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Analysis of the Valuation of Attorney Work Product According to the Market for Claims: Reformulating the Lodestar Method

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Analysis of the Valuation of Attorney Work Product According to the Market for Claims: Reformulating the Lodestar Method

By: George B. Murr

"Soon, my good man, we will know better. Think about something like the following. ls the pious loved by the gods because it is pious, or is it pious because it is loved?"

Socrates, The Euthyphro 1

I. INTRODUCTION

Suppose I owned a property interest, a mineral interest in fee simple. Suppose I were to assign to you a working interest in that property as part of an oil and gas lease, and you agreed to be the oil and gas operator. The oil wells you had drilled on the property came in, and we struck it rich. Or suppose I owned a property interest, rights in a trademark or a patent. Suppose I were to assign to you a share of that interest with the agreement that you would provide capital to market the product. The product was a success and became immensely profitable.

The value of the mineral interest would be determined by the expected production from the interest in the mineral lease. Likewise, the value of the patent would be determined by the market for the product or innovation patented. The central component to the price negotiated for these interests would be the ability of the parties to apply their labor and obtain a return on the property. Moreover, the profitability of the mineral or patent interest rests upon its actual production. Therefore, parties would pay for the mineral or patent interest according to what they thought it would be worth, in essence creating a market for the interest. Driven by competition, this market automatically would factor the risk accompanying the investment into the price. But suppose that instead of receiving a return on these interests based upon their actual production, I told you that your recoverable royalty would be limited to a "reasonable royalty."

Now suppose I had a legal claim. I was injured, or my business was injured. Suppose I were to assign to you a share of that claim with the agreement that you would provide legal services and attempt to recover damages and attorney's fees. Both the quality of the legal work I could seek and the merits of the claim would be a function of the fee interest negotiated. The case was a winner and we were awarded a significant damage award. The court, however, would limit the attorney's fee award to a "reasonable fee." Further, the court's determination of the reasonableness of the fee would be based not upon the actual production, but upon the "rules of discipline." All of the sudden everything has changed. Or has it?

In virtually every American jurisdiction, the rule is that attorney's fees awarded must be "reasonable."2 Questions remain, however. What are the guidelines used by the courts to determine reasonable attorney's fees? How are the guidelines to be applied?3 Most important, are the guidelines used by the courts in fact reasonable?4 This Article argues that reasonable attorney's fees are those that an attorney would be able to recover on the market for attorney's fees.

After over twenty years of attorney's fee litigation and the application of various and sundry elements of "reasonableness," the courts are only now beginning to grapple with this principle of market value.5 Courts in virtually every American jurisdiction evaluate the reasonableness of the attorney 's fee claim using the elements for reasonable fees articulated by the United States Supreme Court in H ensley v. Eckerhart. 6 The elements proposed by the Hensley Court to determine the reasonableness of attorney's fees were "derive[d] directly from the American Bar Association Code of Professional Responsibility."7 In addition, these same elements govern the reasonableness of attorney's fees in both the Model Code of Professional Responsibility and the newer Model Rules of Professional Conduct and have been adopted in virtually every state.8 This Article suggests that the current lodestar method may be adjusted to evaluate attorney work product better by including a contingent fee market valuation in the lodestar procedure. Such an adjustment would allow the federal courts to accommodate and enjoy the market valuation for attorney work product without having to drastically overhaul or scuttle the lodestar procedure. 9 Part II examines the development of the lodestar procedure and highlights its administrative and evaluative problems. 10 Part III examines the suitability of using the market for claims to determine reasonable attorney's fees, comparing the market for claims to model markets for mineral interests and patents. 11 Part III further proposes that the administrative and evaluative problems of the lodestar can be addressed by simply altering the procedure to include an evaluation according to the market of claims. Moreover, Part III suggests that courts can tap the market for legal claims, already in place to some degree, in order to ascertain the reasonableness of attorney fees more easily and accurately. 12 Part IV concludes that courts may better analyze and evaluate attorney work product according to the existing market for claims by reformulating the lodestar. 13

