Avoiding Ethical Pitfalls in Flat Fee Arrangements - The D.C. Bar Legal Ethics Committee Weighs In

It is hard to open a law periodical these days without hearing about the shift from hourly billing to alternative fee arrangements such as flat fees. It may be premature to mourn the demise of the billable hour, but it is nevertheless imperative for lawyers to become familiar with the ethical pitfalls inherent in alternative billing arrangements.

The D.C. Bar Legal Ethics Committee (the “committee”) recently provided additional guidance on the use of flat fees in Opinion No. 355, published in June 2010.[1] Opinion 355 was a response to In re Mance,[2]in whichthe District of Columbia Court of Appeals addressed “the question whether a ‘flat fee’ paid in advance for legal services is to be deemed an ‘advance…of unearned fees’ that is required to be treated as property of the client.”[3] Opinion 355 and Mance provide some useful insights into flat fee arrangements and how to avoid running afoul of Rule of Professional Conduct 1.15.

In re Mance
Attorney Robert Mance agreed to represent William Saunders’ son in a criminal matter for a flat fee of $15,000, with the initial $7,500 paid “up-front” and the remainder paid “after Saunders’ son turned himself in to the police.”[4] Mance placed the bulk of the up-front payment in his client escrow account, with the remaining amount, about $1,500, going into his operating account.[5] When the attorney-client relationship soured, Saunders demanded his down payment back, only to learn that Mance did not have enough in his client escrow account to refund the money.

The D.C. Board of Professional Responsibility concluded that the initial $7,500 had become Mance’s property upon delivery and, even if the down payment remained Saunders’ property when it was tendered to Mance, Saunders “consented to having the fee treated as belonging to the attorney.”[6] Nevertheless, because Mance commingled his property—i.e., the initial $7,500—with client trust funds, the Board of Professional Responsibility recommended public censure.

On appeal, the D.C. Court of Appeals held that an attorney does not earn a flat fee simply by agreeing to represent a client.[7] Flat fees must be earned through actual legal services.[8] Thus, the court held that a flat fee provided at the outset of the attorney-client relationship must be kept in a client trust account until it is earned.[9] Any unearned portions must, of course, be returned to the client.

Mance allows for an exception to this rule. An attorney may place unearned portions of a flat fee in his or her operating account if the client provides informed consent.[10] Mance follows Sather’s prescription for informed consent, holding that (1) the client must be meaningfully informed of the default rule (i.e., that unearned portions of a flat fee belong to the client), (2) the attorney must communicate both verbally and in writing that fees will be “treat[ed]…as the attorney’s property upon receipt,” (3) the client must be told that the attorney can keep fees only to the extent they are earned, (4) an agreement to treat flat fees other that as provided by the default rule “must spell out the benefit to be conferred upon the client” and (5) the client must understand that unearned unreasonable fees must be returned if the client terminates the representation.[11]

Opinion 355
The Mance court expressly asked the D.C. Board of Governors to provide additional clarity on the retention and use of flat fees, and the Committee took up that task in Opinion 355. Mance holds that an attorney cannot take possession of fees until they are earned, which begs the question: when exactly are flat fees earned? The committee opines that Mance allows an attorney to keep flat fees in a client trust account until the conclusion of the representation. This rule is noteworthy because at least some of these fees are earned during the course of the representation, thereby becoming the attorney’s property. Thus, there is a potential concern about commingling funds if “earned” flat fees are kept with “unearned” flat fees—although the concerns should be largely mollified by Opinion 355.

The committee allows that, as an alternative to waiting until the representation is completed, an attorney and client may agree to conditions upon which funds can be withdrawn from a client trust account and placed in an operating account. An attorney and client may specifically agree to “milestones based upon the passage of time, the completion of certain tasks, or any other basis mutually agreed upon between lawyer and client.”[12] These milestones must not be used to defeat the spirit of the rule announced in Mance. Conditions for withdrawing fees from a client trust fund must be reasonable and “must avoid excessive ‘front-loading.’”[13] Notably, agreements regarding “earned” fees can be reached even “after the fee agreement has been signed and the engagement is underway.”[14] Although agreements as to when fees are earned are not required to be in writing, the committee stresses that such agreements “should be in writing or at least memorialized in writing.”[15]

Finally, Opinion 355 notes that an attorney may withdraw fees from a client trust account absent an express agreement (and, indeed, is required to do so in order to avoid commingling). In such cases, however, withdrawals must be reasonable and the client is entitled to notice.

Best Practices
The rules announced in Mance and Opinion 355 are not altogether new. It has long been recognized that attorneys must return unearned retainers or advance fees.[16] Indeed, Mance itself notes that its holding is not without precedent.[17] What Mance and Opinion 355 contribute, however, is (1) a clear rejection of the theory that flat fees are earned upon receipt, and (2) clarity on how to charge and accept flat fees without running afoul of Rule 1.15.

On the first point, Mance may not represent the majority view. In a recent article,[18] Alex Rothrock provides an exhaustive survey of the relevant case law and ethics opinions. He notes that

In general, state and local ethics opinions concerning advance fee payments, including flat fees, fall into three categories: (1) opinions holding that such funds are not "funds of clients" subject to entrustment; (2) opinions holding that such funds may, by agreement with the client, be considered earned upon receipt in whole or in part and thus are not subject to entrustment; and (3) opinions holding that the client has an interest in the funds until earned and, thus, the funds are required to be deposited initially into the client trust account. As will be evident, the majority of ethics opinions fall into the second category.[19]

Mance seems to articulate a fourth view: Flat fees are client funds until they are earned, although a client may give informed consent to have flat fees placed in an attorney’s operating account.

On the second point, Mance and Opinion 355 suggest a number of sound practices for an attorney accepting a flat fee. Obviously, it is critical for an attorney to understand the default rules for treatment of flat fees in his or her jurisdiction. Beyond that, the following are prudent steps in any jurisdiction to avoid running afoul of Rule of Professional Conduct 1.15:

1. Make sure clients truly understand the default rules regarding flat fees, particularly if they are providing informed consent to a departure from the default rules.
2. Address issues regarding treatment of flat fees both orally and in writing.
3. If a client agrees to an alternative arrangement (assuming that alternative arrangements are permitted), document specific milestones in writing and withdraw funds as earned in order to avoid any concerns about commingling.
4. In all cases, ensure that total fees are reasonable and that the payment of fees is in keeping with the spirit of Rule 1.15.

For the bankruptcy practitioner, Mance and Opinion 355 raise issues beyond dealing with one’s own client relationships. If a debtor enters into an attorney-client relationship pre-petition and tenders a flat fee in exchange, some or all of that fee may—depending on the jurisdiction—be part of the debtor’s bankruptcy estate under 11 U.S.C. § 541, even if the fees are held by the attorney in a client trust account. Therefore, Mance and Opinion 355 have important implications not only for structuring attorney-client relationships but for substantive rights under the Bankruptcy Code as well.