THE PROBLEM WITH “NONREFUNDABLE” ADVANCE FEES
By Jeffrey Messing
February 28, 2016
As part of its 2003 amendment to E.R. 1.5, the Arizona Supreme Court added a new subpart 1.5(d)(3) which specifically addressed the circumstances under which a lawyer may charge a fee termed “earned upon receipt” or “nonrefundable.”1 After more than a decade of experience with the Rule, a number of recurring problems and practical difficulties have become apparent. This article will examine the history of nonrefundable or earned on receipt fee in Arizona, the problems that have arisen, and suggest alternatives to eliminate or at least reduce future difficulties.
As Comment 7 to Arizona’s E.R. 1.7 recognizes, there are a number of types of advance payment arrangements that are often loosely termed “retainers.”2 The terms “advance fees” and “retainer” are often used loosely and have been the source of much confusion. The “true,” “classic” or “general” retainer is rare. It is a fee paid to ensure the lawyer’s availability for a representation that may or may not be necessary in the future. It is sometimes characterized as an option agreement in which the client purchases the right to call upon the lawyer’s services for a specified period of time or a specified case or matter.3
A classic or general retainer agreement establishes a current attorney/client relationship and as a result, conflicts the lawyer out of representing a party adverse to the client.4 It is truly earned when paid because the client obtains the rights it bargained for (the lawyer’s availability and the assurance the lawyer will not represent an adverse party) at that time and the lawyer has “earned” the fee charged by agreeing to make him or herself available. If and when the client exercises its option to have the lawyer perform work on the client’s behalf, the lawyer will be paid separately for the actual services performed.
Few lawyers have the luxury of being able to charge a client a fee simply to be available if and when their services are needed. Much more common are various forms of “special” retainers. Special retainers are more properly categorized as an advance payment for future services and/or a security deposit to ensure that future bills are, in fact, paid. The problems addressed in this article stem from lawyers’ attempts to label and treat such advance payments as “nonrefundable” or “earned upon receipt.” In such cases, lawyers purport to charge “a flat fee … paid in advance that is deemed earned upon payment regardless of the amount of future work performed.”6
A Brief History of Nonrefundable Fee Agreements in Arizona (Or How Did We Get Here?)
Mr. Hirschfeld7 was a Phoenix attorney who practiced primarily in the area of family law, specifically representing fathers in contested custody cases. He obtained advance fees pursuant to written fee agreements which stated they were “earned upon receipt” and “nonrefundable.”8 He then relied on that language to keep the full amount he received no matter how long the representation lasted or how much work he had actually performed.
Mr. Hirschfeld was ultimately disbarred for a multitude of ethical violations which went far beyond the issue of nonrefundable, advanced fee payments. As to the fee issue, the Supreme Court held that nonrefundable retainers are not “per se violations of E.R. 1.5.”9 But in so doing, it cited to the “classic” or “general” retainer example of “a fee paid to secure a lawyer’s availability.” The Court also acknowledged that a flat fee for a specific service can be proper, but emphasized its holding in In re Swartz11, which established that regardless of the terms of a lawyer’s fee agreement, the amount the lawyer actually charges must be reasonable in hindsight.12 “[I]f at the conclusion of a lawyer’s services, it appears that a fee, which seemed reasonable when agreed upon, has become excessive, the attorney may not stand upon the contract; he must reduce the fee.”13
The Hirschfeld Court emphasized the vulnerable nature of the clients who hired him “in the emotionally volatile area of domestic relations . . . at extremely difficult periods in their lives. They frequently had been served with petitions for dissolution and injunctions prohibiting them from entering their own home. In some cases, they faced imminent hearings to determine the custody of their own children.”14
Although In re Hirschfeld’s approval of nonrefundable retainers could be read as limited to the now-rare classic or “general” availability type retainer, its discussion was in the context of Mr. Hirschfeld’s specific flat fee advance payment agreements and, fairly read, held such agreements can be valid if fairly applied with a retrospective analysis to ensure that the fee ultimately collected is reasonable.
