Permission Plus: Reaching the Pareto Optimal Guideline for Contingency Fees in Mediation All progress is precarious, and the solution of one problem brings us face to face with another problem.
Martin Luther King Jr., 'Strength to Love,' 1963
Introduction The term “contingency fee” comes with baggage. You have probably heard it on television in a context similar to this: “If you have been hurt in a car accident or on the job, call us. We don’t get paid unless you get paid.” But do contingency fees belong in mediation? Many of mediation’s commentators, ethics codes and court rules answer that question with an emphatic “No”.1 However, the most recent draft of the Model Standards of Conduct for Mediators says: “Yes”.2
The foremost argument against contingency fees in mediation is that this type of fee structure gives the mediator a stake in the outcome, causing the mediator to become biased, lose impartiality, and undermine party self-determination by employing unethical tactics to move parties towards settlement.3 The counterargument is that there are different categories of contingency fee such as; percentage-of-settlement, success fee, percentage-of-cost-saving and percentage-of-value-created.4 Percentage of settlement is not the sole method of contingency fees and some of the other forms, when coupled with informed party consent, align the mediator’s goal with the parties’ goal of reaching settlement without infringing on impartiality.5 Additionally, rather than undermining party self-determination, allowing contingency fee structure bolsters party self-determination by giving the parties a voice in creating their own fee structure.6
This paper argues for the Model Standards of Conduct for Mediators to adopt a more nuanced standard that adds safeguards requiring high quality, explicit, and informed party consent combined with a prohibition against contingency fees based on the percentage of the parties’ settlement.7 The contingency fee structure creates self-interest on the part of the mediator in the outcome of the mediation, and efforts to get party consent must be made mandatory in order to counterbalance the compromising affect that contingency fee structure has on the bedrock principle of mediator neutrality. Part I looks at the Model Standards of Conduct for Mediators and how the change in the 2004 Draft’s approach to contingency fee mediation came about. Part II focuses on the argument made by Scott Peppet that not all forms of contingency fee mediation destroy mediator impartiality.8 In Part III, this paper looks at mechanisms to insure informed consent in contracting for a contingency fee structure in mediation. Part IV focuses on precedents from other states and organizational mediator guidelines that cover fees in mediation. Part V advocates that the Model Standards of Conduct for Mediators should adopt language banning only the percentage of settlement contingency fee structure, allow other forms of contingency fee mediation, and implement required informed consent mechanisms which insure that parties understand the tradeoffs that they make when hiring a mediator to work on a contingency fee basis. As it stands today, the 2004 Draft leaves the door open for the use of contingency fee mediation without properly safeguarding a potentially exploitative practice.
I. The Model Standards of Conduct for Mediators and the Rationale for Change a. The Model Standards of Conduct for Mediators
The American Arbitration Association (AAA),9 the American Bar Association (Section of Dispute Resolution),10 and the Society of Professionals in Dispute Resolution (now merged into the Association for Conflict Resolution)11 collaborated in 1994 to draft the Model Standards of Conduct for Mediators (1994 Standards).12 The 1994 Standards served three purposes: as a guide for practitioners, to inform potential clients, and to increase the public confidence in the mediation process.13 Since 1994, mediation has grown exponentially.14 As a result, “representatives from the original participating organizations [Joint Committee]15 believed it important to review the 1994 Version to assess whether changes were warranted.”16
The Joint Committee started their review of the 1994 Standards in September of 2002.17 “[O]ne of the Joint Committee’s guiding principles was that substantive changes to the 1994 Version would be made only if there were evidence that current practice or policies warranted such changes.”18 The Joint Committees’ final draft dated December 29, 2004 (2004 Draft) contains substantially different language from the 1994 Standards in the area of fees.19 In the comment section of Standard VIII, the 1994 Standards spell out an absolute prohibition against mediator’s use of contingency fees stating that: “A mediator should not enter into a fee agreement which is contingent upon the result of the mediation or the amount of the settlement.”20 The 2004 Draft replaces the 1994 Standards prohibition against contingency fees with language which leaves the door open to the use of contingency fees in mediation. Standard VIII of the 2004 Draft