Alternative Fee Arrangements December 19, Moderator: Seth H. Row, Partner, Parsons Farnell & Grein LLP, Portland

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1 Alternative Fee Arrangements December 19, 2013 I. INTRODUCTION Moderator: Seth H. Row, Partner, Parsons Farnell & Grein LLP, Portland Speakers: Rich Oberdorfer is a frequent lecturer on DUII, alcohol, and drivingrelated topics. He graduated cum laude from the Northwestern School of Law at Lewis & Clark College in 2001, and since that time has fought for thousands of motorists in trouble with the law. He is an active member of the Oregon Criminal Defense Lawyers Association (OCDLA). He lives in North Portland with his wife and law partner, Emily Oberdorfer; two little girls; and a particularly cranky old cat. David Wang serves as in-house counsel at Vestas-American Wind Technology, the U.S. sales unit of the world s leading wind turbine manufacturer. He represents the company during negotiation of new sales and long-term service contracts. He graduated cum laude from Cornell Law School, and has a B.S. degree in Electrical Engineering and Computer Science from the University of California at Berkeley and a M.Sc. in Risk Management and Regulation from the London School of Economics. Prior to joining Vestas, he was a partner in the Corporate and Securities practice at Holland & Knight LLP s Portland office. Marc Alifanz is Senior Associate Counsel for Litigation and Employment at Portland-based Knowledge Universe-U.S., the world s largest private provider of early childhood education. Marc graduated from Washington University School of Law in St. Louis in 2003, and previously represented and advised employers on labor and employment issues and litigation at Stoel Rives in Portland and Proskauer Rose in Newark, New Jersey. He currently serves as Secretary for the Friends of the Multnomah County Library. Marc lives out near the farmlands of Sauvie Island with his wife Tracy and twin four year old daughters. Dayna Underhill is a partner at Hinshaw & Culbertson LLP. Licensed and active in both Oregon and Washington, her practice focuses on legal ethics and risk management for law firms, lawyers and corporate in-house counsel. She Page 1

2 represents and advises lawyers on all aspects of the law governing lawyers including the defense of bar disciplinary complaints, lawyer mobility, lateral hiring, client engagement, conflicts of interest, attorney-client privilege and print and internet lawyer advertising. Dayna is a nationally recognized speaker on the full range of risk management and professional responsibility issues for lawyers and firms. Dayna serves as a member of the Oregon State Bar Association's House of Delegates, the Washington State Bar Association's Disciplinary Advisory Roundtable, the Multnomah Bar Association's Professionalism Committee, the American Bar Association's Labor and Employment Section and Center on Professional Responsibility, the Oregon Law Institute's Board of Directors and the Northwest Academy's Board of Trustees where she serves as Secretary. Kieran Curley has been the managing partner of Miller Nash LLP since January Previously, he was a partner in the firm's litigation department. Kieran has broad experience in complex commercial litigation matters, including banking, construction, corporate governance, insurance recovery, intellectual property, and commercial transactions. Before attending law school, Kieran came to the Pacific Northwest through the Jesuit Volunteer Corps, and he held accounting and finance positions with The Hillhaven Corporation and the Providence Health System. II. OVERVIEW Alternative fee arrangements or AFA is a new buzzword for an old concept: getting away from the strict regime of hourly-billing at variable rates tied to experience. Many corporations and other large consumers of legal services are moving toward widespread use of AFAs, for a variety of reasons including increasing predictability in legal budgets, and incentivize efficient legal representation. Lawyers who have grown up in a world of billable hours and regular rate increases often scratch their heads at how to come up with AFAs that will adequately compensate them for their work and avoid financial ruin if things don t go as expected. In this CLE we will discuss the ethics of AFAs, different types of AFAs in use in transactional, criminal, and civil litigation settings, how to price AFAs, and other collateral issues. Page 2

3 THE ETHICAL IMPLICATIONS AND RISKS ASSOCIATED WITH ALTERNATIVE FEE ARRANGEMENTS Dayna E. Underhill and Jessica D. Osborne 1 Non-Exclusive List of Types of Alternative Fee Arrangements: o Flat or fixed fee: set price for matter or part of matter typically paid either in advance or at the conclusion of the matter; o Standard contingent fee: fee based on a percentage of client's outcome in matter; o Blended rate fee: an hourly rate set at an amount somewhere between that charged for associate time and that charged for partner time; o Success fee: attorney fee based in part on achievement of specific result; o Collar fee: coupling of a targeted budget for a matter with an hourly rate; o Retainer: fixed fee amount anticipated to cover the costs of the matter in whole in part OR to secure the availability of the lawyer. o Capped fee: a fee agreement setting a ceiling on the maximum amount the firm may recover. o Portfolio fixed fee/volume discounts: fee agreement that covers a series or group of matters for the same client that provides some measure of discount to the client for bringing in a large volume of work. o Performance based hold back: payment by client of a set percentage of hourly fees that would be typically charged (i.e. 80%) then an additional amount paid at intervals based on client's perception of lawyer's performance or successful reaching of specified criteria by lawyer. 1 Dayna E. Underhill is a partner at Hinshaw & Culbertson, LLP. Licensed in Oregon and Washington, Dayna's practice focuses on legal ethics and risk management for law firms, lawyers and corporate in-house counsel. She represents and advises lawyers on all aspects of the law governing lawyers including the defense of bar disciplinary complaints, lawyer mobility, client engagement, conflicts of interest, attorney-client privilege and lawyer advertising. Dayna is a nationally recognized speaker on the full range of risk management and professional responsibility issues for lawyers and firms. Dayna serves as a member of the Oregon State Bar Association's House of Delegates, the Washington State Bar Association's Disciplinary Advisory Roundtable, the Multnomah Bar Association's Professionalism Committee, the American Bar Association's Center on Professional Responsibility, the Oregon Law Institute's Board of Directors and the Northwest Academy's Board of Trustees. Jessica D. Osborne is an associate at Hinshaw & Culbertson LLP. Jessica focuses her practice in the areas of legal ethics, professional responsibility and risk management for attorneys. She represents and counsels lawyers and law firms on matters involving bar disciplinary complaints, bar admissions and reinstatements, disqualification motions, general legal ethics questions, and law firm corporate matters. Jessica serves on the Oregon Gay and Lesbian Law Association's Board of Directors. Page v1

4 o Hybrid hourly rate/success fee: A fee arrangement based on a mix of an hourly rate of payment and a percentage of a successful outcome. o Reverse contingent fee: A fee that is based on a percentage of the difference between the amount demanded by opposing party and the amount ultimately obtained. o Unbundled Fee: Fees paid based on segregated and specific tasks on a matter (rather than the entire matter) which are assigned to the lawyer. Potential ethical implications of various alternative fee arrangements o RPC 1.1 Competence: "A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation." o Rule 1.3 Diligence: "A lawyer shall not neglect a legal matter entrusted to the lawyer." A point of consideration arises when the amount of work required to successfully and ethically complete the task surpasses in some measurable amount the agreed-upon fee. Consider "limited scope agreements" under RPC 1.2 (b) below. Ensure that expected profitability of a matter does not control work on a matter in order to maintain profitability or to the attorney taking a settlement position that might be less advantageous to the client. (RPC 1.2(a)) o RPC 1.2: (a) ***"A lawyer shall abide by a client's decisions concerning the objectives of representation***. A lawyer shall abide by a client's decision whether to settle a matter." (b) "A lawyer may limit the scope of the representation if the limitation is reasonable under the circumstances and the client gives informed consent." RPC 1.0(g): informed consent requires lawyer to "give adequate information and explanation about the material risks of and reasonably available alternatives to the proposed course of conduct." Informed consent need not be in writing unless the specific ethics rule requires it (e.g., conflicts of interest), but a writing never hurts. The attorney must abide by the scope of the representation as defined and abide by the client's wishes such as whether or not to accept a settlement. See Oregon Formal Ethics Op ("Fee Agreements: Contingent to 2 Page v1

5 Hourly Fee When Client Rejects Settlement Offer" permissible BUT when considering an alternative fee provision based on the client's refusal to accept a "reasonable" settlement agreement, lawyer should consider whether the fee could be considered excessive under RPC 1.5). o RPC 1.5. "A lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses." In Oregon, the fee must be "reasonable" (check jurisdictional rules for exact language). Reasonableness is measured at the time the agreement is entered into, at the time the client is billed and at the time the lawyer collects. Reasonableness is determined based on factors contained in subparagraph (b): o Time, labor, novelty, difficulty, skill required; o Employment precludes other employment; o Customary fees for similar services in the locale; o Amount involved and results obtained; o Time limitations; o Nature and length of professional relationship; o Experience, reputation and ability of the lawyer; o Fixed or Contingent fee. Whether a fee may be "earned on receipt" (and how such funds must be handled) will depend on your jurisdiction check the rules. In Oregon "earned on receipt" or "nonrefundable" fees must be agreed upon in a written agreement signed by the client. RPC 1.5(c)(3). In Oregon, the fee must be deposited in the lawyer's general or operating account and must NOT be deposited into the trust account due to commingling risk. A refund may be allowable if the lawyer is discharged. RPC 1.5(c)(3)(i) See also Washington RPC 1.5(f)(2) (providing detailed explanation, in conjunction with Washington RPC 1.15, about how such fees must handled). If all contemplated work is not completed, the fee may be considered excessive and a partial refund may be required. RPC1.5(c)(3)(ii). 3 Page v1

6 A contingency fee may not be entered into for certain domestic relations matters or representation of a defendant in a criminal matter. RPC 1.5(c) o RPC 1.7: Personal interest conflicts: (a)(2) "there is a significant risk that the representation of one or more clients will be materially limited by *** a personal interest of the lawyer" The temptation may be to underwork the case or push for a settlement that might not be best for the client. A conflict may arise when a lawyer's work becomes unprofitable because the amount of time the matter required outpaced the agreed upon fee. Can you change the fee agreement midstream? While an initial fee agreement with a client is an arms-length negotiation, a renegotiation during the course of the representation is not. The lawyer becomes adverse to the client for the purposes of negotiating a new fee agreement. This implicates a personal interest conflict under 1.7(a)(2) and informed consent confirmed in writing must occur. See, Oregon Formal Ethics Op and (lawyer may not charge or collect more than the agreed-on fee). See also, In re Yacob, 318 Or 10, 860 P2d 811 (1993). See, Oregon Formal Ethics Op ("Fee Agreements: Modification of Fee Agreements and Interest Charges)(modification of a fee agreement in the lawyer s favor requires client consent based on an explanation of the reason for the change and its effect on the client. See In re Skinner, 14 DB Rptr 38 (2000). In addition, the modification must be objectively fair. o RPC 1.8: Specific rules relating to conflicts of interest with current clients. Consider whether your AFA has you doing business with your client. (a) "A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless... o The terms of such an agreement are fair and reasonable; o Fully disclosed to the client; o Transmitted in writing; o The client has a full opportunity to seek independent counsel; and o The client gives informed consent. 4 Page v1

