It Time to Get Rid Of Them," My Shingle, Jan. 27, 2016, myshingle.com/2016/01/articles/ethics-issues/if-lawyer-trust-accounts-dont-keep-clients-money-safe-isnt-it-time-to-get-rid-of-them/.

15 Rothrock, supra note 8, at 347-48 ("Since flat fees are always subject to refund, they are not "earned" until corresponding services are performed. Unless and until such services are performed, they are unearned fees, however solemnly the fee agreement states otherwise."); Richmond, supra note 13, at 134 (scheme that allows attorney to designate fee as earned but to inform client of right to refund "makes little sense . . . because it effectively enables commingling and it deprives the client of the protections that attend the deposit and maintenance of funds in a trust account.").

16 Rothrock, supra note 8, at 346 (scheme that allows unearned fees to be considered earned results in an "inconsistent legal fiction").

17 Moore, supra note 13 at 710; Richmond, supra note 13, at 134.