That was precisely the interpretation the State Bar Committee on the Rules of Professional Conduct gave to In re Hirschfeld in its subsequent Opinion 99-02.15 That Opinion re-examined the issue of nonrefundable advance fee agreements in the wake of the New York Court of Appeals’ decision in In re Cooperman16, which barred them as against public policy in New York. The Committee’s Opinion recognized that nonrefundable fee agreements pose two potential problems. First, they burden the client’s right to discharge a lawyer for any reason at any time, because the client may be unable to afford to hire new counsel. 17 Second, they can give rise to excessive fees. 18 As the Committee noted, “There is little doubt that some attorneys have attempted to disguise excessive fees using a nonrefundable clause.”19 The Committee concluded that regardless of the potential risks to clients, its opinion was controlled by In re Hirschfeld, which upheld the validity of such agreements. The Committee therefore limited itself to advising lawyers to specify in the fee agreement their rationale or justification for making their flat fee nonrefundable.20
The Supreme Court reaffirmed its approval of nonrefundable advance fee agreements three years later in In re Connelly21. Connelly was unusual for a nonrefundable advance fee dispute because the advance fee in that case was, in fact, the product of an arms-length negotiation.22 Mr. Connelly, the attorney, discussed the fee on two occasions with the client and the client’s mother, an attorney in Chicago, and the flat fee was actually negotiated down from the $75,000 Mr. Connelly initially asked for to $50,000.23 Mr. Connelly successfully resolved the case without filing any motions or going to trial. The client then filed a Bar complaint accusing Mr. Connelly of charging an unreasonable fee, without complaining to Mr. Connelly or seeking fee arbitration.
The Court held that because the only issue presented was the reasonableness of Mr. Connelly’s fee (which he defended with an accounting and expert testimony), the case should have been referred to fee arbitration and only gone to discipline if and when the Arbitrators found the fee was unreasonable.24 However, the Court also reaffirmed its acceptance of nonrefundable fee agreements.25 The Court reasoned that a nonrefundable flat fee “reflects ‘a negotiated element of risk sharing between attorney and client’ whereby the ‘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 have earned the agreed-upon amount even if that amount would exceed the attorney’s usual hourly rate’ because ‘the client often has limited resources and therefore requires the certainty of a preset fee.’”26 The Court acknowledged that because of the balancing of risks to both client and lawyer, a flat fee can, at times, be larger than a fee generated by hourly rates without being excessive.27
Those observations were hardly novel or surprising, but they addressed only the second of the two potential issues raised by nonrefundable fee agreements, i.e., the possibility they will generate excessive fees. What is surprising is the Court’s complete failure to discuss the first issue – the burden such agreements place on a client’s right to discharge a lawyer at any time for any reason.
The 2003 amendment to E.R. 1.5 arguably addresses the first issue by requiring a lawyer’s fee agreement to inform the client that notwithstanding the fee charged is “nonrefundable,” the client may still discharge the attorney at any time and “may be entitled to a return of all or part of the fee based upon the value of the representation. . . .”28
Experience with “Nonrefundable” Advance Fees Since 2003
In theory at least, labeling a fee paid in advance as nonrefundable should not affect whether the client can obtain a refund if the lawyer fails to perform as required. Both E.R. 1.7 and Comment 7 expressly require a lawyer to explain in the written fee agreement, now required in every engagement, that even if the retainer is called “earned upon receipt,” “nonrefundable” or something similar, the client can still discharge the lawyer and may be entitled to a full or partial refund based “upon the value” of the work actually performed up until that date.29 That statement is, of course, simply a summary of the holding of In re Swartz.30
Unfortunately, the client’s theoretical right to a refund, often breaks down in practice. A nonrefundable fee paid in advance immediately becomes the lawyer’s property and is not deposited in the lawyer’s Trust Account.31 As several commentators have noted, such fee agreements are used primarily in family law, immigration, bankruptcy, and criminal law cases, often with unsophisticated clients.32 In a perfect world, all prospective clients would carefully read and understand a lawyer’s retention letter/fee agreement. But the reality is we do not practice in that world and never will. Some clients have limited English reading skills, and many fail to understand that the “nonrefundable retainer” their lawyer told them they have to pay before he or she will start to work on their case is, in fact, refundable. Even if the written fee agreement does contain the required language, in practice many clients rely primarily on what the lawyer (and/or the non-lawyer assistant who often handles most of the client contact) tells them.
