Dividing Attorney Contingent Fees in Divorce
© 2005 National Legal Research Group, Inc.
A recent Minnesota decision provides a good entry point for reviewing the law on the division of contingent fees received by an attorney-spouse after the marriage, based in part upon work performed during the marriage. The case is Stageberg v. Stageberg, 2005 WL 1020881 (Minn. Ct. App. 2005).
The parties in Stageberg were married for 12 years. The wife was a psychologist in private practice, earning her income entirely from fees billed at an hourly rate. The husband was a plaintiffs' personal injury attorney, earning his income primarily from contingent fees. These fees consisted of a percentage of any jury verdict or settlement recovered by his client.
At the divorce hearing, the husband produced a list of his pending contingent fee cases. Some of the cases had already ended with a favorable verdict or settlement; other cases remained pending. The wife argued that any recovery in the pending cases was marital property to the extent that work had been performed on the case during the marriage. The husband argued that pending contingent fees were not marital property. The trial court adopted an unusual approach not previously seen in the reported cases:
[T]he district court acknowledged that the majority of jurisdictions view contingency fee contracts as having "marital value," but determined that the best way to determine that value is to apply what it called "The Historical Average Income Approach." In this approach, the district court assumed a 40% tax rate and calculated husband's average annual net profit over the past five years (excluding costs). Because husband would resolve some cases each year and take on additional cases, the court then reduced husband's net profit by 50% to reflect the average declining percent of marital effort in the cases that are concluded during the course of a year. The court found that wife was entitled to one-half of the remaining after-tax marital share.
2005 WL 1020881, at *2. Thus, while the court recognized a marital interest arising from the husband's pending cases, it did not base that interest upon specific actual or predicted recoveries in the cases themselves. Rather, it computed the husband's average annual net post-tax profit over a five-year period, and reduced that amount by an arbitrary 50% to account for expenditure of post-divorce effort on the cases. This amount was treated as marital property, and one-half of it was awarded to the wife.
The court did not attempt to relate the amount of its award to any facts regarding the actual cases pending, and it cited no support in case law or academic discussion for the average income approach it followed. Not surprisingly, both parties appealed from the trial court's decision.
Classification as Property
On appeal, the husband argued that the trial court had erred by including in the marital estate any amount for his pending contingent fees. He argued that those fees were only an expectancy, not a property right; that the fees were future income rather than present property; and that the fees were too speculative to constitute a marital asset.
The court rejected all three of these points. Contingent fees are not a mere gratuity conferred upon the attorney by a grateful client; they are a benefit which the attorney has earned through prolonged effort. The amount and conditions of the fees are set forth in a retainer agreement signed by both the attorney and the client. If the fee is earned, and the client refuses to pay it, the attorney may bring suit to enforce the contract. Indeed, in Minnesota and most other states, an attorney has a lien upon any recovery by the client to enforce the amount of his or her fee. If the client dismisses the attorney at any point before settlement or verdict, unless the dismissal is for cause, the attorney has a right to recover a partial fee based upon work performed before the dismissal.
The classic example of an expectancy is a professional degree, which offers the holder no guarantee of any specific future benefit. Unlike a degree, a contingent fee contract does offer the holder a guaranteed benefit, secured by a lien and enforceable in court if the client refuses to pay. A pending contingent fee is clearly not a mere expectancy.
The husband's major point, of course, was that his client in any given pending case might lose, so that he would ultimately not recover anything. But this possibility does not render the fee itself an expectancy. On the contrary, the right to receive a fee is guaranteed by a written contract. If the client recovers nothing, the amount of the contingent fee is ultimately zero but the contingent fee contract itself is not retroactively destroyed.
