December 03, 2012 Articles

Avoiding the Pitfalls of Alternative Billing Arrangements

While the hourly rate is a known quantity for law firms, alternative fee arrangements can be fraught with peril.

By Betsy P. Collins

As a litigator for almost three decades, I've seen a lot of changes in the practice of law. From the defense-lawyer perspective we've moved from the kind of relationships with clients where there is loyalty and consistency, to relationships characterized by one-off representations that leave lawyers angling for everyone else's clients and clients angling for the best deal. The cost of litigation, particularly with regard to electronically stored information and e-discovery, has driven up the average nuisance value of cases. Fewer and fewer cases actually make it through the pipeline to trial. Additionally, with outsourcing models, clients are shifting costs of tasks such as document review and production out of defense firms. Law schools continue to pump out more lawyers. In short, competition is keener than ever. Corporate clients want predictability and cost control, which is causing lawyers to turn to more creative ways to appeal to clients' inclination toward bargain-shopping.

Over the last 25–30 years, the hourly rate has reigned supreme in the representation of corporate clients in litigation. In the last few years, there has been growing disagreement about whether the hourly rate produces the value corporate clients want. While the hourly rate is a known quantity for law firms, alternative fee arrangements can be fraught with peril. If you are negotiating alternative fee arrangements, knowing how to spot the pitfalls and how to avoid them is critical to your firm’s financial well-being. If you are a young lawyer, understanding how alternative fee arrangements work can help you cement your relationship with the relationship partner and the client.

What Are the Challenges Law Firms Face with Alternative Fee Arrangements?

  • Ineffective infrastructure. Most defense-oriented firms claim that they are open to alternative fee arrangements, but practically speaking, those firms are not set up to handle modes of billing. Many times, the accounting department does not have the right software to effectively handle alternative fee arrangements on the front end or to track them on the back end.
  • Administrative hurdles for the law firm. Many firms have some form of matter-intake oversight committee that will make life difficult for the lawyer trying to bring business in through creative billing commitments.
  • Administrative hurdles for the in-house counsel. Some executives are unhappy with the cost of litigation and want more predictable costs, but are still unwilling to think outside the box or experiment with other alternatives when it comes to legal fees.
  • Traditional internal compensation models. Realization rates and compensation methods commonly used by law firms actually discourage creative fee arrangements.
  • Fear of the unknown. Many lawyers do not have enough experience with setting and abiding by alternative fee arrangements to give them a comfort level in negotiating alternative fee arrangements with clients.
  • Bad past experiences or horror stories. Making deals on flat fees can be risky for lawyers if they underestimate the time and expense commitments the matter might entail. Litigation can be inherently unpredictable and it takes a leap of faith to make a judgment on what to charge a client in fixed fee arrangements.
  • The “barrister effect.” Many lawyers are uncomfortable “horse-trading” with their clients on fee deals.
  • The “shyster effect.” Clients might have a natural cynicism about fee setting on the part of lawyers. The best alternative fee arrangements are between clients and lawyers who trust each other and "have each other's back.”

What Are Some Alternative Fee Arrangements That Might Be Used in Litigation Matters?

