It has long been the rule in New York that when a client challenges a legal fee after a representation has ended the burden is on the lawyer to establish the fee was not unconscionable. Stated another way, the lawyer must prove the fee agreement was entered into fairly and the fee was not excessive (i.e., fair and reasonable). The New York Court of Appeals has labeled these concepts, respectively, as procedural and substantive unconscionability. Using 20/20 hindsight, in cases such as King v. Fox, 7 N.Y.3d 181 (2006),the Court had allowed a challenge to fees on these grounds years after a representation had ended, notwithstanding the fact that the fee was stated in a written retainer agreement. This appeared to give clients a great incentive and advantage to challenge their fees based upon strong case law supporting such an approach. The tide has now changed with the Court of Appeals decision in Matter of Lawrence, N.Y. (2014), 2014 WL 5430622.

The Lawrence case does not alter the legal landscape by reversing well-established precedent. To the contrary, it confirms that the burden in a fee dispute remains on the lawyer. Nevertheless, the Court's tone and factual analysis sends a clear message that the prior approach must incorporate other overarching considerations that are more favorable to upholding a lucrative fee arrangement. As before, applying the law to the facts may be difficult in certain cases. This is evidenced by Lawrence's tortured procedural history that includes disagreements among a highly respected Referee (a former Court of Appeals judge), a Surrogate, a majority opinion of the Appellate Division (with an outraged dissenter) and ultimately the decision from the Court of Appeals.

After the many twists in the Lawrence case, one thing is clear, "sophisticated clients" must be cautious when entering into, or modifying, retainer agreements. As indicated by the Lawrence decision, such agreements should be fully enforced and difficult to set aside even if there is strong perception that the final fee is unfair and disproportionate to the services performed.

The Legal Fees

The Lawrence case was complex, but it can be distilled to a few basic facts. In 1983 Graubard Miller (Graubard or Firm) represented Alice Lawrence and her children in estate litigation arising from a dispute with her deceased husband's brother, the estate's executor, over an estimated $1 billion real estate empire. The litigation continued over 22 years and the Firm was paid approximately $18 million under its original hourly fee arrangement.

In or about Jan. 19, 2005, Graubard and Ms. Lawrence, who was approximately 80 years old but, purportedly willful and savvy, agreed to a modification of the fee arrangement into a hybrid fee arrangement. Under the new arrangement, Ms. Lawrence's hourly fees for work in 2005 were capped at $1.2 million. In return, Graubard agreed to switch the arrangement to a contingency, under which they would receive 40% of all monies distributed to the beneficiaries, minus the $1.2 million already paid in 2005 hourly fees. A little over four months later, on May 18, 2005, the matter settled for $100 million, purportedly as the result of the disclosure of an unexpected "smoking gun" document. This resulted in an approximate $40 million fee for a little more than four months of work. This translates, using Graubard's fee structure, into a fee of $11,000 per hour.

The Gifts

In 1998, after a partial victory in the litigation, which resulted in a significant payment to Ms. Lawrence and her children, Ms. Lawrence allegedly advised her "legal team" that she wanted to make a gift to them and she wanted them to receive it personally and not the firm. (Under prior legal rulings, the protections of the Dead Man's statute [CPLR §4519] had been deemed waived and the firm's explanation was uncontroverted.) The gifts consisted of $2 million to one attorney, $1.55 million to another attorney and $1.5 million to a third attorney. The attorneys and Ms. Lawrence discussed the substantial gift tax on these payments and she was informed she could pay the gift tax or she could deem the payment a bonus and they would pay the income tax. Ms. Lawrence paid $2.7 million in gift taxes in order to allow the attorneys to receive the full gift without any tax. Stunningly, the attorneys never informed the Firm of the gifts.

The Fee Litigation

Upon completion of the estate litigation, Ms. Lawrence discharged the Firm and refused to pay the $40 million legal fee. The Firm commenced an action in Surrogate's Court in August 2005. A motion to have the legal fees and gifts declared unconscionable on their face led to an appeal, but the Appellate Division remanded for more fact-finding. (Justice James M. Catterson's dissent is particularly interesting because he presents a scathing account of the Firm's conduct, and suggests referring the matter to the Departmental Disciplinary Committee.) The Court of Appeals agreed with the First Department, and the case was returned to Surrogate's Court.

On the remand, the Surrogate referred the fee issues to former Court of Appeals Judge Howard Levine to act as a Referee and to Hear and Report. The Referee concluded that the revised retainer was not procedurally unconscionable when made but became substantively unconscionable in hindsight because of its sheer size. He found it to be disproportionate to the work performed and the fee could not be justified because there was only a small risk to the Firm not receiving a fee in the underlying case. The Referee determined that Ms. Lawrence should pay just $15.8 million based upon an ad hoc formula he devised. The Referee nevertheless approved the gifts based upon evidence that they were "free from undue influence."

The Surrogate affirmed the Referee's recommendations as to the legal fee, but set aside the gifts. The Surrogate emphasized that Ms. Lawrence was an octogenarian who depended upon her attorneys for more than 15 years. The Surrogate alluded to some degree of pressure by the Firm and commented that a "combination of dubious circumstances emit[ted] an odor of overreaching too potent to be ignored." The Court did not find Ms. Lawrence's claim to unwind the gifts time barred even though the gifts had been made in 1998.

The Appellate Division reversed the Surrogate and found the modified retainer was invalid, concluding that the proper remedy was to revert to the original hourly arrangement. The Appellate Division remanded the matter to the Surrogate to determine the amount of the fee based on the hourly rate contained in the original retainer. The Court also invalidated the gifts, finding the Estate's claim to unwind them not time barred pursuant to the doctrine of "continuous representation."

