General Practice, Solo, and Small Firm Division The Compleat Lawyer
Winter 1998 © American Bar Association. All rights reserved.
Surviving a Legal Bill Audit
BY JOHN TOOTHMAN
John Toothman is the founder of The Devil's Advocate, a legal fee management and litigation consulting firm headquartered in Alexandria, Virginia. Mr. Toothman is the author of Legal Fees: Law & Management, to be published soon by Aspen Law & Business. More information is available at www.devilsadvocate.com.
Americans spend more than $100 billion each year in legal fees. As fees soared in the 1980s, incentives to manage them grew, along with client suspicions that a substantial amount of money was being wasted.
Methods for managing lawyers, including alternatives to hourly fees (such as flat fees), stricter billing agreements, bringing work in-house, and alternative dispute resolution, have blossomed in response to client dissatisfaction with the rising cost of legal services. Another byproduct of soaring fees is a new industry: The so-called legal bill auditors clients hire to analyze their legal bills.
For example, a corporation faced with more than 100,000 asbestos-related claims incorporated routine bill reviews into its management procedures "to detect the typical inefficiencies: using too many senior lawyers and partners on the same case; using associates when paralegals would be more cost-effective; assigning junior associates on a rotating basis; sending too many people to depositions; spending more time preparing [for] depositions than taking them; charging for support services [the client] hadn't agreed to; not using standardized processing; handling information inefficiently; over-staffing; and deviating from agreed-upon rates."1
The cost of bill reviews varies depending upon such factors as how much is being reviewed and the level of detail reviewed, but rates charged by auditors typically range from 2 to 5 percent of the gross amount of the bills.
What is Legal Bill Auditing?
Still in its formative years, the concept of legal bill auditing is evolving. The phrase "legal bill auditing" actually encompasses a range of services, from an examination of the face of the legal bill for improper charges or errors to a detailed analysis of original time records, attorney work product, expense and hourly rate benchmarks, and more.
With the "oldest" companies in the field still less than 15 years old, legal bill auditing is a young, growing industry. The 1990 recession probably accelerated the spread of auditing, as more companies and even the federal government (most notably the Resolution Trust Corporation) found that taking a critical look at legal bills can save money—perhaps 10 percent, but often 20 percent or more. In addition to the half-dozen or so independent bill auditing specialists, some traditional accounting firms and freelancers have moved into the field. Several insurers have in-house or captive bill auditing shops. Yet fewer than 5 percent of all legal fees are now being reviewed—probably as little as 2 percent.
In contrast with the elaborate standards that apply to financial audits conducted by CPAs, which typically must comply with procedures and standards maintained by the American Institute of Certified Public Accountants,2 a legal bill audit is not an established examination process nor an expressly defined standard against which to measure legal bills. To avoid confusion with the elaborately defined financial audit, it is best to refer to any sort of legal bill analysis as a "bill review," analogous to what accountants call those financial examinations that fall short of full compliance with AICPA audit procedures or standards.
The purpose of a legal bill review is often to save money for clients, but not necessarily: Many clients audit performance and quality of services either in addition to or instead of cost alone. For example, a bill review in conjunction with analysis of work product can be used to analyze cost-effectiveness of the lawyer's strategy and tactics and assess overall performance. The reviewer may be monitoring the matter as it progresses—perhaps for the purposes of giving the client a second opinion in a major case, or after the matter is closed as a sort of "post-mortem."
Second opinions give clients peace of mind and avoid some mistakes. A second opinion costs far less than the first because the second lawyer typically works from the information and discovery obtained by the first.3 Post-mortems are useful tools for both the law firm trying to learn from past performance and the client trying to decide such questions as whether to hire the same firm again.
Audits that extend into questions of quality and performance are comparable to another type of nonfinancial audit accountants would recognize as an "operational" or "performance" audit, which was developed by the U.S. General Accounting Office.4 Clients use performance audits as a management tool to conduct a more thorough, systematic analysis of their legal service providers, including in-house lawyers as well as outside law firms.