First devised by the Court of Appeals for the Third Circuit in 1973,15 the lodestar method provides an estimate for fee awards based on a combination of hourly rates and hours expended, and then modifies this estimate with fee enhancements. 16 The lodestar method, thus, establishes a two step procedure for determining reasonable attorney's fees. First, the estimate is calculated using the basic hourly rate formula. Second, the estimate is modified, either upward or downward, depending on the circumstances of the case.17 For example, the court may adjust the hourly rate "in light of prevailing community standards to the lawyer's 'experience, skill, and reputation."' 18 In 1983, the United States Supreme Court endorsed the two-step "lodestar" method of the fee calculation. 19 First, a court must determine the initial estimate by "multiplying the number of hours reasonably necessary to conduct the litigation by the reasonable hourly rate for the work of the attorney."20 Second, the court must adjust this estimate to yield an equitable award.21 Since its adoption by the Supreme Court in 1983, the lodestar analysis has been the subject of considerable scholarly criticism and judicial frustration.22

The lodestar method is an artificial valuation of the attorney's work product to calculate attorney's fees.23 This method focuses almost exclusively on hourly rates for attorney 's fees and the valuation of attorney work product. The lodestar considers a contingent fee agreement only secondarily and does not consider the market's effects upon contingency fees at all. Accordingly, the lodestar method reviews contingency fees retrospectively for their reasonableness and, thus, does not account for reasonableness at the inception of the agreement.24 In order to complete the retrospective two-step lodestar analysis, a court must make three determinations: 25 first, the court must determine the nature and extent of the services supplied by the attorney; second, the court must value these services according to prevailing customs; and, third, the court must determine whether other factors warrant any adjustments to the calculated estimate.26

  1. 1. The Nature and Extent of the Services Supplied by the Attorney The first task in the lodestar analysis is to provide an estimate of the number of hours reasonably expended.27 Because the lodestar method bases its calculation upon an hourly rate formula, even in contingency fee cases, attorneys must document time spent on a case with "contemporaneous billing records." 28 The time records submitted are subject to scrutiny. In addition, the court must exclude hours that were not "reasonably expended" from the initial fee calculation.29 The standard lodestar formula further requires that the court disregard the contingency fee agreement negotiated by the attorney and client on the basis of the attorney's expertise, the work product, and the merits of the case. The result is an artificially valued hourly fee based on a market that was neither consulted nor involved in the negotiation of the contingent fee. Courts applying the lodestar method thus exalt hourly market fees in their valuation of attorney work product but ignore the market that shapes contingency fees.
  2. Calculating the Reasonable Rate The second step in the lodestar analysis is to arrive at a reasonable hourly rate for the attorney requesting fees.30 What is considered a reasonable rate may depend not only on the attorney's actual fee, it may also be determined by what are presumed to be prevailing rates for other, similarly situated attorneys.31 Accordingly, parties seeking attorney's fees submit evidence regarding their own rates, as well as the general market rates for attorneys of comparable experience and expertise.32 This two-tiered approach may require that a court expand the range of rates it considers, depending upon what is considered to be within market norrns.33 The court is required to consider both actual fees and what it presumes to be comparable market rates, although the particular circumstances surrounding the case impact the determination of what rates are reasonable. Further, rates charged must incorporate the opportunity cost of other cases and matters that a firm might have turned away in order to take on the litigation.34 Although the court must consider market rates and comparable fees charged by similarly situated attorneys, the fee actually charged in the litigation is that entered into between the attorney and client. The lodestar method instructs courts to determine the prevailing attorney hourly rates according to "the customary range in the community," notwithstanding the fact that the negotiated fee agreement may not be related to the "community" at all. Although the court is required to determine the relevant market for attorney 's fees, the question that arises is how to determine the relevant market.35 Except for calculating fees for local counsel, the local market where the courthouse is seated may have nothing to do with the circumstances under which the claim arose and where counsel was retained. Indeed, the legal market for some types of litigation expertise may not even exist in the locale where suit is filed.36 For example, in Blum v. Stenson,31 the Court considered an award of attorney's fees to nonprofit counsel.38 The Blum Court noted that no market exists for nonprofit counsel, and noted how perfunctory a market analysis becomes:


