Editor's Note:
State Bar Ethics Opinions cite the applicable California Rules of Professional Conduct in effect at the time of the writing of the opinion. Please refer to the California Rules of Professional Conduct Cross Reference Chart for a table indicating the corresponding current operative rule. There, you can also link to the text of the current rule.
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What ethical issues arise in the use of structured settlements to resolve civil disputes?
Members may participate in using structured settlements to resolve civil disputes. It is not a conflict of interest to recommend the acceptance of a settlement. The manner in which the structured settlement is valued must be considered so that the total compensation provided to the member does not violate rule 2-107.
Rules 5-101 and 2-107 of the Rules of Professional Conduct of the State Bar of California.
Counsel in a personal injury action represents the plaintiff pursuant to a contingency fee agreement by which the attorney will receive one-third of the gross settlement obtained in the case or, 40% of any favorable verdict. The agreement also provides that if a structured settlement is agreed to by the client, then the attorney's fees would be paid in a lump sum at the time of settlement. However, the agreement does not state how the attorneys fees are to be calculated in the event of a structured settlement.
The defendant's counsel offers to settle the case alternatively offering a lump sum or a structured settlement by which the plaintiff/client would receive a lump sum cash payment at the time of settlement, plus periodic payments over the course of the remaining life expectancy of plaintiff. The defendant will purchase the structured settlement in the form of an annuity from an insurance company at the cost of $X. However, the structured settlement amounts have a present cash value of $Y if traditional calculations are used to compute the present cash value. $Y in this instance is an amount substantially less than the actual cost of the annuity ($X).
The principal question is to what extent the use of a structured settlement within the context of the above-described hypothetical presents a conflict of interest for the involved attorney. In this regard, rule 5-101, California Rules of Professional Conduct, states as follows:
A member of the State Bar shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless (1) the transaction and terms in which the member of the State Bar acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in manner and terms which should have reasonably been understood by the client, (2) the client is given a reasonable opportunity to seek the advice of independent counsel of the client's choice on the transaction, and (3) the client consents in writing thereto.
In recent years structured settlements have been employed with great frequency to achieve settlement in a host of disputed matters. While the impetus for the use of structured settlements originally came from the personal injury bar, it is now common to find the use of structured settlements in other forms of personal disputes, as well as in sophisticated and complex commercial litigation.
Structured settlements differ from lump sum settlements in several important ways. Unlike lump sum settlements, only a portion of the settlement corpus is paid at the time the settlement is achieved ("up front money"). Most of the proceeds are paid in weekly, monthly, or annual installments to the claimant. The deferred payments might increase over time by an agreed percentage, and may include lump sums at 5, lO, 15 year settlement anniversary dates, or longer. Frequently, the deferred installment payments are guaranteed for a number of years, despite the longevity of the claimant. These are all matters subject to negotiation, and depend upon the circumstances of each case.
One of the principal benefits to the claimant in accepting a structured settlement offer may be the expectation that it will result in substantial tax savings to the receiving party over a lump sum settlement. In appropriate cases, that portion of the structured settlement which involves periodic payments is not subject to federal taxation. Moreover, a fiscally unsophisticated client would realize the benefit of guaranteed, long-term free account management.
On the other hand, an advantage to the defendant offering a structured settlement is that it requires less money to achieve the same net result or benefit to the claimant as does a lump sum. In general terms, a defendant may be encouraged to offer structured settlement because the actual aggregate cost for the settlement is less than a comparable lump sum settlement, both of which achieve the same after tax result to the claimant. Of course, if the paying party is funding the periodic payments out of its own operating capital, its benefit is usually considered to be the value of its continued use of the deferred settlement corpus until the payments are usually made.
The member whose client accepts a structured settlement proposal may well receive less attorney's fees under his contingency fee arrangement than if a comparable lump sum settlement were achieved. This is because the percentage of the attorney's fees in the context of a structured settlement will be based upon the present value of the settlement.1
This same issue has been considered by the Ethics Committee of the Board of Professional Responsibility of the Supreme Court of Tennessee in its opinion No. 84-F-77 (1984). The Tennessee Committee noted succinctly that: "Frequently, structured settlements create a conflict of interest between the lawyer and client because the settlement may be beneficial to the lawyer or the client and detrimental to the other, based on their respective financial situations."
However, in California, our Legislature has decreed that contingency fee agreements, which otherwise involve inherent conflicts of interests (as arguably do other forms of attorney compensation) are exempt from the effect of conflict of interest rules because of public policy (Business and Professions Code section 6146). This is because of the widely held belief that it is in the interest of the public to promote access to the judicial system by allowing those without the means to pay to engage counsel on a contingency fee basis. Since the interests of the public are better served by allowing contingency fee agreements, they have been deemed to be generically beyond the reach of our conflicts of interest rules.
When viewed in the context of our rule 5-10l and the above hypotheticals, the Committee is satisfied that a member does not acquire a pecuniary interest adverse to a client if the attorney advocates that a client accept or reject a structured settlement offer where the attorney's portion of the fee may be adversely affected by the client's decision. We see the question as involving nothing more than a variation of the same considerations that impact contingency fee agreements generally. If public policy prevails over a conflicts analysis when considering contingency fee agreements generically, we see no reason to find that it does not similarly control here.
As noted above, courts have generally viewed counsel's entitlement to fees from a structured settlement to be limited to some percentage of the present cash value of the settlement. (See Johnson v. Sears Roebuck & Company (1981) 436 A.2d 675; Sayble v. Feinman (1981) 76 Cal.App.3d 509 [142 Cal. Rptr. 895].) The manner in which the member's fee is calculated may give rise to another ethical consideration. In many instances, depending upon market factors, the means chosen by the member to calculate a present cash value could result in significantly differing amounts. However, the hypothetical above suggests that there are instances where the assumed present cash value may be less than the actual cost of the annuity.
A member must be mindful of the prohibition against the receipt of unconscionable fees provided for in rule 2-107. Generally, a fee is considered to be unconscionable when:
It is so exorbitant and wholly disproportionate to the services performed as to shock the conscience of lawyers of ordinary prudence practicing in the same community. Reasonableness shall be determined on the basis of circumstances existing at the time the agreement is entered into except where the parties contemplate that the fee will be effected by later events.
A member should employ independent consultants or resources in a good faith effort to calculate the present cash value of a proposed structured settlement.2
This opinion is issued by the Standing Committee on Professional Responsibility and Conduct of The State Bar of California. It is advisory only. It is not binding upon the courts, The State Bar of California, its Board of Governors, any persons or tribunal charred with regulatory responsibilities or any member of the State Bar.
1 Attorneys are not entitled to contingency fees at the time of settlement based upon the total of cash payments to be paid to the injured party over his or her anticipated life expectancy. Rather, the fee must be based on the contingency percentage of lump sum payments plus the value of the annuity. (Johnson v. Sears Roebuck & Co. (1981 Pa.) 436 A.2d 675.)
2 This Committee does not mean to suggest that the actual cost of the annuity, if known, cannot serve as the present cash value. In many cases, the cost will, in fact, represent present value.
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