Bill reviews have uses beyond management of the lawyer-client relationship. For example, reviewing an opposing law firm's bill can rebut an opponent's claim to shift legal fees and expenses in litigation. Most lawyers might view a bill auditor as "the enemy," but some lawyers are hiring auditors as allies whose analyses are presented in expert reports, testimony, or affidavits to contradict petitions for fees by litigation opponents. These fee claims may be incidental to the merits of some other dispute, e.g., where the prevailing party is entitled to relief through a fee-shifting provision in a statute or contract, or fees may be the primary issue, as in a lawyer-client fee dispute or indemnification dispute between co-insurers.
Another use of a bill review is to substantiate the reasonableness of a firm's claim for fees, either against a client or on behalf of a client in a fee-shifting situation. Some firms even hire auditors to analyze their own fees and conduct internal performance reviews. Thus, while the common assumption is that lawyers must always be adversaries of bill auditors, lawyers are a regular source for auditing business.
Why Should the Lawyer in a Smaller Practice Care?
Bill reviews are still concentrated where the largest bills are found, which is often on the doorstep of the largest law firms, but reviews are already reaching smaller firms and bills. The spread is partly due to the dissemination of information about the advantages of reviews among clients and partly because some clients, especially insurance companies, pay large amounts to lawyers but in small increments. These companies are finding ways to streamline their reviews, principally by requiring their law firms to submit their bills electronically in a specified format that facilitates a computerized review for certain easily recognized problems, making them cost-effective for bills of only a few hundred dollars.
Thus, if you work for an insurance company, governmental entity, or large corporation, the odds are getting greater each year that your bills are being reviewed. And, if you are ever involved in litigation where your fees are an issue—whether by fee-shifting or in a dispute with a client—the odds are increasing even faster as more judges and lawyers recognize that a thorough, qualified analysis almost always pays for itself.
Complaints by lawyers stung by unfavorable bill reviews may suggest that bill reviews always convey bad news, but sometimes an audit will recommend that a law firm is a candidate for more work. Instead of focusing on the negative—whether you will ever be caught in an audit—your clients and potential clients will be impressed if you avoid other firms' billing practice errors in the first place.
There is also a silver lining for smaller firms: One message that sophisticated clients are getting as they study their lawyers more carefully is that many larger firms tend to be disproportionately more expensive, due to their internal economics and higher overhead, and may not be any better—a surprisingly large number of "blue chip" firms are inept or are stretching to handle matters for which they lack the experience. These clients are searching for smaller, inherently cheaper firms with the right experience and a cooperative attitude.
With lower overhead, your billing practices should demonstrate that you understand your clients' perspective. Indeed, many smaller law firms are far more cost-effective and tend to exhibit fewer billing problems, in part because they have never had the luxury of clients willing to write five- or six-figure checks without asking questions.
Reviewing the Bill
The typical bill review begins and may end with a review of the face of the legal bills. If bills are available in electronic form or are capable of being "scanned" electronically, some parts of a bill review can be automated. Words and phrases that reveal questionable billing practices can be searched and flagged. Most auditors also have trained personnel review each line of the bill for problems no computer can spot.
Beyond the bill, the basic review typically includes an examination of hourly rates, biographies of timekeepers (to substantiate hourly rates), published hourly rate data for comparable lawyers, and background information about the legal matters that led to the bill. The review also includes billing agreements, budgets or estimates, and correspondence about fees. Another important component of the review is examination of the lawyers' work product, along with the opponents' work product and court orders to gauge quality, tactics, strategy, and performance in context.
One option in a bill review may be examination of records on-site. "On-site" might include the client's office, the lawyer's, or both. Although travel can increase the cost of the review, reviewing the files at a cooperative lawyer's office can be far less disruptive than copying the entire file or looking at bits and pieces out of context. Site work can also include an evaluation of the firm's facilities and filing systems, interviews of key personnel, and so on. (We like to check the cost quoted by copy services "down the street" against the firm's photocopying charges, for example.)