states that “[a] mediator shall not charge fees in a manner that impairs a mediator’s impartiality . . . [and] should not use fee arrangements that adversely impact the mediator’s ability to conduct a mediation in an impartial manner.”21 While some of the Joint Committee’s members interpret the 2004 Draft as not allowing the practice of contingency fee mediation, the reasoning behind the change does not endorse that interpretation.22 b. Rationale for Change In the article Remodeling the Model Standards of Conduct for Mediators, Jamie Henikoff and Michael Moffitt critique the 1994 Standards for leaving out the rich discussion that the drafters held when creating the Standards.23 The recently published Reporter’s Notes partially address that concern. While not officially part of the 2004 Draft, the Reporter’s Notes do provide some commentary regarding the Joint Committee’s revisions process.24 When referencing the change to Standard VIII, the Reporter’s Notes cite the Joint Committee’s concern that a flat ban on certain fee arrangements might raise anti-trust issues and may subject the adopting organizations to Federal Trade Commission (FTC) investigation.25 This concern stemmed specifically from a recent action brought by the FTC against the National Academy of Arbitrators (NAA) for NAA’s alleged unreasonable restraint on competition.26
The FTC’s complaint targeted NAA for restraining competition among its members “by restricting advertising and solicitation by its members.”27 The FTC found that provisions of NAA’s “Code of Professional Responsibility for Arbitrators of Labor-Management Disputes and Formal Advisory Opinions . . . restrain arbitrators from engaging in truthful, non-deceptive advertising and solicitation, regardless of whether such advertising or solicitation compromise arbitrators’ impartiality.”28 In the complaint, the FTC further found that NAA’s restriction on competition was unreasonable and resulted in depriving potential consumers from truthful and non-deceptive advertising and solicitation and the benefit of unrestrained competition among arbitrators.
The problematic language of NAA’s Code of Professional Responsibility (Code) stated: “An [a]rbitrator must not solicit arbitration assignments . . . [S]olicitation, as prohibited by this section, includes the making of requests for arbitration work through personal contacts with individual parties, orally or in writing.”29 Additionally, the NAA’s Code significantly restricted arbitrators from advertising regardless of whether the advertising was false or misleading. The FTC’s investigation also discovered problematic Formal Advisory Opinions (Opinions).30 The Opinions, official interpretations of the Code, were problematic according to the FTC because they did not distinguish between advertising and solicitation, consequently restricting NAA’s members from distributing truthful information.31 Examples of the Opinions alleged as unlawful restriction on commerce by the FTC are Opinion 14 which held that an arbitrator is in violation of the Code if he sends an unsolicited mailing to representatives of both labor and management with truthful biographical information. Opinion 16 found Code violations for sending out change of office address notifications which included both a resume and cost schedule. Opinion 18 concluded that handing out business cards to potential clients unrequested is unethical. And Opinion 19 stated a Code violation for giving out pens to potential clients to inform them of a change of address.32 The FTC found that NAA’s Code combined with the Opinions was a violation of Section Five of the Federal Trade Commission Act.33
In response to the FTC’s complaint the NAA drafted a consent order later adopted by the FTC.34 While NAA’s consent order did not constitute an admission, it did outline the corrective actions the NAA was willing to take to resolve this matter. The NAA agreed to remove restrictions on truthful advertising and solicitation from the Code. However, the consent order did not “prohibit Respondent [NAA] from formulating, adopting, disseminating to its members and enforcing reasonable ethics guidelines governing conduct that Respondent reasonably believes would compromise or appear to compromise the impartiality of Arbitrators.”35 Looking at the language of the 2004 Draft’s standard VIII (B), it is obvious that the Joint Committee took a very conservative approach in mirroring the language of FTC’s decision and order of consent with the NAA.36 II. The Concern: Impact of Contingency Fee on Mediator Impartiality
The literature addressing contingency fees in mediation is sparse.37 One commentator, Scott Peppet, however, has written in depth about the subject. Peppet defines contingency fee mediation as “compensation that depends in any way – such as amount, form, or timing – upon some characteristic of the mediated outcome.”38 He outlines four categories of contingency fee mediations. He labels the first category “percentage-of-settlement” whereby the mediator’s fee is determined by the percentage of the settlement amount. The second category is “success fee” where the mediator’s fee is contingent on the parties reaching settlement in a mediation. The third category “percentage-of-cost-saving” fee is a percentage of the estimated savings that the parties obtained through using mediation rather than an alternative process, presumably litigation. The fourth and final category Peppet describes as “percentage-of-value-created” fee. In this payment scheme, the mediator is paid a percentage of the “new pie”39 created through mediation.40
