Fixed Fee Legal: How general counsels are creating value beyond the billable hour
We all know that the business of law is changing. Since the economic decline of 2008, firms nationwide have had to find new ways to control costs and drive value. In this environment, fixed fee legal arrangements have become a key player. Fixed fees, known as alternative fee arrangements (“AFAs”), are reshaping how general counsels approach outside legal. In short, the billable hour is starting to take a back seat so that a fixed price, negotiated between client and firm, can drive.
On the Rise
Amar Sarwal, chief legal counsel for the ACC, states that the industry is “extremely close to the tipping point” of embracing fixed fee arrangements. The numbers back him up. In 2009, 28% of surveyed firm leaders believed that AFAs would bring a permanent change to the legal industry. By 2013, that number increased to 80%. Presently, 37% of surveyed general counsels expect AFAs to increase—only 4% expect it to decrease. AFAs are on the rise.
The reason for AFA’s newfound popularity? Value. According to Huron Consulting Group’s Impact Benchmarking Survey, companies are realizing an average savings of 40% by using AFAs. Yes, you read that right. Our clients have reported similar savings as well. Given that businesses spend an average 1.2% of their revenue on legal—and 60% of that on outside counsel—the results can be huge.
Yes, Even For Litigation
The conventional wisdom used to be that, while transactions were predictable, litigation had too much uncertainty to allow for fixed billing. Creative corporations and firms have proven that not to be the case. Global industrial conglomerates Tyco International Ltd and United Technologies each spend more than 70% of their legal dollars in fixed fee arrangements. This is not necessarily because they can deal in volume. Rather, they work with firms that are willing to think outside the billable box.
There is no question that litigation is uncertain, meaning that the total outcome is uncertain. The process, however, is fixed and that allows for fixed fees. Every case involves the same set of phases: initial evaluation, pleadings, motions, discovery, ADR, pretrial preparation, trial, and appeal. On the AFA model, the litigation team prices out each phase, which the client pays on an as needed basis. “There are rules and processes,” says Steve Greenspan, head of the litigation department for United Technologies, “you should be able to price a case in most circumstances and negotiate for carve-outs with outside counsel in the event that something unexpected happens.” We have found that it works on almost all types of cases.
But what about the intrinsic uncertainty? Well, the market has found other ways to deal with uncertainty than through a billable hour model. After all, there is plenty of uncertainty in the building of a skyscraper. Lawyers can use carve outs and change orders to accommodate risk without sacrificing cost certainty altogether. Beyond this, there are more sophisticated ways to mitigate the risk of going over or under budget. For example, under a “collar” arrangement, the parties agree to a budgeted fee as well as a collar—a percentage of the fee. If the fees exceed the budget by the amount of the collar, say 10%, the client pays a percentage of the over-run. If less than the collar, the firm pays back a percentage of the savings to the client. Mechanisms like this provide controlled elasticity in the fees, balancing the knowns and the unknowns for the client’s benefit.
Aligned Incentives, Controlled costs
AFAs bring corporations two main benefits. First, the most important benefit for AFAs, and perhaps the reason why companies are able to save 40% of their costs by using them, is the alignment of incentives. There can be no question that the billable hour system incentivizes more work. When attorneys are paid purely for effort instead of progress, inefficiencies are bound to appear. AFAs align the incentives. The lawyer has a bit of skin in the game. The client is no longer buying hours (who ever wants to buy hours?); the client is buying progress in a case or transaction.
Second, AFAs bring cost certainty. General counsels, armed with this certainty, may realize a strengthened relationship with the financial departments, not to mention the C-Suite. Lawyers benefit from this certainty by having more stable clients. Gone are the days of the client scrutinizing every billable entry or hating the fact that s/he has to call the lawyer. In addition, the lawyer, now untethered to the billable hour, gains flexibility in managing the case.
The main burden arises when a company and firm have agreed on a woefully inaccurate estimate. No company wants to overpay and give the firm a windfall. Nor does any client want a firm working for free, as that creates an incentive to cut corners. To mitigate this, the company and the firm must both have an eyes-open approach to estimating the cost of a project. Beyond that, they have to trust each other and work cooperatively to ensure an accurate financial plan that enables the firm to serve the client.
The obvious objection is to ask why aren’t more firms offering AFAs? First, many are. Second, some firms have economic structures that don’t allow fixed fees. Billable hours have become the inventory of firms, instead of the intellectual capital of the attorneys working those hours. When hours dictate pay and performance, it is understandably hard to let go of a model that has been so profitable for so long.
Nevertheless, the growing trend shows that fixed fee legal is a viable and efficient alternative to the billable hour. At Immix Law Group, we have found that the companies who brave these waters are finding greater efficiencies, cost certainty, and real savings. For the general counsel looking to leverage a modernized practice of law into tangible benefits, fixed fee legal is a necessary arrow in the quiver.
About the Author: Nicholas Drum
Email: firstname.lastname@example.org | Direct: (503) 802-5547
Specializing in litigation law, Nicholas advises businesses and individuals on a range of civil matters including real property disputes, commercial transactions and trust litigation. His experience both in and out of the courtroom has enabled him to help clients find economical solutions to uneconomical problems.