More and more clients - and lawyers for that matter - are looking for value-based alternatives to the billable hour. The good news? They can be a win-win for attorney and client.
As all Illinois lawyers since Abraham Lincoln have recognized, their time (and advice) is their stock in trade. And lawyers frequently refer to Lincoln's famous quotation as a rationale for billing their clients by the hour.
But Ungaretti and Harris partners Michael Philippi and Ethan Trull note that the billable hour was not customary in Lincoln's day. Before 1958, in the usual course of events, "The client would come to the lawyer and say, 'I have a problem that I need you to solve. What is it going to cost?' At the end of the day, they had a negotiated fee for the matter," says Trull.
That's how lawyers from all cultures had always charged, adds Philippi. "Since ancient Roman times, in medieval times, in the colonies and early America, lawyers typically charged by the case or capped their fees, according to standard historical reports."
But in 1958, Philippi says, bar leaders recognized that lawyers could and should sell a product. That product was the billable hour.
The idea of the billable hour caught on, and by now is accepted as the standard for lawyer billing in most types of private practices. How much time will a matter require to bring it to a conclusion? How much time for investigation, how much time for researching the law, how much time for drafting pleadings or transactional documents, how much time for negotiating the deal or trying the case? Answering these questions in terms of the billable hour provides a convenient framework for lawyers to advise their clients whether and how to proceed and an equally convenient way to charge them.
But billing clients by the hour has built-in problems. As Philippi points out, the more hours lawyers bill, the more money they make, without regard to the quality of their work, their efficiency, or the result. For some, he says, "that can lead to a tug-of-war with the client. The incentives aren't correctly aligned."
In the 1950s and through the 1970s, the lawyers say, that misalignment seemed unlikely to cause many problems. Back then, lawyers billed around 1,300 hours per year at modest rates, Philippi says. "Nobody dreamed that a number of national law firms in the AmLaw 100 would be billing 2,000 hours plus per year at in excess of $1,000 per hour - or even $500 per hour."
Being an "ingenious bunch," as Philippi puts it, "lawyers found more ways to work and sell hours." Law firms began expanding to unforeseen size and scope, and partners started expecting higher and higher profits.
But, as Trull points out, "To increase your numbers, you need more and more people at the bottom." Those would be the associates, recently out of law school. With the expansion of discovery, says Philippi, "Associates are expected to bill well over 2,000 hours a year. Thirteen hundred hour associates don't last too long in big firms."
Now, some view lawyers as charging whatever hourly rate they think they can get away with and performing whatever tasks they think they can justify. Press reports of lawyers in bankruptcy workouts charging in excess of $900 per hour haven't helped. Comments one government lawyer: "No wonder their clients are in bankruptcy."
In the 21st Century, the world has changed again. "In-house corporate counsel are a very savvy lot," Philippi says. They're saying, 'Enough-this is ridiculous.' They're increasingly unwilling to pay associates $250 an hour to go through tons and tons of work that may not be necessary. They're asking, and should be asking, 'Why are you taking that discovery? How can I pay you so as to align your interest with my interest?'" And they're reviewing every task on their outside lawyers' bills, questioning every tenth of an hour, and often disapproving payment.
A 12-year in-house veteran of overseeing litigation in a Fortune 500 company, Trull says, "There's a lot of frustration on the part of in-house counsel about the inability to predict cost to their client, and about outside counsel's ability to estimate risk. In-house counsel are hungry for a change. They want to be able to predict cost and evaluate risk, early, often, and accurately. The outside law firm who can do that, gets an edge" in getting corporate business.
Law firms are responding to the pushback from their clients by developing new billing models, often known as "value-based billing" or "alternative fee arrangements." Philippi explains the concept in terms of two components: aligning incentives for lawyer and client and creating incentives for law firms to reduce costs and achieve solutions. Put another way, in an alternative fee arrangement, the lawyer takes on some of the risk of a less than ideal result for the client and rewards are for value, not necessarily for hours logged.
Lower costs, not lower profits
Alternative fee arrangements may be as simple as the flat fee or the contingent fee. Trull says he's partial to flat fees because, counterintuitively, "you can still be creative and flexible. You can have a flat fee for a phase of a case, for an entire case, or for a portfolio of recurring cases."
As an example, he suggests considering clients who are involved in, say, asbestos litigation. "You might charge one of those clients a flat fee to handle all of its asbestos cases. Imagine the certainty and the efficiency of that arrangement from the perspective of both client and law firm."
