Larry D. Compton, Trustee in Bankruptcy for Danilo and Angelita Nelvis v. Nicholas Kittleson

Attorney Nicholas Kittleson filed a consumer protection action against an
Anchorage used car dealership on behalf of Danilo and Angelita Nelvis. Kittleson
represented the Nelvises under a "hybrid" fee agreement that called for Kittleson to
receive a contingent fee unless the Nelvises settled the case "for an amount that will pay less than $175.00 per hour for the time [Kittleson] invest[ed]" in the case; in that event,
the Nelvises would be required to pay Kittleson a fee based on the $175 hourly rate.
Before trial the Nelvises turned down a $25,000 settlement offer. They lost at trial, and
the superior court entered a judgment ordering them to pay costs and attorney's fees
totaling almost $100,000. The Nelvises then petitioned for bankruptcy, and the
bankruptcy trustee sued Kittleson to recover their losses, alleging that Kittleson
committed legal malpractice because his fee agreement violated the Alaska Rules of
Professional Conduct. The sole question raised in this appeal is whether the type of
hybrid-fee agreement at issue here is barred as a matter of law. We hold that Alaska law
prohibits a fee agreement that uses a client's decision to settle as a trigger to convert
contingent-fee representation into an obligation to pay hourly fees because a hybrid
agreement of this kind impermissibly burdens the client's exclusive right to settle a case.

II. FACTS AND PROCEEDINGS

In October 1999 Danilo and Angelita Nelvis bought a used SUV in
Anchorage from Cream Puff Auto, Inc. The SUV soon developed serious engine
problems and, by December 1999, had stopped running completely. Dissatisfied with
Cream Puff's response to their complaints, the couple sought help from Kittleson,
contending that Cream Puff had misrepresented the condition of the SUV and had failed
to honor their extended care warranty.

After an initial consultation, Kittleson sent the Nelvises a proposed fee
agreement along with a letter estimating that their case had a seventy percent chance of
success. Kittleson noted that if they won, the Alaska Consumer Protection Act could
entitle them to recover treble damages. Kittleson also advised that if they lost, they
would be responsible for a percentage of Cream Puff's attorney's fees and costs; he
pointed out that the potential cost could "reach $10,000 or more." The letter then told the Nelvises that Kittleson "would be honored to fight for your rights in obtaining a fair
settlement/judgment in this case," that he was attaching a proposed fee agreement, and
that the Nelvises could begin the process of bringing a lawsuit by executing the
agreement and fulfilling its conditions.

The fee agreement attached to Kittleson's letter proposed a hybrid
arrangement that would start with a contingent-fee arrangement entitling Kittleson to
thirty-three percent "of any amounts recovered from all defendants plus any award of
attorney fees"; under the contingent-fee arrangement, the agreement explained, "[i]f there
is no recovery for you, there will be no fee." But the agreement would automatically
convert to hourly-fee representation at the rate of $175 per hour if the Nelvises
"decide[d] to drop the case." Specifically, while noting that the Nelvises retained "final
discretion to settle this case," the agreement provided: "If you agree to settle this case for
an amount that will pay less than $175.00 per hour for the time I invest, then I shall
receive an amount over and above the 33% to compensate me at the rate of $175.00 per
hour before you receive your portion of the settlement." The basis of Kittleson's
compensation thus hinged on whether the Nelvises agreed to settle, the amount of the
agreed settlement, and the number of hours Kittleson had invested in the case at the time
the case settled.

The Nelvises signed the proposed agreement, establishing an attorney-client
relationship with Kittleson. Kittleson then filed a complaint against Cream Puff in the
superior court in Anchorage. The complaint alleged that Cream Puff had committed
fraud and breach of warranty, and had violated the Consumer Protection Act and various
Federal Trade Commission regulations.

While the Nelvises' case was pending in the superior court, a similar
hybrid-fee agreement that Kittleson had used in an unrelated consumer protection case came under scrutiny by a federal judge in an Anchorage bankruptcy case.1 Prompted by
questions raised in the bankruptcy matter, Kittleson wrote to the Alaska Bar Association,
requesting an informal ethics opinion on his use of the hybrid-fee agreement. Bar
counsel issued an informal opinion concluding that the fee agreement raised several
ethical concerns, including the agreement's "potential to significantly inhibit the client's
exercise of his or her right to settle a matter." Bar counsel also stated that he believed
that a fee arbitration panel adjudicating a fee dispute under the fee agreement "would find
impermissible pressure on the client's right to settle or not settle a matter and would
reduce the fee to thirty-three percent and might possibly refer the matter for
investigation."

