There is no ethical duty for a law firm to disclose to a client the difference between an associate's billing rate and the hourly cost of the associate to the firm. In contrast, a law firm ("Hiring Firm") that utilizes a per diem lawyer ("Per Diem") must disclose the difference between what the Per Diem is paid and what the client is charged pursuant to Rule 1.5(g)(2) of the Rules of Professional Conduct ("Rules"). In other words, the Rules treat disclosure of the mark-up for an associate's time differently from the mark-up of the Per Diem's time. This difference results in a less favorable business model for small firms who use Per Diem lawyers, because it is not economical to employ a full time associate, due to the requirement of this fuller financial disclosure.
To place in a broader context, the profitability of law firms is dependent upon a firm paying its attorneys less than clients are billed for their time. For instance, if an associate is paid $150,000 a year for 1,500 hours, the associate costs the firm approximately $100 an hour (putting aside other expenses). However, the client pays a multiple of $100 an hour for the associate's time, but there is no disclosure of this mark-up. Yet, the Rules force disclosure of this mark-up upon firms that utilize Per Diems, simply because Per Diems are deemed "not associated with the firm."
This article will address the application of Rule 1.5(g)(2) to an hourly fee agreement with Per Diems; compare the role of an associate and a Per Diem; discuss the underlying policy and purpose of the Rule and whether these considerations compel a different treatment for associates versus Per Diems in the hourly context; and, present a framework for a proposed rule that attempts to address all the pertinent issues.
In New York, prior to April 2009, Disciplinary Rule 2-107 of the Code of Professional Responsibility ("Code") required a Hiring Firm, which was dividing a fee with an unaffiliated lawyer (e.g., Per Diem), to obtain consent to employ the outside lawyer and to disclose, among other things, that the fee will be shared. However, there was no requirement that the Hiring Firm disclose the precise amount the Per Diem was paid.
In April 2009, New York adopted the Rules of Professional Conduct and modified, among other things, the requirements of DR 2-107, by adopting Rule 1.5(g)(2). The new rule requires that a New York firm who uses the services of a lawyer not associated with the firm to obtain consent from the client in writing to the representation, "... after full disclosure that a division of fees will be made, including the share each lawyer will receive ..." (emphasis added). This last phrase is a significant change from DR 2-107(A).
The Rule would be applied as follows. A client retains a Hiring Firm pursuant to a typical loadstar fee (i.e., hours multiplied by the lawyer's hourly rate). After the retention, the Hiring Firm contracts with a Per Diem to work on the case on an hourly basis (e.g., draft a memorandum, prepare a motion, perform research, or appear in court). The Hiring Firm remains attorney of record. All court filings would be submitted on behalf of the Hiring Firm and any appearance would be on behalf of the Hiring Firm. The Per Diem would submit a bill to the Hiring Firm for the services provided. The client's bill would reflect the time spent by the Per Diem and the hourly rate that the Hiring Firm was charging the client for the Per Diem's services. According to Rule 1.5(g)(2), the Hiring Firm would have to disclose that mark-up, either in the initial retainer, in a written notice thereafter, or in the bill itself.
Per Diem v. Associates
In most respects, the Rules treat Per Diems the same as they treat associates. For instance, with respect to billing, a client cannot be charged an "excessive" fee whether a firm uses an associate or Per Diem. In other words, a Per Diem's fee, after a mark-up, must be reasonable. See Rule 1.5(a); ABA Opinion 2000-420. Similarly, a law firm may not charge an excessive fee for an associate's work. See Rule 1.5(a)(1)–(8). In fact, with hourly billing, a law firm’s bills reflect the billing rate a client is being charged for an associate or Per Diem. This allows a client to assess, notwithstanding a mark-up, if the firm is billing the associate or Per Diem in accordance with their experience, skills, and other appropriate criteria listed in Rule 1.5(a). Id. In most cases, small firms pay Per Diems far less than the market billing rate for their experience and skill level and, therefore, the Hiring Firm can easily include a surcharge without charging an excessive fee.
