Attorney Fees in California Construction Defect Cases What Clients Should Know about Fee Contracts, Referral Fees, And Professional Ethics – Article by by Tyler P. Berding, Esq. and Allison L. Andersen, Esq.

Article by by Tyler P. Berding, Esq. and Allison L. Andersen, Esq.

The successful relationship between a client and attorney is built on trust and confidence. The guiding principal is that the client should be able to make informed decisions concerning all matters substantially impacting the client’s case and recovery. The first big question facing the client in a construction defect case is the basis on which the attorney is compensated. While some firms will offer only one fee agreement option, others are more flexible. Before entering into any arrangement, the client should be apprised of all available alternatives so that the fee option best suited to the client’s needs can be selected. This article explores various fee arrangements, the related legal requirements and considerations bearing on that decision.

The contents of an attorney fee agreement are governed by rules of professional conduct and state law, which require a full disclosure of key terms and restrict an attorney’s ability to share fees with, or pay referral fees to, other attorneys or non-attorneys. California Business and Professions Code sections 6147 and 6148 require written agreements in cases involving contingency fees or those expected to result in fees in excess of $1,000. The contract must contain a general description of the services to be provided, state whether the fee is hourly or contingent, and state how litigation costs will be paid. Additionally, the fee contract must contain a reference to alternative dispute resolution and disclose whether the attorney will be sharing any portion of the fees.

What Are the Fee Agreement Options for Litigation?

Historically, both businesses and consumers paid attorneys’ hourly rates for everything except accident and personal injury litigation, which were usually paid on a contingent basis, that is, the duty to pay the attorney was “contingent” on receipt of a recovery. More recently, the contingency fee arrangement has become a popular option in construction defect cases. Since there are important differences between hourly and contingency fee representation, it is essential that a board of directors be fully informed of the consequences of choosing one method of payment over another. The most important difference concerns how the risk of payment and recovery are divided between the client and its counsel.

Fee agreements allocate some of the financial risk of litigation as between the attorney and the client. There is always the chance the client will receive little or no recovery from the case; but that particular risk cannot be shifted to the attorney (in other words, the lawyer cannot guarantee and underwrite a cash recovery.) However, the financial risk of the expense of the litigation, i.e. the fees and litigation costs necessary to prosecute it, can be born by the client, the attorney or be shared. The typical hourly fee agreement requires that the client pay the fees and expenses of the case as they are incurred. On the other hand, with a contingent fee agreement the lawyer accepts the risk of some portion of the fee and expense until there is a recovery.

An attorney’s agreement to accept some portion of the risk in the litigation is not without cost to the client. The contingent fee in a construction defect matter is a percentage of the recovery; the greater the risk of the particular claim, the higher the percentage. The percentage compensates the law firm for the possibility that its entire investment will go for naught if no recovery can be obtained. Thus, the contingency fee, when and if it is earned, often represents a premium over what a client might expect to pay for the same case with an hourly fee agreement, where the attorney takes no risk because the fee is paid regardless of whether the client obtains a recovery.

Based on a career of litigating construction defect cases, experience shows that the client will likely save money when its fee arrangement is hourly. This proposition is supported by the fact that the hourly fee remains the arrangement of choice for most for-profit businesses who hire attorneys to litigate on their behalf. Because cash flow is not as much of an issue for successful corporations, they are in a better position to pay litigation expenses and avoid any fee premium for “risk insurance”.

For many community associations however, the risk of losing the case altogether, or obtaining an inadequate judgment is simply too great when added to the costs of litigation. They may lack the cash flow necessary to retain lawyers and expert witnesses on an hourly basis. For those associations, contingency fee arrangements are the only viable option. Each situation is different, but for the client the key is to be sure the various fee options are identified and explained. The basic arrangements are described below.

1. Hourly Fee Contract. Under the standard hourly fee agreement, attorneys are paid for their services for each hour billed. Different attorneys and legal assistants will have different hourly rates. While the rates for the most experienced attorneys will be higher than those for junior associates or legal assistants, it isn’t the rate of any individual attorney that is important, but rather the average rate of the firm projected over an entire case. This is because more hours are (or should be) invested into a case by those with lower rates. The partners in the firm, those attorneys with the greatest experience (and the highest rates), will supervise the others and appear at important events like depositions, mediations, and court hearings, but generally will bill fewer hours than other staff members, resulting in an average hourly rate far below that of the partner in charge.

