Howrey’s Demise and Contingency Fees

In the spate of recent articles about Howrey, which formally ceased operations this week, were the familiar causes of law firm financial catastrophes: partner defections, decline of a once-thriving practice area, and internal squabbling. Less familiar among BigLaw firms, which chiefly generate revenue by hourly billing, is the risk of relying on contingency fees. In a recent interview with the Wall Street Journal, Howrey CEO Robert Ruyak cited contingency fee arrangements as having contributed to Howrey’s financial difficulties. The full article is available here. Howrey’s fall is thus a reminder of the truly contingent nature of contingent fees—even more so among firms that rely on contingent fees and judicial approval of fees, such as in class actions, which creates a unique kind of double contingency.

The California Supreme Court has recognized this, citing favorably from Judge Richard Posner’s landmark ECONOMIC ANALYSIS OF LAW: “‘A contingent fee must be higher than a fee for the same legal services paid as they are performed. The contingent fee compensates the lawyer not only for the legal services he renders but for the loan of those services. The implicit interest rate on such a loan is higher because the risk of default (the loss of the case, which cancels the debt of the client to the lawyer) is much higher than that of conventional loans.’” Ketchum v. Moses, 17 P.3d 735, 742 (Cal. 2001) (citing RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 534, 567 (4th ed. 1992)). Even so, a handful of trial court judges seem predisposed to reduce negotiated class action fees (and in doing so, no doubt unwittingly, exemplify Judge Posner’s observation). Posner’s Seventh Circuit colleague, Judge Frank Easterbrook, explains that far from being the boondoggle that these judges apparently presume contingent fees to be, “[t]he contingent fee uses private incentives rather than careful monitoring to align the interests of lawyer and client. The lawyer gains only to the extent his client gains. This interest-alignment device is not perfect. . . . [b]ut [an] imperfect alignment of interests is better than a conflict of interests, which hourly fees may create.” Kirchoff v. Flynn, 786 F.2d 320, 325 (7th Cir. 1986).

In other words, contingent fee awards, and the routine application of multipliers, replicate market forces for legal services so that plaintiffs who cannot otherwise afford a lawyer have access to the courts.