With respect to supervision, all New York law firms must provide proper supervision of subordinates. See Rule 5.1; NYC Eth. Op. 2006-3. A firm is responsible for the work performed for a client, regardless if it is an associate or Per Diem. See, e.g., In re Aranda, 32 A.D.3d 58 (1st Dept. 2006); See generally, Mallen & Rhodes, Legal Malpractice, §5.5 (2015 ed.); Rule 5.1, 5.2(b)(2); Roy Simon, Simon's New York Rules of Professional Conduct Annotated (2014 ed.), at 1269). Therefore, in either case, the firm must make sure of the quality of the attorney and their work product. Thus, in broad terms, there is no substantive difference to the client whether an associate or Per Diem performs the work. In other words, whether it is a solo practitioner needing coverage for a status conference in Bronx Civil Court or a large firm using non-U.S. lawyers overseas to review millions of pages of documents in mega-litigation, the firm will be responsible for the work performed and that it is performed properly.
One difference for the Hiring Firm is that it must obtain a client's consent to employ a Per Diem if applying a mark-up for the services. Rule 1.5(g)(2). Theoretically, this would include the use of a Per Diem for a single innocuous court appearance, a minor drafting assignment, or preliminary research. However, as a practical and realistic matter, it is doubtful that clients' consents are obtained when Per Diems are used for these types of extremely limited, mundane services. Arguably, this de facto carve-out is acknowledged and accepted by NYS Bar Association Opinion 715 (1999), which was issued before the enactment of Rule 1.5(g). See also NYC Bar Eth. Op. 2006-3. In addition, ABA Opinion 88-356 suggests that if there is direct supervision of a "temporary" lawyer it may not be necessary to disclose the attorney's participation. This begs the question, should an amended rule require consent of a Per Diem's work only when the work is substantial and independent? This will be addressed below. Interestingly, Rule 1.5(g) requires client consent to the use of a Per Diem when a fee is being marked-up, but it does not require disclosure when there is no mark-up (i.e., the Per Diem is billed as an expense).
The History and Policy Underlying the Fee Division Rule
In 1970, New York's DR 2-107(A) was amended to require disclosure when an attorney shared a fee with an unassociated lawyer, but as mentioned above, there was no requirement that the lawyer disclose the specifics of the fee split. As former Justice Emily Jane Goodman explained in Lapidus & Assoc. v. Elizabeth St., Inc., 25 Misc. 3d 1226(A), at 6, 906 N.Y.S.2d 773 (Sup. Ct. New York Cnty. 2009), the purpose for the fee division rule was to address referrals on contingency cases, not hourly cases. Judge Goodman stated:
DR 2-107 was intended to address referral situations, to prevent unreasonable fees to a client and to ensure that the client was made aware of the identities of attorneys working on his or her case and there has never been a controversy as to fee sharing where a lawyer works on a case.
See also Lapidus & Assoc. v. Reiver, 2008 WL 909670 (N.Y. Sup. 2008).
Lapidus & Associates v. Elizabeth St., Inc. opinion suggests one reason for full disclosure in contingency fee cases. However, another unspoken reason for authorizing and regulating fee divisions, (e.g., referral fees), parallels the old arguments for legalizing prostitution: it is better to legalize and regulate potentially dangerous conduct than to outlaw the conduct and allow it to thrive due to unrealistic and ineffective enforcement.
The specific danger of allowing fee divisions to continue unregulated was based, in part, upon the Bar's concern that originating lawyers were gathering clients (e.g., by advertising) without any intention of providing legal services or taking any responsibility for the client. Instead, the originating attorney simply referred the client without any concern as to whether the successor attorney would provide competent services. Clearly, the Code was amended to enhance disclosure and provide a client with improved transparency. However, it also required the referring attorney to either perform some services or remain jointly responsible as a predicate to collect a fee. This change served the important public policy of forcing the referring lawyer to take proper responsibility for the referral.
It is important to remember that the rule's focus has always been on referral fees in contingency cases. There is strong anecdotal evidence that the drafters of the rule only focused on the application of the rule in contingency cases and they did not consider how the rule would impact hourly fee divisions. In fact, this myopic view has continued until today with many Professional Responsibility lawyers. The rationale for the expansion of the disclosure pursuant to Rule 1.5(g) in contingency fee cases may remain viable, but the justification in hourly fee cases is less certain. There is less need to disclose the financial stake each lawyer has in the representation where the Hiring Attorney remains responsible for the case as the attorney of record. Most importantly, the client will learn from each bill the amount of work performed by each attorney and how much responsibility each is undertaking.
