Traps for the Unwary – nonrefundable fees and retainers

For my last post of 2015, some thoughts on a frequent source of trouble for lawyers in certain practice areas where efforts are often made to charge nonrefundable fees.  In Tennessee, back in 2011, our rules were revised to specifically acknowledge the legitimacy of the concept of a nonrefundable fee but also to impose certain strict requirements on its use.

Specifically, Tennessee enacted RPC 1.5(f) that reads as follows:

A fee that is nonrefundable in whole or in part shall be agreed to in a writing, signed by the client, that explains the intent of the parties as to the nature and amount of the nonrefundable fee.

We also enacted language in the Comment to the Rule to provide further guidance about this type of fee arrangement:

[4a]  A nonrefundable fee is one that is paid in advance and earned by the lawyer when paid.  Nonrefundable fees, like any other fees, are subject to the reasonableness standard of paragraph (a) of this Rule.  In determining whether a particular nonrefundable fee is reasonable, or whether it is reasonable to charge a nonrefundable fee at all, a lawyer must consider the factors that are relevant to the circumstances.  Recognized examples of appropriate nonrefundable fees include a nonrefundable retainer paid to compensate the lawyer for being available to represent the client in one or more matters or where the client agrees to pay to the lawyer at the outset of the representation a reasonable fixed fee for the representation.  Such fees are earned fees so long as the lawyer remains available to provide the services called for by the retainer or for which the fixed fee was charged.  RPC 1.5(f) requires a writing signed by the client to make certain that lawyers take special care to assure that clients understand the implications of agreeing to pay a nonrefundable fee.

At the same time that Tennessee adopted this new rule, we also adopted revised language in the Comment to RPC 1.15 to help lawyers focus on the earned/unearned distinction, rather than other nomenclature, for making a proper determination about whether money paid to the lawyer by the client should go into the client trust account or somewhere else:

[10] Whether a fee that is prepaid by a client should be placed in the client trust account depends on when the fee is earned by the lawyer.  An advance payment of funds upon which the lawyer may draw for payment of the lawyer’s fee when it is earned or for reimbursement of the lawyer for expenses when they are incurred must be placed in the client trust account.  When the lawyer earns the fee, the funds shall be promptly withdrawn from the client trust account, and timely notice of the withdrawal of funds should be provided to the client.

The Comment goes on to explain, as do other aspects of the Comment accompanying RPC 1.5, that advance fees not earned must be refunded but a reasonable nonrefundable fee does not have to be returned to a client.

Therein lies the rub, of course, or at least one of the two peskier rubs.  The reasonableness requirement that applies over and above the technical/procedural requirements of RPC 1.5(f) can still create real issues.

Just as a 60% contingent fee agreement with a client is subject to challenge as unreasonable even if the client had signed a written agreement otherwise satisfying all the procedural requirements of RPC 1.5(c), a nonrefundable fee agreement remains subject to challenge even if RPC 1.5(f) could otherwise be shown to be satisfied if the amount is unreasonable.

The other pesky rub for lawyers comes when they properly document something with their client as one thing, but then deposit it into the wrong account.  For example, being scrupulous in papering up a fee as nonrefundable and thus earned by the lawyer at the time of payment, but not having faith in the arrangement and depositing the fee into trust “out of an abundance of caution.”  Down that road lies commingling no matter how good the lawyer’s intentions.

Earlier this week, the Tennessee Supreme Court issued a new opinion involving the suspension of a lawyer (who just so happens to be the lawyer whose constitutional challenge argument on behalf of another lawyer was characterized by the Tennessee Supreme Court as “rambling and bordering on incoherent”) for multiple offenses, including charging an unreasonable nonrefundable fee.

Reading the opinion, the lawyer seems to have only attempted to treat the fee as nonrefundable after she was discharged by her client.  The opinion indicates that she believes she deposited the $10,000 into trust and then withdrew amounts from trust as billed.  And her fee agreement, as described, does not seem to have involved an effort to satisfy the language of RPC 1.5(f).   (In fact, rather than make an effort to reference that rule, the agreement referenced instead a 1992 Formal Ethics Opinion that interpreted pre-2003 versions of the ethics rules.)

Nevertheless, even if the lawyer had a well-documented agreement making the $10,000 payment a nonrefundable fee, the facts as they played out were ones in which I suspect most lawyers in Tennessee would likely end up agreeing to refund a substantial amount of the difference between the $10,000 paid up front and the roughly $2,000 worth of work performed at hourly rates before the client discharged the lawyer.  Questions certainly exist in Tennessee about how RPC 1.5(f) will be interpreted with respect to the timing of how to determine reasonableness and whether you only evaluate it prospectively, or retrospectively, or a little of both, but I don’t think many lawyers would want these kinds of facts to be involved in any test case addressing those issues.

Fortunately, the Court did take this opportunity to stress the earned/unearned distinction now spelled out in the Comments to our rules with a reference to one of the best sources of discussion for the distinctions to be drawn among the three arrangements lawyers manage to call “retainers” these days, a law review article by my friend Doug Richmond.

Thus, to the extent that lawyers in Tennessee may continue to focus on what they call a fee when trying to figure out where it should be deposited, our Court considers a “classic” or “true” retainer — a payment to ensure lawyer availability — as earned when paid.  Likewise, “advance fee retainers” are considered to be synonymous with “fixed” or “flat” fees, and also earned when paid.  Thus, both of these types of “retainers” should not go into a client trust account.  The third type of “retainer,” the “security retainer” — the type of advance fee payment that you draw down from as you perform work (i.e. what the $10,000 paid to this now-suspended lawyer actually was — goes into the trust account because at the time it it paid it is not yet earned.

TN’s Approach to Nonrefundable Fees – A Reminder

Near the end of February 2015, the New York City Bar put out its Formal Opinion 2015-2 evaluating a question of propriety of a flat, nonrefundable monthly fee in a retainer agreement and reached the conclusion that a particular one that was something of a “hybrid” was problematic.  Although the NYC opinion makes for a good read, it is of limited utility in evaluating these issues in Tennessee.

While New York has an RPC 1.5(d)(4) that prohibits non-refundable retainer fees, Tennessee has gone in a significantly different direction.  RPC 1.5(f) in Tennessee makes nonrefundable fees enforceable provided that they are reasonable in amount and that the fee is “agreed to in a writing, signed by the client, that explains the intent of the parties as to the nature and amount of the nonrefundable fee.”  Tennessee lawyers, of course, still have to tread carefully in this area — especially with respect to avoiding problems of commingling by depositing a fee designated as nonrefundable (and therefore earned upon payment) into a client trust account rather than into an operating account where it belongs.