A Long Post About Flat-Fee Lawyering

I don’t know what Houston criminal defense lawyer Mark Bennett’s politics are, but over the past couple of months he’s been experiencing a classic example of the sort of thing that turns people into libertarians: Out of the blue, the government–in the form of the State Bar of Texas–wants to outlaw his business model. He usually charges clients a flat fee, but now the State Bar is proposing changes to its ethics rules that would prohibit flat fees.

(Supporters of the proposed changes apparently claim they’re not trying to prohibit flat fees, and the discussion got all lawyer-y real fast. Here’s an example. I’m not going to get into that.)

As I understand it, the basic premise of the new rules is that while lawyers can demand an advance payment of their fee, the money doesn’t actually become theirs until they’ve earned it. And if they don’t earn it all, they have to give it back. That sounds reasonable, but Mark Bennett has an argument for why flat fees are good for clients which I’d like to talk about. I don’t know much about lawyering or the law business, but that won’t keep me from rambling on for a bit. I think it’s a fascinating little lesson in economics.

There are two relevant facts about the practice of criminal law which I think have helped shape how Bennett handles fees. First of all, it’s very hard to predict initially how much a criminal defense is going to cost by the time it’s over. Lawyers can reasonably guess that a routine first-time DUI stop is probably only going to take a few hours of billable time, and that a money laundering case with 400 hours of wiretap evidence is going to be a long battle, but in most cases, there’s a lot of variability, and many of the factors that determine the level of effort won’t be known during the initial consultation with the client.

Second, once a lawyer has worked a case for a while, he can’t easily back out. He’d need permission from the judge, and he’s unlikely to get it without a really good reason. Not getting paid is not a good reason, as far as the judge is concerned. So once a criminal lawyer takes on a case, he’s committed to defending the client, and he’s committed to the entire labor cost of the trial. (He may be the only labor involved, but his time is still his cost of doing business, and he’s going to want to get paid for it.) In other words, even if a criminal lawyer charges by the hour, his minimum unit of commitment is always the entire duration of the case, including any trial. (There are exceptions, but I hear they’re unusual.)

Third, criminal defendants tend not to pay their bills once the lawyer starts work. This means a lawyer discussing representation with a client can get a reasonable amount of money up front as a condition of taking the case, but if the case turns out to require more money than that, he has very little chance of getting it from the client. Most criminal clients don’t have any more money, they’re unlikely to get more money, and even if they get it, they have little incentive to pay it since their lawyer isn’t allowed to walk away from the deal.

This all means that a criminal defense lawyer who bills by the hour is facing a no-win billing scenario: If the initial deposit he demands up front is not enough to cover the true cost of the case, he’s going to run through his client’s money before the case is over and end up working the rest of the case for free. On the other hand, if the case ends quickly and he has money left over at the end, he has to give it back. Breaking even is his best case scenario. The average case is much worse.

(Criminal defense lawyers rarely if ever bill by the hour, but some might bill in stages, such as X dollars for pre-trial work and Y dollars more if there’s a trial. However, just because their billing units are larger than an hour doesn’t mean they aren’t stuck in the same scenario. They’re still charging for their effort, not for the job.)

The only way for a lawyer to avoid losing money in this system is to require every client to provide an initial deposit large enough to cover the entire worst-case cost of the case, including a complete trial.

The problem with that is that most cases don’t go to trial, so most cases will never end up requiring that much effort. The lawyer would be asking clients for large amounts of money up front, which some clients will be unwilling (or unable) to pay. He’ll be losing clients–and they’ll be passing up his services–even though in most cases (i.e. those that do not go to trial) they could have afforded it.

Let’s make up some numbers to illustrate how this works. To keep it simple, let’s use big round numbers and pretend that there’s only one type of case. Assume it costs our lawyer $20,000 worth of his own labor to take a case to trial, but only $10,000 to take a case that ends without a trial (plea, dismissal, or something else), and let’s assume that only 1 case in 10 goes to trial.

So, out of his first 10 cases, our lawyer will take in $20,000 in advance fees for each case up front. He’ll have to keep that money in a separate escrow account of some kind. In nine of the cases, he’ll have to give the clients back $10,000 each, for a total of $90,000, but in the tenth case he’ll get to keep the entire $20,000. In summary, he takes in $200,000 in advance fees, refunds $90,000 of it, and keeps the remaining $110,000 as revenue.

