State Bar of Arizona Ethics Opinions
99-02: Fees; Retainer Fees; Fee Agreements; Retainer Agreements
A non-refundable fee is ethical if reasonable under E.R. 1.5. A client must be fully informed about and expressly agree to such a fee, preferably in writing. Non-refundable fees are earned upon receipt and do not go into a lawyer's trust account. [ER 1.4 (b), 1.5, 1.15, 1.16 (d)]
Two attorneys inquire concerning the ethical propriety of "non-refundable" or "earned-on-receipt" fees and the ethical handling of such funds.
One inquiring attorney asks whether he may charge a flat fee that is characterized as "non-refundable," "flat fee," or "earned upon receipt." The query is presented as a general proposition; the attorney provided no specific facts against which the Committee can measure the operation or effect of such a fee. He also wished to know whether he can refuse to provide an itemized statement upon discharge by a client with whom he has such a fee arrangement. The inquiring attorney is aware of Arizona Ethics Opinion 86-6 that opined there is no per se rule holding "earned upon receipt" fee agreements unethical, but he questions its validity in view of In re Cooperman, 83 N.Y.2d 465, 633 N.E.2d 1069 (1994), and other authorities.
A second inquiring attorney, a criminal defense practitioner, asks how to handle funds received from a client pursuant to an "earned-on-receipt non-refundable flat fee" agreement. Among other things this attorney asks whether some or all of a "earned-on-receipt" or "nonrefundable" fee must be refunded in the event that the charges are filed but then unexpectedly dismissed.
May an attorney enter into a fee agreement that provides that a portion or all of the fee will not be returned to the client under certain conditions? Must the attorney deposit such funds into a trust account, and, if so, under what circumstances and to what extent may the attorney transfer funds to a general account?
RELEVANT ETHICAL RULES:
ER 1.4 Communication
(b) A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.
ER 1.5 Fees
(a) A lawyer's fees shall be reasonable. The factors to be considered in determining the reasonableness of a fee include the following:
(1) the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly:
(2) the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;
(3) the fee customarily charged in the locality for similar legal services;
(4) the amount involved and the results obtained;
(5) the time limitations imposed by the client or by the circumstances;
(6) the nature and length of the professional relationship with the client;
(7) the experience, reputation, and ability of the lawyer or lawyers performing the services; and
(8) whether the fee is fixed or contingent.
(b) When the lawyer has not regularly represented the client, the basis or rate of the fee shall be communicated to the client, preferably in writing, before or within a reasonable time after commencing the representation.
ER 1.15 Safekeeping Property
(a) A lawyer shall hold property of clients or third persons that is in a lawyer's possession in connection with a representation separate from the lawyer's own property. Funds shall be kept in a separate account maintained in the state where the lawyer's office is situated, or elsewhere with the consent of the client or third person. Other property shall be identified as such and appropriately safeguarded. Complete records of such account funds and other property shall be kept by the lawyer and shall be preserved for a period of five years after termination of the representation.
(c) When in the course of representation a lawyer is in possession of property in which both the lawyer and another person claim interests, the property shall be kept separate by the lawyer until there is an accounting and severance of their interests. If a dispute arises concerning their respective interests, the portion in dispute shall be kept separate by the lawyer until the dispute is resolved.
ER 1.16 Declining or Terminating Representation
(d) Upon termination of representation, a lawyer shall take steps to the extent reasonably practicable to protect a client's interests, such as giving reasonable notice to the client, allowing time for employment of other counsel, surrendering papers and property to which the client is entitled and refunding any advance payment of fee that has not been earned. The lawyer may retain papers relating to the client to the extent permitted by other law.
I. Background of the Non-Refundable Fee Controversy
The controversy over non-refundable fee agreements largely began with In re Cooperman, in which the New York Court of Appeals imposed an absolute ban on such arrangements. 83 N.Y.2d at 476, 633 N.E.2d at 1079. Cooperman is a disciplinary case in which the offending attorney repeatedly proffered a non-refundable retainer fee agreement for large sums that had no relationship to the availability or delivery of legal services. The non-refundable portion simply enriched the attorney each time a client left before exhausting the retainer. There has also been criticism of non-refundable fees by two academic commentators who argue for a complete, rule-based ban. See Brickman and Cunningham, Nonrefundable Retainers Revisited, 72 N.C.L.Rev 1 (1993); Brickman and Cunningham, Nonrefundable Retainers: A Response to Critics of the Absolute Ban, 64 U.Cin.L.Rev. 11 (1995) . There have been equally zealous critics of an absolute ban. See, e.g., Lubet, The Rush to Remedies: Some Conceptual Questions about Nonrefundable Retainers, 73 N.C.L.Rev.271 (1994).