To inform and assist the court in the exercise of its discretion, the burden is on the fee applicant to produce satisfactory evidence-in addition to the attorney's own affidavits-that the requested rates are in line with those prevailing in the community for similar services by lawyers of reasonably comparable skill, experience, and reputation. A rate determined in this way is normally deemed to be reasonable, andis referred to--for convenience-as the prevailing market rate.39

Therefore, the lodestar analysis requires that courts create a market for legal services "deemed to be reasonable"40 where in reality no such market exists. "The Court offers no reason why this market disappears only when the inquiry turns to [contingency] enhancement."41 Under the lodestar doctrine, the court is required to conjure an hourly market in a case prosecuted on the basis of a contingent fee agreement.42 Nevertheless, the "relevant market" utilized by the courts to determine reasonable rates is not necessarily even related to the fee agreement reached between the attorney and client.

3. Adjustment Under Other Factors

After the lodestar estimate is calculated by multiplying the hourly rate by the hours reasonably expended, it must still be "adjusted to reflect other factors such as the contingent nature of the suit and the quality of representation." 43 Adjustment of the lodestar is based upon numerous factors.44 Not all courts, however, apply the adjustment factors in the same way.45

In Johnson v. Georgia Highway Express, Inc.,46 the Fifth Circuit listed twelve factors that have been widely adopted, though not uniformly applied, in adjusting the lodestar calculation:

(I ) the time and labor required; (2) the novelty and difficulty of the questions; (3) the skill requisite to perform the legal service properly;

(4) the preclusion of other employment by the attorney due to acceptance of the case; (5) the customary fee [for similar work in the community]; (6) whether the fee is fixed or contingent; (7) time limitations imposed by the client or the circumstances; (8) the amount involved and the results obtained; (9) the experience, reputation, and ability of the attorneys; ( 10) the "undesirability" of the case; (11) the nature and length of the professional relationship with the client; and

(12) awards in similar cases.47 In applying the Johnson factors, courts must make explicit and concise factual findings that outline not only those factors it considered in its cost adjustment, but also those factors that it discounted as of little significance.48

One factor under the Johnson test examines whether the fee is fixed or contingent.49 Therefore, even under the lodestar method of calculating attorney 's fees, a contingency fee arrangement may be relevant.50 The Supreme Court, however, has clearly stated that only the fact of contingency is to be considered and not the contingency fee agreement itself.51

In Pennsylvania v. Delaware Valley Citizen' s Council for Clean Air,52 the Supreme Court addressed the enhancement of the lodestar calculation based on contingent fees. Justice White, in the plurality opinion, expressed three guidelines for determining when contingent fees could be used to enhance the lodestar: (1) determination of whether the lawyer found an apparent risk of losing at the outset of the lawyer's involvement in the case; (2) limiting contingent fees to one-third of the lodestar; and (3) evidence in the record and a specific court finding that without risk enhancement, the plaintiff would have faced substantial difficulty in finding counsel in the local or other relevant market.53

B. Deviation From the Lodestar Method of Determining Legal Fees

The Supreme Court and the circuit courts have made clear that the lodestar method of computing attorney's fees supersedes any contingent fee agreement.54 In 1987, the United States Supreme Court held that

contingency fee enhancements are prohibited in determining attorney's fees in fee-shifting statutes.55 Instead, contingent fee agreements serve only as an enhancement under the Johnson factors. That is, the time/rate calculation is only enhanced by the twelve Johnson factors. The Supreme Court has reiterated time and again that there is to be no separate consideration or adjustment for the fact that a case was taken on a contingency. 56 Nevertheless, one of the twelve Johnson factors specifically requires consideration of "whether the fee is fixed or contingent."57