Observe that over ten cases, our lawyer has an everage revenue of $11,000 per case. In other words, our lawyer could make the exact same amount of money by charging every defendant $11,000 per case regardless of whether it goes to trial or not. This is the economic basis of the flat fee. It requires less up-front money from the client, it’s easy to understand, and it’s simpler for the lawyer to handle.

So what could possibly be wrong with a flat fee? A couple of things:

First, it creates economic pressure for the lawyer to plead clients out instead of going to trial because he makes money faster that way. But on the other hand, if the lawyer uses staged fees, he has an incentive to take more cases to trial to increase his revenue. I don’t think these kinds of problems can be eliminated under any payment system. There’s always going to be an inherent conflict over fees, because the lawyer always wants to earn more and the client wants to pay less. At some point, the client has to trust his lawyer to do the job properly.

(The bar could probably mitigate this problem through better transparency, such as publishing every lawyer’s history of case outcomes. Potential clients could learn to avoid hiring a lawyer who’s plead out his last 50 clients).

The second problem is that it could appear to bar regulators that the lawyer is taking unearned money from some clients to pay for services for other clients. In the example above, the lawyer could be accused of taking $1000 that he didn’t earn from each of the clients that plead out and using it to cover his losses on the client that went to trial.

In fact, that is exactly what he’s doing. But so what? He promised to defend each client for a specified fee, the client accepted the deal, and he delivered on his promise. There’s nothing fraudulent about this. Lots of businesses work this way.

The key to understanding what’s really going on is to realize that a criminal defense lawyer who works for a flat fee is actually selling two services disguised as one. Obviously, he’s selling his legal services: The labor he does to complete the job. Less obviously, however, he’s also selling trial insurance. He’s agreeing to take on the financial risk of bringing the case to trial.

Every client who pays $11,000 is paying $10,000 for the pre-trial stage of the case, plus a $1000 insurance premium which will cover the cost of going to trial, should that prove necessary. As with most insurance, the client is buying some peace of mind. He knows that no matter what happens in the case, it’s not going to cost him (or his family) any more money. And when the time comes to sit down with his lawyer and decide whether to take a plea offer or go to trial, he can make the decision based on the state of the case, without regard for the cost of trial.

Actually, the flat-fee lawyer in this situation should get something extra out of the deal besides the $1000 extra per client. That $1000 only covers his expenses, but insuring the client against the financial risk of a trial is a valuable service for which clients should be willing to pay an additional fee, so he might be able to charge $1100 instead. On the other hand, if the flat-fee arrangement saves him an hour of haggling with the client over the trial fee later–or the risk of being forced by the court to defend the client without a fee–that could make it very attractive for the lawyer as well. He might be willing to lose a little money on the flat fee in order to buy himself a little peace of mind.

Almost every service you buy is sold under similar terms. Get your hair styled, and it’s the same price for a broad range of styles, even if some are more difficult to achieve than others. Buy a new set of tires, and they’ll quote you a price for installation that covers most of the things that can go wrong. Decide you need breast implants, and you can get a doctor to quote you a fee that includes all immediate complications, and maybe some of the less immediate complications as well.

Sometimes, especially when you’re buying a product instead of a service, they don’t call it insurance, they call it a guarantee. Buy a cell phone, and they’ll guarantee it against defects for a year. You may think of this guarantee as a promise of quality, but to the seller–who knows how often defective products are sold–it’s essentially insurance to cover the cost of replacing defective products. That’s why for a small extra fee, they’ll sell you an extended guarantee that covers things that aren’t their fault, such as if you break it, lose it, or drop it in the toilet. In other words, you’re buying insurance for your cell phone much the way you buy collision insurance for your car.

In fact, it might be a more accurate to describe fixed-fee criminal defense as a type of guarantee, given that most cases end in pleas. Our lawyer is charging his clients $11,000 for negotiating the best possible plea deal, and he guarantees that the case will not go to trial. In the unfortunate event that a trial becomes necessary, the lawyer will do it for free.

Update: On re-reading this, I realized I haven’t quite tied it all up. Remember that the original issue raised by the proposed Texas State Bar rules was that a lawyer could be accused of keeping client money that he hasn’t earned if the number of hours worked is too small to justify the fixed fee.

There’s some legal argument over whether a lawyer and client can contractually agree that the fee is earned upon receipt, or at some very early point in the case, regardless of how much effort the lawyer has put into the case. I can’t begin to follow that argument or figure out who’s right as a matter of law.

But regardless of what the law says, the flat-fee lawyer is performing a significant service for his client by assuming the financial risk of a trial, and therefore he really does earn rather a lot of his fee the moment he signs the contract.