Less than a week after the bar issued its ethics opinion, Cream Puff sent
Kittleson an offer of judgment for $25,000, including costs and attorney's fees. In a
letter informing the Nelvises of Cream Puff's offer, Kittleson disclosed that, when
calculated at the rate of $175 per hour, his hourly fees for time worked on the case to date
already exceeded $30,000; thus, Kittleson observed, "acceptance of this offer would
mean no recovery for you, as it would be less than the amount already incurred for my
actual attorney fees." Kittleson nonetheless offered to "compromise my fee arrangement
to the amount of $22,000.00," pointing out that "[t]his would then mean that you would receive a total of $3,000." Kittleson also attached a copy of the bar association's ethics
opinion and advised the Nelvises they could accept Cream Puff's offer and pursue fee
arbitration against him through the bar association.

Despite the availability of these options, in his final analysis Kittleson urged
the Nelvises to reject Cream Puff's offer, stating that "[i]t is my professional opinion that
your recovery will be much greater than this at trial. Furthermore, if you win the
Consumer Protection Act claims, which I think are your strongest claims, then [Cream
Puff] would be required to pay full attorney fees." In keeping with Kittleson's
recommendation, the Nelvises rejected Cream Puff's offer.

Two months later, in response to the bar association's opinion and "the
current status of the case," Kittleson revised his fee agreement with the Nelvises. The
new agreement omitted the fee-conversion clause and called for Kittleson to be paid a
pure one-third contingency fee from any recovery. But Cream Puff evidently extended
no further offers of judgment.

In May 2003 the Nelvises' case went to trial. Cream Puff prevailed on all
claims. Given the Nelvises' rejection of its pretrial offer, the dealership moved for an
award of costs and enhanced attorney's fees under Civil Rule 68 and AS 09.30.065. The
court granted the motion and entered judgment against the Nelvises for fees and costs
totaling $99,169.19.

The judgment forced the Nelvises to file for bankruptcy. Bankruptcy
Trustee Larry D. Compton then sued Kittleson in superior court for legal malpractice in
connection with his use of the "convertible fee" agreement. The parties stipulated that
no issues of fact existed and that the only issue presented was whether the disputed fee
agreement's conversion clause "is prohibited by Alaska law"; Compton then filed a motion for summary judgment and Kittleson filed an opening brief seeking dismissal of
the action.

After hearing oral argument on the point, Superior Court Judge Sen K. Tan
concluded "that the agreement as written, on its face, leaves the decision to settle with
the client and does not impinge on the client's right to make that decision." On this basis
the court determined "that the plain language of the agreement does not violate Alaska
law." While recognizing that the agreement might be invalid if it resulted in an
unreasonable fee, the court observed that "[t]he reasonableness of the fees charged to a
client is a question of fact and not before this court." Accordingly, given the parties'
stipulation, the court denied Compton's motion for summary judgment and dismissed the
complaint.

* * *

In ruling that Kittleson's fee agreement was permissible, the superior court
focused largely on whether the Alaska Rules of Professional Conduct categorically
prohibit the use of agreements providing for hybrid fees. The court concluded that
hybrid-fee agreements do not violate the professional conduct rules per se, as long as the
fee ultimately charged complies with Rule 1.5's directive that a lawyer's fee "shall be
reasonable."4 As a general matter, this conclusion is unassailable. The plain language
of Rule 1.5, which regulates attorney's fees, implicitly recognizes that hybrid-fee
agreements are not categorically barred: "A fee agreement which is in whole or in part
contingent shall be in writing and shall state the method by which the fee is to be
determined . . . ."5

Moreover, even though we have never squarely upheld the validity of
hybrid-fee agreements under Alaska law, we have tacitly condoned their use on at least
one occasion by upholding a hybrid agreement against a challenge directed at the
reasonableness of the particular fee at issue in the appeal, noting that "[a]lthough the
combined hourly and contingent fee arrangement was unconventional, it was not
unreasonable."6 Our recognition that hybrid agreements may properly be used in some
situations appears to reflect the prevailing view in other jurisdictions.7 We thus conclude
that an attorney's use of a hybrid-fee agreement does not necessarily breach the Alaska
Rules of Professional Conduct.

Yet the conclusion that hybrid agreements may sometimes be properly used
hardly establishes that such agreements are always facially valid or that the particular
type of hybrid agreement used by Kittleson was permissible as a matter of law. Here, the
hybrid agreement combines two active ingredients into a potent mix: first, it uses the
client's decision to settle as the trigger for converting from contingent to hourly fees; then, once the conversion is triggered, it operates retroactively to encompass all work
performed from the inception of the case. Whether Alaska law prohibits this type of
hybrid-fee arrangement presents a question of law that cannot be decided without
assessing the combined effects of these features in light of requirements imposed by the
Alaska Rules of Professional Conduct and other relevant provisions of Alaska law.