7 See, ABA Comm. on Ethics & Prof l Responsibility Formal Op (2002), Contractual Security Interest Obtained by a Lawyer to Secure Payment of a Fee (A lawyer may take a security interest in client property when the property is the subject of litigation in which the lawyer represents the client if the disclosures and other provisions of Model Rule 1.8 are satisfied). If client property is to be held by the lawyer, the lawyer also acquires duties to identify the property as the client s and to safeguard it. Model Rules of Prof l Conduct 1.15(a). Risk Management: o Ethics rules vary from state to state. Be sure to check jurisdictional rules relating to permissible fee arrangements. o Before you enter into an AFA with your client, ask whether your AFA triggers your state's ethics rules on fee splitting, doing business with clients, and acquiring an interest in litigation. o Contemporaneous documentation regarding fee agreements and payment should be kept by the lawyer at all stages of the representation. A well-documented file can be the best evidence in a dispute with your client. o If you give a client an "estimate" of hourly fees and you recognize that you will surpass it before the end of the engagement, bring that to the client's attention at the earliest possible point and obtain authority in writing to continue. o Conceptually balance the usefulness of an AFA against the ethical risk. 5 Page v1

8 SELECTED OREGON RULES OF PROFESSIONAL CONDUCT (as amended effective January 1, 2013) RULE 1.1 COMPETENCE A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation. Defined Terms (see Rule 1.0): Reasonably Comparison to Oregon Code This rule is identical to DR 6-101(A). Comparison to ABA Model Rule This is the ABA Model Rule. RULE 1.2 SCOPE OF REPRESENTATION AND ALLOCATION OF AUTHORITY BETWEEN CLIENT AND LAWYER (a) Subject to paragraphs (b) and (c), a lawyer shall abide by a client's decisions concerning the objectives of representation and, as required by Rule 1.4, shall consult with the client as to the means by which they are to be pursued. A lawyer may take such action on behalf of the client as is impliedly authorized to carry out the representation. A lawyer shall abide by a client's decision whether to settle a matter. In a criminal case, the lawyer shall abide by the client's decision, after consultation with the lawyer, as to a plea to be entered, whether to waive jury trial and whether the client will testify. (b) A lawyer may limit the scope of the representation if the limitation is reasonable under the circumstances and the client gives informed consent. (c) A lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is illegal or fraudulent, but a lawyer may discuss the legal consequences of any proposed course of conduct with a client and may counsel or assist a client to make a good faith effort to determine the validity, scope, meaning or application of the law. Adopted 01/01/05 Defined Terms (see Rule 1.0): Fraudulent Page 8

9 Informed consent Knows Matter Reasonable Comparison to Oregon Code This rule has no real counterpart in the Oregon Code. Subsection (a) is similar to DR 7-101(A) and (B), but expresses more clearly that lawyers must defer to the client s decisions about the objectives of the representation and whether to settle a matter Subsection (b) is a clarification of the lawyer s right to limit the scope of a representation. Subsection (c) is similar to DR 7-102(A)(7), but recognizes that counseling a client about the meaning of a law or the consequences of proposed illegal or fraudulent conduct is not the same as assisting the client in such conduct. Comparison to ABA Model Rule ABA Model Rule 1.2(b) states that a lawyer s representation of a client does not constitute an endorsement of the client s political, economic, social or moral views or activities. It was omitted because it is not a rule of discipline, but rather a statement intended to encourage lawyers to represent unpopular clients. Also, MR 1.2(c) refers to criminal rather than illegal conduct. RULE 1.3 DILIGENCE A lawyer shall not neglect a legal matter entrusted to the lawyer. Adopted 01/01/05 Defined Terms (see Rule 1.0) Matter Comparison to Oregon Code This rule is identical to DR 6-101(B). Comparison to ABA Model Rule The ABA Mode Rule requires a lawyer to act with reasonable diligence and promptness in representing a client. 2 Page 9

10 RULE 1.5 FEES (a) A lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses. (b) A fee is clearly excessive when, after a review of the facts, a lawyer of ordinary prudence would be left with a definite and firm conviction that the fee is in excess of a reasonable fee. Factors to be considered as guides in determining the reasonableness of a fee include the following: (1) the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly; (2) the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer; (3) the fee customarily charged in the locality for similar legal services; (4) the amount involved and the results obtained; (5) the time limitations imposed by the client or by the circumstances; (6) the nature and length of the professional relationship with the client; (7) the experience, reputation, and ability of the lawyer or lawyers performing the services; and (8) whether the fee is fixed or contingent. (c) A lawyer shall not enter into an arrangement for, charge or collect: (1) any fee in a domestic relations matter, the payment or amount of which is contingent upon the securing of a divorce or upon the amount of spousal or child support or a property settlement; (2) a contingent fee for representing a defendant in a criminal case; or (3) a fee denominated as "earned on receipt," "nonrefundable" or in similar terms unless it is pursuant to a written agreement signed by the client which explains that: (i) the funds will not be deposited into the lawyer trust account, and (ii) the client may discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee if the services for which the fee was paid are not completed. 3 Page 10

11 (d) A division of a fee between lawyers who are not in the same firm may be made only if: (1) the client gives informed consent to the fact that there will be a division of fees, and (2) the total fee of the lawyers for all legal services they rendered the client is not clearly excessive. (e) Paragraph (d) does not prohibit payments to a former firm member pursuant to a separation or retirement agreement, or payments to a selling lawyer for the sale of a law practice pursuant to Rule Adopted 01/01/05 Amended 12/01/10: Paragraph(c)(3) added. Defined Terms (see Rule 1.0): Firm Informed Consent Matter Reasonable Comparison to Oregon Code Paragraphs (a), (b) and (c)(1) and (2) are taken directly from DR 2-106, except that paragraph (a) is amended to include the Model Rule prohibition against charging a clearly excessive amount for expenses. Paragraph (c)(3) had no counterpart in the Code. Paragraph (d) retains the substantive obligations of DR 2-107(A) but is rewritten to accommodate the new concepts of informed consent and clearly excessive. Paragraph (e) is essentially identical to DR 2-107(B). Comparison to ABA Model Rule ABA Model Rule 1.5(b) requires that the scope of the representation and the basis or rate of the fees or expenses for which the client will be responsible be communicated to the client before or within a reasonable time after the representation commences, preferably in writing. Model Rule 1.5(c) sets forth specific requirements for a contingent fee agreement, including an explanation of how the fee will be determined and the expenses for which the client will be responsible. It also requires a written statement showing distribution of all funds recovered. Paragraph (c)(3) has no counterpart in the Model Rule. Model Rule 1.5(e) permits a division of fees between lawyers only if it is proportional to the services performed by each lawyer or if the lawyers assume joint responsibility for the representation. 4 Page 11

12 RULE 1.7 CONFLICT OF INTEREST: CURRENT CLIENTS (a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a current conflict of interest. A current conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer; or (3) the lawyer is related to another lawyer, as parent, child, sibling, spouse or domestic partner, in a matter adverse to a person whom the lawyer knows is represented by the other lawyer in the same matter. (b) Notwithstanding the existence of a current conflict of interest under paragraph (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not obligate the lawyer to contend for something on behalf of one client that the lawyer has a duty to oppose on behalf of another client; and (4) each affected client gives informed consent, confirmed in writing. Adopted 01/01/05 Defined Terms (see Rule 1.0): Believes Confirmed in writing Informed consent Knows Matter Reasonably believes 5 Page 12

13 Comparison to Oregon Code The current conflicts of interest prohibited in paragraph (a) are the self-interest conflicts currently prohibited by DR 5-101(A) and current client conflicts prohibited by DR 5-105(E). Paragraph (a)(2) refers only to a personal interest of a lawyer, rather than the specific financial, business, property or personal interests enumerated in DR 5-101(A)(1). Paragraph (a)(3) incorporates the family conflicts from DR 5-101(A)(2). Paragraph (b) parallels DR 5-101(A) and DR 5-105(F) in permitting a representation otherwise prohibited if the affected clients give informed consent, which must be confirmed in writing. Paragraph (b)(3) incorporates the actual conflict definition of DR 5-105(A)(1) to make it clear that that a lawyer cannot provide competent and diligent representation to clients in that situation. Paragraph (b) also allows consent to simultaneous representation not prohibited by law, which has no counterpart in the Oregon Code. According to the official Comment to MR 1.7 this would apply, for instance, in jurisdictions that prohibit a lawyer from representing more than one defendant in a capital case, to certain representations by former government lawyers, or when local law prohibits a government client from consenting to a conflict of interest. Comparison to ABA Model Rule This is essentially identical to the ABA Model Rule, except for the addition of paragraphs (a)(3) and (b)(3) discussed above; also, the Model Rule uses the term concurrent rather than current. The Model Rule allows the clients to consent to a concurrent conflict if the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal. RULE 1.8 CONFLICT OF INTEREST: CURRENT CLIENTS: SPECIFIC RULES (a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless: (1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner that can be reasonably understood by the client; (2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and (3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction. (b) A lawyer shall not use information relating to representation of a client to the disadvantage of the client unless the client gives informed consent, confirmed in writing, except as permitted or required under these Rules. (c) A lawyer shall not solicit any substantial gift from a client, including a testamentary gift, or prepare on behalf of a client an instrument giving the lawyer or a person related to the lawyer 6 Page 13

14 any substantial gift, unless the lawyer or other recipient of the gift is related to the client. For purposes of this paragraph, related persons include a spouse, domestic partner, child, grandchild, parent, grandparent, or other relative or individual with whom the lawyer or the client maintains a close familial relationship. (d) Prior to the conclusion of representation of a client, a lawyer shall not make or negotiate an agreement giving the lawyer literary or media rights to a portrayal or account based in substantial part on information relating to the representation. (e) A lawyer shall not provide financial assistance to a client in connection with pending or contemplated litigation, except that: (1) a lawyer may advance court costs and expenses of litigation, the repayment of which may be contingent on the outcome of the matter; and (2) a lawyer representing an indigent client may pay court costs and expenses of litigation on behalf of the client. (f) A lawyer shall not accept compensation for representing a client from one other than the client unless: (1) the client gives informed consent; (2) there is no interference with the lawyer's independence of professional judgment or with the client-lawyer relationship; and (3) information related to the representation of a client is protected as required by Rule 1.6. (g) A lawyer who represents two or more clients shall not participate in making an aggregate settlement of the claims of or against the clients, or in a criminal case an aggregate agreement as to guilty or nolo contendere pleas, unless each client gives informed consent, in a writing signed by the client. The lawyer's disclosure shall include the existence and nature of all the claims or pleas involved and of the participation of each person in the settlement. (h) A lawyer shall not: (1) make an agreement prospectively limiting the lawyer's liability to a client for malpractice unless the client is independently represented in making the agreement; (2) settle a claim or potential claim for such liability with an unrepresented client or former client unless that person is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel in connection therewith; (3) enter into any agreement with a client regarding arbitration of malpractice claims without informed consent, in a writing signed by the client; or 7 Page 14