The other major cost component is the fees of experts–architects, engineers, and others–who provide the expert testimony necessary to successfully prosecute a claim. With an hourly fee arrangement, the experts are typically paid by the client on an hourly basis. In a construction case with a potential recovery in excess of a million dollars, attorney and expert fees can easily reach six figures, so the client must have sufficient cash flow or commit other financial resources (reserves, loans) to finance the case to conclusion. With this type of contract, the risk of success or failure resides with the client. The attorney and the experts are paid regardless of the outcome.

2. Contingent Fee Contract. A contingent fee contract provides that the attorney’s fee will be a percentage of any recovery. If there is no recovery, there is no fee. Where cash flow is a big issue with the client, as it often is with community associations, the attorney’s willingness to defer fees until and unless there is a recovery is a substantial benefit to the client. The client must keep in mind that with a contingent fee contract, the attorney is acting as the bank and that service is not without cost to the client. To the extent that the resulting fee is greater than what the client might have paid with an hourly fee agreement, the client is paying the attorney a premium to accept some or all of the client’s risk. If that risk is minimal, the client may be paying for insurance that it doesn’t need.

Under a contingent fee arrangement, the attorney and client must determine whether the attorney will also advance litigation costs. Litigation costs include all costs necessary prosecute the case such as expert fees, court filing fees, copy costs, service fees, etc. In a big case, litigation costs can be substantial. If the attorney is willing to advance costs in a particular case, it is again of great benefit to the client which has limited cash flow. The lawyer does have a right to recover those costs from any resulting settlement or verdict. If there is no recovery, however, the attorney will absorb those costs.

The client should pay particular attention to the fee agreement provisions that dictate the manner in which the litigation costs are reimbursed to the attorney at the time of settlement or judgment. There are typically two alternatives: the costs are either deducted from the gross settlement prior to payment of the attorney’s fee, or the costs are deducted from the net settlement after the payment of the attorney’s fee. If the costs are taken from the gross settlement amount, the attorney is essentially sharing the costs with the client. If the costs are deducted from the net settlement amount, the client is paying for all of the costs.

Associations should be wary of law firms that insist upon a contingent fee arrangement. While this option is attractive to and appropriate for some clients, the attorney should always explain the implications of a contingency fee and offer the client an hourly option.

3. Hybrid Arrangements. There are also fee arrangements where the client may pay a lower hourly fee coupled with a lower contingent fee percentage paid at the end of the case. This type of arrangement allows the attorney and client to share the risk attendant to the prosecution of the action in exchange for a lower contingent fee. Similarly, in such an arrangement, the client may pick up some or all of the costs. Another form of hybrid is shifting from an hourly fee contract to a contingent fee agreement sometime during the course of the litigation if and when the cash flow burden becomes too great.

Which Agreement is Right for My Association?

For some community associations, the decision of whether to enter into an hourly or contingent fee arrangement is easy. Where there simply is not sufficient cash flow to sustain construction defect litigation, the contingent option is really the only option. For associations who can bear the financial burden, however, the board of directors should consider whether the fee premium under a contingent arrangement is warranted by the particular facts of the case.

At the outset, the attorney should be able to provide a preliminary assessment of the case and its prospects for success. Construction defect law and procedure is fairly clear. Where the case involves new construction by a nationwide developer with good insurance coverage, the risk may not be all that great. The majority of the issues are fact-based: Is a particular building component defective? If so, what is the cost to repair it? Which, if any, of the defendants (developer, contractors, etc.) built the defective component? Was the design improper? Did the Association wait too long to bring the claim or otherwise contribute to the defects by improper maintenance? When the issues are fact-based, they are capable of compromise and resolution through pre-trial mediation. For cases involving residential or commercial conversions, special developer defenses or insurance coverage problems, however, the legal issues are complicated and the risks are significantly greater. The attorney will spend a higher percentage of time focusing on unique legal or coverage issues that could drastically impact the success of the case. While these cases can also be resolved through the mediation process, it is often later in the litigation. Cases which are legally complicated or those with difficult insurance coverage problems are also the ones that may have to be resolved at or near trial, further increasing the risk and expense of the litigation.

Attorneys have a professional responsibility to make sure that the client understands any fee arrangement. The client should always take the opportunity to discuss the details of the problem, which fee options are available to the association, and whether one option is best suited to the association’s needs. The important thing to remember is that any proposed agreement needs to be read, carefully explained and negotiated. Attorney’s fees are not set by law; they are a matter of agreement between the attorney and the client. Like any contract, the client is free to negotiate the terms and the attorney is free to accept or reject them.