The non-refundable fee agreement was first addressed by this Committee in Opinion No. 86-6. That terse opinion simply found that there was no support for a per se ban. It did not address the various arguments that have been advanced in the last five years for and against a compete ban. This opinion addresses those arguments.
II. Analysis of the Ethical Propriety of Non-Refundable Fees.
A. Potential Problems of and Approaches to Non-Refundable Fees.
A non-refundable fee agreement poses two potential problems. First, it may burden the client's right to discharge a lawyer for any reason and at any time. See Restatement of Law Governing Lawyers § 44(1) (Tentative Draft No. 5, 1992) ("A client may discharge a lawyer at any time."). This right flows from the fiduciary obligations imposed on the lawyer for the client's benefit, which assume that a client must be able to trust and confide in the lawyer. If that trust and confidence is lost for any reason, the client must be able to discharge the lawyer. If the client has paid the lawyer fees that will not be returned even though the lawyer has not performed specific services, the right of the client to discharge the lawyer could be burdened.
The second issue potentially raised by a non-refundable fee agreement is whether it is excessive. There is little doubt that some attorneys have attempted to disguise excessive fees using a non-refundable clause. In fact, Cooperman is a prime example of such a practice. In that case, the disciplined attorney charged anywhere from $5,000 to $15, 000 to file a notice of appearance; the client forfeited a large portion of the retainer if the lawyer was discharged soon after entering his appearance. 83 N.Y.2.d at 466, 63 N.E.2d at 1070.
The ethics opinions and disciplinary cases that have imposed a per se ban on non-refundable fee agreements have been careful to exclude arrangements whereby the attorney is paid in advance for availability at some future time. This is occasionally, but not uniformly, referred to as a "general retainer." The rationale for excluding general retainers from this ban is that they represent an "option" on the lawyer's time. Brickman and Cunningham, supra 72 N.C.L.Rev. at 23. Conversely, the opinions that have declined to impose the ban generally cite the difficulties with carving out permissible fees that are earned when paid, but for which the attorney may never undertake any legal services. See, e.g., Ky. Ethics Committee, Op. E-380 (1994). Additionally, critics of the ban point out that it permits a client to retain a lawyer solely for the purpose of disqualifying that person from representing other parties, such as multiple criminal defendants or mass tort cases.
A broad ban on a particular practice should be stated in the ethical rules or the practice should be so patently offensive to ethical mores that it is within the spirit of the rules. Proponents of an absolute ban cite Cooperman for the latter proposition. Brickman and Cunningham, supra, 64 U.Cin.L.Rev. at 37-38. Even ardent proponents of a ban admit, however, that the authority of Cooperman alone may not be sufficient to create a bright line rule. To bolster Cooperman, they propose an additional ethical rule that would specifically ban non-refundable fee agreements. See Brickman and Cunningham, supra, 72 N.C.L.Rev. at 38-40.
After the inquiring attorneys posed their questions and this Committee issued its draft opinion, the Arizona Supreme Court held that "non-refundable retainers" are not per se violations of ER 1.5. In re Hirschfeld, 274 Ariz. Adv. Rep. 17, 960 P.2d 640 (1998). Although the Court did not discuss Cooperman or non-refundable fees, there is no doubt that the holding applies to any funds that an attorney intends to keep regardless of whether legal services are performed. The Court gave a general admonition that "regardless of how the fee is characterized, each situation must be carefully examined on its own facts for reasonableness." Id. Moreover, the respondent in Hirschfeld stated in his fee agreements that "the initial retainer is earned upon receipt and is non-refundable." Id. This Committee believes that to the extent Cooperman and the academic commentators raised questions about the ethical propriety of non-refundable fees, Hirschfeld holds that fee agreements are subject to individual analysis rather than a per se ban.
If an attorney elects to use a non-refundable fee agreement, ER 1.5(b) cautions that the terms and basis for them should be explicitly set out for and explained to the client, preferably in a written fee agreement. For instance, if the non-refundable fee is intended to compensate the attorney for work that must be declined because of conflicts or time commitments, then the communication to the client should say so explicitly. Of course, such statements must be true. Mere recitation of this language in a form agreement that bears no relationship to the attorney's workload or the likelihood of conflicts would violate ER 1.4.
III. "Flat Fees" Distinguished.
Both inquiring attorneys posed their questions in a manner implying that a non-refundable fee agreement is synonymous with a "flat fee." In fact, they are independent aspects of a fee contract that cannot be used interchangeably and, if confused, may result in an incorrect interpretation of this opinion.