15 (4) enter into an agreement with a client or former client limiting or purporting to limit the right of the client or former client to file or to pursue any complaint before the Oregon State Bar. (i) A lawyer shall not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except that the lawyer may: (1) acquire a lien authorized by law to secure the lawyer's fee or expenses; and (2) contract with a client for a reasonable contingent fee in a civil case. (j) A lawyer shall not have sexual relations with a current client of the lawyer unless a consensual sexual relationship existed between them before the client-lawyer relationship commenced; or have sexual relations with a representative of a current client of the lawyer if the sexual relations would, or would likely, damage or prejudice the client in the representation. For purposes of this rule: (1) "sexual relations" means sexual intercourse or any touching of the sexual or other intimate parts of a person or causing such person to touch the sexual or other intimate parts of the lawyer for the purpose of arousing or gratifying the sexual desire of either party; and (2) "lawyer" means any lawyer who assists in the representation of the client, but does not include other firm members who provide no such assistance. (k) While lawyers are associated in a firm, a prohibition in the foregoing paragraphs (a) through (i) that applies to any one of them shall apply to all of them. Adopted 01/01/05 Amended 01/01/13: Paragraph (e) amended to follow ABA Model Rule 1.8(e). Defined Terms (see Rule 1.0): Confirmed in writing Information relating to the representation of a client Informed consent Firm Knowingly Matter Reasonable 8 Page 15

16 Reasonably Substantial Writing Comparison to Oregon Code This rule has no exact counterpart in the Oregon Code, although it incorporates prohibitions found in several separate disciplinary rules. Paragraph (a) replaces DR 5-104(A) and incorporates the Model Rule prohibition against business transactions with clients even with consent except where the transaction is fair and reasonable to the client. It also includes an express requirement to disclose the lawyer s role and whether the lawyer is representing the client in the transaction. Paragraph (b) is virtually identical to DR 4-101(B). Paragraph (c) is similar to DR 5-101(B), but broader because it prohibits soliciting a gift as well as preparing the instrument. It also has a more inclusive list of related persons. Paragraph (d) is identical to DR 5-104(B). Paragraph (e) incorporates ABA Model Rule 1.8(e). Paragraph (f) replaces DR 5-108(A) and (B) and is essentially the same as it relates to accepting payment from someone other than the client. This rule is somewhat narrower than DR 5-108(B), which prohibits allowing influence from someone who recommends, employs or pays the lawyer. Paragraph (g) is virtually identical to DR 5-107(A). Paragraph (h)(1) and (2) are similar to DR 6-102(A), but do not include the unless permitted by law language. Paragraph (h)(3) retains DR 6-102(B), but substitutes informed consent, in a writing signed by the client for full disclosure. Paragraph (h)(4) is new and was taken from Illinois Rule of Professional Conduct 1.8(h). Paragraph (i) is essentially the same as DR 5-103(A). Paragraph (j) retains DR 5-110, reformatted to conform to the structure of the rule. Paragraph (k) applies the same vicarious disqualification to these personal conflicts as provided in DR 5-105(G). 9 Page 16

17 Comparison to ABA Model Rule This rule is identical to ABA Model Rule 1.8 with the following exceptions. MR 1.8 (b) does not require that the client s informed consent be confirmed in writing as required in DR 4-101(B). MR 1.8 (h) does not prohibit agreements to arbitrate malpractice claims. MR 1.8 (j) does not address sexual relations with representatives of corporate clients and does not contain definitions of terms. 10 Page 17

18 FORMAL OPINION NO Fee Agreements: Contingent Fees Paid in Installments Facts: Lawyer settles a contingent fee case for Client. The settlement provides that payments will be made over time. Question: Absent a contrary agreement by Client, may Lawyer ethically take more than the applicable percentage fee from each payment as made? Conclusion: No. Discussion: Oregon RPC 1.5(a) provides: A lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses. Lawyer s contingent fee agreement provides for Lawyer to get a percentage of any settlement and not for Lawyer to be paid off the top. Because the Oregon Supreme Court has held that an illegal or clearly excessive fee under former DR 2-106(A) is present whenever a lawyer charges more than a client has agreed to pay, Lawyer cannot receive more than a prorated portion of each settlement payment that is made. Cf. In re Sassor, 299 Or 720, 725, 705 P2d 736 (1985) (applying former Page 18 33

19 Formal Opinion No DR 2-106(A) which, for purposes of this opinion, is the same as Oregon RPC 1.5(a)); Oregon RPC 1.8(i)(2) (lawyer may contract with a client for a reasonable contingent fee in a civil case ). Approved by Board of Governors, August COMMENT: For additional information on this general topic and other related subjects, see THE ETHICAL OREGON LAWYER 3.2, 3.5, 3.7, 3.20 (Oregon CLE 2003); RESTATEMENT (THIRD) OF THE LAW GOVERNING LAWYERS (2003); and ABA Model Rule 1.5(a). See also OSB Formal Ethics Op Nos (lawyer may not receive more than previously agreed-on fee even though lawyer fee award is larger and reasonable under the circumstances), (lawyer may not charge fee in excess of fixed fee unless agreed to beforehand or fee agreement provides notice of possibility of increased fee). 34 Page 19

20 FORMAL OPINION NO Fee Agreements: Contingent to Hourly Fee When Client Rejects Settlement Offer Facts: Lawyer frequently represents plaintiffs in personal injury contingent-fee litigation. Lawyer proposes to provide as a term in Lawyer s standard contingent-fee agreement that if a client rejects a settlement offer that Lawyer deems reasonable, Lawyer may, at Lawyer s option, transform the fee agreement into one that entitles Lawyer to the agreed-on percentage of the rejected settlement amount plus an hourly fee from the point of rejection forward. Question: If the requirements of ORS are met, and the terms and conditions of the fee agreement are explained to and understood by Lawyer s clients, may Lawyer employ and enforce such a provision? Conclusion: Yes, qualified. Discussion: Oregon RPC 1.2(a) requires a lawyer to abide by a client s decision whether to settle a matter. Because lawyers are agents for their clients, and not principals, it is up to the clients and not the lawyers to decide whether to settle a matter. See, e.g., OSB Formal Ethics Op No But cf. Hagans, Brown & Gibbs v. First Nat., 783 P2d 1164 (Alaska 1989) (noting very limited bad-faith exception to this general rule). Depending on the circumstances, the proposed clause could unduly interfere with the client s unfettered decision whether to settle. Oregon RPC 1.5(a) provides that [a] lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses. The use of a provision in a fee agreement such as the one outlined here could very well turn an otherwise lawful fee into a clearly excessive fee in violation of Oregon RPC 1.5(a) or into a fee that was not a reasonable contingent fee in 128 Page 20

21 Formal Opinion No violation of Oregon RPC 1.8(i). Cf. OSB Formal Ethics Op No See also In re Kerrigan, 271 Or 1, 530 P2d 26 (1975). In addition, and because Oregon RPC 1.5(a) prohibits not only entering into an agreement for but also charging or collecting a clearly excessive fee, it may happen that subsequent events make it improper for a lawyer to charge or collect the full amount of an agreed-on fee that turns out to be excessive in fact even though it did not appear to be excessive at the outset. Cf. Hayes v. Secretary of Health and Human Services, 916 F2d 351 (6th Cir 1990). We cannot say as a matter of law, however, that all uses of split contingent fee/hourly fee agreements will necessarily violate these standards. Cf. In re Yacob, 318 Or 10, 860 P2d 811 (1993) (lawyer disciplined for charging client more than previously agreed-on fee). Approved by Board of Governors, August We construe the clearly excessive standard under Oregon RPC 1.5(a) and the unreasonable standard under former DR 5-103(A) to be the same. COMMENT: For additional information on this general topic and related subjects, see THE ETHICAL OREGON LAWYER 3.2, 3.5, 3.8, 4.8, 11.6 (Oregon CLE 2003); RESTATEMENT (THIRD) OF THE LAW GOVERNING LAWYERS 34 35, 37 (2003); and ABA Model Rules 1.5(a), 1.8(i). Page

22 FORMAL OPINION NO Fee Agreements: Dividing Court-Awarded Fees with Nonlawyer Facts: Lawyer represents Plaintiff in litigation. Plaintiff s claims include attorney fee claims. When judgment is entered, the amount awarded by the court for attorney fees exceeds the amount that Lawyer is due under Lawyer s contract with Plaintiff. Question: Who is entitled to the difference between the amount of the attorney fee award and the amount of agreed-on compensation? Conclusion: Plaintiff. Discussion: Oregon RPC 1.5(a) prevents a lawyer from enter[ing] into an agreement for, charg[ing] or collect[ing] an illegal or clearly excessive fee or a clearly excessive amount for expenses. A fee is illegal or clearly excessive if it exceeds the amount previously agreed on. In re Kerrigan, 271 Or 1, 530 P2d 26 (1975); In re Sassor, 299 Or 720, 705 P2d 736 (1985) (applying former DR 2-106(A)); OSB Formal Ethics Op No Absent a valid amendment to the substantive terms of the fee agreement, Lawyer may not receive more than the previously agreedon fee even though a larger fee might also be reasonable under the circumstances. Cf. OSB Formal Ethics Op No ; In re Skinner, 14 DB Rptr 38 (2000). 1 Subject to certain exceptions not applicable here, Oregon RPC 5.4 prohibits a lawyer from shar[ing] legal fees with a nonlawyer. Payment of the excess amount to Plaintiff would not violate this rule. See In re Griffith, 304 Or 575, 748 P2d 86 (1987) (primary purpose of former DR 3-102(A) is to prohibit lawyers from sharing legal fees with nonlawyers 1 The result in this instance would differ if the terms of the fee agreement expressly provided that Lawyer was entitled to the greater of the fee computed thereunder or the court-awarded amount. Page

23 Formal Opinion No in exchange for services related to obtaining or performing legal work). Cf. Venegas v. Mitchell, 495 US 82, 110 S Ct 1679, 109 L Ed2d 74 (1990) (prevailing party, not lawyer, is entitled to award of attorney fees). Approved by Board of Governors, August COMMENT: For additional information on this general topic and other related subjects, see THE ETHICAL OREGON LAWYER , 4.8, (Oregon CLE 2003); RESTATEMENT (THIRD) OF THE LAW GOVERNING LAWYERS 10(3), 18, 34, 38 (2003); and ABA Model Rules 1.5, 5.4. See also Washington Informal Ethics Op No 1570 (unpublished). 162 Page 23