Justice O'Connor, in a concurring opinion, suggested an alternate two-part test for evaluating contingency enhancements. 58 Under Justice 0'Connor's test, a fee petitioner must first "establish that 'without an

adjustment for risk the prevailing party would have faced substantial difficulties in finding [competent] counsel in the local or other relevant market."' 59 Next, the fee petitioner must demonstrate that "the market rate of 'compensation . . . for contingency fee cases as a class' was different from cases in which payment was certain, win or lose."60

Although Justice O'Connor's lodestar enhancement properly focuses on the contingent fee agreement, her proposal suffers from the same problems as the hourly rate analysis under the conventional lodestar procedure. By emphasizing the "local or other relevant market," Justice O'Connor's test ignores the fact that contingent fee agreements are the product of a market. As such, contingent fee agreements better reflect fee agreements produced on that market and the value of the attorney work product in a particular case.

Justice O'Con nor's upward contingency adjustment factors were proposed for adoption and rejected by the Supreme Court in City of Burlington v. Dague.61 Justice Scalia, writing for the majority, rejected the use of the contingency fee to determine reasonable attorney's fees under the lodestar method.62

We have established a "strong presumption" that the lodestar repre­ sents the "reasonable" fee . . . . The Court of Appeals held, and Dague argues here, that a "reasonable" fee for attorneys who have been re­ tained on a contingency-fee basis must go beyond the lodestar, to compensate for risk of loss and of consequent nonpayment. Fee­ shifting statutes should be construed, he contends, to replicate the economic incentives that operate in the private legal market, where attorneys working on a contingency-fee basis can be expected to

charge some premium over their ordinary hourly rates.63

Justice Scalia, however, assumed what he sets out to prove-that "the lodestar represents the 'reasonable' fee."64 Furthermore, Justice Scalia dismissed the market for contingency fee claims, assuming that attorneys' hourly rates are their "ordinary" rates.65 The fact is that hourly rates are no more "ordinary" than contingency fee rates. The market for fees in both market and contingency claims determines the value of the attorney's work product and sets the price accordingly.66

However, the renaissance of diversity among fee agreements between attorneys, law firms, and their clients increasingly has pressured the strict hourly fee lodestar to change.67 Indeed, some federal district courts have already begun to stray from the strict lodestar approach by giving the contingent fee agreement negotiated by the parties greater weight in a courts' lodestar analysis.

Although the rule has long been that a percentage of damages may be awarded as attorney's fees in cases involving the recovery of a common fund, the percentage recovery approach has been employed with increasing frequency in common fund cases.68 The District of Columbia Circuit and the Eleventh Circuit require the rule's use.69 At least five other circuits allow the use of either the lodestar approach or the percentage recovery approach.70 Additionally, the Fifth Circuit, although purporting to use only the lodestar approach, has seen its district courts apply the percentage recovery in combination with the lodestar with increasing frequency.7 1 Moreover, while the percentage of recovery approach is supposed to be limited to common fund and class action cases,72 the Seventh Circuit stated that district courts have discretion in the decision to apply a percentage method in other instances.73

In the Fifth Circuit, despite the warning in Johnson that the "criterion for the court is not what the parties agreed but what is reasonable,"74 district courts frequently award contingency percentage awards from common funds recovered in litigation.75 In order to ensure a reasonable percentage, however, courts continue to apply the Johnson factors.76 In other words, although these courts have allowed the recovery of percentage awards in common fund cases, they also apply the lodestar method to ensure "the reasonableness" of the amount.77 Consequently, most applicants seeking attorney's fees submit their lodestar application and analysis to arrive at and support the contingency fee percentage. Thus, the lodestar method seems to be simply a default method with

which the courts are left to deal.78

As litigation has become more costly, clients have demanded increasing flexibility in the way they negotiate and arrange fee agreements for legal services with attorneys. This demand has resulted in variegated contingent fee agreements and combinations of contingent fee and hourly fee agreements on the market for legal services where the simple hourly fee agreement was once the rule. The federal courts are being asked why they consider percentage fee agreements in "common fund" cases only, and not in direct injury cases brought on a contingent ee arrangement. 79 C. Shortcomings of the Lodestar Method

The lodestar method of calculating attorney 's fees contains both administrative and evaluative problems. First, the lodestar creates administrative problems because the method places an inordinate administrative burden on the courts in the form of attorney 's fee award litigation. Second, the lodestar generates evaluative problems because it does not accurately value attorney work product according to the relevant market for attorney's fees. Both of these problems can be addressed by incorporating market analysis of contingent legal fees into the lodestar equation. Indeed, the contingent fee market provides a ready and accurate valuation of the attorney's work product, without the administrative cost to judicial resources.

