As reported below, Virginia Attorney General Ken Cuccinelli is the latest attorney general to hire private-sector attorneys to sue a company on a contingency basis. Unfortunately, it’s not only state attorneys general who allow profit-seeking trial lawyers to undertake the government’s business. City and county officials have done the same thing.

The most prominent example comes from the oft-bizarre government of Santa Clara County and its running mates in California. In 2000,  Santa Clara and nine other cities and counties retained Motley Rice and three other law firms to bring a lead pigment public nuisance action against a group of manufacturers. The retainer agreement specified that the government would “retain final authority over all aspects” of the litigation, an arrangement that is difficult to maintain in practice — “How’s the case going?” “Oh, good. I’ll fill you in later” — and deeply suspect on policy grounds. Indeed, the trial court held that a previous ruling in the well-known Clancy case (People ex rel. Clancy v. Superior Court, 39 Cal.3d 740) precluded the government from hiring lawyers on a contingency-fee basis.

The California Court of Appeal concluded otherwise, holding that the “control” language in the retainer agreements means that the outside lawyers are merely “assisting” the government in a subordinate role and lack any decision-making authority or control over the case. This July, the California Supreme Court upheld the appellate court’s ruling.

The manufacturers are now appealing the California ruling to the U.S. Supreme Court, and the National Association of Manufacturers and other business groups last week joined in an amicus brief in support of the appeal in Atlantic Richfield et al. vs. Santa Clara County et al. The amicus brief, available here, frames the discussion:

The Supreme Court of California held that govern-mental plaintiffs pursuing civil public nuisance prosecutions brought “in the name of the People of the State of California” may do so under a contin-gency fee retainer agreement with outside plaintiffs’ law firms in which the government entities agree to compensate the law firms by paying them 17 percent of any recovery. This brief addresses the following question:

1. Whether contingency fee agreements that give private prosecutors a direct, personal, and substantial pecuniary interest in the outcome of governmental prosecutions seeking to vindicate the sovereign’s interests in public nuisance cases violate the Due Process Clause of the Fourteenth Amendment of the U.S. Constitution.

Yes, yes they do.

Others joining the brief are the American Chemistry Council, American Coatings Association, National Petrochemical and Refiners Association, Property Casualty Insurers Association, and the Public Nuisance Fairness Coalition. Filing on our behalf is the Houston office of Gardere, Wynne, Sewell LLP. For more background, see the NAM’s Manufacturing Law Center’s entry. We’ve blogged previously on the issue here.

Dianne Searcey of the Wall Street Journal’s Law Blog provides more detail on the possible $1.6 billion tax break for contingency fee litigation. Having failed to move legislation to accomplish this special-interest policy change in Congress, the American Association for Justice has been trying to gain the same benefit from Treasury.

Apparently at the heart of the matter is an April letter Sens. Max Baucus (D., Mont.) and Richard Durbin (D., Ill.) sent to Michael Mundaca, assistant secretary for tax policy seeking clarity on the 9th Circuit ruling in the 1995 case of Boccardo v. Commissioner.

In the Boccardo case, the IRS asserted that out-of-pocket expenses incurred by attorneys on behalf of clients while prosecuting contingency cases are not deductible because the law firm expects reimbursement upon getting a settlement or judgment. The Tax Court agreed.

The 9th Circuit took up the matter. The letter sums up the ruling like this:

The court “held that attorneys who represent clients in contingency fee cases may treat litigation costs that are paid by the attorneys, such as filing fees and witness expenses as deductible ordinary and necessary business expenses . . . when the attorney and client agree to a specific fee arrangement known as a gross fee contract.”

The IRS issued a memo saying that the ruling applied only to attorneys in the 9th Circuit. But the Tax Court has since recognized the validity of the decision in at least one other case, according to the letter.

Here’s an analysis dated June 14 of the underlying and complicated tax law issues from Robert W. Wood of the San Francisco law firm of Wood and Porter, “Lawyers Who Deduct Client Costs: Revisiting Boccardo“. Abstract:

In this article, Wood considers how contingent fee lawyers treat costs and when they can deduct them, explaining the relationship between this issue and the fee agreement. He notes that Sens. Baucus and Durbin have recently entered the fray, but that 15 years after the Ninth Circuit decided Boccardo, considerable confusion remains.