For single-plaintiff employment cases, Philippi suggests that a company might figure out how many such claims it receives, on average, in the course of a year. Large companies might further break down the matters into type: sexual harassment, Americans with Disabilities Act, race, and so on. The company can also determine its average annual cost for that litigation. "With that information, you can come up with a number for a flat fee per case in exchange for the company's giving you the entire portfolio of those cases to handle."
Trull explains what the risk is to the lawyer and how such an arrangement aligns the incentives of lawyer and client. "If I take a matter on for $50,000, I have to monitor it effectively so as not to lose my shirt on it. I have to evaluate the case early on to identify the key issues and what we have to do. I have to sit down with the client and ask 'What would you consider a successful outcome?' The client should be concerned with how much the whole episode is going to cost, whether that cost is paid out to the lawyers, the court reporter, or the opponent. The client's goal should be to make this bad situation go away for fewer dollars rather than more dollars. If the attorney has an incentive to help the client with that goal, the cases tend to go away more quickly, not always for less money, but overall for fewer transactional costs."
Taking on that sort of risk isn't something that comes naturally to defense lawyers of his generation. But the concept, Philippi says, is the same as the risk with which the plaintiffs' bar is intimately familiar.
"Most good plaintiffs' lawyers do not do unnecessary things. They take a two-hour deposition, they're out, they're done. Most defense lawyers take two-day depositions. Do the details of the deponent's first job out of high school really matter to the case? The whole notion of efficiency is something the defense lawyer is borrowing from what the plaintiffs' bar has been doing for years. And they make a ton of money. Ask [a prominent Chicago plaintiffs' attorney] whether he's made any money on alternative fee structures."
Indeed, both attorneys are quick to note that alternative billing arrangements are not designed to lower the profitability of lawyers' work. Says Philippi, "I'm talking about lowering cost, not profit. If a law firm can have a higher level of profitability at a lower cost structure, that's a win-win" for lawyer and client alike.
Aligning the interests of lawyer and client
Alternative fee structures can be far more complex than plain flat or contingent fees, depending on the nature of the matter or portfolio of matters and the client's needs. The billable hour may even be a component of an alternative fee structure. To illustrate, Trull says his firm sometimes uses different billing structures for different phases of litigation.
"In larger, more complex cases we may work with our clients early and often during the first 60 or 90 days to figure out what the dispute is about and what the parties' expectations are. We might bill at a greatly reduced rate for that phase."
Going forward, the firm might agree to cap their hourly fee, bill at a lower rate, or agree to a reasonably modest flat fee until the end of the litigation. "But we keep track of our time, as any lawyer would, so we know what we're spending. We refer to that as our virtual bank. At the end of the litigation, we look at that and talk to the client about what we'd agreed up front. Depending on the outcome, we get paid either all of the bank, some of the bank, or, if there's an exceptionally good outcome, a multiple of the bank." Or, if the outcome is poor, "we might get paid none of it."
For lawyers, sharing some of the risk of litigation with their clients puts them back squarely in their clients' corners, Trull says. "If the case turns out to be a disaster and the client is unhappy, the law firm is also unhappy, because it gets paid nothing. But if the outcome is so good that it is unexpected, the client may pay an additional fee with a smile on its face because it got exactly what it wanted, if not more."
Trull provides an example from his own practice. "I've litigated two cases in the past couple of years where my client was the defendant and the claims were very, very substantial. We not only achieved a zero liability result but got the plaintiffs to pay money to our clients."
Under the fee agreement, the clients had to pay Trull and his firm a bonus. "Were they unhappy? No! They were thrilled. They achieved a knock-it-out-of-the-park result. In one of those cases, our client actually recovered millions of dollars in fees that it had already paid."
Such arrangements, Philippi warns, make a very clear, written fee agreement absolutely essential. He further cautions that, though they frequently masquerade as alternative fee structures, neither blended rates nor discounted rates qualify.
"Think about it: lawyers who offer a crazy low blended or discounted rate, are still billing hourly, and their incentive is still to bill as many hours as they possibly can. It doesn't really matter what the hourly rates are if the monthly bill is $100,000 either way. A lot of clients get confused and think that those arrangements are value-based billing, but those systems encourage inefficiency and don't save clients money."
Trull sums up: "Value-based billing discourages inefficiency and aligns the interests of attorney and client. If what's being proposed doesn't do those two things, it isn't value-based billing."
Be flexible, willing to take risk
Jason Maxwell, vice president and associate general counsel for litigation at a Fortune 25 company, says he's pleased to count Philippi and Trull among his stable of outside counsel. Confirming their explanation of alternative fee arrangements, Maxwell also emphasizes that the right alternative fee structure for a matter needs to fit the best interests of both lawyer and client.
