If you’ve never sued or been sued, you may be forgiven for thinking that the costs of the lawsuit are paid by the losing party. However, after a case is closed, the winner of the suit may easily find that its win was a Pyrrhic victory, and that it is left with substantial costs to shoulder, without compensation. What are the impacts of this on business and how should parties best manage the related risks?
The reason for this phenomenon is a ministerial decree stating that “the amount of the lawyer’s fee charged may, in justified cases, be reduced by the court”; in other words, the court may decide to pass on to the losing party only some of the lawyer’s fee actually paid by the winning party. And the courts usually use this hammer liberally to hit anything that looks vaguely like a nail.
The lawyer’s fee is the outcome of a free-market agreement, but at the same time it accounts for a significant share of the total cost of a lawsuit.
Of course, it is understandable that the courts should be able to intervene in exceptional cases, for example if they come across an unreasonably high fee or if they suspect some fiddling behind the scenes. But the courts do not use this tool only on an exceptional basis. They do so quite routinely, even in lawsuits between businesses. So much so that it’s newsworthy among lawyers if a losing party in a case is ordered to pay the full legal fees that were incurred by the winner. There is a tendency for the courts to reduce what were actually market-rate legal fees to an amount well below the market rate, ultimately penalising the winning party.
What reasons do the courts usually cite for reducing the legal costs?
The most common reason for lowering the fees is that the lawyer’s fee is excessive, relative to the subject matter of the dispute. In such cases the court sets the legal costs to be passed on to the losing party well below the value of the claim in the case. In reality, however, a case of low value or even of no financial value may present a more complex legal challenge than a “six-figure” dispute, and may therefore require far greater expertise, more time, and more in the way of language skills or even teamwork. Not to mention the fact that the case can quite legitimately be attenuated due to difficulties in presenting proof. Besides this, the value of the disputed claim may not accurately reflect what is actually at stake in the case: there may be some other business reason for bringing the case, or the outcome of the case may determine the fate of other, contingent, claims, all of which may more than justify the client’s “investing” a significant amount in what ostensibly is a low-value suit.
The other common instance occurs with hourly-rate agreements. Here, the court tends to reduce the final amount that it considers excessive by leaving the hourly rate unchanged but by deeming a certain proportion of the hours worked to be “unreasonable” or “excessive” and thus not agreeing to pass them on to the losing party. Thus, the court does not appear to be giving an opinion on the agreement between the client and the lawyer, but on the lawyer’s pace of work –the result being the same. The work requirement as estimated by the courts is usually far from the amount of work actually warranted. The hours that are clearly visible to an outside observer (e.g., those spent in the courtroom) are usually only the tip of the iceberg in terms of the lawyer’s work – most of their work takes place behind the scenes and out of sight. Hazarding a guess as to the amount of preparatory work that was carried out behind the scenes often results in very unrealistic numbers.
The consequences of “market distortion”
In certain areas of civil law (such as family law or succession cases), it may of course be appropriate to take “social” considerations into account. But when the courts wish to take the invisible hand of the market into their own in the business arena as well, it tends to cause more problems than it solves.
This practice of the courts has many disadvantages for the litigating parties. In many cases, the winner of a lawsuit is obliged to suffer a loss of half a million forints or more, even if he or she acted in a perfectly lawful manner, and it turns out that he or she did not give cause for the lawsuit. This sometimes leads to a situation where the lawsuit is not even break-even for the winner, but is actually paid for by that party, thus ruining the “customer experience” of civil litigation as a public service.
“Unrecoverable” lawyer’s fees can also destroy the winning party’s confidence in his own lawyer. Reading the court’s judgment may lead the client to believe that his lawyer has overcharged him for her services and thus defrauded him.
In low-value cases, it is currently more “painful” to win a long-running lawsuit than not to launch the lawsuit in the first place and simply write off the amount in dispute. The result is that businesses such as insurers, banks and online stores, that handle a large number of low-value complaints, adopt the rational “dispute resolution” strategy of not making concessions to anyone, as they have no real fear of retaliation. Very few people would risk pursuing a relatively small-value dispute against them.
The winning party’s “loss” is, by the same token, the losing party’s “gain”. In a pre-litigation situation, the prospective defendant’s negotiating position is significantly better, even in the case of high-value lawsuits. The prospective defendant has no incentive to settle, because even if he loses the case, he will only have to pay (in addition to his own legal fees, of course) what he should have paid anyway. And he’ll only need to pay it many months or even years down the line. For this reason, it is currently very cheap to break a contract.
How do we deal with this phenomenon?
During the pre-litigation negotiations, it is worth estimating and “pricing in” the likely unrecoverable legal costs and then developing negotiating strategy accordingly. Whichever side you’re on, if you conclude that even if you lose the case, you won’t be significantly worse off than with the offer on the table, then it’s not worth agreeing to any disadvantageous compromises.
It makes the cost of the suit more predictable if you charge a flat rate in the suit rather than the (hourly) fee stipulated in the engagement contract with your lawyer. The relevant regulation allows you to claim a percentage, specified in the regulation, of the value of the dispute as a lawyer’s fee. Indeed, only very rarely, exceptionally in fact, do the courts reduce the rate stipulated in the regulation. The flat fee varies depending on the type and stage of the case, but can be up to 5% of the total value. A flat fee is obviously a good choice from the perspective of the winner in higher value cases.
The problem can be avoided entirely through an arbitration proceeding. In arbitration proceedings, there is usually no, or only a minimal, reduction of the requested lawyer’s fee. If the parties agree to submit their dispute to the arbitration court in their contract, the losing party will face a higher loss and the winning party will have, at most, minimal irrecoverable costs. For this reason, it’s worth “modelling” the situations in which a lawsuit may arise when drawing up the contract. If, in these situations, the lawyer’s fee is likely to be significant relative to the size of the claim, an arbitration clause may encourage the parties to cooperate and comply, even if they do end up in court.