  • Administrative Problems

The lodestar method of calculating attorney's fees places a significant burden on the courts and taxes judicial resources. Although a "second major litigation" should not arise from a request for attorney's fees,80 some litigation over attorney's fees is unavoidable. 81 This is because the lodestar method requires courts to re-examine and re-litigate the case from the standpoint of the attorney's work product and attorney's fees. The party seeking attorney's fees has an incentive to maximize the fees by exaggerating the amount of work and the magnitude of success enjoyed in the prosecution of the case. The party resisting payment of attorney's fees has an incentive to unfairly downplay the amount of work and disparage the resulting success of the party prosecuting the case.82 The Report of the Third Circuit Task Force on Court Awarded Attorney Fees ( "Third Circuit Task Force Report"), which identified nine deficiencies of the lodestar approach, emphasized the administrative problems of the lodestar method.83 First, the analysis under the lodestar is more burdensome than a contingent fee evaluation. Litigation over attorney's fees can become both more complicated and more time consuming than the underlying lawsuit because the analysis of the hourly fees requires the submission of time records prepared by the attorneys and comparison to fees in the relevant market.84 Indeed, the failure of attorneys to present detailed time records of hours expended may lead to denial or reduction of the fee requested.85

Moreover, in the most complex forms of litigation, the lodestar method may require the court to scrutinize the "prevailing rates charged in the community for similar work, the availability of adequate local counsel, customary billi ng rates, the experience of the attorney[s], and the complexity of the work" to determine hourly rates for lawyers with varying expertise, doing different work in different parts of the country.86 Likewise, underlying lawsuits, which present multiple and distinctly different claims for relief, further increase and complicate the burden upon the court to determine which claims were meritorious and which deserved enhancement under the lodestar method.87

Rehashi ng the work performed on the case along with the accompanying representation of the hourly market of fees creates a significant burden on the courts and an inefficient use of scarce judicial resources. The analysis of the contingent fee market, on the other hand, does not require the submission of time records, only the submission of the contingency fee agreement. The market determi nes the reasonableness of this fee agreement and the court will determine the amount of recovery for each claim by the merits of the prosecution of that claim.88

In addition, federal courts do not apply the lodestar method uniformly. The resulting chaotic state of law fosters an excessive amount of litigation concerning the proper fee amount.89 At times, appellate courts may apply the Johnson factors differently than trial courts. The inevitable consequence of the lodestar procedure is the burgeoning of attorney's fee litigation on both the appellate and the trial court levels. For example, courts differ as to which hours may be included in computing the lodestar figure-sometimes including time spent in preparing the fee application itself.9° Courts apply varying standards of reasonableness, leading to divergent decisions regarding attorney's fees. Accordingly, the varying standards prevent parties from plan ning for and providing for the award of attorney's fees and increases litigation over the varying standards.91

2. Evaluative Problems

Perhaps the more important problem with the lodestar method is that it does not accurately value the attorney's work product. Regardless of the number of factors considered by the courts, no precise formula for computing attorney's fees exists.92 This lack of precision imbues the lodestar method with an unhealthy dose of subjectivity as courts vary in the weight or consideration given to each factor.93 The lodestar method, further, offers "no guidance on the relative importance of each factor, whether they are to be applied differently in different contexts, or, indeed, how they are to be applied at all."94 Likewise, the lodestar

method often flies in the face of the proposition that an attorney should recover a fully compensatory fee, where a plaintiff has achieved his or her desired results.95