Contingent fee contracts are not the only enforceable contract right which may have a value of zero if future events develop in a particular manner. The most common such contract right is unvested retirement benefits, which will be worth zero if the owner leaves the employer or dies before the date of vesting. Yet unvested retirement benefits are unquestionably treated as property in Minnesota and in all other states except Indiana and Arkansas. Brett R. Turner, Equitable Distribution of Property 6.09 (2d ed. 1994 & Supp. 2004). The courts reason that unvested retirement benefits are an enforceable contract right, earned by the employee as compensation for actual work effort. A pending contingent fee contract is no different. The mere fact that a benefit might eventually be worth zero is no excuse for assuming that the benefit actually will be worth zero. The logical course of action in both situations is to hold that whatever value eventually does materialize is marital property to the extent earned during the marriage.
Another similar benefit is an unvested stock option, which again is treated as property in every state which treats unvested retirement benefits as property. Turner, supra, 6.15; Fisher v. Fisher, 564 Pa. 586, 769 A.2d 1165 (2001). Many unvested stock options are awarded as a benefit of employment by technology companies whose values are subject to significant fluctuation. In financial terms, stock options are probably harder to value than either unvested pensions or pending contingent fees; the difference between the worst-case and best-case scenarios can be the difference between bankruptcy and a successful public stock offering. Yet the uncertainty in value does not change the fact that a stock option gives the holder legally enforceable rights. A stock option is not an expectancy; it is an interest in property with a highly uncertain value.
Stageberg expressly held that pending contingent fees are not materially different from unvested retirement benefits or unvested stock options:
We conclude that the portion of a contingent fee for work in progress on the valuation date that is attributable to work done before the valuation date is sufficiently analogous to unvested pensions and incentive stock options and therefore those fees may be treated as marital property for dissolution purposes. Significantly, under Minnesota law, once a legal proceeding is started, an attorney has a lien for compensation on any money involved. Minn. Stat. 481.13 (2004). Furthermore, the right to compensation for the reasonable value of services continues even if the attorney rightfully withdraws from representation or the client discharges the attorney. Nordling v. N. States Power Co., 478 N.W.2d 498, 501 (Minn.1991); Ashford v. Interstate Trucking Corp. of Am., Inc., 524 N.W.2d 500, 502-03 (Minn.App.1994). Thus, like a pensioner's ability to collect on an unvested, unmatured pension, counsel's ability to collect a fee is a right vesting before the valuation of that right, and the existence of counsel's right is not affected by the fact that the actual recovery of a fee depends on a contingent event a favorable resolution of the case.
Stageberg, 2005 WL 1020881, at *4. Because a contingent fee contract is a legally enforceable property right even if the client ultimately loses, the husband was fundamentally addressing a classification issue by making a valuation argument:
With contingent-fee cases, the attorney is not assured of earning anything for efforts expended, nor does he acquire a vested interest in the actual agreed contingency fee unless the client recovers. But, as noted above, the contingent nature of the fees does not preclude their treatment as property. Moreover, unless one assumes that husband will lose all of the contingent-fee cases he had in progress on the valuation date, the root of husband's third challenge to the treatment of the fees as marital property lies in valuing the marital interest in the fees, not treatment of the fees as marital property.
Id. at *5.
The husband's second point began from the premise that a contingent fee cannot constitute both a property right existing at the time of divorce and income earned after the divorce. Granting the truth of this premise, it is not a valid reason to refuse to treat a contingent fee contract as a property right. Such a contract is enforceable at law, and the fee was earned at least partly through marital effort. Rather, the remedy is to limit the amount of the fee which is treated as income for purposes of support:
Treating contingency fees as income, however, is inconsistent with the above-cited Minnesota authority on the characterization of contract rights. In addition, treating the fees as income rather than property would preclude wife from receiving a portion of the fees as part of the property division. Under these circumstances, we reject husband's argument that the fees must be deemed income.
Id. Since there was no spousal support award in Stageberg both spouses were self-employed professionals the court did not have occasion to address the exact extent to which the contingent fees at issue can be treated as income. Logically, the amount excluded should be only that portion of the fees earned through marital effort. The portion earned through post-divorce effort is logically not property existing at the time of divorce, and therefore logically would constitute future income.