For a bill review that approaches the detail of a financial audit, several additional steps may be involved: verification of raw data, interviews of key personnel, examination of firm billing systems, checking the original time records against time entries in invoices, and reconciling receipts for expenses with the bill. For larger jobs (or large numbers of small bills) verification may be accomplished by using appropriate sampling techniques.
A review, including review of correspondence and work product in the client's possession or available in court, may be conducted without the knowledge or cooperation of the lawyer. Some lawyers find this unfair, but that decision is the client's to make. The client may be using the review internally, to assess its own fee management systems.
If the bill is within expected limits, the lawyer may never hear a thing. A bill outside expected limits might lead to a call from a client-contact attempting to adjust the bill informally, but without revealing how the issue came to the client's attention. In more extreme situations, exceeding expected amounts, failing to follow billing guidelines, or other negative comments from a review may lead to a decision to replace the lawyer immediately, or more commonly, to let the lawyer finish the matter in question, then replace him or her in the future.
Clients often request this secrecy because they fear retaliation from the lawyer and do not wish to jeopardize the lawyer-client relationship until a preliminary review suggests that there is sufficient cause for concern and the lawyer's input might allay that concern. Contact with the lawyer may give the auditor the chance to have questions answered and to refine the report based on the lawyer's comments, if the lawyer cooperates.
What Should the Lawyer Do?
The short answer is, cooperate, especially if the audit has been commissioned by a current client. The client and auditor may draw adverse inferences from your failure to cooperate. Remember as well that professional and ethical duties include the responsibilities to report to the client (ABA Model Rule of Professional Conduct 1.4(b)); to abstain from "false or misleading communication[s]" to the client (Model Rule 7.1); and to explain the basis for a fee (Model Rule 1.5(b)). A responsibility to cooperate may also be spelled out in a client-friendly retention agreement. If the lawyer-client relationship has been properly terminated, some but not all of these duties may have expired.5
The lawyer may request the chance to review a draft of the auditor's report. Feedback from the lawyer may allow the auditor to resolve issues triggered by ambiguous or uncertain facts. This may in turn reduce the amount of the bill the auditor has "flagged" or questioned.
Consider consulting another billing expert. In addition to the difficulty of giving oneself good advice when your own fees are at stake, few lawyers can separate their ego from the many insults they infer from even the most dispassionate audit of their bills and performance. Ego causes some lawyers to forge ahead on a path that may lead to ethical sanctions because legal fee law is full of counterintuitive traps for the unwary or inexperienced.
Generally Accepted Legal Billing Standards
While there is no general standard or uniform set of rules for what may or may not be billed by lawyers, some generally accepted rules can be derived from common law, application of fee-shifting statutes (such as the federal civil rights statutes), and ethical rules.
In a typical audit, the first "standard" against which the law firm's bills will be measured is compliance with the lawyer-client retention or billing agreement, if there is one, or the lawyer's statement of the basis for his or her fee.6 Also important are the course of their dealings, including client instructions and lawyer estimates. Billing agreements are subject to more judicial or bar second-guessing than most commercial contracts anyway, especially if entered into or modified after the lawyer-client relationship exists.7 While compliance with the agreement may not be enough to make the fee reasonable, a lawyer's failure to adhere to an agreement or policy will catch an auditor's eye.
With or without the agreement, the law, including common law and professional ethical duties, provides another layer of standards against which to audit.8 "A lawyer may not charge a fee larger than is reasonable9 in the circumstances or that is prohibited by law."10 There are also standards provided by statute or regulation, e.g., in fee-shifting statutes or with regard to compensation of bankruptcy lawyers. Ultimately, every lawyer has the burden to properly document his or her bills and to demonstrate that the resulting fee is reasonable.11
As a recent formal ethics opinion issued by the ABA succinctly put it: "The lawyer's stock in trade is the sale of legal services, not photocopy paper, tuna fish sandwiches, computer time or messenger services."12 Expenses rarely exceed 10 percent of a legal bill. Yet they can exhibit their own problems, including waste, mark-ups of expenses over cost, recovery of firm overhead covered by hourly rates, and personal expenses of the lawyer.