All of these payment mechanisms are outcome focused and if the mediation does not result in settlement, then the mediator does not get paid the contingent fee. Peppet concedes that the classic form that many people associate with a contingency fee structure i.e. taking a percent of the settlement reached, is not appropriate for mediation because it creates mediator self-interest in a settlement with the highest payout.41 However, he contends that there is room in mediation for the other three models which include success fess and fees that are contingent on a percent of transaction cost saving or the increased value created, because it does not create mediator bias towards a specific form of settlement.42 He argues that “in some instances a mediator can be self-interested . . . in the outcome – without sacrificing impartiality.”43
Peppet recognizes that mediating on a contingency fee basis creates both a “settlement bias” and a “process bias”, but he draws the conclusion that this “settlement bias” and “process bias” do not undermine mediator impartiality.44 “Settlement bias” is when the mediator is no longer neutral as to whether the dispute reaches settlement, but does not bias the mediator towards one outcome versus another. In relation to “settlement bias,” Peppet explains that “[a]lthough the success fee creates a settlement bias, it does not necessarily make the mediator partial to one side or the other . . . [and] does not undermine the mediator’s . . . core functions.”45 Peppet argues that the “settlement bias” can be a good thing by aligning the mediator’s interest with the parties’ joint interest of settlement.
Peppet defines “process bias” as mediators utilizing techniques that lead towards settlement, rather than techniques that target less tangible issues such as transforming the parties’ relationship. This bias, Peppet contends, can be combated by informed party consent. Due to the “settlement bias” and “process bias” created by the contingency fee structure, Peppet suggests a rule that “would categorically deny the possibility of percentage-of-settlement fees” because that fee structure creates mediator partiality towards the outcome of high money payment.46 Additionally, Peppet stresses the importance of “high quality consent.”47 According to Peppet's argument, the Model Standards can be interpreted as permitting contingency mediation because, as he explains, not all forms of contingency fees result in a lack of mediator impartiality. The concern then becomes, where are the safeguards for party informed consent? Furthermore, what should those safeguards look like?
III. The Plus of Permission Plus: Informed Consent Party informed consent is crucial to the principle of self-determination and this need is compounded when practitioners offer parties the choice of working on a contingent fee basis.48 Providing parties with an understanding of how mediating on a contingency changes the dynamic in mediation involves two elements, disclosure and consent.49 Disclosure involves educating the parties about the outcome and process bias that contingency mediation creates. Consent covers the voluntary agreement of a party to participate in the mediation once they have understood the disclosures.
Peppet outlines two ways that mediators might give disclosures and obtain party consent. One way, the far less protective of party self-determination, is to gain party consent to contingency mediation through constructive consent and let market forces keep the mediator honest.50 Constructive consent puts the burden on the mediator to decide for the parties “whether either party could reasonably reject the mediator’s proposed intervention if that party had full information about the mediator’s proposed actions and intentions.”51 If the mediator decides that the parties could not reasonably reject the mediator’s actions, were they fully informed, then the mediator should “feel comfortable” proceeding in that manner.52 The constructive consent mechanism violates the principle of party self-determination because the mediator is substituting their own judgment for the parties. By using constructive consent the mediator is giving themselves, rather than the parties, the decision making capacity. Even though the mediator is subject to outside forces such as reputation, and in some cases the presence of counsel, it is the mediating parties themselves who are the decision makers, and no market force is a legitimate substitute for the opportunity of those parties to understand and consent to the effects of paying the mediator on contingency.