24 FORMAL OPINION NO Fee Agreements: Modifications of Fee Agreement and Interest Charges Facts: Lawyer would like to charge clients 18% interest on accounts that are 30 days or more past due. 1 Questions: 1. May Lawyer charge 18% annual interest if a client expressly agrees to it as part of the fee agreement? 2. What interest rate may Lawyer charge in the absence of an interest rate agreement? 3. If no agreement concerning a charge of 18% is reached, may Lawyer amend the fee agreement to include an 18% per annum charge by stating on a bill sent to the client that, in the future, the client must begin to pay 18% per annum if payment is not received within 30 days? Conclusions: 1. Yes, qualified. 2. Nine percent, pursuant to ORS (1)(a). 3. No. Discussion: 1. Eighteen Percent Per Year Is Not Excessive Per Se. Oregon RPC 1.5(a) provides that [a] lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses. See also Oregon RPC 1.8(i)(2), which permits a lawyer to contract with a client for a reasonable contingent fee in a civil case subject to certain limitations. We held in OSB Formal Ethics Op No that the clearly excessive standard in Oregon RPC 1.5(a) and the reasonable contingent fee standard in Oregon RPC 1.8(i)(2) are the same. See also ORS , which places 1 We assume that the manner in which Lawyer would charge interest does not violate Regulation Z or other similar credit laws or requirements. See CONSUMER LAW IN OREGON ch 7 (1996 & Supp 2005). Page

25 Formal Opinion No certain limitations on personal injury or wrongful death contingent fee agreements. Apart from such limitations, however, the content of a fee agreement is up to the lawyer and the client to decide under general principles of substantive contract law. An 18% interest charge on past-due amounts would not be clearly excessive if the charge is within the range of interest normally charged for credit transactions. In Oregon, as in many other states, clients may now pay for legal services with credit cards. See OSB Formal Ethics Op No A substantial portion of the public also uses credit cards for other purposes. Because many credit cards provide for interest charges of 18% or more, we do not believe that an 18% charge would be clearly excessive or unreasonable unless the fee agreement taken as a whole could be said to be clearly excessive or unreasonable. 2. Only 9% May Be Charged If No Enforceable Agreement Is Reached. If no enforceable agreement is reached between Lawyer and Client regarding payment of interest on past-due amounts at a greater rate, Lawyer would be limited to interest at 9% pursuant to ORS (1)(a). See In re Schroeder, 15 DB Rptr 212 (2001). Cf. United Farm Agency v. McFarland, 243 Or 124, , 411 P 1017 (1966). 3. A Statement on the Monthly Bill Would Not Support an 18% Charge. In OSB Formal Ethics Op Nos and , we noted that a lawyer may not charge or collect more than the agreed-on fee. See also In re Yacob, 318 Or 10, 860 P2d 811 (1993). Cf. Com. on Legal Ethics of W. Va. v. Tatterson, 319 SE2d 381 (W Va 1984) (lawyer has burden to establish terms of fee agreement in the event of dispute). Because fee agreements can, in principle, be modified to make them more favorable to the lawyer (such as by including greater interest), it is necessary to consider whether the mere addition of a statement on a bill that 18% interest will be charged in the future constitutes a valid and enforceable modification. A modification of a fee agreement in the lawyer s favor requires client consent based on an explanation of the reason for the change and its effect on the client. See In re Skinner, 14 DB Rptr 38 (2000). In addition, the modification must be objectively fair. See, e.g., Ward v. Richards & Rossano, Inc., 51 Wash App 423, , 754 P2d 120 (1988); Durr v. Beatty, 491 NE2d 902, (Ill App 1986); Sabin v. Terrall, 186 Or 238, 250, 206 P2d 100 (1949); Jacobson v. Sassower, Page 25

26 Formal Opinion No NY2d 991, 499 NYS2d 381, 489 NE2d 1283 (1985). See also Cord v. Smith, 338 F2d 516, (9th Cir 1964) (discussing fiduciary obligations of lawyers in conflict-of-interest context). The mere addition of a statement on a client s bill to the effect that 18% interest will be charged does not meet these standards and thus could not justify a charge of 18% interest rather than 9% interest. Moreover, this is true even if, as a matter of general substantive contract law, the addition of such a statement would be sufficient to modify a contract not involving a lawyer. 2 Approved by Board of Governors, August It is not clear that such a practice would necessarily create a binding contractual amendment in a transaction not involving a lawyer. Cf. Empire Building Supply v. EKO Investments, 40 Or App 739, 746, 596 P2d 593 (1979). If the addition of a reference on a bill to 18% interest would not create a contractual obligation to pay 18% as a matter of general substantive contract law, Lawyer could not ethically charge 18% for this reason as well. COMMENT: For additional information on this general topic and other related subjects, see THE ETHICAL OREGON LAWYER , , 3.11, 3.22, 3.25, 3.42 (Oregon CLE 2003); RESTATEMENT (THIRD) OF THE LAW GOVERNING LAWYERS 18, 34 (2003); and ABA Model Rules 1.5(a), 1.8(i)(2). See also Washington Formal Ethics Op Nos 157, 158; Washington Informal Ethics Op No 1960 (unpublished). Page

27 Facts: FORMAL OPINION NO [REVISED 2011] Fee Agreements: Fixed Fees Lawyer wishes to use fixed fee agreements for certain types of services that Lawyer will perform for clients. Lawyer intends to obtain most or all of the fixed fee in advance of performing any services for the client. Question: 1. May Lawyer enter into fixed fee agreements with clients? 2. May Lawyer deposit prepaid fixed fees in Lawyer s general account? 3. May Lawyer keep all of the prepaid fixed fee even if the representation ends before all of the work is performed by Lawyer? 4. May Lawyer charge more than the fee fixed by the agreement when the matter unexpectedly involves more work than usual for the particular matter? Conclusion: 1. Yes, qualified. 2. No, qualified. 3. No, qualified. 4. No, qualified. Discussion: For purposes of this opinion, the term fixed fee agreement includes any fee agreement in which the lawyer s charge for specified services is a fixed dollar amount, regardless of when the lawyer is paid or how much work the lawyer must do and regardless of the name applied by the lawyer to the agreement e.g., flat fee, nonrefundable retainer, prepaid legal fee, etc. 1. Propriety of Fixed Fee Agreements. Oregon RPC 1.5(a) and (b) provide: (a) A lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses. Page

28 Formal Opinion No (b) A fee is clearly excessive when, after a review of the facts, a lawyer of ordinary prudence would be left with a definite and firm conviction that the fee is in excess of a reasonable fee. Factors to be considered as guides in determining the reasonableness of a fee include the following: (1) the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly; (2) the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer; (3) the fee customarily charged in the locality for similar legal services; (4) the amount involved and the results obtained; (5) the time limitations imposed by the client or by the circumstances; (6) the nature and length of the professional relationship with the client; (7) the experience, reputation, and ability of the lawyer or lawyers performing the services; and (8) whether the fee is fixed or contingent. The Oregon RPCs do not prohibit fixed fee agreements. In addition, case law establishes that fixed fee agreements are permitted as long as they are not excessive or unreasonable. In re Hedges, 313 Or 618, , 836 P2d 119 (1992) ( [W]here a [nonrefundable fixed fee] arrangement is used the designation of the fee as nonrefundable must be made by a clear and specific written agreement between client and lawyer. ); In re Biggs, 318 Or 281, 293, 864 P2d 1310 (1994). The mere fact that a fixed fee may result in a fee in excess of a reasonable hourly rate does not in itself make the fee unethical. In re Gastineau, 317 Or 545, 552, 857 P2d 136 (1993). On the other hand, [t]he disjunctive use of the word collect means that the excessiveness of the fee may be determined after the services have been rendered, as well as at the time the employment began. In re Gastineau, 317 Or at ; OSB Formal Ethics Op Nos , , ; In re Sassor, 299 Or 720, 705 P2d 736 (1985). 2. May Prepaid Fixed Fees Be Deposited into the Lawyer s General Account? Oregon RPC 1.5(c) provides, in part: A lawyer shall not enter into an arrangement for, charge or collect: * * * (3) a fee denominated as earned on receipt, non-refundable or in similar terms unless it is pursuant to a written agreement signed by the client which explains that: 548 Page 28

29 Formal Opinion No (i) the funds will not be deposited into the lawyer trust account, and (ii) the client may discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee if the services for which the fee was paid are not completed. Oregon RPC (a) provides, in pertinent part: (a) A lawyer shall hold property of clients or third persons that is in a lawyer s possession separate from the lawyer s own property. Funds, including advances for costs and expenses and escrow and other funds held for another, shall be kept in a separate Lawyer Trust Account maintained in the state where the lawyer s office is situated, or elsewhere with the consent of the client or third person. Each lawyer trust account shall be an interest bearing account in a financial institution selected by the lawyer or law firm in the exercise of reasonable care. Oregon RPC (c) provides: A lawyer shall deposit into a lawyer trust account legal fees and expenses that have been paid in advance, to be withdrawn by the lawyer only as fees are earned or expenses incurred, unless the fee is denominated as earned on receipt, nonrefundable or similar terms and complies with Rule 1.5(c)(3). Ordinarily, fees are earned as work is performed. See OSB Formal Ethics Op No Without a clear written agreement between a lawyer and a client that fees paid in advance are earned on receipt, such funds must be considered client property and are, therefore, afforded the protections imposed by Oregon RPC In re Biggs, 318 Or at 293 (discussing former DR 9-101). If there is a written agreement with the client that complies with the requirements of Oregon RPC 1.5(c)(3), the funds belong to the lawyer and may not be put in the lawyer s client trust account. If no such agreement exists, the funds must be placed into the trust account and can only be withdrawn as earned. See, e.g., In re Hedges, 313 Or at ; OSB Formal Ethics Op No Early Termination by Client and the Nonrefundable Fee. A lawyer who does not complete all contemplated work will generally be unable to retain the full fixed fee. This is consistent with In re Thomas, 294 Or 505, 526, 659 P2d 960 (1983), in which the court stated: It would appear that any fee that is collected for services that is not earned is clearly excessive regardless of the amount. Moreover, Oregon RPC 1.5(c)(3)(ii) requires the lawyer to inform the client in the written fee agreement that the client may be entitled to a refund of all or part of the fee if the services for which the fee was paid are not completed. Page

30 close Attorney s file and return original documents to Client. Attorney will then store the file for approximately 10 years. Attorney will destroy the file after that period of time. 9. Client acknowledges reading a copy of this Agreement and consents to its terms. [Attorney] [Date] [Client] [Date] NOTE: This is a sample form only. Use of this agreement will help to establish clear expectations and avoid misunderstandings between you and your client. It will not, however, provide absolute protection against a malpractice action. Practitioners are advised to carefully read and understand: OSB Formal Opinion No Fee Agreements: Fixed Fees, Oregon ORPC 1.5(c)(3), Oregon RPC (c), [11Oct13 Rev 5/11] PROFESSIONAL LIABILITY FUND (FEE AGREEMENT - EARNED UPON RECEIPT.DOC) Page 30

