Monday, January 11, 2010

Can flat fees be non-refundable?

I have blogged before about the increasing attention that the concept of flat fees is getting, particularly at a time when clients are looking for ways to lower their legal costs. Some commentators, I have said, are predicting the death of the hourly fees and predicting 2010 to be the year of the flat fee. I continue to be skeptical since hourly fees have been pronounced dead many times before and, like zombies, they continue to come back to life.

In any case, a number of jurisdictions are not helping the case for the adoption of flat fees by continuing to blur the distinctions between "flat fees" and "security retainers."

Let me provide some background here. I always thought of flat fees as a predetermined amount charged for the performance of a predetermined task. For example, I could say to the client that I would draft a contract for $500. Whether it took me 4 hours or 4 days, I'd get $500. Presumably, the attorney has figured out the amount to charge based on a number of factors including the going rate for similar work in the market and the amount of time that the lawyer expects the work to take. The risk for the lawyer is that if the work ends up taking up more than that amount of time, the return for the time spent diminishes. (In some cases the miscalculation may turn out to be so off that the lawyer would end up losing money compared to what he or she could have gotten for the work if he or she had charged by the hour.)

The advantage of the flat fee for the client is that the client knows exactly how much the job is going to cost and does not have to worry about having to pay more charges. The client also, presumably, gets a lot of efficiency since the attorney knows that the longer the work takes the less value he or she will end up earning. Finally, the client, again presumably, would be saving some money when compared to what the charges would be if billed by the hour.

Now let me introduce to you the concept of the security retainer: an amount of money that the client gives the attorney up-front from which the attorney deducts the value of services as the services are provided. That amount of money belongs to the client until it is earned and if there is any amount left when the task is finished, the attorney is obligated to returned the unearned portion to the client.

Now the question is, how is a flat fee different from the security retainer? Well, presumably the flat fee is earned when agreed to. The client pays the $500 for the contract, whether it takes the lawyer 4 hours or 4 days to prepare. Assume the lawyer charges $100 an hour. If the client was paying by the hour and the contract took 4 hours to prepare, the client would owe $400. But if the client agreed to a flat fee of $500 and the lawyer was able to finish in 4 hours, the client would have to pay $500. Is that unreasonable? In my opinion, not if there was a chance that the work would take more than 5 hours. That is why the client agreed to the flat fee. The client takes the risk of having to pay $100 over the hourly bill, for the chance that he will save a lot more if the work takes longer. In this particular case, it did not work out for the client, but in most cases it does.

The problem is that, concerned with the possibility that clients who agree to a flat fee may end up paying more than what they would have paid if they had agreed to be billed by the hour, some jurisdictions have held that flat fees are not "earned" until the work is done and that any unearned portion must be returned to the client. This is consistent with the basic principle of what I call "no money for nothing" - which means that a fee is unreasonable if it is an expression of value for services that are not provided. BUT this view also eliminates the distinction between a flat fee and a security retainer and thus the advantage of flat fees as an alternative to hourly billing.

The latest example comes from the District of Columbia where the District of Columbia Court of Appeals has held that flat fees do not become attorney property — and therefore must be held in trust — until earned by the attorney. The case is In re Mance, 980 A.2d 1196 (D.C. 2009). Go here for a discussion of this case and examples from other jurisdictions.

I've said it before and I will say it again, it is way too early to pronounce hourly fees dead.

1 comment:

  1. "The risk for the lawyer is that if the work ends up taking up more than that amount of time, the return for the time spent diminishes."

    I wonder if this loss could constitute a deductible business expense for income tax purposes. My guess is that it could because the client would receive a service for an amount greater than its presumed fair-market value. and it's an ordinary and necessary expense. But, perhaps it isn't so ordinary because the lawyer doesn't anticipate going over the predetermined amount. Before I start making deductions in my own practice, I'll ask a real tax attorney first ...