The second course of action is explicit informed party consent. Explicit disclosure and consent is achieved by the mediator explaining the effects of contingency fee mediation to the parties either in a handwritten or verbal form and then obtaining the parties voluntary consent.53 Some critics argue that mediators will not use this method because it is more labor intensive and may be seen as a turn off to the parties.54 Others say that “at a minimum, the principle of informed consent requires that parties be educated about the mediation process before they consent to participate in it.”55 In order to preserve the integrity of the mediation process, which is founded on the principle of party self-determination, any ethical standard that allows for contingency fee mediation should also provide the safeguard of requiring mediators to give explicit disclosures and get explicit consent from the parties. In fact, most standards that permit contingency fee mediation do provide such safeguards.56 IV. Current Landscape: Two Approaches Prohibition Versus Permission57 a. Prohibition
The majority of organizational ethical guidelines and state rules do not allow for mediators to work on contingency.58 These standards regulate contingency fee mediation by incorporating a flat ban on the use of contingency fee mediation (traditional approach). Prominent organizational standards that adopt the traditional approach include the Association of Attorney-Mediators Ethical Guidelines for Mediators, which states: “A mediator should not charge [a] contingent fee or a fee based on the outcome of the mediation.”59 Likewise, the Proposed Standards of Practice for Lawyers Who Conduct Divorce and Family Mediation, drafted by the American Bar Association Family Law Section Task Force, taking the language from the 1994 Standards, states: “A mediator should not enter into a fee agreement which is contingent upon the results of the mediation or the amount of the settlement.”60 Additionally, in 1984 The Academy of Family Mediators (AFM) and the Association of Family and Conciliation Courts (AFCC) drafted standards which also adopt the traditional approach by stating: “It is inappropriate for a mediator to charge contingent fees or to base fees on the outcome of mediation.”61
Many state standards also implement the traditional approach to contingency fee mediation. Two leaders, Florida and California, ban the use of contingency fee mediation.62 The Florida Rules for Certified and Court Appointed Mediators prohibit contingency fee mediation by stating: “A mediator shall not charge a contingent fee or base a fee on the outcome of the process.”63 California’s standards of practice state: “A mediator shall not charge a fee contingent upon the outcome of the mediation.”64 Other states, which like California and Florida take the traditional route, include (but are not limited to) Alabama,65 Arkansas,66 Georgia,67 Idaho,68 Illinois,69North Carolina,70 Pennsylvania,71 Texas,72 Virginia,73 and states such as Alaska,74 Colorado,75 Kansas,76 Maryland,77 South Carolina,78 and Washington79 that have adopted the language from the 1994 Model Standards.
b. Permission Juxtaposed with the myriad of organizational and state specific standards that regulate contingency fee mediation in the traditional manner of banning the practice, there is a minority of modern standards that exhibit a small but significant shift away from the traditional flat ban on contingency fee mediation (modern approach). These more recently revised standards include, CPR-Georgetown Model Rules for the Lawyer as Third-Party Neutral (CPR Model Rules),80 Hawaii’s Mediation Guidelines,81 the February 25, 2004 Committee Recommendation to Oregon State Mediation Standards of Practice,82 and the European Code of Conduct for Mediators (European Code).83
The CPR Model Rules are the most comprehensive of the standards that utilize the modern approach. CPR’s Model Rule on fees couples contingency fee mediation with requirements for explicit disclosures. The CPR Model Rules were completed in 2002. The CPR Model Rules are intended to apply to lawyers who serve as third party neutrals in different Alternative Dispute Resolution (ADR) settings. They are not meant to cover ethical requirements for non-lawyers acting as third party neutrals or for lawyers in the role of advocates in ADR. Furthermore, the CPR Model Rules were drafted with disciplinary consequences in mind for violations of the Rules. The relevant commentary section addressing contingency fee states:
While controversial, contingent fee or bonus compensation schemes are sometimes used to provide incentives to participate in ADR or to reward the achievement of an effective settlement. Section (c) does not prohibit such fee arrangements (which some jurisdictions or provider organizations do) but requires the neutral to explain what the effects of such a fee arrangement may be, including conflicts of interest. This Model Rule imposes two obligations on the neutral. The lawyer-neutral is required to assess the possible conflicts attendant to use of such fee arrangements and whether the appearance or actuality of partiality prohibits its use under this Model Rule 4.5.3 (Impartiality). If use of the compensation arrangements is not prohibited under that standard, the neutral is required to disclose the possible consequences of this fee arrangement to the parties.84 As stated in the comments, the CPR Model Rules do not implement the traditional approach, but the Rules do require the mediator to take two affirmative steps if they choose to mediate on a contingency basis (permission plus). One, the mediator must personally assess how working for a contingency fee will affect the process. Although not explicitly expressed in the comment, this part of the two step requirement could be interpreted as banning percentage of settlement contingency fee mediation because as explained in Part II, the percentage of settlement fee structure creates an unethical level of mediator partiality towards a specific outcome.85 The second affirmative step the lawyer-mediator is obligated to take is giving parties express disclosure of the affect contingency fee mediation may have on the process. CPR’s Model Rules outline a permission plus model, wherein it permits contingency fee mediation while at the same time placing affirmative obligations on the mediator who chooses to work on a contingency. It is this type of permission plus that the 2004 Draft of the Model Standards lack.