31 AFAS IN THE CRIMINAL SETTING Rich Oberdorfer Overview: Flat fees earned on receipt are fine, if explained in writing. The fees cannot be excessive prospectively or retrospectively. From the PLF website s Frequently Asked Questions, last revised October, 2013: Q. Can I charge nonrefundable flat fees? A. Flat fees, earned on receipt, are allowed if the fee arrangement complies with ORPC 1.[]5-1(c) and ORPC 1.5(c)(3). However, there is no such thing as a nonrefundable fee. Fees are always subject to refund if the specified services are not performed. In re Thomas, 294 Or 505, 526, 659 P2d 960 (1983). Also see ORPC 1.5(c)(3)(ii) as amended, December ORPC (c) and ORPC 1.5(c)(3) provide that a lawyer shall not enter into an arrangement for, charge, or collect a fee denominated as earned on receipt unless it is pursuant to a written agreement signed by the client which explains that: (a) the funds will not be deposited into the lawyer trust account, and (b) the client may discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee if the services for which the fee was paid are not completed. (ORPC 1.5(c)(3), amended December 2010). Whether, or to what extent, a lawyer must refund fees paid in advance when a client terminates the lawyer s services in bad faith near the end of a matter is an open question. OSB Legal Ethics Op No Practice Tip: Avoid using the term nonrefundable in your written agreement with the client. Such a designation may be misleading, if not false, in violation of ORPC 8.4(a)(3), which prohibits conduct involving dishonesty, fraud, deceit or misrepresentation that reflects adversely on the lawyer s fitness to practice law. OSB Legal Ethics Op No ORPC 1.5 in pertinent part: RULE 1.5 FEES (a) A lawyer shall not enter into an agreement for, charge or collect an illegal or clearly excessive fee or a clearly excessive amount for expenses. (b) A fee is clearly excessive when, after a review of the facts, a lawyer of ordinary prudence would be left with a definite and firm conviction that the fee is in excess of a reasonable fee. Factors to be considered as guides in determining the reasonableness of a fee include the following: Page 31

32 (1) the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly; (2) the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer; (3) the fee customarily charged in the locality for similar legal services; (4) the amount involved and the results obtained; (5) the time limitations imposed by the client or by the circumstances; (6) the nature and length of the professional relationship with the client; (7) the experience, reputation, and ability of the lawyer or lawyers performing the services; and (8) whether the fee is fixed or contingent. (c) A lawyer shall not enter into an arrangement for, charge or collect: (1) any fee in a domestic relations matter, the payment or amount of which is contingent upon the securing of a divorce or upon the amount of spousal or child support or a property settlement; (2) a contingent fee for representing a defendant in a criminal case; or (3) a fee denominated as "earned on receipt," "nonrefundable" or in similar terms unless it is pursuant to a written agreement signed by the client which explains that: (i) the funds will not be deposited into the lawyer trust account, and (ii) the client may discharge the lawyer at any time and in that event may be entitled to a refund of all or part of the fee if the services for which the fee was paid are not completed. The PLF has a form earned on receipt agreement (reproduced in these materials and available online at: %20Earned%20Upon%20Receipt.pdf) And we ve got a formal ethics opinion: OSB Formal Opinion No Fee Agreements: Fixed Fees (reproduced in these materials and available online at: QUESTION FOR DISCUSSION: In light of the Ethics Opinion, what effect would the following statement have in a flat fee agreement: "I understand that the law firm may make further arrangements with me if it appears that a substantially longer amount of attorney hours will be consumed than is currently anticipated." Page 32

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38 FEE AGREEMENT - EARNED UPON RECEIPT (Sample Modify as appropriate) THIS FEE AGREEMENT ( Agreement ) is made this day of,, between [Name of Client], hereinafter referred to as Client, and [Name of Attorney(s)], Attorney at Law, hereinafter referred to as Attorney : 1. Client agrees to employ Attorney for representation in a legal matter in connection with [describe]. 2. Attorney has consented to accept such employment and agrees to render the following services on the terms and conditions herein stated: [Carefully describe scope of services.] This agreement does not include [describe services that are not included within the scope of the earned upon receipt fee agreement.] 3. Client agrees to cooperate fully with Attorney and others working on Client s case by keeping appointments, appearing for depositions, producing documents, attending scheduled court appearances, and making all payments. Client also agrees to keep Attorney informed of any change of address or telephone number within five (5) days of the change. 4. Client agrees to pay Attorney the sum of [dollar amount] for [his/her] services in this matter. Attorney will not commence representation of Client until such funds are received. These fees are fully earned upon receipt. Payment indicates Client s understanding that these fees will not be deposited into Attorney s Lawyer Trust Account. 5. Client may discharge Attorney at any time, and in that event may be entitled to a refund of all or part of the fee if the services for which the fee was paid are not completed. Attorney reserves the right to withdraw from further representation of Client at any time on reasonable written notice to Client at Client s last known mailing address. If Client discharges Attorney or Attorney withdraws from the Client s case, Client shall be responsible for all costs incurred in [his/her] case under Paragraph 6 below. Attorney shall prepare an itemized statement of work performed and Client shall be billed at Attorney s usual hourly rate of $ for Attorney s services. Any unearned fees shall be refunded to client. 6. In addition to the attorney fees described above, Client agrees to pay all of the costs incurred in [his/her] case. Examples of such costs include filing fees, service fees, court reporter fees, and [describe other costs]. Attorney will provide Client with a monthly itemized invoice describing [optional: services rendered and] costs incurred. Each invoice is due and payable [insert days] business days after mailing. Client s failure to pay costs on a timely basis may result in Attorney withdrawing from Client s case as described in Paragraph 5 above. 7. Attorney may appoint another attorney to assist with the closure of Attorney s law office in the event of Attorney s death, disability, impairment, or incapacity. In such event, Client agrees that the assisting attorney can review Client s file to protect Client s rights and can assist with the closure of Attorney s law office. 8. Attorney will send Client information and correspondence throughout the case. These copies will be Client s file copies. Attorney will also keep the information in Attorney s file. When Attorney has completed all the legal work necessary for Client s case, Attorney will [11Oct13 Rev 5/11] PROFESSIONAL LIABILITY FUND (FEE AGREEMENT - EARNED UPON RECEIPT.DOC) Page 38

39 Formal Opinion No Accordingly, even a fee designated as nonrefundable is subject to refund if the specified services are not performed. Thus, designation of a prepaid fixed fee as nonrefundable may be misleading, if not false, in violation of Oregon RPC 8.4(a)(3) (prohibiting conduct involving dishonesty, fraud, deceit or misrepresentation that reflects adversely on the lawyer s fitness to practice law ). Whether, or to what extent, a bad-faith termination by a client near the end of a matter requires a refund of fees paid in advance is a question beyond the scope of this opinion. 4. Charges in Excess of Fixed Fee Agreement. A lawyer may not charge more than the agreed-on fee, and any fee charged in excess of the agreed-on fee is excessive as a matter of law. It follows that unless either (a) the fee agreement itself allow for changes over time 1 or (b) the fee agreement is permissibly modified pursuant to OSB Formal Ethics Op No , the agreed-on fixed amount is all that the lawyer may collect. Approved by Board of Governors, June For example, a fixed fee agreement might provide a fixed fee for each stage of a project rather than a fixed fee for the whole. Similarly, agreements that allow periodic adjustments to hourly fees or costs are also permissible unless illegal or otherwise unreasonable. COMMENT: For additional information on this general topic and other related subjects, see THE ETHICAL OREGON LAWYER 3.2, 3.14, 3.19 (Oregon CLE 2003); FEE AGREEMENT COMPENDIUM ch 11 (updated 4/2011, available only in BarBooks TM online library); RESTATE- MENT (THIRD) OF THE LAW GOVERNING LAWYERS 34, 38 (2003); and ABA Model Rule Page 39

40 ABA Section of Litigation, 2013 ABA Annual Meeting, August 8-12, 2013: Has the News of the Death of the Billable Hour Been Greatly Exaggerated? Has the News of the Death of the Billable Hour Been Greatly Exaggerated? Moderator: Jessica K. Hew Burr & Forman LLP Orlando, FL Speakers: Jean L. Bertrand Schiff Hardin LLP San Francisco, CA Evelyn H. Brantley DuPont Legal Wilmington, DE Patrick J. Lamb Valorem Law Group LLC Chicago, IL Joelle Ryssemus The Presidio Group LLC San Francisco, CA Page 40

41 HAS THE NEWS OF THE DEATH OF THE BILLABLE HOUR BEEN GREATLY EXAGGERATED? The Issue For a number of years now, there have been numerous industry and news reports predicting the swift demise of the billable hour. The thinking was, with the collapse of the financial markets, companies would demand alternative fee arrangements to reduce their legal spend. And, with demand for legal services declining, law firms would quickly acquiesce to that demand. Yet, here we are in 2013 and the billable hour remains very much part of the legal billing landscape. Why won t the billable hour just go away? The answer is hard to pin down. No question, the legal market is still, at best, sputtering along. According to Citi Private Bank s Law Firm Group, demand for legal services dropped an average of 0.4 percent between 2008 and 2012, compared with an average 3.7 percent increase between 2004 and That dip in demand led Citibank to declare it is time to let go of any lingering notion that the industry will revert to the boom years before the Great Recession any time soon. 2 Law firms have responded to the flat demand by reducing head count and slashing overhead costs. 3 Those initiatives certainly help, but firms recognize that in today s ultracompetitive environment retaining clients over the long term is critical to their financial success. To that end, law firms have been devoting substantial resources to developing alternative fee arrangements to the billable hour. Assisted in some cases by in-house pricing directors, 1 Sara Randazzo, Report: The Boom Years Are Not Coming Back, Get Used to It, The Am Law Daily (Jan. 13, 2013), available at ming_back_get_used_to_it. The article also notes that average hours per lawyer fell to 1,641 in 2011, versus an average of 1,742 from 2001 to Id. 3 See, e.g., Jennifer Smith, Law Firm Partners Face Layoffs, The Wall Street Journal (Jan. 6, 2013). 1 Page 41

42 firms are offering up a menu of options that include blended rate, capped fees, contingent fees, fixed fees and performance/rewards based fees. 4 Many believed that these alternative fee arrangements, or AFAs for short, would become a one-way street of billing, a permanent trend that would cause the billable hour to disappear as clients reaped their new found savings. 5 The changeover to AFAs, however, has been slower than expected. In fact, according to at least one study, the use of AFAs may be declining. A survey of 275 participating in-house U.S. attorneys by Fulbright & Jaworski L.L.P. found that only 51 percent used some form of alternative fee arrangement, down from 61 percent the previous year. 6 This trend-defying result surprised many industry analysts. Other recent studies, however, show that AFAs are increasing in popularity and expected to accelerate in the coming years. 7 Conflicting data like this have left everyone wondering just what the future holds for both the billable hour and the AFAs that were supposed to displace it. 8 Has the death of the billable hour been greatly exaggerated? We examine the issue below. What Are AFAs? When people talk about AFAs, one problem is that not everyone is always talking about the same thing. What exactly are AFAs? In this presentation, we define AFAs as any billing 4 See, e.g., Martha Neil, Meet the Hot New Hire of 2012, Law Firm Pricing Directors, ABA Journal (Sep. 24, 2012) (noting that law firms are hiring directors who help law firms organize data and think strategically about setting prices for legal work that demonstrate value to clients, yet contribute to a solid bottom line for legal services providers ). 5 See, e.g., Jim Hassett and Matt Hassett, Legal Pricing in Transition: How client demands and alternative fees are changing the way that law firms price their services, LegalBizDev White Paper (2012) at p. 25 (stating [c]onservative clients often require a long time to take the leap to try non-hourly fees, but this particular change is a one-way street. ). 6 Fulbright s 9th Annual Litigation Trends Survey Report at p See, e.g., ALM Legal Intelligence Report, Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments at p. 6 (April 2012). 8 Andrew Strickler, Shine Might Be Off Alt Fee Arrangements, GC Survey Shows, Law360 (Feb. 26, 2013). 2 Page 42

