Some insurance companies and law firms are entering into flat fee agreements to handle cases without disclosing to and getting informed consent from clients. Because these flat fee agreements create a different concern compared to similar fee agreements with clients (like a plaintiff’s contingency fee agreement) and other methods used in the past by insurance companies to control legal costs (like panel contracts that lock in hourly rates), there is a need for full disclosure to and consent by the client. Thus far, California does not have a clear rule requiring full disclosure and consent in such situations. This article argues that, whenever an insurer retains a law firm to represent and insured under a flat fee approach, the law firm is ethically obligated to obtain the informed consent of the insured/client.
Insurance companies and institutional clients are always looking for ways to control legal costs. Over the past few years, one of the ways used to control legal costs has been through alternative fee arrangements (AFA), i.e., something other than hourly billing. One such AFA is a flat fee agreement. Although flat fee agreements can come in different forms, at the most basic level it is simply an agreement that the attorney is paid a preset amount for the legal service, regardless of the time spent. These flat fee agreements can contain thresholds over which the fee can be renegotiated or jump to a different level or under which the full fee is not owed, but generally the idea is that each side is agreeing that the fee is a certain, predetermined amount.
There are various justifications that can be used for this fee arrangement. The insurance company may use the fact that, with a flat fee agreement, the party that has sued its insured cannot use the cost of defense argument in settlement negotiations. That argument is that the case has a settlement value of at least the cost to defend. Or, the insurance company may argue that work on certain cases are fairly similar and predictable. Or, along with the law firm, that a flat fee will promote efficiency in handling cases.
While all of those and other arguments may be valid, there is also the pure economic incentive that drives the use of this AFA. Is not the insurance company betting that the flat fee will be less than what would have been paid by the hour and the law firm betting that the flat fee will be more than what would have been paid by the hour? Those bets, if you accept the premise, are then based upon the notion that either the insurance company does not want to pay the reasonable value of the services on an hourly basis or that the law firm is not to be trusted to perform and bill reasonably. In either case, the flat fee serves as a potential obstacle for the attorney to exercise her/his professional, independent judgment because the attorney may not be doing work that is required to most benefit the client, either because he/she is not getting paid to do more or because he/she is getting paid regardless of how much work is performed, resulting in a failure to do what should be done.
There are similarities between a flat fee agreement between an insurance company and attorney and both a contingency fee agreement in a plaintiff case and a flat fee agreement between an attorney and client. The latter two, however, are always negotiated and disclosed to the client. Of course, in each of those arrangements, there is the same conflict for the attorney in terms of the economic incentive to do less work, but the clients are aware of that, have consented to it and can theoretically monitor the attorney armed with that information. Thus, while one can argue that the economic disincentive is the same in all three and that the attorney’s ethical obligations to do what is reasonably necessary is consistent and a check for the attorney in all three, the nondisclosure issue in the situation when the insurance company and attorney have made the arrangement, deprives the client of material information with which to evaluate the performance of the attorney.
Moreover, the more traditional way insurance companies have dealt with controlling legal costs, through a contract with a so called “panel firm”, does not result in the same economic disincentive that attends the flat fee agreement and therefore the need for disclosure does not seem as compelling, at least as such disclosure relates to the agreement to work at a reduced rate. (There are other reasons to disclose this relationship between the insurance company and the law firm that are not the subject of this article.) Insurance companies typically select a group of law firms in various regions to handle cases for their insureds and, in return for the insurance companies agreeing to potentially use these firms, the firms agree to billing guidelines that set hourly rates and identify what can and cannot be billed for, among other things. These guidelines do not create a disincentive to bill, only a reduced billing rate or preclusion from billing for certain items at all. Therefore, this panel contract does not have the same problematic element that the flat fee arrangement does.
Different State Bar’s have dealt with the flat fee agreement between an attorney and insurance company, dealing with the issue of consent in different ways.  New Hampshire, for example, allows for the flat fee agreement between an insurance company and attorney but requires it to be disclosed to the client/insured if there is a material possibility the fixed fee may have a financial impact to the insured. N.H. Bar Association, Ethics Committee Formal Opinion, 1990-91/5, Jan. 28. See also 7C Appleman, Insurance Law and Practice, Section 4687 at page 194 (1979). It is unclear why New Hamshire requires disclosure based only on the possibility of an adverse financial impact to the insured rather than some adverse impact from not doing something that needs to be done, unless it is simply presumed the attorney would always do what was needed whether or not the attorney was paid for it due to the attorney’s ethical obligations. Such a presumption should not dictate whether or not is required, otherwise one could argue all potential conflicts need not be disclosed because the attorney would be presumed to avoid such conflicts. Moreover, in the New Hampshire system, it appears that the attorney is called upon to make the decision as to whether there is a possibility of an adverse financial impact, since the client is not advised of the arrangement, and the attorney is the person who has negotiated the arrangement.