Given that pending contingent fees are a contract right, the court was unmoved by the husband's final argument, which stressed the sheer speculativeness of the fees involved. This argument, once again, was fundamentally a matter of valuation. It is also worth noting that the court did not mention any data in the record as to the percentage of the husband's cases which had traditionally resulted in no recovery. Unless the chance of no recovery in any given case was very substantial, the speculativeness argument would probably fail on the facts. There is likewise a chance that an unvested pension or stock option will ultimately produce no value, but that chance is generally not viewed as a sufficient basis for holding that the asset involved does not constitute property.
As Stageberg recognized, a large majority of states agree with its holding that an attorney's pending contingent fee cases constitute property and not a mere expectancy. They are therefore subject to division to the extent that the fees were earned during the marriage. See Garrett v. Garrett, 140 Ariz. 564, 683 P.2d 1166 (Ct. App. 1983); McDermott v. McDermott, 336 Ark. 557, 986 S.W.2d 843 (1999); In re Marriage of Kilbourne, 232 Cal. App. 3d 1518, 284 Cal. Rptr. 201 (1991); In re Marriage of Vogt, 773 P.2d 631 (Colo. Ct. App. 1989); Quinn v. Quinn, 83 Md. App. 460, 575 A.2d 764 (1990); Lyons v. Lyons, 403 Mass. 1003, 526 N.E.2d 1063 (1988); Erlanger v. Erlanger, 364 N.J. Super. 449, 836 A.2d 859 (Ch. Div. 2003); Block v. Block, 258 A.D.2d 324, 685 N.Y.S.2d 443 (1st Dep't 1999); Litman v. Litman, 123 A.D.2d 310, 506 N.Y.S.2d 345 (2d Dep't 1986); Metzger v. Metzger, 191 W. Va. 378, 446 S.E.2d 165 (1994); Weiss v. Weiss, 122 Wis. 2d 688, 365 N.W.2d 608 (1985); In re Marriage of Estes, 84 Wash. App. 586, 929 P.2d 500 (1997).
A small minority of states hold that a pending contingent fee is an expectancy. The stated rationale is almost always that the ultimate recovery is speculative. See Roberts v. Roberts, 689 So. 2d 378 (Fla. 4th Dist. Ct. App. 1997); Goldstein v. Goldstein, 262 Ga. 136, 414 S.E.2d 474 (1992); In re Marriage of Hershewe, 931 S.W.2d 198 (Mo. Ct. App. 1996); Musser v. Musser, 909 P.2d 37 (Okla. 1995); Beasley v. Beasley, 359 Pa. Super. 20, 518 A.2d 545 (1986); cf. In re Marriage of Zells, 143 Ill. 2d 251, 572 N.E.2d 944 (1991) (future fees not marital property, but affirming a lower court decision which treated a lesser amount as marital property). None of these cases explains persuasively why a pending contingent fee contract is more speculative than an unvested pension or unvested stock option, or why an earned contract right, secured by a lien and enforceable at law, would not constitute property.
Lurking beneath some of the cases is the fear that the process of dividing contingent fees would interfere with the rights of the attorney's clients. While Stageberg did not directly address this issue, it has been addressed in other cases. E.g., In re Marriage of Lopez, 38 Cal. App. 3d 93, 113 Cal. Rptr. 58 (1974). Determining a present value for pending contingent fees cases would pose a risk of disclosing confidential information, as the evaluator would need to assess the chance that the plaintiff will prevail. But very few courts divide contingent fees based upon present value, as the attorney will either prevail and receive a full fee, or lose and receive nothing. There are likewise few decisions dividing unvested retirement benefits or stock options based on present value. The logical method of division for any unvested benefit is to order the owning spouse to pay the nonowning spouse a set percentage of whatever value is realized. This approach requires no disclosure of confidential information, and it is used almost universally in the majority rule cases.
Classification, Valuation, and Division
Both spouses in Stageberg argued that the trial court's method of classification, valuation, and division was seriously flawed. The appellate court agreed with these concerns, and remanded the case for application of more traditional procedures.