43 mechanism that does not rely on the traditional straight billable hour. Using this framework, five of the most common AFAs are blended rate fees, capped fees, contingent fees, fixed fees, and performance/milestone based fees. Blended fees A blended fee typically takes the differing hourly rates of all the attorneys working on a matter and blends them to create one hourly rate for which all the firm s work is charged. Blended rates have been criticized for not delivering expected savings and value. 9 Capped fees Capped fees are hourly fees that are billed at a normal rate with an aggregate ceiling that caps what the client will pay for a particular matter. Capped fees can be seen as a fee goal rather than a dollar limit, and are therefore disfavored by some in-house counsel. 10 On the other hand, if a legal service takes longer or is more complex than first anticipated, capped fees can result in considerable savings. Contingent fees These are fees that are contingent on the success of the matter being handled. They are usually calculated as a percentage of a recovery or total deal value. Typical among plaintiff s firms, they have increased in popularity in recent years for certain high-stakes matters. Fixed fees A fixed fee arrangement sets one price to handle an entire matter from start to finish. Fixed fees can be attractive because they allow for more predictable legal budgeting and require little oversight once the fee price is negotiated. Moreover, fixed fees can be segmented for different phases of a transaction or negotiation. 9 See generally, Shannon Hesson, Blended Fees May be on Their Way Out, Law360 (Jun. 17, 2010). 10 Andrew Stickler, GCs Rate Fixed Fees Best Bang for Their Buck, Law360 (Feb. 26, 2013). 3 Page 43

44 Performance/milestone based fees These are legal fees that are paid in stages during a matter based on certain milestones reached. If the firm does not reach a particular milestone, it is not paid for that portion of its work. Among the AFAs specifically listed, various surveys indicate that fixed fees are the most popular, with 46% of in-house counsel deeming them to be very effective in one survey and 89% of in-house counsel endorsing them in another. 11 Other arrangements had varying degrees of reported success. Notably, however, in the Fulbright survey very few respondents selected not effective at all for blended fees (1%), capped fees (1%), contingent fees (3%), fixed fees (1%) and performance fees (1%). Likewise, another survey found that 84% of legal departments were somewhat or very satisfied with AFAs. 12 These results suggest that when AFAs are implemented, they tend to produce positive results. Why Have AFAs Not Displaced the Billable Hour? With so many AFAs to choose from, it s surprising that the billable hour has had such staying power. There has been a variety of economic, psychological and practical reasons offered up for this phenomenon. The most prominent are summarized below: Transparency One Executive V.P. and General Counsel recently commented to the press that alternative fee arrangements were disfavored because they do not allow a client the same opportunity to see the work as it is being done, evaluate its worth, and challenge when 11 Fulbright s 9th Annual Litigation Trends Survey Report at p. 21; ALM Legal Intelligence Report, Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments at p. 7 (April 2012). 12 Id. at p. 6 (April 2012). 4 Page 44

45 appropriate the relationship of time, task and cost. 13 In other words, clients like to know what work is being done, by whom, and how much that work costs. With the traditional billable hour, the client can see down to quarters or tenths of an hour the work being performed by the firm s attorneys. This level of granularity, unless requested, is lost in most alternative fee arrangements. On the other hand, the billable hour is a lagging indicator of what a law firm is doing for its clients. Tasks performed cross a client s desk weeks if not months after they happened. And, many times, descriptions of the work performed are too generalized for in house counsel to perform any meaningful evaluation of whether they are getting good value for their legal spend. In other words, the billable hour does not always guarantee greater transparency. Cost The whole AFA movement was spurred by companies trying to control spiraling legal costs under tightening budget constraints. But some industry consultants say the results have not materialized the way that in-house counsel thought they would. As one legal consultant observed, Right now, general counsels are figuring out with a good billable auditing staff, and a tightly written agreement, they can control rates better with billable hours than with alternative fees. 14 In particular, the boom in the legal billing audit industry has allowed many companies to reject or ask for discounts on hourly invoices that reflect purported overbilling, always a concern with billable hour arrangements Alan B. Moldawer, Letter to the Editor, The New York Times (Apr. 2, 2013), available at 14 Andrew Strickler, Shine Might Be Off Alt Fee Arrangements, GC Survey Shows, Law360 (Feb. 26, 2013). 15 Steven J. Harper, The Tyranny of the Billable Hour, The New York Times (Mar. 28, 2013) (discussing adverse effects of billable hour system including the development of a cottage industry in auditing outside law firm invoices to clients to detect overbilling). 5 Page 45

46 Others, however, disagree that AFAs do not result in cost savings. A recent article penned by Veta T. Richardson, the president and chief executive officer of the Association of Corporate Counsel, noted the substantial decrease in legal fees AFAs were generating for corporations like Whirlpool, Sherin Williams and Home Depot. 16 In particular, Home Depot was cited for cutting its legal fees in half after adopting various AFAs. 17 Similarly, Mike Roster, former General Counsel of Stanford, and Ken Grady, General Counsel of Wolverine, both say the expected savings from using just AFAs alone is 25%. 18 When combined with other tools, the savings can be even greater. In short, there seems to be conflicting data and viewpoints on whether AFAs are delivering value as promised. 19 Familiarity Certainly the billable hour remains entrenched in many lawyers minds. Having cut their teeth accounting for every minute of their day, today s general counsels may just simply be accustomed to seeing bills that reflect time spent for each discreet task. In that sense, implementing AFAs may seem like more trouble than they are worth Veta T. Richardson, More In-House Lawyers question the Billable Hour, Corporate Counsel (Mar. 13, 2013), available at, he_billable_hour. 17 Id. 18 Presentation: Mike Roster, 4 th Annual Alternative Fee Arrangements Forum, Ark Conference, Chicago, IL (May 16, 2013); Private communication (Apr. 10, 2013). 19 Id. For example, Ms. Richardson takes issue with the results of the Fulbright & Jaworski L.L.P. survey, suggesting that perhaps the survey suffered from a low response rate. Accordingly, in her view, the Fulbright survey may not be the best reflection of in-house counsel trends. 20 See, e.g., Patrick Lamb, Why Clients Fear Alternative Fee Arrangements, ABA Journal Legal Rebels (Feb. 27, 2013) available at (observing that many general counsels fear alternative billing arrangements because of the difficulty they have in changing from the billable hour mindset). 6 Page 46

47 Fit Some legal matters do not lend themselves well to AFAs. For example, a flat fee may make sense for a historically routine legal matter, but law firms and/or in house counsel may not have a sense of what an appropriate flat fee arrangement would be for a novel piece of litigation or a deal with thorny corporate issues. Similarly, large, unpredictable, labor-intensive matters may not be well-suited to a capped fee arrangement. Quality Wrongly or rightly, some data suggests that companies will pay top dollar for what it perceives is the best legal talent in the market. 21 For these lawyers, companies may be more willing to pay by the hour rather than through an AFA. Where Do We Go From Here? The perception in the legal industry has traditionally been that in-house counsel are demanding better value and driving toward more AFAs, and there s no turning back. 22 And, with companies continued scrutiny on cutting legal costs and more law firms being asked to demonstrate efficiency and flexibility through AFAs, that trend will undoubtedly continue. Nevertheless, it appears the billable hour, at least for now, will remain viable. Perhaps reflecting a no one size fits all approach, companies and law firms alike still seem to view the billable hour in some circumstances as a better alternative to AFAs. As the AFA dialogue between law firms and in house counsel continues, time will tell whether the billable hour will have the kind of lasting power it has enjoyed so far. 21 Debra Cassens Weiss, Legal Fees Jump 15 Percent over Two Years, Even as Billables Remain Flat, Study Says, ABA Journal Business of Law (Jan. 10, 2013), available at, lat_stu/ 22 Veta T. Richardson, More In-House Lawyers question the Billable Hour, Corporate Counsel (Mar. 13, 2013), available at, he_billable_hour. 7 Page 47

48 APRIL 2012 Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments Sponsored by Written by ALMlegalintel.com Page 48

49 A report from ALM Legal Intelligence INTRODUCTION This report, sponsored by LexisNexis and conducted by ALM Legal Intelligence, provides an overview of the alternative fee arrangements used by large law firms and corporate legal departments. About CounselLink from LexisNexis CounselLink from LexisNexis is a matter management, e-billing and legal hold software that helps corporate law departments effectively manage matters, spend and legal holds while optimizing outside counsel relationships. Through its flexible system configuration, the CounselLink solution addresses the unique requirements of both large and small law departments. Expert professional services and product support teams are available to help users maximize the benefits of the system. For more information, visit About LexisNexis LexisNexis is a leading global provider of content-enabled work flow solutions to a wide range of professionals in the legal, risk management, corporate, government, law enforcement, accounting, and academic markets. One of these solutions, Redwood Analytics Planning Application for law firms, connects day-to-day matter management with increasing client demands for alternative billing arrangements. LexisNexis serves customers in more than 100 countries with 15,000 employees worldwide. For more information, visit About ALM Legal Intelligence ALM Legal Intelligence offers detailed business information for and about the legal industry, focused on the top U.S. and international law firms. The division s online research Web service ( provides subscribers with direct, on-demand access to ALM s extensive database of surveys, rankings, and lists related to law firms and the legal industry. The site also includes an online store where non-subscribers can, on an individual basis, purchase and download preformatted individual law firm reports, ALM Legal Intelligence research reports, and selected current-year survey data. Permission to Republish Data Please contact Rashmi Shah at rashmi.shah@lexisnexis.com if you are interested in republishing any or all of the data found in this report. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 2 Page 49

50 A report from ALM Legal Intelligence PREFACE Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments is an ALM Legal Intelligence white paper sponsored by LexisNexis. ALM Legal Intelligence gathered data, conducted interviews, and administered the online survey. Erik Sherman wrote the report and Jennifer Tonti conducted the survey and was the report editor. We would like to thank all those who participated in the survey and agreed to be interviewed for this report. APRIL 2012 DISCLAIMER 2012 ALM Legal Intelligence. All rights reserved. All information in this report is verified to the best of the author s and the publisher s ability. However, neither ALM Legal Intelligence nor LexisNexis accepts responsibility for any loss arising from reliance on it. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of LexisNexis or ALM Legal Intelligence. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 3 Page 50