How Much Can an Attorney Charge a Client?

The California Rules of Professional Conduct govern the relationship of the attorney’s fee to the work that is to be performed under the fee agreement. Rule 4-200 states that a “member shall not enter into an agreement for, charge, or collect an illegal or unconscionable fee”. “Illegal” is easy to understand, but what about “unconscionable?” The rule weighs the following factors:

(1) The amount of the fee in proportion to the value of the services performed.

(2) The relative sophistication of the attorney and the client.

(3) The novelty and the difficulty of the questions involved and the skill requisite to perform the legal service properly.

(4) Whether the attorney would be precluded from accepting other employment while working on the client’s case.

(5) The amount involved and the results obtained.

(6) The time limitations imposed by the client or by the circumstances.

(7) The nature and length of the professional relationship with the client.

(8) The experience, reputation, and ability of the attorney.

(9) Whether the fee is fixed or contingent.

(10) The time and labor required.

(11) The informed consent of the client to the fee.

In summary, the fee must be fair in light of the specific circumstances and the foregoing factors. With an hourly fee arrangement, the time spent and the hourly rate must be appropriate for the complexity of the case. With a contingent fee arrangement, the percentage must reflect the risk undertaken as measured by the above factors. When the client and the attorney meet to negotiate the fee contract, the factors should be discussed in order to determine whether the proposed fee is reasonable for both the client and the attorney.

What Provisions Govern Who Gets Paid?

The California Rules of Professional Conduct are very clear with regard to who can be paid from or share in the attorney’s fee. As you might guess, it is limited solely to other attorneys and must be approved by the client. Rule 2-200 states: “A member [attorney] shall not divide a fee for legal services with a lawyer who is not … [in the same firm] unless the client has consented in writing thereto after a full disclosure has been made in writing that a division of fees will be made and the terms of such division; and the total fee charged by all lawyers is not increased solely by reason of [the division of fees.]” All such arrangements must be fair to the client, disclosed in advance, and be approved by the client in writing.

That rule further states that unless disclosed to, and approved by, the client, “a member shall not compensate, give, or promise anything of value to any lawyer for the purpose of recommending or securing employment of the member or the member’s firm by a client, or as a reward for having made a recommendation…”

Why is this important? Quite simply, because the client has a right to know when its lawyer is being paid to refer the construction defect case to another lawyer. Many attorneys refer clients to other attorneys who practice in a specialized area, but often they do it without any expectation of payment. When a lawyer is being paid for the referral, the client must be told so that the client can give appropriate weight to the referring attorney’s recommendation. Since such an arrangement requires client approval, any potential client should feel free to ask if recommended counsel will be paying a portion of the fee to the referring attorney. The response should reveal whether the referring attorney has a financial interest in the recommendation made to the client as well as whether the referred attorney would be working for less than his or her normal fee.

A lawyer may not share legal fees with non-lawyers under any circumstances. Rule 1-320 states: “Neither a member nor a law firm shall directly or indirectly share legal fees with a person who is not a lawyer…” It also states: “A member shall not compensate, give, or promise anything of value to any person or entity for the purpose of recommending or securing employment of the member or the member’s law firm …” There are many players involved in construction defect litigation. Besides attorneys, there are design experts, construction companies, property managers, vendors and directors. Each may find themselves in a position to recommend work to one attorney or another. These referrals are proper so long as they are not done in anticipation of monetary payment, gifts or a share of the fees paid to the attorney.

Conclusion

An attorney fee agreement is never a “one size fits all” contract. Attorneys and potential clients must consider the association’s financial condition, the specific facts of the case and the risk involved in prosecuting the matter. Before a client accepts a fee agreement, the attorney and client should review each of the terms and the attorney should provide a detailed explanation as to why the particular agreement is best suited to the client’s needs.

Clients should understand that attorneys are required to abide by ethical rules which are intended to benefit and protect the public. Referrals are valuable, but clients should feel free to ask questions, determine the interests of any attorney who provides services or referrals, negotiate their best fee deal, and approve of who receives payment for legal services. If a client suspects that the rules are not being followed, the client should report such violations to the state bar.

Complex construction defect litigation is expensive to prosecute, but the cost to repair the damages sustained by building owners and community associations is often extraordinary. With some cases, litigation becomes a necessary evil — one that must be pursued to achieve some measure of justice and hopefully the benefit of the consumer’s bargain. When that happens, clients can and should be assured that the lawyers they hire will give them their best shot and represent them under arrangements which comply with the rules of fairness and professional responsibility.

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