Yet after over twenty years of applying these factors and achieving poor results, these factors remain. Instead of giving various weight and consideration to the Johnson factors, the market itself provides a more accurate determination of the degree to which claims were successful. Nevertheless, in Hensley v. Eckerhart, the Supreme Court struggled with determining the degree of success on which to base attorney's fees.96 The problem facing the Supreme Court is how to determine "reasonable fees" based on the attorney's work product and the attorney's success without any objective valuation of that work or success.97 The market for legal claims, however, has already made a determination of the value and merit of the claim, and this is tested by he prosecution of the claim and trial or settlement. Through the contingent fee arrangement, the "critical factor" of the "degree of success" necessarily calculates the attorney's fee based on the success of the claim.

The Third Circuit Task Force Report emphasized the unwarranted sense of precision and the inherent subjectivity of the lodestar method in its critique.98 Since the publication of the Third Circuit Task Force Report, federal courts have acknowledged and grappled with the lack of mathematical precision.99 Instead of tapping the legal market for services to determine the market price for those services, the lodestar method requires that the trial court simulate the market for attorney 's fees and make an artificial economic finding of reasonable attorney's fees. The valuation of the attorney's work product under the contract is not "manipulation," as it is termed by the Third Circuit. Rather it is the actual value of the attorney's work product based on an objective and real world valuation. 100

The lodestar method mixes the markets for hourly rates and contingent fees, rather than exclusively utilizing one or the other. Indeed, the lodestar method's "preoccupation with attorneys' time and market rates encourages the expenditure of excessive or unnecessary hours." 101 The Fifth Circuit noted that the hourly rate approach "equates professional services to those of laborers and mechanics." 102 The Fifth Circuit further observed a "flash of brilliance by a trial lawyer may be worth far more to his clients than hours or days of plodding effort." 103 In essence, the lodestar method ignores the value placed on the attorney's work product by the market itself.

The lodestar method ignores the fact that, in addition to legal services, a contingent fee arrangement also provides credit and. legal­ cost insurance. 104 Accordingly, "in the private market, lawyers charge a premium when their entire fee is contingent on winning." 105 Courts, nonetheless, cling to hourly rates in a legal marketplace that has seen something of a renaissance in the ways attorneys and clients contract fee agreements. Despite the adherence to the lodestar method of calculating attorney fees, the use of contingency fee arrangements, though still most prevalent in personal injury litigation, has spread to antitrust litigation, shareholder derivative suits, patent litigation, mergers and acquisitions, securities litigation, and even lobbying. 106

The evaluative problems created by the lodestar method of calculating attorney's fees further lead to increased agency costs. By importing the hourly rates into the contingency fee valuation, the courts import the problems with charging client's hourly fees without any accompanying evaluative benefit. Although courts may be able to recognize thoroughly superfluous and unnecessary work, the lodestar method, because it focuses upon hourly rates rather than results, creates an incentive to maximize time spent on a plaintiff 's case. 107 This, in turn, may create a disincentive for the early settlement of cases. 108 Utilizing hourly rates can create disincentives for providing an efficient work product to clients and consumers of the market for legal services.

"The high degree of subjectivity involved in most fee decisions is unhealthy for both the legal profession and for the conduct of litigation." 109 No matter how many factors the courts consider or how they weigh each in their consideration, "[t]here is no precise rule or formula for making these determinations." 110 "Where a plaintiff has obtained excellent results, his attorney should recover a fully compensatory fee."111 Instead of applying factors and disagreeing as to their weight in consideration, it should be left to the market to determine which claims were successful and how successful they were.

Ill. REFORMULATING THE LODESTAR TO INCORPORATE THE MARKET FOR LEGAL CLAIMS AND ATTORNEY FEES

Both the administrative and evaluative problems of the lodestar can be addressed by incorporating the market for legal claims and attorney's fees into the lodestar calculation. The market for legal claims encompasses both the factors that the federal court considers in determining attorney's fees and the factors that burden the federal court in administrative determinations and costs.