51 A report from ALM Legal Intelligence TABLE OF CONTENTS Executive Summary...6 About the Survey...8 Part I: The Billable Hour Makes Way for AFAs...9 Table: Types of Alternative Fee Arrangements Economic Imperative...11 Case Study: Medtronic...11 Part II: Obstacles to Growth...13 The Devil in the Details It Still Comes Down to the Billable Hour Software Not Sufficient Case Study: Goodwin Procter Part III: AFAs Are Here To Stay (So What To Do?) Conclusion Endnotes Appendix: Survey Results...21 Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 4 Page 51

52 A report from ALM Legal Intelligence Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 5 Page 52

53 A report from ALM Legal Intelligence ExECUTIve SUMMARy For years, there was ALways a lot of talk about ALtERnative FEE arrangements approaches to billing that are not based on traditional hourly rates but very little action. Then came the economic collapse of 2008 to Corporations needed to cut expenses, and nothing was left off the table, including outside legal costs. Alternative fee arrangements (or AFAs) obtained a new urgency, as research and a survey of law firms by ALM Legal Intelligence suggested. * But a study focusing on the momentum of AFAs among law firms misses half the story. That is why ALM Legal Intelligence took another look at the issue, this time surveying both large law firms and corporate legal departments. Although the results support some prior conclusions, they also show new complexities of how legal departments and law firms both view and use AFAs and where things may go from here. The main findings of our research into AFAs include the following: 1(ALMost) EvERybody s doing it. Of the 218 law firm respondents, only one reported that their firm does not employ alternatives to the hourly billing rate model other than discounting. On the legal department side, 18% of the 206 corporate respondents reported that they do not employ AFA billing. 2AFAs start to PICk up steam... One issue law firms and legal departments agree on is the rate to which AFAs have increased since About 62 percent of firms saw an increase in AFA billing, with only 2 percent citing a decrease, and the remainder seeing no change. One in two legal departments saw an increase, and the other half say that the degree of AFA billing has essentially remained the same. Looking forward to 2016, about three-quarters of legal departments (76 percent) and law firms (74 percent) alike predict AFA billing will increase in the next five years. 3...but no overwhelming AFA champions. Only 6 percent of law firm respondents said that more than half of their outside corporate legal work was billed using an alternative fee arrangement, whereas the majority (67 percent) used AFAs for less than a quarter of their work. Legal departments are less bearish, with 12 percent reporting use of AFAs for more than half of their legal work. Even more telling is that 6 percent of legal departments and 17 percent of law firms did not know what percentage of their legal work was billed not using the standard hourly rate model. 4Though increasingly PERvASIve, FEw ARE truly happy with AFAs. On the whole, legal departments are more satisfied about using AFAs than law firms, with about 84 percent of legal departments responding that they are somewhat or very satisfied with AFAs. Comparatively, 72 percent of law firms gave AFAs the same satisfaction rating. The difference was even sharper when looking at only those that were very satisfied : 26 percent of legal departments vs. 11 percent of law firms. This suggests that full acceptance of and satisfaction with AFAs still has a ways to go. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 6 Page 53

54 A report from ALM Legal Intelligence 5DIFFEREnt motivations. Although law firms and legal departments understandably must cooperate when establishing and billing alternative fee arrangements, they have largely different reasons for instituting AFAs. Firms want to attract clients (91 percent), simplify billing and operations (50 percent), increase billing realization (43 percent), and predict costs (37 percent). Legal departments share an interest in cost predictability (at 87 percent, the biggest driver), but also look for cost savings (68 percent), increased efficiency (44 percent), and risk-sharing (35 percent). 6The billable hour still DRIvES the boat. Law firms and companies opinions differ as to who they think is responsible for the lag in AFA adoption, with either side pointing the finger at the other. According to law firms, the top obstacles to increased use of AFA billing focus on either side feeling more comfortable with hourly billing in general. Legal departments agree that law firms are more comfortable with billable hours, but they go on to find lack of experience in defining and managing work and billing matters on a basis other than hourly as big a stumbling block. 7FavoRIte AFA models ARE the SAME for LEgAL DEPARtMEnts and LAw FIRMS ALIke. The top three choices for types of alternative fee arrangements were shared by both firms and departments: flat fee (89 percent of legal departments, 93 percent of firms); blended rate (47 percent of legal departments, 89 percent of firms); and capped fee (57 percent of legal departments, 83 percent of firms). 8Competitive bidding hits the legal SECtor. In most areas of business, seeking bids on work is common. And although bidding is not the norm in legal work, it has become an increasingly popular way for legal departments to request outside counsel legal work. One-fifth of legal departments said that they had instituted a reverse auction or competitive bidding on high-volume and repetitive work. Just over a third of the firms said that they had participated in such a bidding process. 9A generation gap MAy exist. Although not quantitatively indicated, some in-depth interviews suggest that both law firms and legal departments face a generational challenge. We hear that younger attorneys at law firms and legal departments are more willing to employ AFAs than their older peers. Smart management at both these institutions will have such people spearhead alternative fee arrangements efforts in their organizations going forward. IS one way to FACILItate ALtERnative FEES but it IS not 10SoftwARE sufficient. A majority of legal departments are now using ebilling software to plan, manage and track alternative fees. This is more effective than matter management and accounting software but does not facilitate the use of alternative fees in every case. Law firms are primarily using their accounting software for the management of alternative fees. These systems built for billing and timekeeping do not fully support AFAs, but there are some emerging financial planning software products that work with these systems and have functionality for evaluating and managing alternative fees, better meeting the need. However, software by itself is not enough. Both law departments and law firms talk of a need for culture change, collaboration and the establishment of trust to have alternative fee arrangements work effectively. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 7 Page 54

55 A report from ALM Legal Intelligence About the Survey This report, sponsored by LexisNexis and conducted by ALM Legal Intelligence, provides an overview of the alternative fee arrangements used by law firms and legal departments. The data was collected via invitations to a Web-based survey conducted between March 6, 2012, and April 6, The survey sought to document how frequently the parties use such arrangements; how they manage and monitor the arrangements; the forms of AFAs employed; and the perceptions of both sides toward AFAs and each other. Invitations were sent to senior management (General Counsel, Deputy GC, Corporate Counsel) in corporate legal departments for one survey. Among the responding law departments, 206 opted into the survey and 141 were qualified to respond (the law department uses AFA billing methods). Law department respondents came from a combination of small companies ( employees, 22 percent), midsized companies (500 4,999 employees, 25 percent), large companies (5,000 9,999 employees, 15 percent), and very large companies (10,000+ employees, 37 percent). Invitations for a separate but similar survey were sent to partners at Am Law 200 and NLJ 250 size (large) law firms. 218 firms opted in and 194 qualified to respond (the law firm uses AFA billing methods). Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 8 Page 55

56 A report from ALM Legal Intelligence PART I: The BILLABLE hour MakES Way FOR the AFA AltERnative FEE ARRAngEMEnts ARE of growing IMPortanCE to both law firms and legal departments because they currently represent one of the periodic shifts in how legal business is conducted. What does alternative fee mean? asks David Susler, associate general counsel of Elk Grove Village, Illinois based National Material L.P. It depends on the context. The hourly billing became king in this country only within the last 25 or 30 years. There are countries where billable hours are unheard of. In the context of the last few decades, alternative has come to mean some approach other than straight hourly billing. (See Types of Alternative Fee Arrangements sidebar.) The concept of the AFA, however, is not new. We ve had alternative fee We ve had alternative arrangements going back to the early to mid-1990s, says King & Spalding fee arrangements partner Dwight Davis. Hourly billing is still widely used, but there is a change going back to the in the unquestioned primacy of the billable hour, as both legal departments and early to mid-1990s. law firms have increased their AFA activity since the economic recession of the Dwight Davis, King & late 2000 s. Half of the legal department respondents had seen an increase in the Spalding partner. volume of AFAs between 2010 and 2011, and the average increase was almost 30 percent. The change for law firms was even more dramatic, as 62 percent of respondents saw an increase in AFA matters between those two years. Projections about the strong future of AFAs is underscored by respondents answer to a question asking whether AFAs would become more important in their legal work from 2011 to Fifty-five percent of legal departments expect the use of AFAs to increase, while only 7 percent say they would decrease. On the law firm side, 74 percent of law firms believe AFA use will increase, while 2 percent expect a decrease. Looking further down the road to 2016, 76 percent of legal departments expect an expansion of AFA use, while 4 percent foresee a decrease. Just over one-quarter believed the level will remain the same. On the law firm side, 82 percent of law firms Between 2010 and 2011, what change did your law department/ law firm see in the volume of AFAs? Law Departments % Increase: 50% % Decrease: 1% No change 49% Law Firms % Increase: 62% % Decrease: 2% No change 35% foresee an increase, 3 percent expect a decrease, and just 15 percent said that AFA use will be static. Part of the belief in the future of AFAs may have to do with a corporate financial reality check. Hopefully the economy goes back up, and the GC goes to the company and says to the CFO, The company is doing better and I want to restore my budget, says Gary Hoffman, partner at Dickstein Shapiro. [The CFO would say], The sky didn t fall. You re going to have to learn to live with [a reduced budget] for years to come. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 9 Page 56

57 A report from ALM Legal Intelligence TyPES OF ALTERNATIve FEE ARRANgEMENTS Alternative fee arrangement refers to a mutual agreement between a law firm and corporate legal department for billing and payment of outside legal services that does not rely on straight hourly billing by the firm. Below are nine types of AFAs that our survey tracked, a description of each, and the Association of Corporate Counsel s assessment of the most appropriate circumstances for each: ** BlenDED RAte Sets an agreed-upon hourly rate that applies to all lawyers working on a matter, regardless of their seniority. Encourages firms to staff matters efficiently. CAPPED FEE Limits the total cost of an agreed-upon amount of work. It is often used in conjunction with an hourly rate arrangement. Provides a degree of predictability to clients who are otherwise comfortable with hourly billing. Contingency Specifies that a firm will be paid only if it achieves a financial recovery or other agreed-upon result for the client. Typically, the firm receives a percentage of a total recovery. Provides protection from a bad result for clients who are willing to forgo a large portion of a positive result. DEFEnSE contingency Establishes an expected outcome for a defendant in a monetary claim and specifies that if the firm obtains a better-than-expected result, it will receive a portion of the savings. Encourages the firm to limit damages. FLAt FEE Sets an agreed-upon sum of money for a discrete amount of work. The firm, not the client, assumes the risk of cost overruns. Encourages firms to perform distinct pieces of work efficiently. FLAt FEE with shared SAvings Sets a flat fee for a matter while allowing the firm to track the work on an hourly basis. If, at the conclusion of the matter, the hourly fee is lower than the flat fee, the client and the firm share the difference. Provides a guarantee of a low cost to clients who are otherwise comfortable with hourly billing. HoLDbACk Specifies that the client will withhold an agreed-upon portion of the total fee unless the firm obtains a particular result. Encourages both the firm and the client to measure success quantifiably. PARtIAL contingency (or success FEE) Sets a bonus that the firm receives in addition to its hourly, flat, or capped-fee arrangement if the result meets agreed-upon criteria. Encourages the firm to obtain a positive result for the client. PhASED FEE Sets agreed-upon fees, perhaps using differing structures, for discrete phases of a matter. Gives maximum flexibility to both the firm and the client. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 10 Page 57