Reasonable and necessary expenses, permitted by agreement and not part of firm overhead, may be passed through at actual cost. Sometimes the examination of expenses is most valuable to the auditor as a window into fees. For example, a phone company charge reflecting a five-minute phone call is hardly worth auditing, but it would be if the $200/hour lawyer billed half an hour for the same call—examples like this can undermine credibility of the entire bill.
Given that many clients can relate to the cost of doing business more readily than they can to the time it takes a lawyer to perform arcane legal tasks, clients tend to criticize expenses far out of proportion to their impact on the bill. For this reason, lawyers might wish to consider passing through fewer costs, except those that are uniquely ascribable to individual clients.
- N. Weinstock, "Corralling Your Runaway Legal Costs," Financial Executive (January/February 1995).
- In a nutshell, AICPA promulgates Generally Accepted Auditing Standards (GAAS) to describe the procedure and content of audits and Generally Accepted Accounting Procedures (GAAP), which are the rules by which accountants are to prepare financial statements and the standard against which the auditor then tests those statements for compliance.
- See John Toothman, "Second Opinions may Trim Legal Bills," 16(24) The National Law Journal 17 (Feb. 14, 1994).
- GAO, Government Auditing Standards: 1994 Revision 14 (June 1994). See also, H. Reider, The Complete Guide to Operational Auditing (J. Wiley & Sons 1994). Performance audits typically focus on economy, efficiency, and cost-effectiveness.
- Some firms claim, for example, that their client files cannot be disclosed—even to the client. While lawyers might have a lien on work product for which a client has not paid, other files clearly belong to the client and withholding any file (work product included) risks an ethical sanction when the client is thereby prejudiced. See Model Rule of Professional Conduct 1.16(d).
- While Model Rule 1.5 does not require an agreement per se, it does require the lawyer to disclose to new or irregular clients the basis for the lawyer's fee, "preferably in writing." Model Rule 1.5(b). Moreover, written contingent fee agreements are generally mandatory, Rule 1.5(c), and some jurisdictions, including the District of Columbia, make written disclosure under Rule 1.5(b) mandatory for all fees.
- ALI, Restatement (Third) of the Law Governing Lawyers, § 29A (Prop. Final Draft # 1; March 1996).
- Model Rule of Professional Conduct 1.5(a) provides:
(a) A lawyer's fee shall be reasonable. The factors to be considered in determining the reasonableness of a fee include the following:
- the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly;
- the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;
- the fee customarily charged in the locality for similar legal services;
- the amount involved and the results obtained;
- the time limitations imposed by the client or by the circumstances;
- the nature and length of the professional relationship with the client;
- the experience, reputation, and ability of the lawyer or lawyers performing the services; and
- whether the fee is fixed or contingent.
- Lawyers occasionally suggest that whatever amount they bill must, by definition, be "reasonable," relying sometimes on their duty of zealous representation as an excuse. But see John Toothman, "Real Reform," 81 ABA Journal 80 (Sept. 1995).
- ALI, Restatement (Third) of the Law Governing Lawyers, § 46 (Prop. Final Draft # 1; March 1996).
- "In any [fee adjudication] the lawyer has the burden of persuading the trier of fact, when relevant, of the existence and terms of any fee agreement, the making of any disclosures to the client required to render an agreement enforceable, and the extent and value of the lawyer's services." ALI, Restatement (Third) of the Law Governing Lawyers, § 54(b) (Prop. Final Draft #1; March 1996).
- ABA Formal Ethics Opinion 93-379 at 10 (Dec. 1993). The opinion has further analysis of both fee and expense issues.