Even if clients recognize they have a right to a refund, a lawyer who has received a nonrefundable, advance fee as current income and spent it, may have little incentive (or ability) to provide a refund, even if he or she has performed poorly or not at all. A client whose request for a refund is refused or ignored must file a lawsuit and/or a bar complaint and face months or years of delay before having even a chance of receiving a refund. Again, that assumes the client is sophisticated enough to bring such an action on their own or has the money to pay a second lawyer to do so on their behalf.
This problem has been compounded by the growing use of “nonrefundable,” advance fee agreements by lawyers who accept partial payments “on account.” That is, lawyers who agree to accept a nonrefundable advance fee for specified services from clients who cannot pay the full agreed upon fee when the lawyer is initially hired. Often these lawyers encourage the clients to make partial payments on a lay-a-way type arrangement. These lawyers take the position that the partial payments are earned on receipt and therefore need not be deposited into their trust accounts even though no work has been or will be performed unless and until the full retainer is received. In cases where the client fails to pay the full retainer the lawyer performs no work. In other cases, where payments are made over months or years, no work is performed during the interim, yet the fees are treated as “earned upon receipt.”
A Modest Proposal to Limit the Use of Nonrefundable Advance Fee Payments.
Fees paid for services to be rendered in the future have not yet been earned and under the holding of In re Swartz, they are, in fact, refundable. A fee agreement that says such fees are “earned upon receipt” or “nonrefundable,” even if followed by the written disclaimer required by E.R. 1.5, is confusing at best. Based on the volume of disciplinary complaints filed involving such agreements, the public and the Bar would be better served by a ban on such agreements such as those adopted as in New York and other jurisdictions. Advance fee agreements are typically used in cases where both the scope of representation and the tasks required to complete, that representation are well defined. Rather than stating the fee is “nonrefundable” or “earned upon receipt,” lawyers could achieve much the same result with less confusion by specifying what portion of the fee will be earned as each task is completed, an approach adopted by the Indiana Supreme Court in In re O’Farrell.33
Treating advance fee payments as earned, on receipt or otherwise, can only be justified if the lawyer actually does perform the agreed upon work. It is impossible to justify treating a partial payment as “earned” if the parties have agreed the lawyer will perform no work unless and until the advance is paid in full. In such cases, the lawyer has performed no work and has not earned any portion of his or her fee. The client has the absolute right to terminate the relationship and demand a full refund at any time. At least in that context, telling a client that such fees are “earned upon receipt” or “nonrefundable” is simply false and misleading. That practice, which the Court has never had occasion to address, should be expressly banned. Partial payments should, under such circumstances, be treated as the client funds they are and held in trust.
*Jeffrey Messing is a member of the Phoenix law firm of Ball, Santin & McLeran, PLC He has in the past served as a volunteer Bar Counsel, a Hearing Officer, a Member and Chair of the Disciplinary Commission and currently serves as a Member of the Probable Cause Committee.
1 Ariz. Sup. Ct. Rule 42, E.R. 1.5(d) provides in part:
(d) A lawyer shall not enter into an arrangement for, charge or collect:
* * *
(3) a fee denominated as “earned upon receipt,” “nonrefundable” or in similar terms unless the client is simultaneously advised in writing that the client may nevertheless discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee based upon the value of the representation pursuant to paragraph (a) [which addresses the factors considered in determining the reasonableness of a fee].