A "flat fee" describes an agreement whereby the attorney renders a specified legal service for an amount that is fixed at the start of the representation. Cf., Nolan v. Foreman, 665 F.2d 738 (5th Cir. 1982). Typically, the specified legal service is a self-contained task that can easily be described from start to finish, such as drafting a will, obtaining a divorce decree, documenting a real estate transaction, or handling a litigation from complaint to judgement. In setting the amount of the flat fee, the lawyer assumes the risk of accurately estimating the probable time required to complete the service; in this respect, it is analogous to a contingency fee agreement. Of course, a flat fee, like a contingency fee agreement, is always subject to a reasonableness analysis. See Opinion No. 94-02. A flat fee is simply another method, different from the ubiquitous hourly rate, to calculate the amount of the attorney's fee.
A flat fee may or may not be paid in advance and non-refundable. The agreement between the lawyer and the client determines these additional matters. The agreement could provide, for example, that the fee would be paid in advance and then "earned" at an hourly rate until exhausted. When treated in this fashion, the amount tendered is no different from a retainer drawn on at an hourly rate, except that the fee establishes an upper limit on the client's liability. A flat fee also may be paid in advance and then deemed earned in part upon the completion of specified portions of the task or the occurrence of specified events in the representation. The fee could be paid and earned in installments triggered by the specified events or tasks. Or, the fee could be paid in advance and treated as "earned on receipt" or non-refundable.
The ethical rules limit a lawyer's freedom to agree with a client that a flat fee paid in advance will be non-refundable. If the service is not completed and the flat fee was paid in advance, then the client may rightfully expect that the unearned portion of the fee will be returned. Accordingly, a flat fee paid in advance presumptively remains the property of the client until the lawyer has completed the contracted-for services. See infra at p.7. The attorney cannot change this, and avoid returning an unearned fee, merely by labeling a flat fee paid in advance "non-refundable." In order to comply with the ethical rules, the attorney must explicitly describe what justifies treating all or a portion of the flat fee as non-refundable or "earned on receipt."
There are a number of circumstances in which a non-refundable fee may be justifiable. For example, a non-refundable fee may be appropriate if the attorney must reserve significant time to complete the service, or the attorney must turn away other work because of conflicts created by the particular flat fee matter. The critical point is that a flat fee, like any other kind of fee agreement, must carry independent justification for it to be non-refundable. See, ER 1.5(a)(2). A well-regarded and busy lawyer might justify charging a non-refundable fee to secure his or her services. See, ER 1.5(a)(7). The charges customarily levied in the local market for a particular kind of legal service, and the manner in which they are levied, are also relevant. See, ER 1.5(a)(3).
In addition, a non-refundable fee agreement may appropriately reflect a negotiated element of risk sharing between attorney and client. They attorney takes the risk that she will do more work than planned, without additional compensation; and the client, in return, agrees that the attorney will earn the agreed-upon amount, even if that amount would exceed the attorney's usual hourly rate. This notion of risk-sharing is one reason for the prevalence of non-refundable fees in criminal cases. In such cases the client often has limited resources and therefore requires the certainty of a pre-set fee. The lawyer also faces a risk, since the courts are often reluctant to permit the withdrawal of a defense attorney because of non-payment of fees. A flat, non-refundable fee may be appropriate to balance the risks on both sides.
IV. Analysis of How the Attorney Should Handle Non-Refundable Fees.
Not all fees paid in advance are, or are intended to be, non-refundable. The attorney must distinguish between a prepaid fee that is nonrefundable, and an advance fee payment or "retainer" against which the lawyer draws as her or she earns the fee.
A non-refundable fee becomes the property of the lawyer when paid. Such funds should not be placed in a trust account where they will commingle with client funds. ER 1.15(a).
On the other hand, the client retains ownership of, or at least an equitable claim to, funds representing an advance payment of fees. Accordingly, those funds must be deposited in the lawyer's trust account. See ER 1.15(c); In the Matter of Carragher 157 Ariz. 219, 221-22, 756 P.2d 316, 318-319 (1988) (funds characterized as a "retainer" to pay future hourly services must be placed in a trust account, not used to operate lawyer's office). The lawyer may withdraw the advanced fee from the trust account only when, and to the extent that, he or she earns the fee by the criteria specified in the fee agreement. In the case of a "hybrid" fee--in part non-refundable, and in part earned on an hourly or other basis--prepaid funds advanced to secure the hourly fee would go into the trust account, but funds earned on receipt would not.