And again, Victor Schwartz and Chris Appel of Shook, Hardy & Bacon explained why such a deduction would amount to a taxpayer subsidy of speculative lawsuits in a paper last year for the Washington Legal Foundation, “Federal Government Bailout for Trial Lawyers.”

Earlier posts here.

UPDATE: Good, newsy report in National Law Journal, in which the American Association for Justice confirms its lobbying: “‘Obviously, we are exploring all avenues to clarify this confusing tax code,’ said Ray De Lorenzi, a spokesman for the American Association for Justice, which advocates for trial lawyers, in a statement. He declined to give details on any meetings or exchanges with Treasury Department officials.”

Or, as today’s Wall Street Journal’s editorial puts it, “A Bill Lerach Tax Cut“:

Taxes are going up in January for millions of Americans, but that means it’s even more important to have friends in Washington. And nobody has friends in higher places than the plaintiffs bar.

The American Association of Justice, or the trial bar lobby, is meeting in Canada this week to raise money for Senate Democrats and plot new openings for its legal raids on business. According to Legal Newsline, AAJ director of federal relations John Bowman told attendees the awesome, fabulous, wonderful news that he expects the Treasury Department to soon issue an order giving a tax break for contingency fee lawsuits.

The AAJ announced its new president for 2010-2011 yesterday, C. Gibson Vance, a stockholder in the poiltically connected Alabama law firm of Beasley Allen. So here’s his first challenge, handling the crisis PR: Will he choose to be upfront, open with the media, explaining why the news accounts of the Treasury action are wrong or, alternatively, why the $1.6 billion tax cut to stimulate litigation is necessary?

More …

• Daily Caller, “Payday: Trial lawyers could get major tax cut despite major federal deficit“
• The Louisiana Record (blog), “LLAW decries potential trial lawyer tax break“
• Southeast Texas Record, “Watchdog groups fear trial lawyer tax break will ‘suck marrow out of economy’“
• Washington Examiner, “No special tax cuts for wealthy trial lawyers “
• Legal News Line, “Treasury not commenting on trial lawyer tax break“

Legal News Line, a Chamber of Commerce-backed publication, broke this story. Love this detail from its follow-up: The White House referred questions to the Treasury Department, which declined comment.

As the American Association for Justice works with Treasury to circumvent Congress and gain a tax deduction for contingency fee litigation (see post below), it’s important to realize how damaging to jobs creation such a tax break could be.

Victor Schwartz and Chris Appel of Shook, Hardy & Bacon wrote a briefing paper on the issue last year for the Washington Legal Foundation, “Federal Government Bailout for Trial Lawyers.” They explain:

How Plaintiff’s Lawyers Weigh Whether to Bring a Case. Those who practice plaintiffs’ lawyer work learn quickly that it is a business similar to other capital businesses. Capital is placed at risk and a judgment is made whether or not it will bring a profit. 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% 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.

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 present legal system, additional weaponry in the plaintiffs’ bar is not needed. To the contrary, additional weaponry is needed to stop marginal litigation and frivolous claims. Some of that marginal litigation is highly likely to be directed at financial institutions, potentially reducing those companies’ capital at the very time the federal government’s policy is to increase it.

That was written in May 2009 but applies just as well today.

There’s also a timely political angle. If you ever doubted how unpopular the litigation industry is, just look how much effort the trial lawyers and Democratic Senators went to keeping this weekend’s fundraiser in Vancouver, B.C., quiet. Republican campaign operatives certainly thought the news was damaging.

• HotAir.com, “Why are Senate Democrats fundraising in Canada?”
• The Day, Connecticut, “Blumenthal was at Reid’s Vancouver fundraiser, campaign confirms”
• New Orleans Times-Picayune, “Sen. David Vitter criticizes Rep. Charlie Melancon for fundraiser in Canada“
• Town Hall, “Updated: Harry Reid & Co. Attend Weekend Fundraiser… in Canada“
• Politico, “Dems take flak for Canadian fundraiser“
• Chicago Sun-Times, “What Giannoulias did not want you to know: In Canada, fund-raising from U.S. trial …”
• The Hill, “GOP hits Reid and others for raising money in Canada“

Follow these hits with a special-interest tax ruling from Treasury, and you can create a major political story all the way through November.

To summarize: A tax break for trial lawyers would be damaging to the economy and damaging to supporters’ political prospects. On the plus side, it might inspire the major media to pay more attention to one of the most politically powerful special interests, trial lawyers, and their lobbying arm, the American Association for Justice.