Contingent-fee caps don't achieve 'reform' goals, study finds.

Capping contingent fees isn't helping accomplish tort "reform," according to a study published by the conservative American Enterprise Institute. (Two Cheers for Contingent Fees (Aug. 2005).) Two economics professors found that restrictions on contingent fees are unjustified, produce unintended negative consequences, and "will most likely tend to wash more low-value 'junk suits' into the legal system." Also, they found, the fees do not cause higher awards.

"This is a significant study because it comes from an unusual source: supporters of tort restrictions," said Bob Peck, president of the Center for Constitutional Litigation in Washington, D.C. "The economists who wrote this study went beyond anecdote and biased assumptions and looked at the data to find that the contingent-fee system works to enable access to the courts and weed out frivolous cases. It makes one hope that the same technique would be applied by them to realize the poverty in the arguments for other so-called reforms," Peck said.

Professors Alexander Tabarrok of George Mason University and Eric Helland of Claremont McKenna College analyzed closed cases in 16 states--8 with no caps and 8 with contingent-fee caps for medical malpractice cases (but not auto cases). They used data from the 1992 Civil Justice Survey of State Courts, compiled by the Department of Justice and the Bureau of Justice Statistics. The survey did not include class actions--which are a "special problem," the authors said--but they reasoned that contingent-fee caps would have the most effect in individual med-mal and personal injury suits.

"If America has been called 'lawsuit hell,' contingent-fee lawyers have often been cast as the devils," Tabarrok and Helland wrote. The argument runs like this: Contingent fees encourage excessive and frivolous litigation and create conflicts of interest between client and attorney; thus, they should be capped or limited, like noneconomic damages.

However, the AEI study found that contingent fees

* give lawyers an incentive to screen cases and weed out the "frivolous" ones.

* motivate lawyers to win.

* improve access to the courts for low-income plaintiffs, because they don't pay if they lose and they would otherwise lack the financial resources to file meritorious suits.

* help spread risk, because "a contingent-fee lawyer is, in effect, a venture capitalist of torts," who takes significant risks, puts up funds, and brings needed expertise to a case.

Screening is a major function of contingent fees. "We should expect contingent-fee lawyers to tell their clients they are fools more often, or at least earlier, than lawyers paid by the hour," wrote the authors. Hourly fees actually increase the frequency of low-value claims, they argued, because lawyers paid by the hour will be more willing to take weaker cases. Eventually, clients with weak cases will drop them when they realize they cannot win.

To back this up, the authors examined the rates of dropped cases in states with contingent-fee caps, where presumably more lawyers charge by the hour. In states with caps, a "whopping 18 percent" of cases were dropped, compared with about 5 percent in states without caps.

The study found no evidence that contingent fees affect settlement rates, but it did find that they reduce the time to settlement. The authors hypothesized that lawyers charging by the hour have no incentive to settle, so when contingent fees are restricted and more lawyers move to hourly charges, "we expect that cases will take longer to be settled." The data revealed that restricting contingent fees increased the time to settlement by 22 percent.

The authors also found little evidence that contingent-fee lawyers earn above-normal returns; rather, they concluded that hourly and contingent-fee lawyers earned roughly equivalent returns.

And capping contingent fees did not lower awards. The data showed the exact opposite: Awards in the states with caps were more than twice as high as in those without restrictions. This data should be taken "with several grains of salt," the authors wrote, since they did not control for other factors. But they wanted to "make the prima facie argument that restricting contingent fees does not greatly reduce awards."

The authors concluded that the problem is not how lawyers are paid, but that the court system does not do a good job of screening meritless cases. "Blaming contingent fees for out-of-control courts is like blaming credit cards for personal bankruptcy," they wrote.

"Contingent-fee caps are a poor proxy for better-targeted reforms that would address the true problems of the liability system."

"While it is heartening that these economists have found that contingent fees are a positive good and not the devil they are portrayed to be, they would now be well advised to bring the same empirical scrutiny to the false claim that the courts are out of control," said Peck.