How an Important German Constitutional Court Decision May Change the Nature of Law Practice in Germany

Last week, the German Constitutional Court(the "Bundesverfassungsgericht") published a decision that may have far-reaching implications for how law is practiced in Germany. The Court decided that a law barring contingency fees in all cases was unconstitutional. It held that, under certain narrow circumstances, there was a constitutional right to be able to bring a civil action by means of a contingency fee contract with a lawyer.

The Facts Behind the Suit

The case arose as a result of a lawsuit brought by a woman the court referred to as "Frau Hanna N." She is a descendant of a German Jew who wished to sue to receive compensation for the expropriation by the German government of an estate near Dresden. In 1990, a lawyer, "Frau Dr. T." offered to litigate the suit for a 33% contingency fee. In 1998, Frau Dr. T. prevailed and received compensation on behalf of her client of DM 312,000 (about $204,000), of which she took DM 104,000 (about $68,000).

According to statute, that was illegal: In Germany, lawyers may work for clients on an hourly basis, or they may be paid according to a legally-set schedule which links the amount of their compensation to the value of the amount in dispute. Under the schedule for example, in 1998, Frau Dr. T. would have received DM 3,300 (about $2,175) for her work. Today, she would receive about $4000.

For employing a contingent fee, Frau Dr. T was fined EUR 5,000 (about $6,590 dollars), and forced to return all but the fee she was allowed by statute to retain. She then appealed.

The Court's Decision: A Balance of State Interest Versus Individual Rights

On appeal, the Court voted 5-3 to overturn the law but not the civil penalty. Using an analysis similar to that which is used in American constitutional law, the German Court identified the state's interest in regulating legal fees, and weighed it against the rights or freedoms burdened by such a regulation.

The state's interest, the Court noted, is to protect clients from their lawyers' greed. The Court pointed out that where a lawyer's own "business interest" is introduced into a case, she might - albeit perhaps unconsciously -- pursue her own goals over that of her client.

Against this evil, the Court weighed two rights, or freedoms: the client's right to access to the courts in civil cases, and the lawyer's right to freely practice her profession. The absolute bar on contingency fees interfered with both these rights.

The First Right: Hanna N.'s Right to Access to the Courts

First, let's look at Frau Hanna N's right to access to the courts. Like most American states, and the federal courts, Germany guarantee access to the court in civil cases against unreasonable limitations on the kind of claims that can be brought and the procedures under which those claims must be brought. Moreover, in Germany, there is legal aid for the poor in civil cases. (In the U.S., of course, there is not.)

But Hanna N. was not poor. She just did not want to pay Dr. T. by the hour. Nor did Dr. T. want to take the case for the statutory amount that would apply if she did not charge an hourly rate. Furthermore, Hanna N. was also concerned about the cost of potentially paying her opponent's attorney's fees if she lost. (Germany follows the "English Rule"--loser pays.)

The Court held that Hanna N.'s access to the courts in this restitution case was burdened in this case, because although she believed she had a strong case, she was neither rich enough to risk losing it, nor poor enough to qualify for legal aid.

The Second Right: Dr. T's Right to Practice Her Profession

The Court also held that Dr. T.'s right to practice her profession was burdened by the ban on contingency fees. Dr. T., after all, did believe in Hanna N.'s case. Indeed, she was willing to invest her own money in the case. Like contingency fee lawyers in the U.S., she offered to work for nothing if Hanna N. lost. Moreover, she also offered something contingency fee lawyers in the U.S. do not offer (since we in the U.S. do not follow the English Rule): She also offered to pay the legal fees of Hanna N.'s opponent's lawyers if she lost.

The Court noted that the German Constitution guarantees German lawyers the right to practice their profession without undue interference from the state (a right that has a particular significance given the history of German lawyers under the Third Reich). In this case, a lawyer claimed she could bring a meritorious case only if she was able to carry the cost of the litigation for her client, and only if she were able to receive a share of her client's award if she won.