2 Ariz. R. Sup. Ct. Rule 42, E.R. 1.5 Comment 7.
3 See generally Douglas R. Richmond, Understanding Retainers And Flat Fees, 34 J. Legal Prof. 113, 115-116 (2009).
5 The word earned is in quotes because even a true, general retainer is subject to challenge as unreasonable under E.R. 1.5(a). See In re Sather, 3 P.3d 403, 414 (Col. 2000) (General retainers, which the Court termed “engagement retainers,” “are always subject to refund if excessive or unearned, and an attorney cannot communicate otherwise to a client.”); Guidelines for Fees Paid in Advance, 2008 NC Eth. Op 10, 2008 WL 5021158 *2 (“a general retainer, like all other fees, must not be clearly excessive…”)
6 Ariz. R. Sup. Ct. Rule 42; E.R. 1.5 Comment 7.
7 In re Hirschfeld, 192 Ariz. 40, 960 P.2d 640 (1998).
8 192 Ariz. at 42, 960 P.2d at 642.
9 192 Ariz. at 43, 960 P.2d at 643.
11 141 Ariz. 266, 686 P.2d 1236 (1984).
12 The lawyer in In re Swartz took a personal injury case on a one-third contingency fee basis. Liability and damages were clear. No suit was ever filed. The case settled within two months for the $150,000 policy limits after minimal negotiations. The lawyer nonetheless claimed his full $50,000 contingency. 141 Ariz. at 268, 686 P.2d at 1238.
13 In re Swartz, 141 Ariz. at 273, 686 P.2d at 1243.
14 192 Ariz. at 43, 960 P.2d at 643.
15 Arizona State Bar Committee on the Rules of Professional Conduct Opinion 99-02.
16 83 NY.2d 465, 611 W.Y.S.2d 465, 633 N.E.2d 1069 (1994); see also Cuychoga County Bar Assn, v Ack, 121 Ohio St.3d 9, 901 N.E.2d 225 (2009) (disapproving of nonrefundable earned upon receipt fees outside of the context of a true general retainer that secures attorney’s availability); and articles cited in footnote 32.
21 203 Ariz. 413, 55 P.3d 756 (2002).
22 The case is unusual because most of the disciplinary cases involving non-refundable fees and/or retainers involve unsophisticated clients with no ability to negotiate the fee. In most disciplinary cases, the fee involved is less than $5,000.00, but a substantial sum to the individual client who, as discussed below, is often required to pay the full amount over time before the lawyer will begin to do any work on their case.
23 203 Ariz. at 415, 55 P.3d at 758
24 203 Ariz. at 418, 55 P.3d at 761.
25 Id. The Court defined a non-refundable fee as a lump sum fee constituting a lawyer’s entire fee for services. 203 Ariz. at 419, n. 7, 55 P.31 at 762, n. 7. It reserved the terms “non-refundable retainer” or “advanced payment” for classic or general retainers paid to ensure a lawyer’s future availability. Id.
26 203 Ariz. at 419, 55 P.3d at 762, quoting Opinion 99-02 at 6.
28 Ariz. Sup. Ct. R. 42, E.R. 1.5(d)(3).
29 Ariz. R. Sup. Ct. 42, E.R. 1.5, Comment 7; see also Ariz. R. Sup. Ct. 42; E.R. 1.16(d), “Upon termination of representation, a lawyer shall take steps to the extent reasonably practicable to protect the client’s interests, such as giving reasonable notice to the client, allowing time for employment of other counsel, surrendering documents and property to which the client is entitled and refunding any advance payments of a fee that has not been earned.” (Emphasis added.)
30 141 Ariz. 266, 686 P.2d 1236.
31 Ariz. R. Sup. Ct. Rule 42; E.R. 1.5 Comment 7.
32 See generally Brickman & Cunningham, Nonrefundable Retainers Revisited, 72 N.C.L. Rev 1, 12 (1993); Richmond, Understanding Retainers and Flat Fees, 34 J. Legal Prof. 113 (2009).
33 942 N.E.2d 799, 807 (2011).