The trial court measured the marital interest in the fees as an amount equal to the husband's average annual net post-tax profit (based upon a five-year average), reduced by 50% to reflect post-divorce efforts. No other court or commentator has ever suggested such a method. The method fundamentally assumes that the marital estate has an interest only in cases which terminate within one year after divorce in other words, that all of the cases pending at divorce will be resolved within one year. That assumption is unsupported and probably wrong:
[B]y using an annual-income figure in its formula and applying the formula to only one year of husband's practice of law, the district court implicitly assumed that all of husband's contingent-fee cases that were in progress on the valuation date would be resolved within one year of that date. This assumption is supported neither by evidence in this record nor by general experience.
Stageberg, 2005 WL 1020881, at *6.
The trial court's method also gave the wife a present award based upon contingent fees which the husband would receive only in the future. When the court makes a present award of future dollars, the future dollars must normally be reduced to present value. Such reduction is done routinely when computing the present value of retirement benefits. Turner, supra, 6.12. "[B]ecause the judgment currently awards wife a share of the marital interest in fees husband has yet to receive, the judgment overstates wife's interest in those fees by not reducing her interest to its present value." 2005 WL 1020881, at *6 (court's emphasis).
Still another problem with the trial court's methodology, not discussed in the Stageberg opinion, is its assumption that 50% of the fees would be earned by the husband's post-divorce efforts. The opinion mentions no evidence to support this assumption. The 50% figure to all appearances was based upon no evidence at all, a serious defect in methodology. Surely the percentage of fees earned by future effort should depend upon the facts, and not upon an arbitrary assumption.
Moreover, even if an expert were to testify that the husband had probably put forth 50% of the effort needed to resolve his pending cases, the very concept of using a single average percentage is wrong. Even the most accurate predicted average percentage will still be based upon speculation as to future events. Unless the expert who determines the percentage is very lucky, the percentage of post-divorce effort will probably differ materially from exactly 50%. If the estimate is reasonably made, the likelihood of underestimation should be generally equal to the likelihood of overestimation, but the fact remains that some degree of error in either direction is almost inevitable. Division of contingent fees is hard enough without the use of a method which requires additional speculation as to future events. A better result can be reached with less speculation by dividing the fees if, as, and when they become payable, and basing the future effort percentage upon the actual efforts expended to obtain the recovery.
Looking at the case law nationwide, the Stageberg court recognized that the great majority of all cases applying the majority rule and dividing attorney contingent fees make a deferred future distribution, based upon actual records of the time spent obtaining the recovery. "A majority of courts allowing pending contingent-fees cases to be treated as generating a marital interest in yet-to-be-recovered fees instruct the district court to reserve jurisdiction over the fees until the underlying actions are resolved." Id.
The husband argued that the use of actual data to classify the ultimate awards received in pending cases was not reasonable. He identified three reasons in support of this contention, each of which the appellate court rejected. First, use of actual data did not ignore the cost of losing cases, because costs incurred during the marriage had already been subtracted from marital income, so that the marital estate had already borne its fair share of the costs. To the extent that costs are paid at a different time than they are incurred, so that the actual expenses paid with marital income do not fairly reflect the marital investment in the case, the remedy should be to adjust the cost allocation, and not to reject use of actual data. E.g., White v. Williamson, 192 W. Va. 683, 453 S.E.2d 666 (1994) (marital share applies to net fee, after subtraction of expenses necessary to obtain it).
Second, use of actual data is not speculative merely because "attorneys who do contingent-fee cases typically do not keep time records." Stageberg, 2005 WL 1020881, at *6. In many states, if the attorney is discharged without cause before recovery, the attorney's fee may be based upon time expended on the case, so that the attorney should be keeping time records. The divorce court also has the power to place upon the attorney a duty to keep records:
While husband's second concern will require a certain amount of candor on his part, he has a fiduciary obligation to present full and complete information to the dissolution court. See Doering v. Doering, 629 N.W.2d 124, 130 (Minn.App.2001) (discussing affirmative duty to disclose information present for parties to dissolution proceedings), review denied (Minn. Sept. 11, 2001); see also Minn.Stat. 518.58, subd. 1(a) (2004) (noting parties' fiduciary duty to each other regarding marital assets). And the district court will be aware that husband's evidence on the question of the amount of time spent on the cases before and after the valuation date may be less than precise.
