Among the ethical constraints governing lawyers in the Golden State, is a problematic situation that involves Rule 3-700(D)(2) of the California Rules of Professional Conduct (RPC).
The dilemma stems from a specific issue: when does a particular retainer payment constitute a non-refundable "true-retainer"?
Many a California lawyer has gotten into trouble by failing to appreciate the nature of a "true-retainer," which many attorneys mistakenly conflate with a "flat-fee." Making matters worse, many practice areas have an ingrained tradition of charging "non-refundable fees."
Refunding Unearned Fees
Improper retention of client funds can result in discipline, even disbarment. An attorney who fails to refund money owed to a client may also face civil liability for breach of fiduciary duty, which may be determined as a matter of law based on a breach of the rules of professional conduct which "help define the duty component of the fiduciary duty which an attorney owes to his [or her] client." (Stanley v. Richmond, 35 Cal. App. 4th 1070, 1086 (1995).)
When a client discharges an attorney, the Rules of Professional Conduct require the attorney to "[p]romptly refund any part of a fee paid in advance that has not been earned." (RPC 3-700(D)(2).) However, a refund is unnecessary if the money paid is "a true retainer fee which is paid solely for the purpose of ensuring the availability of the member for the matter." (RPC 3-700(D)(2).)
State Bar Opinion
The State Bar most recently addressed the issue of retainers in Arbitration Advisory 2011-01 (available at http://www.calbar.ca.gov/Portals/0/documents/mfa/arbAdvisories/2011-01_EnforcementOfNonRefundableRetainerProvisions_r.pdf. The advisory explains that "unless the attorney and client have contracted for a 'true retainer' (also known as a 'classic retainer'), the attorney must refund any portion of the advance fee that the attorney has not yet earned."
The key characteristic of a true retainer is that it is paid solely to secure the "availability" of the attorney and is not paid for the performance of any other services. Conceptually, an attorney who is paid a "true retainer" is being paid for something in addition to or other than the performance of legal services. Where a valid true retainer exists, if the attorney's services are eventually needed, those services are billed and paid for separately; no part of the retainer is applied to pay for them. Thus, any fee arrangement in which the attorney bills against the retainer is not a true retainer.
True retainers "in essence, are option agreements: in exchange for the payment of an engagement retainer fee, the attorneys commit themselves to take on future legal work, regardless of inconvenience, client relations or workload constraints." (Banning Ranch Conservatory v. Superior Court, (2011) 193 Cal. App. 4th 903, 917.) A true retainer may be a single, up-front payment which guarantees the attorney will be available for a specified period of time, or it may be a recurring payment, where the client pays, for example, a monthly retainer solely to assure the attorney's availability to represent the client for that month if the need arises.
True Retainers: Rarely Used
Although true retainers used to be common, the State Bar does not contemplate many appropriate true retainer situations today. In fact, Advisory 2011-01 speculates that there are probably only a handful of situations in which a client would want to pay a true retainer. Such an arrangement may be appropriate to secure the availability of an attorney whose reputation may cause a threatened lawsuit to vanish. In addition, a true retainer may be a reasonable way to ensure that an especially talented attorney is available to handle a matter; it may also be used to prevent the attorney from representing an adverse party. But keep in mind that these justifications for a true retainer do not create a true retainer. For instance, a "towering reputation" is also reflected in the attorney's rate. So if an attorney with a "towering reputation" is paid a "non-refundable" amount of money in order to represent a client through trial, that would not be a true retainer. It would be a flat-fee and it would be refundable if not earned. Confused yet?
Cases have helped to define the true retainer. Consistent with the State Bar advisory, cases identify two main characteristics of a true retainer: a true retainer is (1) paid to reserve the availability of a specific attorney and (2) not used to pay fees for services. It is important to note that the language of Rule 3-700 (D)(2) and the cases interpreting it indicate that a true retainer reserves the time of a specific attorney at a firm, and not the firm in general.