As stated above, the client's agreement with the lawyer determines whether prepaid funds are earned on receipt -- and therefore the property of the lawyer -- as opposed to an advance against future fees that must be held in trust. It is the lawyer's responsibility to ensure that the fee agreement clearly describes, in terms intelligible to the client, how the lawyer will treat a prepaid fee. Absent a fee agreement explicitly stating that a prepaid fee is non-refundable or "earned on receipt" and will not be held in trust, a lawyer who deposits the funds into his operating account risks a violation of ER 1.15. Several state bar ethics committees have held that a prepaid fee, tendered with no specific agreement that it is "earned on receipt" or nonrefundable, must be deposited into the lawyer's trust account. See e.g., Florida Op. 93-2, 1993 WL 761327, (October 1, 1993) (prepaid funds are presumed a fee advance that must be deposited in a trust account, unless agreement specifically says otherwise); North Carolina Op. RPC 158, 1994 WL 899345 (April 15, 1994) (fee paid in advance with no agreement as to refundability must go in trust account notwithstanding the lawyer's intention that the fee was earned on receipt); Texas Op. 391, 1978 WL 14284 (April 1978). One state has gone so far as to hold that, absent an agreement addressing refundability or setting out the circumstances under which all or part of the fee is deemed "earned" the lawyer must leave the entire fee in the trust account until the contracted-for services are completed. Michigan Op. RI-69, 1991 WL 519888 (February 14, 1991).
In some cases a "non-refundable fee" may include advance payment of costs as well as the attorney's fee. The attorney should place in the operating account the portion of the payment that represents a non-refundable fee, leaving in trust the portion representing the costs. If the amount of costs is not yet fixed, the attorney should make a good faith estimate of the costs to be incurred, and hold that amount in the trust account. See, e.g. Florida Op. 93-2, 1993 WL 761327 (October 1, 1993).
Since the lawyer's agreement with the client determines whether and to what extent a prepaid fee must be held in trust, there is no fixed rule requiring the lawyer to handle the funds in a particular way for a certain period of time or pending a specific event such as the filing of criminal charges. The fee agreement could provide that portions of the total fee are "earned" upon the occurrence of specified events. If the fee agreement states that some portion of the fee is "earned" upon the filing of charges, that amount should be transferred out of the trust account when the charges are filed. Otherwise an event such as the filing of charges does not affect how the lawyer should handle the funds.
The inquiring attorney asks whether some or all of a nonrefundable fee must be refunded in the event that the charges are filed but then unexpectedly dismissed. The same question may arise in the context of other unexpected representation-ending events, such as the death of the client. The ethical rules explicitly direct that, upon termination of representation, the attorney must "[refund] any advance payment of fee that has not been earned." ER 1.16(d). But an "earned on receipt" fee by definition has been "earned." Moreover, under the view expressed in this Opinion, the attorney will not have held the funds in trust.
Notwithstanding that the fee agreement characterizes the fee as "nonrefundable" or "earned on receipt" and that the funds have not been held in trust, the attorney may be ethically required to give the client a refund. In all cases the fee is subject to the reasonableness requirement of ER 1.5(a). Pursuant to ER 1.5, the lawyer will have determined at the outset that the fee is reasonable in light of the reasonably anticipated course of the representation. Nevertheless, at the close of the matter the attorney must review the services rendered if the "nonrefundable" fee turns out to exceed what would be reasonable under the circumstances, in light of unexpected circumstances or viewed with the benefit of hindsight, the attorney must refund a portion of the fee. In re Hirshfeld, 960 P.2d 640; In re Swartz, 141 Ariz. 266, 273, 686 P.2d 1236, 1243 (1984). But the mere possibility of a refund does not compel the attorney to hold the fee in trust. See ER 1.15 ("matured legal or equitable claim" required to trigger attorney's duty to third parties).
One of the inquiring attorneys also asks whether an itemized statement must be provided upon request of the client at termination of the representation. As noted above, ER 1.5 (b) requires the lawyer to explain the "basis or rate of the fee" to the client. Accordingly, the lawyer should provide the client with a statement containing itemization or detail sufficient to explain "the basis or rate of the fee", including the time spent on the case if that is a relevant factor.
Although the ethical rules do not categorically prohibit non-refundable fees, a lawyer must carefully scrutinize such a fee to ensure that the fee is "reasonable" under the eight factors set forth in ER 1.5(a). A non-refundable fee is ethical if reasonable under ER 1.5. The lawyer further must adequately inform the client and obtain the client's express agreement, preferably in writing, as required by ER 1.4 and 1.5(b). The Committee expresses no opinion here about the ethical propriety of any specific "non-refundable fee" agreement, since none has been presented for the Committee's consideration.
A fee clearly and properly denominated as non-refundable becomes the property of the lawyer upon receipt. The lawyer therefore need not (and, indeed, should not) place the money in a trust account together with clients funds.