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Scholarship

Nora Freeman Engstrom on the Contingency Fee Cost Paradox

engstrom_nora017_fmtThe spark for Nora Freeman Engstrom’s interest in “settlement mills” came at 
an unexpected moment while she was watching the 2004 World Series. 
One law firm ad stood out because it ran over and over again—with the lawyer in the ad 
enthusiastically encouraging clients to bring their cases to his firm for a quick settlement. 
“I had to wonder how a local law firm could possibly generate enough profit 
to purchase expensive ad time during the World Series. What was going on there?”

Since then, Engstrom, JD ’02, has learned a lot about settlement mills, as she calls these high-volume personal injury law practices, and how they resolve a staggering number of claims each year—with virtually no meaningful client interaction, rarely filing lawsuits, and almost never taking claims to trial. Today, her research is filling a significant gap in existing scholarship on how legal services are delivered and marketed at these settlement mills and the profound implications they have on legal ethics, tort law, and the operation of the civil justice system.

Engstrom’s study of settlement mills led her from private practice to academia, from Washington, D.C., to Stanford. It also left her with a lingering question.

“Everyone says that attorney advertising lowers the cost of legal services,” says Engstrom. “But the settlement mills I studied are all extremely heavy advertisers—these are the guys on big-city billboards and late-night TV. And, they all charge higher-than-average contingency fees, often 36 to 40 percent.”

This made Engstrom, an associate professor of law, wonder: Might the conventional wisdom about the salutary price effect of attorney 
advertising be wrong? That question culminated in Engstrom’s forthcoming Stanford Law Review article, “Attorney Advertising and the Contingency Fee Cost Paradox,” which indeed casts serious doubt on that “conventional wisdom.”

Engstrom began her inquiry by looking at the history of attorney advertising. “The bar banned attorney advertising starting in 1908, and the ban remained in place for many decades. Then, starting in the 1970s, the ban came under fire, in part, because it was seen as stunting the growth of new law firms called legal ‘clinics.’ ”

Invented in the 1970s, these clinics offered routine legal services (such as uncontested divorces, bankruptcies, and name changes) to a mostly middle-income clientele, for flat, transparent, and reasonable rates. Clinics were applauded as a way to provide inexpensive legal services to those who had traditionally been denied legal access. But in the early years, ad restrictions hindered their growth. Offering low-cost services such as $95 name changes, they needed a high volume of clients to stay afloat. “Without advertising, attracting that quantity of clients was nearly impossible,” says Engstrom.

On February 22, 1976, one Phoenix, Arizona, legal clinic challenged the bar’s advertising prohibition. Its challenge led to the Supreme Court’s landmark ruling, Bates v. State Bar of Arizona.

Bates struck down the bar’s long-standing prohibition on attorney advertising. In so doing, it helped legal clinics prosper. In the years after Bates, legal clinics took off and as they did, the cost of many legal services plunged. “You could get a divorce in Florida for $35,” Engstrom explains, “and newspapers in the late 1970s and early 1980s are replete with stories about new discount legal services.” Further, in 1984, these 
anecdotal reports were corroborated by an ambitious study of 3,200 lawyers by the staff of the Federal Trade Commission (FTC), which found that attorney ads reduced fees and also that those attorneys who advertised tended to charge lower fees than their non-advertising counterparts.

Since then, she said, the beneficial price effect of attorney advertising has appeared settled.

But the problem, says Engstrom, is that “a lot of time has passed since 1984 and in that time a lot has changed.” Engstrom’s research shows that legal clinics, with their routine services and reasonable rates, aren’t the biggest advertisers anymore. They scarcely even exist. Today, the dominant advertisers, by far, are personal injury lawyers. This switch in advertiser identity has long been overlooked—though it’s critically important. “There’s ample reason to believe that clinic advertising in the late 1970s and early 1980s did reduce the cost of legal services. But there’s really no reason to believe that advertising has reduced or will reduce the contingency fees charged by personal injury practitioners,” Engstrom explains.

Indeed, Engstrom’s research reveals that the FTC recognized this anomaly in its 1984 report. “Buried deep in the study,” says Engstrom, “was a brief note that, in those cities with statistically significant results, personal injury lawyers who advertised charged a 3 percent higher contingency fee, as compared with those who did not advertise.”

“Further, if advertising reduced fees, you might expect contingency fees to have dropped, while personal injury ad expenditures have soared,” she says. “But they haven’t. Contingency fees remained remarkably sticky, at around 33 percent.”

Engstrom also relies on an economic theory to challenge the putative cost-lowering effect of personal injury advertising. “Unlike legal clinics, which competed on price, personal injury lawyers compete based on quality. Economic theory suggests that, while price advertising facilitates comparison shopping, quality advertising can make prices less elastic.”

“Additionally, along a number of dimensions, personal injury lawyers closely resemble physicians,” says Engstrom, “and there’s quite good empirical evidence that physician advertisers charge more than their non-advertising counterparts.”

The upshot is that, while advertising probably did bring down the cost of routine legal services in the years immediately following Bates, there is scant evidence that advertising drives down prices in the context where it’s now most common. “This helps to unravel that settlement mill puzzle I encountered years ago—and has profound implications for the future legality of attorney advertising.” SL

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One Response to “Nora Freeman Engstrom on the Contingency Fee Cost Paradox”

  1. Thanks for a great post! In South Africa, personal injury lawyers have been charging up to similar rates, but the courts have recently intervened. South Africa has a Contingency Fees Act that regulates fees up to a cealing of 25%. However many firms have been contracting their claimants to even higher rates claiming it is legal. Of course it is these same firms with the higher percentage of fees who are the biggest advertisers.

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