The Court of Appeals

In the Firm's appeal of the decision, the Court of Appeals was presented with two issues: whether the $40 million legal fee was excessive; and whether the gifts could withstand scrutiny. The Court began the opinion confirming long-standing precedent regarding attorney-client fee arrangements. First, the Court confirmed that the burden was on the attorneys to establish their agreements as "fair, reasonable, and fully known and understood by their clients." The Court also stated that the revision of an agreement after the representation was underway must be given heightened scrutiny. As a threshold issue, the Court explained that a 40% contingency fee in a commercial or estate litigation is not per se unconscionable. (Court Rules govern contingency rates for various types of other cases.)

In broad terms the Court reiterated that:

[a]n unconscionable contact is generally defined as "one which is so grossly unreasonable as to be unenforceable according to its literal terms because of an absence of meaningful choice on the part of one of the parties [procedural unconscionability] together with contract terms which are unreasonably favorable to the other party [substantive unconscionability]" [citation omitted]

The Court explained that to avoid procedural unconscionability a lawyer must prove that the retainer was free from fraud by the attorney and free from misconception on the part of the client. As to substantive unconscionability, the Court stressed that the fee must be proportionate to the value of the legal services. There was also reference to the fact that contingency fees involve "risk" and such risk it is a factor to be taken into consideration in deciding whether a fee is excessive.

All of these concepts were well established, but the Court presented a thorough analysis of the facts to support upholding the $40 million fee. With respect to procedural unconscionability, the Court emphasized more than once the sophistication of the client and her willingness to question and overrule her lawyers. This was necessary, in part, because Ms. Lawrence was 80 years old. The Court also stressed the detailed information given her by the firm.

The Court changed the legal landscape in its analysis of substantive unconscionability, by sharply limiting the basis for a retrospective review of a contingency fee. The Court clarified that it does not support a broad, unlimited review of fees when there is a written retainer that is not void at the time of inception. In other words, a retainer should generally be enforced as written. This viewpoint became the fulcrum of the entire opinion.

The Court held that there are two primary factors in determining whether a contingency fee is unreasonable: the risk to the attorneys, and the value of their services proportionate to the overall fee.

With respect to risk, the Court stressed that a contingency client could lose interest in the case, the firm could be fired, or the case could take a very long time. Why these risks were of importance here was left unclear. The Court did not mention that years before settlement Ms. Lawrence was offered a settlement of $60 million and refused it. The Court also did not mention that the Firm would have a charging lien if it was fired. Moreover, it seems dubious that Ms. Lawrence or her family would lose interest in a claim for which $60 million was already offered.

More important, the Court seemed uninterested in reviewing the fee for sheer size. Although the Court stated it must consider the proportionality of the value of the legal services, it refused to give much weight to the fact that a $40 million fee was earned in a little more than four months, or that it amounted to an $11,000 per hour rate.

It is also interesting that the Court mentioned the heightened scrutiny of a midstream fee modification. Yet, it did not delve into the details and refused to adopt Judge Catterson's view that such a modification should be deemed the equivalent of a business transaction with a client that would create a much heavier burden for the lawyer.

With respect to the gifts, the Court did not evaluate their propriety because it simply found that the claim was time barred. The Court held the "continuous representation" doctrine (which tolls limitations) applied only to malpractice claims, not one for legal fees.

Conclusion

Although the Court of Appeals did not overrule long-standing precedent, the tone and factual analysis in Lawrence appears to have turned the tide on retroactive fee evaluations. In short, a "sophisticated client" who has sufficient information to evaluate a fee agreement should not be able to rescind an otherwise extremely lucrative, arguably unfair, retainer or modified retainer. Notwithstanding the stricter standard for sophisticated clients, lawyers must be mindful that courts still have great discretion in setting aside a fee. Consequently, for "ordinary," and even sophisticated clients, lawyers should make sure their retainers are clear and fully explained to avoid any argument that there was a misunderstanding as to its terms. Legalese should be avoided, particularly with clients with limited education.

Lawyers must be particularly cautious when modifying a retainer, even if it is at the request of the client. Since the Courts have uniformly held that modifications must be given heightened scrutiny, there is no question that there must be full disclosure and informed consent. It is also advisable to discuss the advantages and disadvantages of any modification and, depending on the scope of the modification, advising clients to consult counsel if they deem it appropriate. Although not required by Lawrence, but alluded to in the Catterson dissent, lawyers could avoid any issue if the requirements of the business transaction rule, Rule 1.8(a), are fully followed. This would include the modification being fair and reasonable to the client.

A review of a fee based upon the sheer size and proportionality has been greatly limited when there is a retainer entered into properly at the inception of the relationship. Nonetheless, lawyers must always consider the global context of the fee arrangement. For instance, was the client warned of the potential size of the fee in relation to the ultimate potential resolution (e.g., damages incurred or received)? Did the lawyer create a client's misconception, by requesting a small retainer even though the final projected fee would inevitably be disproportionate to the initial payment. A court's visceral reaction to these types of issues may drive the final result in a fee dispute.

Notwithstanding Lawrence, courts still have great discretion in rescinding unfair retainer agreements and therefore, lawyers must be vigilant in following the letter and spirit of the law because the burden in a fee dispute remains on the lawyer.


This article originally appeared in the New York Legal Ethics Reporter, January 2015

Richard Maltz is counsel to Frankfurt Kurnit where he represents lawyers in disciplinary matters, and lawyers and law firms in partnership disputes. Mr. Maltz also handles litigation involving professional responsibility issues, fee disputes, law firm disputes, disqualification, sanctions, and problems in the admission process for law graduates.

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