Abogado Aly: Reverse Contingent Fees

Monday, June 1, 2015

Reverse Contingent Fees

Originally published by Barry Barnett.

In a couple of weeks, Blawgletter will end its eight-year run as my principal law blog.

On Tuesday, June 16, I will launch The Contingency: Insights on Sharing the Risks and Rewards of High-Stakes Business Disputes. You’ll get more info on The Contingency, including how to subscribe.

Turning down the lights on Blawgletter will give me a pang of loss, but as Shakespeare said, what’s past is prologue. I’ve wanted to write about things that The Contingency will address for a long time.

Take this early Blawgletter post (on Jan. 5, 2008) — on “How to Negotiate a Reverse Contingent Fee” as a for-instance. The post has held up pretty well. I’ll have more to say about the subject (and others) on The Contingency. But in the meantime, I’ve copied it below.

Barry Barnett

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How to Negotiate a Reverse Contingent Fee

D. Todd Smith — master blogger over at Texas Appellate Law Blog — commented a couple days ago on The Hourly Fee Must Die — Some More. He said:

I’m still trying to break free from the billable hour, with increasing success. From the plaintiff’s side, evaluating whether to accept a matter on a contingent fee is fairly straightforward. But I still haven’t settled on the best alternative-fee arrangement when working for the defense. A “reverse contingent” fee perhaps?

Great question, Toddster.

Blawgletter’s firm, Susman Godfrey L.L.P., has handled some cases on a reverse contingent fee (RCF) basis. The agreement with the client calculates the RCF as a percentage of the savings off of a benchmark number. The benchmark reflects an estimate of the client’s possible exposure.

By way of example, if the law firm and client agree that a patent infringement case exposes the client to potential liability of $10 million, the RCF would equal a percentage — 40 percent, say — of the difference between $10 million and any lower amount that the client pays in settlement or as a result of a judgment. If we zero out the plaintiff, our fee totals $4 million — .4 x ($10 million – $0) = $4 million.

Negotiating an RCF presents unique challenges. The hardest part probably is arriving at the benchmark number. The law firm will want to use the plaintiff’s demand as the starting point, but the client will prefer to begin at bupkes. Unless some reliable methodology for assessing exposure exists, the discussions may lead nowhere.

A second barrier to negotiating an RCF results from the fact that the client must come out of pocket to pay the fee. Fortune 500 companies can do that, but smaller enterprises may lack the necessary liquidity. A letter of credit or other security could bridge the gap.

The best candidates for RCF arrangements thus are cases that (1) have a track record and (2) involve clients that have the resources to pay the RCF.

Patent litigation springs to mind as a likely occasion to represent a defendant on an RCF basis. Cisco Systems, for instance, draws its share of patent infringement complaints. Say Cisco gets a complaint for infringing a patent that the plaintiff already litigated against another company and settled for $X. The $X could provide a baseline for determining the benchmark in the RCF agreement.

Cisco is a good example, by the way. Its General Counsel, Mark Chandler, has led the charge against the hourly fee as the principal basis for paying lawyers. He’s worked out a number of creative ways to align the interests of the company with the interests of its lawyers — including by way of an agreement that had an RCF element in it. Excellent.