The two state standards that permit contingency mediation are Hawaii’s and Oregon’s Committee Recommendations. Both involve replacing the traditional approach to contingency fee mediation with the modern approach. Hawaii revisited its Mediation Guidelines in 1999 upon the request of Hawaii’s Chief Justice. The Hawaii Chapter of the Society of Professionals in Dispute Resolution revised the Mediation Guidelines and submitted recommendations on May 14, 2002. The Judiciary endorsed the changes.86 The Hawaii Guidelines lay out three options that agencies and private mediators can choose from when dealing with contingency fee mediation. The three possibilities are:
(1) Neither mediators nor their agencies should charge contingent fees or base fees on the outcome of mediation.
(2) Neither mediators nor their agencies should charge contingent fees or base fees on the outcome of mediation unless special precautions are taken to minimize potential conflicts associated with the fee arrangement.
(3) Charging contingent fees or fees based on the outcome is normally discouraged, although in special situations with competent advice, both participants may agree to such arrangements.87 The reporter’s notes, although not eloquently written, highlight the reason that Hawaii chose the three prong solution:
Reporter Note: There have been unresolved discussions about whether contingency fees should be allowed, i.e., this section eliminated or modified. Concern is: What happens to the mediation process if the mediator has a financial stake in the outcome? On the other hand, if contingent fees are prohibited then sophisticated participants who desire and use this type of fee arrangement would be prevented from using it.88
The Hawaii Guidelines do not go into detail about what it means to take “special precautions” or give “competent advice.”89 The reporter’s notes do give direction to practitioners about what the concerns with the use and ban of contingency mediation are and warn that “[v]irtually all standards which have considered this issue have categorically disallowed such fees.”90
The Oregon Mediation Association (OMA) Core Principles of Mediation Practice (Principles), which were adopted September 9, 2000 state: “A mediator shall not charge contingent fees or base fees on the outcome of mediation.”91 In February 2004 Committee Recommendations called to remove the categorical ban in contingency fee mediation. Although not officially adopted, the language that the Committee proposed stated: “Contingent fees, and fees based in advance, on the outcome of the mediation have a negative impact on impartial regard. Mediators are discouraged from charging them.”92 This approach discourages contingency fees without banning them. But, it fails to provide any significant guidelines for practitioners that work on contingency.
The European Code was created at a conference in Brussels held on July 2, 2004. The European Code is applicable to all practice areas of mediation and was created to promote public trust and confidence in the mediation process. The European Code does not regulate the mediation process itself but rather outlines model principals to which individual mediators or organizations can choose to subscribe. When addressing fees, the code states: “Where not already provided, the mediator must always supply the parties with complete information on the mode of remuneration which he intends to apply. He/she shall not accept a mediation before the principles of his/her remuneration have been accepted by all parties concerned.”93 The European Code seems to adopt the modern approach of permission plus by leaving the form of remuneration up to the individual mediator’s choosing and requiring that the mediator both provides explicit disclosures to the parties about the fee arrangement and get explicit consent from the parties.