Others, recognizing the economic disincentive to a limited degree, allow flat fee agreements, but the lawyer must comply with the lawyer’s ethical responsibility to provide the necessary professional representation to the client. Also, the amount must be reasonable and based upon the case to which the fee applies. Finally, the fee arrangement cannot require the attorney to pay costs. Such states reason that the insured has already consented to the insurance company paying the fees (which seems only to beg the question presented here) by the language in the insurance policy so there is no need to ask again. As to costs, requiring the attorney to pay costs regardless of the outcome of the case would violate the rule that prohibits a lawyer from rendering financial assistance to a client in connection with a pending or contemplated litigation. See Texas, Ethic’s Opinion 524, June 2002; Employer’s Casaulty Co. v. Tilly, 496 S.W. 2d 552 (Tex. 1973); See also, Ohio CPR Opinion 97-7, December 5, 1997 (fixed fees are allowed if amount is reasonable and adequate compensation so as to insure competent, zealous and diligent advocacy). In these states, again, the reasonableness of the fee is theoretically left up to the person who has negotiated it.
Finally, some do not allow flat fee agreements without the express consent of the insured because of language in the insurance policy and the inherent conflict that is presented in such an arrangement. For example, Kentucky requires full disclosure to and consent by the insured because the insurance company, based upon the language in the insurance policy, has promised a full defense and a flat fee arrangement limits a full defense. In addition, they reason that disclosure is required because the lawyer who has agreed to such an arrangement, to some extent, becomes the insurer and could financially gain by limiting services to the insured. See K.Y. Bar Associtation, Ethics Opinion, KBA E-368, July 1994.
In California, there is no clear guidance as to whether a flat fee arrangement between counsel and the insurer must be disclosed to the insured. The California Rules of Professional Conduct do not explicitly address the issue and there are no cases or opinions on it.
But, in addition to how other states have dealt with the issue, there are rules, opinions and cases that may serve as guidance and suggest disclosure is appropriate. As a general principal, an attorney must disclose both actual and potential conflicts. Spindle v. Chubb/Pacific Indemnity Group (1979) 89 Cal. App. 3d 706, 713; Rules Of Professional Conduct, Rule 3-310 (A). We also know that an attorney must not permit compliance with “guidelines” and other directives of an insurer relating to the lawyer’s services to impair materially the lawyer’s independent professional judgment in representing the insured. ABA Publication, “Ethical Obligations of Lawyer Working Under Insurance Company Guidelines and Other Restrictions” February 16, 2001; Rutter’s Insurance Litigation Guide, Section 7, Third Party Coverage. Nor should an attorney accept compensation from one other than a client unless there is no interference from the one paying and there is consent from the client (consent maybe provided by the language in the insurance policy). California Rules of Professional Conduct rule 3-310 (F). Moreover, a lawyer should not represent a client “…if representation of that client may be materially limited by…the lawyer’s own interest, unless the lawyer reasonably believes the representation will not be adversely affected and the client consents, preferably in writing, after consultation.” State Bar of Nevada, Standing Committee on Ethics and Professional Responsibility, Formal Opinion No. 9, September 24, 2007. Finally, lawyers should not form partnerships with non-lawyers or enter into financial relationships with non-lawyers, except under prescribed circumstances. California Rules of Professional Conduct, Rules 1-310 and 1-320.
Moreover, there really is not any significant adverse effect of such disclosure. One can imagine a scenario of disclosure in which the attorney writes a disclosure letter consistent with Rule 3-110 (A) which prompts concerns in the client/insured. The attorney and client would discuss the issue and the attorney would be called upon to explain the arrangement and the fact that the flat fee is, in fact, a reasonable fee for handling the case and would not interfere with the professional judgment and handling of the case. Either the client would accept that explanation and consent or the client would not consent. In theory, the client would consent only if there is a reasonable basis for the fee (required under California Rule of Professional Conduct, Rule 4-200). In the case of refusal to consent, the attorney could simply change to an hourly rate.
While controlling costs and maximizing efficiency are worthy goals, as attorneys our most important duty is to our client. Anything that potentially detracts from that duty requires a close look and, in appropriate circumstances, disclosure to and consent of the client. Flat fee arrangements with insurance companies when representing an insured is such a situation.