In a leading case, the court defined a true retainer, as "a sum of money paid by a client to secure an attorney's availability over a given period of time. Thus, such a fee is earned by the attorney when paid since the attorney is entitled to the money regardless of whether he actually performs any services for the client." (Baranowski v. State Bar, 24 Cal. 3d 153, 164 n. 4 (1979).)
Another court discussed the circumstances under which an attorney may retain client funds, identifying three types of payment arrangements: (1) the classic/true retainer, (2) the security retainer, and (3) the advance payment retainer. The court concluded that only a true retainer is earned upon receipt by the attorney; all other retainers must be placed in a client trust account and refunded to the client if unearned. (See T & R Foods v. Rose, 47 Cal. App. 4th Supp. 1, 7 (1996).)
In the T & R Foods case, the court identified a true retainer as the payment of a sum of money to secure availability over a period of time and found that entitlement to the fee exists whether or not services are ever rendered. (T & R Foods, 47 Cal.App.4th Supp. at 6). The court observed that a "security" retainer, on the other hand, is a sum of money that will be held by the attorney to secure payment of fees for future services that the attorney is expected to render. It is important to note that a security retainer remains property of the client until the attorney applies it to fees and costs for services actually rendered, and any unearned funds must be returned to the client. An "advance payment" retainer occurs where the client pays in advance for some or all of the services that the attorney is expected to perform. In such a case, said the court, "ownership of the funds is intended to pass to the attorney at the time of payment." (47 Cal. App. 4th Supp. at 7.) However, the court also found the law unsettled as to whether funds can be retained by the attorney if unearned. Ultimately, the court concluded that there was an intent expressed in the State Bar rules that funds "retain an ownership identity with the client until earned." (See T & R Foods, 47 Cal. App. 4th Supp. at 7.)
The fee agreement in the T & R Foods case did not create a true retainer because it stated that the attorneys would charge their services against the retainer, which was to be replenished by the client each month in order to assure that the attorneys were always holding $25,000 on their books to cover ongoing fees. The court properly found that the $25,000 deposit was in fact "an advance payment retainer." The court required the attorneys to segregate the funds until they had been earned. (T & R Foods, 47 Cal.App.4th Supp. at 6.)
State Bar Discipline
In cases where counsel has not properly structured a true retainer, the State Bar repeatedly finds that clients are due a refund of unearned fees, even if a payment is denominated as "non-refundable" in the parties' agreement. In other words, the actual treatment of the funds trumps the language of the retainer agreement.
In Matthew v. State Bar (49 Cal. 3d 784 (1989)), an attorney was retained to handle a real estate fraud matter. The attorney required his client to provide a nonrefundable retainer "to ensure that his client would 'work with him on the case.'" The fee agreement required $5,000 up front, with a $10,000 ceiling on fees, and stated that the attorney would "bill for his time at the rate of $70 per hour until the bill reached $5,000." (49 Cal. 3d at 787.) The attorney represented the client for 7 months, and the client paid over $6,000 during that time. The attorney kept no time records and provided no billing statements, but estimated he spent 32 to 40 hours on the case. After unsuccessfully seeking a refund, the client took the attorney to arbitration to recover unearned fees. The arbitration panel found in the client's favor, but the attorney still did not refund the money.
The same attorney provided for a $1,000 non-refundable retainer in another fee agreement. After the client terminated the representation, a dispute arose as to unearned fees. The attorney failed to perform needed work; provided no billing statements; was unavailable; and "admitted that he was not diligent in this matter and that he was unable to work on the matter in a timely fashion due to his caseload." (49 Cal.3d at 789.)
The California Supreme Court emphasized the seriousness of the attorney's misconduct, identifying failure to refund "unearned fees as serious misconduct warranting periods of actual suspension, and in cases of habitual misconduct, disbarment." (49 Cal. 3d at 791.) In addition to discipline, the attorney was required to return all unearned fees, notwithstanding the "non-refundable" language in the retainer agreements. (49 Cal. 3d at 792.)