  • Flat fees. You might define what the fee will be for each phase of litigation or for certain tasks or you might quote an overall fee for the entire representation. You can also do a combination of fixed or flat fees per task or per phase with an overall cap on fees for the entire representation.
  • Flat fees with collars. The value of the lawyer’s services to the client is not necessarily equivalent to the cost or time expended by the firm, so you have to be careful when agreeing to flat fees, especially for an entire representation. One way to spread the risk between the client and the law firm is to agree to a collar. For example, in a case in which we knew we would have a lot of depositions, I agreed to flat fees for depositions. We used a collar to hedge against the risk of underestimating on my part or overestimating on the company's part. We kept track of hourly billing on depositions and deposition preparation. At the end of the discovery period, we were to add it all up and if we were over, we would bill 50 percent of the amount over. If we were under, we would give a refund of 50 percent of the amount we were under. If you can handle the matter more efficiently than you predicted, you can give your client a refund under this system, which engenders good feelings on the client’s part. In some instances, a corporation will insist that the firm bear some portion of the cost of exceeding the cap before splitting the difference. For example, say the cap is $100,000; the corporation’s obligation to split the overage on a 50/50 basis only kicks in after the cap is exceeded by 10 percent. Thus, if the firm spends $120,000 worth of time on it, the firm will collect $100,000 plus another $5,000.
  • Flat fees with holdbacks. Some companies pay flat monthly fees, but also have holdbacks that are paid to the firm based on satisfactory outcomes.
  • Retainers. I have had clients that paid a set retainer on a yearly basis for the firm to handle all routine litigation matters. Years ago, retainers were more prevalent than hourly rates. A retainer agreement for all “routine litigation” would need to specifically detail what is and is not routine litigation so that there is absolute clarity on what falls under the retainer and what necessitates an hourly fee or some other fee arrangement. Additionally, when I’ve been involved with retainers, we kept track of our hours and the retainer agreement was renegotiated on an annual basis with adjustments being made based on experience and anticipated usage.
  • Contingency fees. Obviously, contingency fees are used often by plaintiffs’ counsel in consumer or individual plaintiff representations, but they can also be useful in certain types of commercial litigation. Many firms are reluctant to agree to advance costs through the end of litigation for commercial plaintiffs because expert fees and other out-of-pocket costs can be quite large. When the firm works on a contingency-fee basis and the client pays the costs as they are incurred, both the client and the firm each have skin in the game and an incentive to stay focused on reaching a speedy and satisfactory result.
  • Mixed contingency fees. Let’s face it, most traditional defense firms have a hard time with the risks associated with contingency fees, but combining a reduced hourly rate or capped fees with a reduced contingency fee for a successful resolution can alleviate the pressure the firm might feel, while allowing the firm to enjoy the fruits of the success. For example, the firm agrees to work at a certain hourly rate, but to cap fees at $100,000. The client pays the costs as incurred. The matter is settled for $1 million after the client has paid the $100,000 in capped fees and $100,000 in costs. The client gets $200,000 off the top and the client and the firm split the remaining $800,000 on an 85/15 basis.
  • Success or bonus fees. Some companies will agree to pay some type of incentive in addition to flat fees or standard hourly fees for a defined strategic outcome. This should be carefully considered and negotiated in advance if it is part of the firm’s incentive for taking the case.
  • Reduced hourly rates with kicker. We have a deal with one client where the effective hourly rate is higher depending on how long we have the file before there is a satisfactory resolution. In other words, we are paid a set, reduced hourly rate, but we get an adjustment to that hourly rate for hours expended if we get the matter resolved within 6 months or 12 months. This assumes that it is costlier for a defendant the longer a case goes on, so the client is willing to pay more if there is an earlier resolution.
  • Blended rates. Many times I have encountered situations with insurance carriers who were not willing to pay the full rack rate for the lawyers they wanted to hire or whom the corporate client wanted to represent it. To satisfy the insurer’s need for a lower hourly rate, you can agree to a blended rate. With a blended rate, you calculate the average rate for all of the timekeeper lawyers on the file and apply that rate across the board whether the time spent is by a partner or an associate. For this to work to the firm’s maximum advantage, most of the work has to be handed down to the lower-rate timekeepers.
  • Cash flow management strategies. Sometimes, the greatest need for the client is predictability and elimination of cash-flow pressures. Commercial litigation can challenge the cash-flow operations of small companies in particular. For example, in one situation, a small publicly held insurance-group client with a huge bet-the-company case headed for trial. The company was experiencing cash-flow challenges because of the cost of experts and lawyers and costs associated with the litigation and a peril-filled tornado and hurricane season. That client didn't have a problem with the fees it would incur in the fight of its life—it just needed to smooth out the cash-flow problem, so we capped the amount it was obligated to pay each month and allowed it to pay the bills over a longer time.

