We have all heard of federal bailouts for our insurance companies, automobile companies, and even banks, but few realize that buried in a deep silo on Capitol Hill is a proposal which, as a practical matter, would be a bailout for trial lawyers.
The bill, introduced by Sen. Arlen Specter (D-PA) and co-sponsored by Senators Lindsey Graham (R-SC), Patrick Leahy (D-VT), Ron Wyden (D-OR), Mike Crapo (R-ID), Mel Martinez (R-FL), and Mary Landrieu (D-LA), would amend the Internal Revenue Code of 1986 to allow personal injury lawyers to deduct “loans” made to clients at the time the loans are made, not, as is in the case under current law, in the future if and when, at the end of the litigation, the loans are not repaid.
In most states, plaintiffs’ lawyers are not allowed to advance expenses for their clients. Ethics Committees may scrutinize lawyers if the expenses they advance are substantially large. In common law terms this is called “champerty,” whereby the attorney, not the client, is the driving force in the litigation.
Circumventing the Rules
To circumvent champerty rules, a tradition arose a long time ago for a plaintiffs’ lawyer to make a “loan” to the client. The loan would cover all major expenses. If the plaintiff won the case under what is called a net fee contingency contract, the cost of that loan plus a modest amount of interest would be added to the fee.
Thirty years ago, trial costs were relatively modest. But today, if a plaintiffs’ attorney wishes to pursue a major case, expenses can total a quarter to a half a million dollars or more. Thus, what some consider a charade of the “loan system” has become increasingly important. These “loans” create economic risk for plaintiffs’ lawyers and can act as a deterrent against bringing marginal cases.
If Specter’s proposed modification of the Internal Revenue Code succeeds, the federal government will, for all intents and purposes, share in the cost and risk of bringing the initial litigation.
Under current and certainly potential future tax laws, this could be as much as 40 percent of the cost of bringing litigation.
Impetus for Lawsuits
Those who practice plaintiffs’ lawyer work learn quickly that it is a business similar to other capital businesses. Today the costs of litigation act as a curb against marginal and frivolous litigation. This is what makes the plaintiffs’ lawyers’ tax proposal of such great practical importance.
While one cannot calculate it mathematically, having the federal government bear 40 percent of the initial costs allows plaintiff’s attorneys to take more cases with higher risks. The result to industries targeted by plaintiffs’ lawyers will be staggering.
Specter justifies his proposal by saying the modification would “treat these businesses the same as other small businesses.” But a principal difference between a plaintiffs’ lawyers’ fronting of costs and a business’s deductible expenditures is that the former carries a formal contractual obligation for future payment (much like any other type of loan agreement). Deductible business expenses are a different animal in that they represent sunk capital costs that are not based on the vagaries of litigation.
The activity of the contingency fee lawyer is also not like other businesses. It is a business that threatens other businesses with major lawsuits and is directed at using every possible weapon to settle those lawsuits. Under the current legal system, additional weaponry in the plaintiffs’ bar is not needed.
Top Priority for Lawyers
A careful reading of the American Association for Justice’s (AAJ) (formerly the Association of Trial Lawyers of America) First Quarter 2009 Lobbying Report shows virtually the entire AAJ lobbying team is directed at helping ensure the passage of the proposal.
In the 110th Congress, the Joint Tax Committee scored this federal bailout for trial lawyers at $1.57 billion over 10 years. We do not believe the American taxpayer will want to bear this cost.
At that time, The Wall Street Journal editorialized the tax change “would allow plaintiffs lawyers to deduct the up-front expenses of pursuing contingency-fee lawsuits, even in cases where the lawyer is expecting to be reimbursed for these expenses. . . Allowing these big deductions now would mean that future reimbursements are taxed, but with some monster class-actions, the lawyers could avoid the tax bill for a decade or more. Naturally, this would be an incentive to file more class-action suits, because the lawyers could write off their up-front expenditures to pursue them” (“The Bill Lerach Tax Cut,” The Wall Street Journal, May 30, 2008, A14).
Support Is Increasing
Although the proposal had bipartisan support in the U.S. House of Representatives last year, the spotlight of publicity killed it. Now it is being renewed with more vigor and has more monetary and political support behind it.
While the strength of political support for the bill has grown, the need for it has been reduced. In our current economic situation, proposals encouraging litigation are exactly contrary to the stimulus needed to advance a recovery. As the merits of the proposal become known, hopefully more people will be asking: Do we really need a federal bailout for trial lawyers?
Victor Schwartz ([email protected]) is chairman of the Public Policy Group in the Washington, DC office of the law firm of Shook, Hardy & Bacon L.L.P. Christopher E. Appel is an attorney in the Public Policy Group.