In any event, with respect to the Bar's primary goal, to protect clients, one American Bar Association opinion stated that it is not necessary to disclose a surcharge for a "Contract" lawyer working on an hourly basis when the Hiring Firm will supervise the lawyer or when the work of the lawyer is "adopted" by the Hiring Firm. See ABA 2000-420, at 5. The opinion does not address the "financial disclosure" provision in Rule 1.5(g)(2), which did not exist at the time. Nonetheless, it implicitly supports the contention that it is not inherently unfair or prejudicial to a client not to disclose a mark-up. Prior to ABA 2000-420, the ABA took a similar approach for temporary lawyers. See ABA 88-356. In line with this approach, some trial courts implicitly held that it was not inherently unfair to clients to not disclose the specifics of a fee division. See, e.g., Lapidus & Assoc. v. Elizabeth St., Inc., supra; Carter v. Katz, Shandell, Katz & Erasmous, 120 Misc. 2d 1009 (Sup. Ct. Queens Cnty. 1983). In short, this was a consistent position prior to the adoption of Rule 1.5(g)(2).
One might suggest that an easy solution is for the Hiring Firm not to impose a mark-up and bill the Per Diem as an expense. Yet, this begs the question: why should some firms be permitted to use a business model not available to solo practitioners or smaller firms when there is no valid policy reason for the distinction in the hourly billing context?
Another solution is to deem a lawyer "of counsel" because this would avoid the fee division issue. It is true that in the past firms were willy-nilly deeming anyone "of counsel" and placing their names on letterhead. However, the Rules now require that an "of counsel" attorney have a real and continuous relationship with the firm. Rule 7.5(a)(4). This would not be a valid designation in instances in which a Per Diem lawyer was used sporadically for limited purposes. Moreover, if a formal "of counsel" relationship is established, it may create conflict and other issues.
Maybe the easiest solution to leveling the playing field is to disclose the mark-up only for Per Diems, notwithstanding the different approach for associates. Yet, it could hardly be disputed that if a firm disclosed the mark-up it would create serious problems with client relations. Thus, full disclosure is not a fair solution. It might be considered that other professionals do not disclose to clients, patients, or customers, the cost of a service and the profit margin.
Parenthetically, one may argue that large firms do not comply with the Rule if they use temporary lawyers placed by agencies and the firm surcharges the client to include the agency fees. Cf.; ABA Opin. 2000-420, at 4. There are ethics opinions that partially address the issue for temporary/contract lawyers, but the issue has not been addressed in New York since the adoption of Rule 1.5(g)(2). This related issue underscores the necessity to examine the Rule.
As it stands now, Rule 1.5(g)'s detailed disclosure requirements were adopted to protect clients with respect to contingency referral fees and the rule continues to protect those interests. However, small firms that charge hourly fees are forced to disclose their mark-up for a fee division without a valid justification.
One solution is to change the current rule to address this issue. Specifically, to exempt from Rule 1.5(g) the use of an hourly Per Diem lawyer when the Hiring Firm maintains complete control and sole responsibility for a matter. This would include the Hiring Firm remaining sole "attorney of record," or at minimum, equal co-counsel. There is reference in some of the above-cited opinions to "control" by the Hiring Attorney and "independence" of the Per Diem as important factors when determining whether any disclosure should be required. An amendment to Rule 1.5(g) could exclude disclosure of the use and fee arrangement of a Per Diem unless the Hiring Firm delegated "substantial" responsibility to the Per Diem who was expected to act independently, (e.g., appear as attorney of record). With such a change, clients would be protected and small law firms provided an equal opportunity to compete in the market place.
Leveling the playing field on this issue may not be a high priority for members of the Bar who do not utilize Per Diems. However, imposing a rule that treats a portion of the Bar unfairly that is not based upon sound policy should be a concern for the entire Bar.Originally published by the New York Legal Ethics Reporter.
This alert provides general coverage of its subject area. We provide it with the understanding that Frankfurt Kurnit Klein & Selz is not engaged herein in rendering legal advice, and shall not be liable for any damages resulting from any error, inaccuracy, or omission. Our attorneys practice law only in jurisdictions in which they are properly authorized to do so. We do not seek to represent clients in other jurisdictions.