What Are the Keys to Success with Alternative Fee Arrangements?

  • Plan for how you will respond to clients seeking alternative fee arrangements ahead of time. Because the economic decline of the last few years, more and more clients are asking for alternative fee arrangements. If you are well informed about how you manage and bill for cases, that can help you when you are faced with an actual request to propose an alternative fee arrangement. Indeed, many firms are proactively marketing their ability and willingness to offer alternative fee arrangements in an attempt to set them apart from the competition.
  • Keep statistical information on all alternative fee arrangements for use in later situations.
  • Study your closed matters to ascertain benchmarks for what affects fees, e.g., types of motion practice and discovery issues, and how much was spent in fees and costs on those efforts, staffing, etc.
  • Identify the client’s optimal objective in the matter, identify your staffing, outline a preliminary strategy for attaining the optimal result, and create a realistic budget for what is expected to transpire in the course of litigation.
  • Develop a transparent relationship with the client so that mutual respect and trust become central to the relationship.
  • Make sure both the client and the law firm each have “skin in the game.” For example, in large commercial litigation, some companies pay firms flat monthly fees based on the anticipated level of activity in the case, which includes a holdback to be paid if the matter is resolved satisfactorily.
  • Offer the client more than one option on alternative fees. For example, develop a budget and a litigation plan so that you can show the client what the anticipated fees would be based on a traditional hourly rate as compared to a couple of other alternatives. The client might well prefer to take the traditional route, but likely will feel good about having the ability to choose based on an informed basis.
  • Bring in the result quicker rather than later.
  • Consider whether to outsource some aspects of the matter, such as document review to contract lawyers. Be sure to negotiate this on the front end with the client and be transparent about how those contracted services will be billed to the client.
  • Don’t lose sight of your budgeted activity levels. Some firms have invested in software that enables them to keep up with expenses and time expenditures in real time and to chart the progress of the case against the planned or budgeted activity.
  • Make sure your timekeepers understand your budget and alternative fee arrangement.
  • Make sure your firm’s financial oversight committee understands the alternative fee arrangement.
  • If you find the arrangement is not working out for the firm, don’t be afraid to revisit it with the client. The last thing a corporate client wants is for a lawyer to give the matter less attention than is warranted. I have known of situations where firms began to be less attentive when the system was proving costly to the firm. That is a sure way to lose a client.
  • If you see that the arrangement is not working to the client’s benefit, offer to revisit it. You don’t want to kill the goose that laid the golden egg, and again, trust and fairness are important to a workable client relationship, especially where alternative fee arrangements are involved.

As with almost any unknown quantity, you will be able to overcome your fears and insecurities with alternative fee arrangements once you’ve had experience in negotiating and using them. Hopefully you can avoid some of the potential pitfalls associated with alternative fee arrangements by knowing what to look out for in advance.

Resources and References:

Roya Behnia, “Alternative Fee Arrangements Are a Tool, Not a Strategy,” ABA Journal, (March 21, 2012).

Meredith Hobbs, “Big Profits to Fall at Big Law?” The Daily Report (Oct. 15, 2012).

Julie McMahon, “Despite Stagnant Economy, Movement Toward Alternative Fees Still at a Crawl,” The Am. Law Daily (July 10, 2012).

Mark A. Robertson, “Marketing Alternative Fee Arrangements,” Volume 37 Law Practice Magazine Number 5 (Sep./Oct. 2011).

Rachael M. Zahorsky, “Facing the Alternative: How Does a Flat Fee System Really Work?” ABA Journal (Mar. 2, 2012).

Keywords: litigation, pretrial practice and discovery, electronically stored information, ESI, motion to compel, objection, production request

Betsy P. Collins is a partner with Burr & Forman, LLP, in Mobile, Alabama. She is a cochair of the Pretrial Practice & Discovery Committee.

Copyright © 2012, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).