The ban on that contract, held the Court, could have interfered with Dr. T.'s ability to bring a certain set of cases which the courts ought to hear. Thus, Dr. T's right was burdened too.

The Outcome, and Its Possible Implications for Law Practice in Germany

In the end, the Court decided that neither of these rights was unconstitutionally burdened (perhaps because the case was in fact brought). However, it held that the prospect of future violations of these rights was so substantial that it required the German Parliament, within a year, to amend the law banning contingency fees.

It is not clear what the future will bring. The Court suggested at the very conclusion of its decision that the German government could repeal the law prohibiting contingency fees in its entirety, but it is unlikely that will happen. The more likely scenario is that the new law will create exceptions for persons who can credibly claim that, absent the availability of a contingency fee, they could not find a lawyer willing to take their case.

Of course, it is hard to know how this exception could be written into law. As one German lawyer told me, "What is to prevent a lawyer and a client from colluding to say that the lawyer would not take the case but for a contingent fee?"

Many American tort reformers would argue, I imagine, that the fact that no lawyer would take a case except for the existence of the contingent fee is the best evidence that the case should never be brought at all. (There is a very interesting discussion of this argument here) I do not want to enter this debate now, except to point out the ways in which the current German situation helps us better understand the problems caused or cured by contingent fees.

Is the Contingent Fee System Necessary In Germany, Where Nonlawyers Can Legally Finance Plaintiffs' Lawsuits?

A contingent fee really represents two distinct ideas: First, that a lawyer should be paid an amount which correlates with the size of the award won by the client. Second, that a plaintiff should be able to get someone else to maintain the cost of the lawsuit, in exchange for a portion of the award won by the client.

The two ideas come together in the contingent fee, but they don't have to: For example, one could imagine a system where nonlawyers put up the cost of litigation in exchange for 33% of the award won by the plaintiff (and lose their money if the plaintiff loses her case).

Farfetched? While this is illegal in the U.S., there are a number of very large companies that do exactly this in Germany. See, for example, the website of Foris, a German lawsuit finance company which takes between 20% and 30% of the award in any suit for which it has fronted the legal expenses (and promised to pay the opponents' lawyers' fees in the event of a loss).

Second, recall that in Germany, a lawyer is paid in proportion the size of the amount at stake in litigation. The schedule created by the German Parliament pays a lawyer more for a case in which 1 million Euros is in controversy, than for a case where 1000 Euros is in controversy. The problem, it seems, is simply that the amount chosen by the legislature is too low to attract lawyers to cases that have any degree of complexity. In such cases, the lawyer will demand to be paid by the hour.

So we come back to the question of why a system based on hourly fees alone cannot work. In the United States, defenders of the contingency fee system (like Herbert Kritzer and Alex Tabarrok) argue that lawyers provide liquidity plaintiffs lack. An individual plaintiff cannot afford to pay a lawyer the equivalent of the hourly rate it would take to bring a case if there is a 50% chance that the case will be lost. A lawyer, on the other hand, who handles a "portfolio" of cases, can invest her own money into the cases of her clients because she has a stream of cases, some which will lose, some which will win, and a few of which will win big.

Lawyers have to do this in America because, as noted above, in the U.S. nonlawyers cannot take a contingent investment in a lawsuit.

But in Germany, they can. And thus, Germany has companies like Foris to supply the liquidity plaintiffs lack. In addition, other mechanisms, such as litigation insurance, allow German plaintiffs to have their legal costs guaranteed by their insurer. One would think that with all these devices, plaintiffs like Hanna N. would be able to finance a lawsuit without resort to the contingency fee.

Of course, the German Supreme Court knew all this when they held that, nonetheless, there is still a possibility that some cases that ought to be tried will be unjustly suppressed. It is possible that the Court is wrong and there are no such cases; on the other hand, it is possible that there may be far more than the Court imagined.

All that is certain is that it will be very interesting to see how Germany's experiment with contingent fees develops over the next year and beyond.