Alaska's Rules of Professional Conduct follow the mainstream in
recognizing that clients, and not attorneys, possess the right to decide whether to settle
or drop a case. Because this right is personal to the client, an attorney cannot demand
relinquishment of the right as a condition of representation. Rule 1.2(a) provides that
"[a] lawyer shall abide by a client's decision whether to accept an offer of settlement of
a matter." Other authorities support this strict view that the right belongs to the client
alone. The American Bar Association's Annotated Model Rules of Professional Conduct
emphasize that "[a] lawyer has no inherent power, by virtue of the fact that he or she
represents a client, to settle the client's claim."8 The Restatement (Third) of the Law
Governing Lawyers explains that the decision to settle is reserved to the client "because
a settlement definitively disposes of client rights."9 And Charles W. Wolfram's treatise,
Modern Legal Ethics, notes that a lawyer may, at times, have a duty to encourage a client
to settle, but "the decision whether or not to settle is for the client to make."10

Applying these principles, courts have consistently declined to enforce fee
agreement provisions that give attorneys control over settlement by requiring the attorney's approval or by requiring the client to accept an offer that the attorney
considers favorable.11 Because these cases rest their outcomes on the personal nature of
the right to settle, they do not consider it relevant to inquire into how clients' choices
might affect the economic interests of their attorneys. For example, in Mattioni, Mattioni
& Mattioni, Ltd. v. Ecological Shipping Corp., a law firm sued a former client based on
a provision in its fee agreement stating that the client "agrees not to compromise its suit
without its attorneys' consent" after the client negotiated a settlement without the firm's
involvement.12 The United States District Court held that despite the firm's reasonable
expectation of a "very substantial fee" for its work on the client's behalf, the consent
provision of the fee agreement violated public policy and could not support the firm's
claims against its former client.13 The court went on to observe that if the client's actions
unfairly deprived the attorney of a reasonable expectation of compensation, the attorney's
proper remedy would not be to enforce the void fee agreement but rather to seek recovery
of the reasonable value of services rendered under a theory of quantum meruit.14

Also relevant are cases declining to enforce fee agreements that interfere
with the client's analogous right to end the attorney-client relationship.15 In confirming
that this right belongs exclusively to the client, courts have invalidated not only
agreements that directly restrict the client's ability to exercise the right, but also
agreements that use mechanisms such as nonrefundable retainers16 to discourage exercise
of the right by burdening it indirectly.17 As the New York Court of Appeals stated in In
re Cooperman, an attorney disciplinary case, the problem with "special nonrefundable
retainers" is that they "alter[] and economically chill[] the client's unbridled prerogative
to walk away from the lawyer."18 The court added that to "answer that the client can technically still terminate misses the reality of the economic coercion that pervades such
matters."19

In their treatise, The Law of Lawyering, professors Geoffrey C. Hazard, Jr.
and W. William Hodes conclude that the pressure inherent in convertible fee agreements
makes them unacceptable. Describing an analogous fee-conversion provision, albeit one
triggered by a client's decision to reject a settlement offer, they write:

Even if an adequately counseled client had agreed in advance
to such an arrangement, it probably could not stand in the
face of Model Rule 1.2(a) and Restatement § 22, which
allocate decisions as to settlement to the client . . . . Although
a lawyer can and should forcefully argue against rejection of
an offer that ought to be accepted, she cannot use this form of
economic coercion to force the issue.[20]

A number of bar association ethics opinions support this view, ruling that
conversion agreements are invalid if they change contingent fees to hourly fees when a
client wishes to accept a settlement that the attorney thinks is inadequate. The State Bar
Professional Ethics Committee of Wisconsin has written, after describing such an
agreement:

In that situation, it would be improper for the lawyer
to attempt to charge on an hourly basis. If the lawyer were
permitted to charge on an hourly basis, the client, to some
extent, loses control of his case as he or she would face the
choice of a lawyer's bill he cannot afford and a lawsuit which
he or she doesn't want to pursue. Moreover, the large
attorney's fees which are generated by the contingent fee can only be justified because of the risks the lawyers must bear of
not making an adequate recovery to cover his or her time in
certain cases. The client's desire to accept a less than
satisfactory settlement offer is an inherent part of that risk.
To suggest a lawyer can have it both ways with the use of the
proposed clause is not acceptable to the committee.