Id. at *7. Finally and most fundamentally, the attorney spouse's failure to keep accurate time records cannot be a sufficient reason for reducing a marital property award to the other spouse. There is no other situation in which one spouse's unilateral failure to keep accurate records can increase that spouse's share of the marital estate.
Third, the use of actual data will not "prolong already contentious dissolution cases by requiring a new evidentiary hearing when each case is resolved." Id. at *6. As each future fee is received, the attorney spouse must compute the total time spent on the case before and after the divorce, compute the marital share, and send the nonattorney spouse a check for his or her share of the fee, along with a copy of the computations. But this will not require a new evidentiary hearing for every contingent fee case. A hearing will be needed only if the nonattorney spouse objects to the accounting. Since an evidentiary hearing is expensive for the attorney spouse, and attorney spouses who engage in deliberate misconduct will risk sanctions from the divorce court (and possibly ethical charges as well), attorney spouses will have an incentive to present reasonable accountings. Many states use actual data to classify contingent fees, and there is no indication that these states have been swamped with post-divorce litigation on the issue. Since most of the personal injury cases at issue will be resolved within a period of a few years after the divorce, it should also be possible to resolve most accounting issues at a single post-divorce hearing and deposit the disputed amount of each fee into escrow until the dispute is resolved. The experience of other states suggests that the burden of administering awards based upon actual data is tolerable.
Stageberg may have overstated in one sense the future burden of administration, by consistently referring to the actual data approach as one which involved "reserved jurisdiction" over the issue. This term does to some extent imply that the court will not exercise its jurisdiction to classify and divide the award until a hearing held after the award is received. But this is not how the method actually operates in other states. Ordinarily, the general ground rules for classifying future awards are set forth in the final property division order. The order must admittedly use formulas rather than actual amounts, as the amount of post-divorce effort which will ultimately be required is not yet known. Still, the court does not divide each individual pension payment, stock option, or contingent fee individually as it is received. Rather, the court sets forth a general formula for computing the nonowning spouse's interest. Future jurisdiction is then exercised only to supervise the application of the formula to the facts (e.g., to resolve factual disputes regarding the accounting). Because the court is not making a new division of each future payment, the method is more accurately known as deferred distribution, rather than as reserved jurisdiction.
Indeed, the final conclusion of the Stageberg court suggests a very workable deferred distribution formula:
[W]e reverse the district court's valuation of the marital interest in the fees to be generated by husband's contingent-fee cases in progress on the valuation date, and remand for the district court to either value the marital interest in those fees in a legally and factually supportable manner, or to retain jurisdiction over the matter and to calculate and divide the marital interest in the unrecovered contingent fees when (and if) those fees are received. If the district court retains jurisdiction over the question, it shall determine the marital and nonmarital interests in the recoveries based on the pro rata amounts of time husband put into the cases before and after the valuation date. While we do not require the district court to retain jurisdiction over the contingent-fee question, we note that doing so would be consistent with the "reserved jurisdiction method" of addressing pensions.
Stageberg, 2005 WL 1020881, at *6 (footnote omitted). By suggesting that a future distribution compute the marital share "based on the pro rata amounts of time husband put into the cases before and after the valuation date," id., the court provided a very workable potential formula for classifying future contingent fees, one which resolves most of the real work involved in applying an actual data approach. (The nonowning spouse's percentage interest in the marital share would of course also be established at the time of the initial property division.) Future proceedings would then be needed only to resolve factual disputes over the variables used in the formula the amounts of time spent on the case before and after the divorce.
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