"It has to be a marriage between the law firm and the client. You don't want either the law firm or the company to get the short end of the stick in a matter, unless you have a longer-term relationship and you know it's going to be made up in the long run. I want something that's fair, not an arrangement where I'm getting the best of the law firm or they're getting the best of me. That makes for a short relationship."
Maxwell says it can be very difficult to say what a case should be worth when initially hiring counsel. "When you get sued, you sometimes have very little information at the outset. If all we have is a complaint where someone's making allegations, it can be hard to size it up."
In such cases, he says, he and other companies sometimes engage a firm at a negotiated hourly rate. "Once you learn more down the road, though usually still early on in the matter, you can re-evaluate your billing arrangement."
Maxwell recalls that years ago a matter ended unpleasantly. "I asked for proposals based on the complaint, without much more information. One law firm bid a surprisingly low flat rate. We had no idea what the case would turn into, and neither did they. They ended up with far more work than they had anticipated and lost money on it. Consequently, they didn't put in the work they should have, and we had a very rare dispute with that firm on the competency of their work. It was a relationship killer."
An individual case may be better suited for the now-traditional hourly billing model than for alternative fee structures precisely because of the risk of its ending up as The Case From Hell. Unless a matter is part of a portfolio of cases offered to a law firm, law firm and client must have a relationship of trust so that the lawyers know that the client will make up the shortfall by offering them more business.
"In my experience, the matters that are the easiest fits for alternative fee arrangements are cases of a recurring nature or similar type." They might be sets of litigation, sets of cases, sets of cases in which the company is the plaintiff, or other matters for which the lawyer and client desire more billing certainty. "While they may not be the ideal fit for every case, alternative billing structures certainly help to align incentives between law firm and client. The ultimate objective is to select the fee structure that provides the most value to the company and reduces overall long and short term costs," Maxwell says.
Though his default arrangement with outside counsel remains hourly billing, Maxwell says he and other in-house counsel are increasingly looking for alternative fee structures from their outside attorneys. The certainty of those arrangements benefits companies significantly.
"Publicly traded companies in particular must meet budgets and comply with a variety of accounting rules. If we have a deal that says we'll pay you a million dollars a year [to handle all cases of a certain type], we know there will be no cost overruns and it gives us budgeting certainty."
Asked how lawyers who wish to be considered for more business from companies such as Maxwell's can enhance their chances, he suggests demonstrating a willingness to take on some risk, be flexible, and reach an agreement quickly, without requiring layers of approval. Smaller firms may actually have an edge over larger shops.
"In my experience, the larger national and international law firms tend to be more risk-averse in their willingness to enter into alternative fee structures and require more layers of management approval. Smaller and more local firms tend to have less bureaucracy and to be more willing to take on risk."
Helen W. Gunnarsson is an associate counsel at the American Bar Association's Center for Professional Responsibility in Chicago. As the IBJ's first contributing writer, she wrote the LawPulse feature since its inception in 2001 and most of the cover stories from 2004 through this issue in 2012. She can be reached at Helen.Gunnarsson@americanbar.org.
• Boston lawyer, writer, and consultant Jay Shepherd provides a memorable "Coffee Parable" to illustrate the problems with billing by the hour at http://www.clientrevolution.com/2009/01/a-coffee-parable.html.
• 'Billable Hour' Under Attack: In Recession, Companies Push Law Firms for Flat-Fee Contracts, by Nathan Koppel and Ashby Jones, appeared in the August 24, 2009, issue of The Wall Street Journal and is available at http://www.carrollpc.com/resources/corpgen-news/wsj-billable-hour-under-attack/.
• Aon Corporation's Mark Herrmann, Vice-President and Chief Counsel - Litigation, writes a column for the Above The Law blog. His December 15, 2011, post, Inside Straight: Inflating Your Own Outside Legal Spend, addresses alternative fee arrangements.
• Canadian lawyer Jordan Furlong's post, The Best Pricing Advice Ever, is available at http://www.attorneyatwork.com/the-best-pricing-advice-ever/.
• Oklahoma lawyer Jim Calloway, director of the Oklahoma Bar Association's Management Assistance Program, posts on alternative billing on his blog at http://jimcalloway.typepad.com/lawpracticetips/alternative_billing/.
• Matt Homann, a lawyer formerly based in Illinois, dedicates his blog, "The [non]billable hour," to making law practice more effective: http://www.nonbillablehour.com/.