Therefore, to include the proposed language in the
contingent fee contract so as to permit charging a client on an
hourly basis if the lawyer deems a settlement offer
inadequate, is, in the opinion of the committee, overreaching
and, therefore, unethical.[21]

The Nebraska State Bar Association's ethics committee reached a similar
conclusion:

It is the opinion of the Committee that a contractual
agreement whereby a client electing to settle a case for an
amount less than the amount which the attorney believes is
the reasonable value of the case, may be charged an hourly
fee, instead of the contingent fee otherwise agreed upon,
unduly restricts the client's ability to accept settlement offers
and may result in excessive charges. Such a contractual
provision is not permissible.[22]

And the Ethics Committee of the Colorado Bar Association has similarly
indicated that "a contingent fee agreement that converts to an alternate fee if the client
settles a claim (or refuses to accept a settlement) contrary to the attorney's advice is
void."23

The case at bar exemplifies the tensions created by the structure of hybrid
agreements like the one used by Kittleson. Under a pure contingent-fee agreement, the Nelvises would have recovered approximately $15,000 from Cream Puff's $25,000 offer
- only slightly less than the price they paid for the used car. But under the feeconversion
provision, Kittleson's fees, when calculated at the agreement's hourly rate,
exceeded the amount of Cream Puff's offer, leaving the Nelvises with less than nothing:
under the hybrid agreement, accepting the offer would have triggered the conversion
from contingent to hourly fees, thus obliging the Nelvises to pay Kittleson more than
$30,000 in fees while giving them only $25,000 to satisfy the new obligation.24

The impact of this "fee surprise" is compounded by the predictable
difficulty of forecasting the effects of the fee-conversion provision. Given the number
of variables involved - the merit and strength of the client's claims, the probable timing
and size of a settlement offer, and the work required to achieve settlement - it seems
unrealistic to expect that prospective clients like the Nelvises would be able to appreciate
the risks and benefits of the disputed fee provision. It seems unlikely, too, that the
attorney-client agreement between Kittleson and the Nelvises, with a single sentence
devoted to the fee-conversion provision, satisfies an attorney's duty to fully explain the
terms of a fee agreement in such a way that the client can understand.25

In defense of his agreement, Kittleson argues that attorney's fees are a
"constant pressure" in almost any litigation and quite often influence settlement decisions. Kittleson also contends that the Nelvises "would have been in exactly the same
position" had they entered into a traditional hourly fee agreement. While it is true that
the costs of litigation often influence strategy, Kittleson's response ignores a key
distinction between a convertible fee agreement and one based on straight hourly fees:
the delayed impact of actuating a "springing" obligation to pay for work already
performed but never before chargeable to the client. Because the potential cost of a
future obligation of this kind and the potential value of the right the client is asked to
forgo to avoid the obligation are both largely incalculable at the inception of the attorneyclient
relationship, when the fee agreement is signed, we conclude that the fee-conversion
provision at issue here impermissibly burdens the client's right to settle a case.

Kittleson nonetheless defends the convertible fee agreement as justified on
public policy grounds. He notes that Alaska's consumer protection laws are designed to
encourage the use of private damages actions as a means of curtailing unfair trade
practices.26 He further notes that, to encourage attorneys to handle such cases, Alaska
law also authorizes an award of "full reasonable attorney fees at the prevailing reasonable
rate" when the client wins a claim at trial.27 According to Kittleson, then, to give full
effect to the legislative intent, the attorney must be allowed to include an "hourly
component" to a standard contingent-fee agreement in order to promote the attorney's
ability to earn full fees. "It is not the law or an ethical canon that an attorney must work
for free," Kittleson reasons, "and because the Legislature wants to encourage private
enforcement and representation . . . it is imperative that attorneys in the consumer protection arena be allowed to utilize fee agreements that lead to adequate
compensation."

Moreover, Kittleson alleges systematic abuses in such cases by defendants
who use a "divide and conquer" strategy that aims to encourage early settlement by
clients for modest sums, while driving up unrecoverable costs to their attorneys.
Kittleson suggests that a hybrid hourly fee provision like the one he uses is justified as
a response to these abuses; he asserts that as matters currently stand, it is difficult for
consumers like the Nelvises to find attorneys willing to handle small unfair practices
claims.

Although Kittleson offers no support for his claim that a shortage of willing
attorneys exists, we readily accept his premise that the attorney's fees provisions of
Alaska's consumer protection laws were designed to encourage attorneys to handle
consumer protection complaints, even when they are small. Yet the policy of
encouraging attorneys to participate in these cases subserves the Consumer Protection
Act's overarching goal of encouraging small consumer protection claims. It hardly
follows that this broader policy goal would be served by a fee agreement enabling
attorneys to compromise the procedural rights of their clients - the parties whose rights
the law ultimately strives to promote. To the contrary, it would seem anomalous to
encourage the successful resolution of consumer rights claims by adopting a practice
designed to penalize the claimant for accepting a reasonable offer to settle. In light of
the ethical and practical dangers posed by the hybrid agreement, then, we think that
Kittleson's policy arguments lack merit.

* * *

For the full text of this opinion, go to: http://www.state.ak.us/courts/ops/sp-6197.pdf