Referral Fee Agreements: What are the Hidden Traps and How to Avoid Them
By David A. Grossbaum, Esquire Cetrulo & Capone, LLP, Boston, Massachusetts
It is common practice for lawyers to refer cases to one another. It is also common for lawyers to collect a fee for those referrals. Most of these cases involve contingent fee matters, but it is also possible to pay the referring attorney a percentage of any hourly fee. There are, however, strict requirements which the referring attorney must meet in order to collect the referral fee. The failure to satisfy these requirements can be an ethical violation, can cause the loss of the fee, and can result in vicarious liability being placed upon the referring attorney for the misdeeds or negligence of the working attorney. See generally Annotation, Validity and Enforceability of Referral Fee Agreement Between Attorneys, 28 A.L.R. 4th 665 (1984).
In most states, the rules regarding fee splitting are contained in the Rules of Professional Conduct. The American Bar Association's Model Rule is 1.5(e). This rule generally sets forth the following requirements for fee splitting agreements between lawyers who are not in the same firm: (1) the client must be informed that the lawyers will be splitting the fee; (2) the client must consent to the arrangement; (3) the total fee must be reasonable; and (4) the division of fees must be in proportion to the work performed by each attorney. It goes without saying that the referral fee must be paid to a lawyer, not a layperson. See Trotter v. Nelson, 684 N.E. 2d 1150 (Ind. 1997) (referral agreement is unenforceable where the referral source was an employee of the lawyer).
Some states have tinkered with this basic format. Massachusetts, California, and Texas do not require that the division of fees be proportional to the work performed by each lawyer, opening the door to lawyers being paid a referral fee even where they perform absolutely no work on the file whatsoever. Massachusetts Rules of Professional Conduct 1.5(e); Texas Rule of Professional Conduct, 1.04(f); California Rule of Professional Conduct 2-200(A). Many states seem to use a hybrid: the fee must be proportional to the work performed, or pursuant to an agreement signed by the client and the attorneys, under which the referring attorney is jointly responsible for the case. See e.g., Florida Bar Rules 4.4-1.5(g) & 4-1.5(f)(4)(D); N.Y. Code of Professional Responsibility, DR 2-107(A)(2).
In all states, it appears that the client must be informed that there is a referral fee. This requires a direct communication between the attorneys and the client. Fleming v. Campbell, 537 S.W. 2d 118 (Ct. App. Tex. 1976) (oral promise by client's attorney to pay referral fee is not enforceable where the client himself was unaware of the arrangement). Although the model rule does not require that the client be informed in writing, you should always look at the rule governing the practice in your state on this issue.
Next, the client must actually consent to the referral fee. This requires more than just notifying the client about the referral fee. California Rule of Professional Conduct 2-200(A)(1) (requiring that client has "consented in writing thereto after a full disclosure..."). In a recent California case (involving fee-splitting, not a referral fee), the Court found that, although the client had received a copy of a letter setting forth the fee splitting arrangement, she never actually was asked to, nor did she, consent in writing . Chambers v. Kay, 29 Cal. 4th 142, 56 P 3d 645 (2002). The Court refused to award any money to the attorney, as this would circumvent the clear requirements of the rule. See also Bertucci v. McIntire, 693 So. 2d 7 (La. Ct. App. 1997) (client was not informed in writing of precise amount paid to each lawyer, even though she knew that original lawyer had brought in additional lawyers to work on the case and she did not object).
Another requirement of the rule is that the total fee be reasonable, and no greater than it would have been if there had been no referral fee paid. In other words, the contingent fee percentage, or the hourly rate, must be the same as it would have been if there had been a single lawyer or law firm working on the case.
Some of the more unusual issues are not squarely addressed by the rules. First of all, courts have routinely found that a lawyer cannot receive a referral fee if he would have been prevented from handling the case directly due to a conflict of interest. Polland & Cook v. Lehmann, 832 S.W. 2d 729 (Ct. App. Tex. 1992); Evans & Luptak v. Lizza, 251 Mich. App. 187, 650 N.W. 2d 364 (2002).
Courts have also dealt with the question of whether there was sufficient consideration to support the payment of a referral fee where the referring attorney had already referred the client to the working attorney prior to the working attorney's agreement to pay the referral fee. Crill v. Bond, 76 S.W. 3d 411 (Ct. App. Tex. 2001)(consideration found); Fleming v. Campbell, 537 S.W. 2d 118 (Ct. App. Tex. 1976) (no consideration).