To be valid, an agreement calling for a true retainer should show that the client is purchasing something valuable beyond the services of the attorney. For example, the agreement may refer to specific blocks of time when a specific attorney will be available, whether or not the client actually needs the attorney during those times, or that the payment guarantees the attorney will refrain from taking adverse clients. The agreement might also state that the payment secures the attorney's availability for a future engagement. In that sense, the attorney's "availability" that is being purchased must be different than the normal "availability" purchased when retaining an attorney. Many attorneys mistakenly believe that a "true retainer" is justified because they are "available" to their clients when they are retained. But that level of "availability" is part of an attorney's fiduciary responsibilities and is different than what is required for a "true retainer."
The Banning Ranch Conservatory comparison to an option agreement is a perfect analogy. In exchange for payment, the attorney will be "available" to perform an unknown type or quantity of work at the option of the client, or just to create a situation that takes the attorney out of the marketplace so that the opposing party cannot retain that attorney. For that reason, an agreement calling for a "true retainer" might best be structured as two separate agreements - one describing the availability, and another for services that only goes into effect once the "option" is exercised.
Flat Fee Alternative
Flat fees are a popular alternative to hourly billing, but flat fees should not be confused with true retainers. In a true retainer situation attorney services (as opposed to availability) are charged to the client separately and no part of the retainer is applied to pay for such services. A flat fee is, by definition, a payment for services, not for availability. It should be tied to the accomplishment of a specific milestone and refunded if the milestone is not reached. This may explain part of the confusion that attorneys have - a true retainer is basically a flat fee to reserve the attorney for future services.
For example, a lawyer may charge a flat fee of $1,000 that is advanced by the client to form a limited liability company; the parties may stipulate that the fee is earned after the attorney files articles of organization and delivers the completed operating agreement to the client. Under these circumstances, the fee should be deposited in the attorney's trust account. If the attorney does not complete those tasks, the fee has not been earned and must be refunded.
On the other hand, if the client is considering two different lawyers for the formation of the limited liability company, he may pay both of those lawyers a "true retainer" of $100 so that they will both be available once the client decides who to retain. Once the decision is made, the lawyer will charge a flat fee of $1,000 for the formation of the limited liability company and both lawyers get to keep their $100 "true retainer."
A well-drafted flat fee agreement should specifically state what services will be performed and when the fee is earned. If several services are involved, a portion of the fee should be earned after each service is completed. Not only is this fair to both parties, but it also avoids confusion if the attorney's services are terminated short of the final milestone.
There are alternatives to the flat fee for clients who seek to economize. For example, an attorney may choose to bill the client hourly but cap the fee at a specific amount within the client's budget.
Is it Unconscionable?
The true retainer seems to be a vestige of days gone by. Today it is not infrequently attempted, although it is rarely used correctly. Many attorneys continue to insist on "non-refundable" retainers. Such agreements are risky, and must be structured carefully. A non-refundable retainer must fit within the narrow definition of a true retainer; must be appropriate to the client's situation; and the State Bar will scrutinize the arrangement to determine whether the fee is unconscionable. A true retainer will be unconscionable if a client receives little or no value by ensuring the availability of the attorney; or where the attorney has no particular reputation or expertise to justify a non-refundable payment; or if there is "an abundance of other competent attorneys available to handle the client's matter." (See Opinion 2011-01 at p. 4 (subsection C [Unconscionability].) Of course, if an attorney is paid a "nonrefundable true retainer" and is then unavailable, then even the "true retainer" would be subject to refund.
Proper true retainers exist, but they are very rare. In most cases, advance payments are just that: advances that cover fees to be earned in the future. And remember that if the fees are not earned, those advanced funds must be returned to the client at the conclusion of the engagement.
Aaron Shechet and Leigh Chandler are the founders of Chandler & Shechet, a business litigation firm based in Los Angeles.