Courts differ as to whether the size of the referral fee is subject to the standards applicable in determining if the total fee is reasonable. In one case, the Court determined that these standards are not applicable with respect to the split of a fee between lawyers. Frost v. Lotspeich, 175 Or. App. 163, 30 P. 3d 1185 (Or. Ct. App. 2001) (although Oregon disciplinary rule relating to reasonableness of fees did not apply as to split of fees between lawyers, the California statute required the referral fee itself be reasonable).
Some of the cases deal with the question of whether an attorney can refer cases to other law firms without breaching his or her fiduciary duty to his employer. Johnson v. Brewer & Pritchard, P.C., 73 S.W. 3d 193 (Tex. 2002). In this case, as long as the attorney did not personally profit from referring the case to another firm, he was not necessarily in breach of a fiduciary duty to his own firm.
Problems may arise where the referring lawyer is fired before the client receives a judgment. Where the attorney has been discharged by the client without cause, there is some precedent for the attorney recovering the referral fee on a quantum meruit basis. Barwick, Dillian & Lambert, P.A. v. Ewing, 646 So. 2d 776 (Dist. Ct. App. Fla. 1995)(attorney could collect under quantum meruit for unenforceable referral fee agreement, but the lawyer did not make that argument). Of course, it is difficult to prove the value of the referring lawyer's services where the lawyer did no actual work on the case. Bertucci v. McIntire, 695 So. 2d 7 (La. Ct. App. 1997) (based on contacts with client, referring lawyer awarded a 10% fee not the 20% agreed upon orally between the lawyers).
Referral fees do not come without some risk. There are cases finding that the referring attorney has vicarious liability for the negligence or misconduct of the working attorney. See e.g., Fitzgibbon v. Henry A. Carey, P.C., 70 Or. App. 127, 688 P 2d 1367 (1984); Duggins v. Guardianship of Washington, 632 So. 2d 420 (Miss. 1993); Floro v. Lawton, 187 Cal. App. 2d 657, 10 Cal. Rptr. 98 (1960); Noris v. Silver, 701 So. 2d 1238 (Fla. Dist. App. 1997). These cases involve situations where the referring attorney is also actively involved in the case (creating a joint venture) or there is a particular ethical rule providing that a referring attorney has joint responsibility for the case. Other cases find no such liability. Foster v. Mclain, 198 So. 2d 463 (La. Ct. App. 1967) (firm did receive a portion of the fee but was not at all involved in the misconduct). There is also at least one case imposing liability on a referring lawyer for "negligent referral" where the working attorney was clearly ill qualified to do the work because of his history of embezzlement and other criminal acts. Tormo v. Yormark, 398 F. Supp. 1159 (D.N.J. 1975).
Important lessons can be gleaned from these cases. First, do the same type of conflict-of-interest check when making a referral that you would do if you were handling the case directly.
Second, all referral fee agreements should be in writing, should contain full disclosures, should contain language that the client has the right to consent or refuse, and should require the client's signature. It is also best to establish in writing a clear division of responsibility between the referring firm and the working attorney and make sure the client is aware of this division of labor. If a referring firm is in a state where it is acceptable to obtain a fee based on a mere referral, and the referring firm will not be working on the case, inform the client that the referring firm is not involved and is not exercising any oversight. A referring firm should not permit its name to be placed on any pleadings that it has not reviewed and for which it cannot vouch.
Third, you should have clear policies and procedures for referring cases to outside counsel. If referrals are handled on an ad hoc basis, problems can arise for the entire firm. For example, if a case that is referred out involves large damage exposure, a referring firm may find itself under-insured if a vicarious liability claim is ultimately asserted for the wrongdoing of the working attorney. If the working attorney commits fraud, or is uninsured, his or her policy will not be there to help pay a malpractice judgment.
If you are going to refer a case to a lawyer you do not know, you should check with the local professional conduct committee to make sure that there are no complaints against that lawyer. It is also advisable to work through your network of contacts to find someone who is familiar to you or to others in your firm. Due diligence should include asking whether the lawyer under consideration has been the object of any malpractice claims; confirming that he or she has some experience handling the type of matter that is being referred; and confirming that he or she has the time and the staff to handle the matter. A review of a working lawyer's errors and omissions policy, including the policy's declarations page (listing limits of coverage) is also recommended.
Referral fees are an important source of revenue for many lawyers. Nonetheless, it is not "easy" risk-free money. Risk management is critical when it comes to these agreements.