58 A report from ALM Legal Intelligence Economic Imperative For many in business, 2008 was clearly a watershed year whose ripple effects were felt in all parts of the organization, especially in the legal department. Suddenly, managing legal budgets in particular outside counsel spend took on a whole new level of importance and immediacy. We probably started using [AFAs] heavily when the economy started to turn because it gave you a lot more certainty in terms of the legal spend, says Verona Dorch, vice president, deputy general counsel, and assistant corporate secretary of Camp Hill, Pennsylvania headquartered Harsco Corporation. It became a way to start smoothing out the bumps. Others point to a financial imperative. A couple of years ago, we were bleeding money, subprime was killing everybody, and management said get costs [including legal] under control, says the chief counsel of a large U.S. bank. The target [to cut expenses] was 30 percent, and we ended up at 55 percent year over year. Apart from the pure economics of cost control, there is another reason why legal departments like to use AFAs: aligning business interests. From the perspective of many clients, hourly billing offers a conceptual problem. It incentivizes inefficiency because lawyers get paid based on how much time they spend on a matter, says Joshua Frank, general counsel and secretary for DHL Americas. In theory, hourly can drive a firm to inefficiency because spending more time on a matter than it deserves increases total billing. [The billable hour] incentivizes inefficiency because lawyers get paid based on how much time they spend on a matter. Joshua Frank, general counsel and secretary for DHL Americas. CASE STUDy: Medtronic (Legal Department) I d love to say that we got involved in alternative fee arrangements because of our farsightedness and the great vision we have, says Medtronic general counsel and corporate secretary D. Cameron Findlay. But we were driven to look at them because of the cost pressures that companies all over the country are facing. That was three years ago, when e-discovery started to drive up the cost of litigation. I looked at the bills coming in and they were 50 percent higher than they ought to be, Findlay says. Findlay has tried a number of different AFA structures: monthly flat fees, contingencies as both plaintiff and defendant, blended rates, and combinations. As each case comes in, we think about what sort of alternative fee arrangement do we use here? The company is currently using contingency on one case. When we get to the end of the day, I have a feeling we will have paid the law firm more than we would on an hourly basis, Findlay says. But it gave the firm an enormous incentive to work hard to win the case and it relieved the business unit from the burden of having to fund the litigation, when there might not be a return on it. Medtronic will often propose a contingency arrangement to test a matter s merits. If [the law firm] won t [take it], it tells us that they don t think they will win, Findlay says, and we have to [re]consider whether we can. But it s never a negotiation tactic to get a concession. I think you d only get to do that once before someone wouldn t do the work for you next time. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 11 Page 58

59 A report from ALM Legal Intelligence The survey finds that cost predictability, cost savings, and increased efficiency are the major benefits of instituting AFAs from the perspective of the legal department, with risk-sharing appearing in a strong fourth place. But while a number of law firm attorneys in interviews talked about aligning interests with and providing value for clients, their top reasons for using AFAs were different than their counterparts in legal departments, in that their focus is more on attracting or maintaining clients, simplified billing and operations, and increased billing realization. What do you believe to be the THREE major benefits of using alternative fee arrangements for a legal department? Law Departments Cost predictability / transparency 87% Cost savings 68% Increased efficiency (e.g. quality and value for legal service) 44% Risk-sharing 35% Ease of comparing law firm cost-effectiveness 11% Other (please specify): 2% What are the THREE major benefits of using alternative fee arrangements for the law firm? Law Firm Attracting or maintaining clients 91% Simplified billing and operations 50% Increased billing realization 43% Cost predictability 37% Ease of comparing law firm cost-effectiveness 23% Cost savings 11% Each side has its reasons for and incentives to using alternative fee billing, and both expect AFAs to expand their presence in corporate law matters. However, if the billable hour is to go the way of the dinosaur, law firms and legal departments alike will have to overcome some significant challenges. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 12 Page 59

60 A report from ALM Legal Intelligence PART II: OBSTACLES TO growth Ask a LAw FIRM PARtnER LIke king & SPALDIng s Dwight DavIS about why AFAs had not become a bigger deal sooner and the answer points to the client. As a young partner, I used to make pitches like this all the time: Say, don t you think this makes more sense? he says. After some futzing around, the client would come back and say, No. How about that 10 percent discount? I think, historically, it sounds like a great idea but is challenging for clients to get their arms around, says Pillsbury Winthrop Shaw Pittman partner Robert Wallan. They get uncomfortable with the possibility of the law firm making a much higher fee than on an hourly basis. And yet, the view from the other side of the department-firm debate is often at odds with what the law firms are reporting. According to Dorch, At the beginning, our law firm partners weren t embracing [AFAs] with open arms. What do you believe to be the THREE biggest obstacles to the growth of AFAs? Law Firms Law firms are more comfortable with the billable hour 52% Firms have insufficient experience defining or managing work on an AFA basis 54% Absent better metrics and data, it is difficult to determine AFAs 34% Corporate law departments have insufficient experience defining or managing work on an AFA basis 26% There is not sufficient billing history or pricing methodology to know how to bill AFAs 32% Corporate law departments are more comfortable with the billable hour 40% Alternative arrangements are too difficult to negotiate or hold to 13% Compensation models at the firm are still based on hours billed 24% AFAs are too risky for the firm s overall revenue 10% Partners object or refuse to cooperate 4% Other (please specify): 5% Law Departments Law firms are more comfortable with the billable hour 61% Firms have insufficient experience defining or managing work on an AFA basis 51% Absent better metrics and data, it is difficult to determine AFAs 36% Law firms resist alternative fee arrangements 32% Corporate law departments have insufficient experience defining or managing work on an AFA basis 25% There is not sufficient billing history or pricing methodology to know how to bill AFAs 25% Corporate law departments are more comfortable with the billable hour 15% Legal department personnel lack the time to structure AFAs 13% Alternative arrangements are too difficult to negotiate or hold to 10% There is insufficient technology to analyze billing history or pricing methodology 9% Other (please specify): 9% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 13 Page 60

61 A report from ALM Legal Intelligence The Devil in the Details Probe more, and you realize that both sides of the legal coin have major challenges in adopting alternative fee arrangements. One obstacle that is proving exceptionally difficult to overcome is the amount of work required in figuring out how to structure the alternative fee arrangement. The truth is, it s been harder to change the mind-set of the inside counsel than the law firm, says an inside counsel who wishes to remain anonymous. In many legal departments, lean staffing and demanding workloads make this extra work especially burdensome. Then there s a lack of training in undertaking a business analysis to learn how to structure the fees. The attorneys here want to practice law, and the law schools don t teach lawyers that it s a business, says the anonymous in-house lawyer. They teach lawyers that it s a noble pursuit and that nobody wants to dirty their hands with money. I have a hard time convincing the lawyers here, and it makes them angry and crazy when I say this, but at the end of the day we buy legal services the way some people buy copy paper. Additional work also means additional hours in a schedule that is already packed full. Convincing in-house counsel to devote time to fee structuring becomes even more difficult when they see that the money saved in one matter seems insignificant compared the size of the overall department budget, let alone overall corporate net profits or losses that are exponentially larger. Not all in-house lawyers enjoy the process of structuring an AFA. You have to have the right type of people negotiating this, says Harsco s Dorch. I m a deal lawyer, so I m comfortable negotiating. Some aren t, even when they are lawyers. Legal departments also have a long-standing disincentive to structure AFAs: traditional discounts that have made them look like heroes to their organization. [If an in-house counsel] accomplished getting a 10 percent discount on every legal dollar we spend, everyone would say, You did a good job, says Goodwin Procter partner Laura Hodges Taylor. But that eventually becomes a dead end. They can t show that they re doing better, she says. It s oddly unsatisfactory after a time. Law firms also have their issues with AFAs, particularly in terms of workloads. It s the same for the lawyers, Taylor says. The amount of time it takes to analyze 30 transactions of a particular type, figure out where the variations were, interview the lawyers that did each one before you make your own budget that allows you to figure out how and whether the fee arrangement would be profitable [is] enormous. According to one major firm partner who asked not to be identified, even getting lawyers to track their time in the ways necessary to obtain the data to analyze is challenging. Not only do I have to write down my fricking billable time for every matter, but I have to code it, says the partner. And we already don t like keeping track by the six minutes. Imagine if in every six minutes you had to track by task and phase. It s the old geezers like me that really can t stand the thought. If your company puts pressure on the law department to demonstrate value, do they request that the law department use AFAs, discounting, both or do they even have a preference? Law Departments They don t have an opinion 73% They ask that we use both 17% AFA and discounting They ask that we discount 7% They ask that we use AFA pricing 3% Is there an effort underway at your firm to train associates and/or partners in implementing AFAs? Law Firms for attorneys at the firm We train both associates and partners 36% We train partners 24% We train associates 0% Not sure 3% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 14 Page 61

62 A report from ALM Legal Intelligence It Still Comes Down to the Billable Hour Firms have an additional problem with the increase of AFAs in that their compensation models focus on individual billable hours and realized rates. Even when we talk about billable hours and alternative fee arrangements, if your internal structure doesn t change, in the long run it s doomed to failure, says the chief counsel of outside counsel relations at a major banking institution. You re still converting the value of your work to billable hours. I don t think it s appropriate to compensate an associate who bills The attorneys here want 3,000 hours more than an associate who provides higher-quality work to practice law, and the law and more efficiently but who only bills 2,000 hours. Unfortunately, the schools don t teach lawyers way law firm compensation is structured, that s what happens. that it s a business. Compensation commonly presents a challenge to companies when Anonymous in-house lawyer strategy asks for one behavior but promotes another, as employees will do what they are paid for, not what they are told. In this case, law firms run into the classic business problem of sub-optimization: when one part of a system improves its production of a given criterion but the larger whole is hurt as a result. A law firm presumably wants to maximize total profit for billable time, so maintaining target hourly rates would seem desirable. However, there is an underlying assumption that the number of billing hours does not change. That is not necessarily correct. There are a number of ways in which an alternative fee arrangement could increase the total number of billing hours: Firms could attract a greater portion of business from their clients. AFAs could make the firms more competitive in gaining new work. By locking down blocks of work, firms would open the marketing time that would have been necessary to win it for other billable use. A simple example shows the issue. Law Firm A has ten hours available for billing. Because it focuses on maintaining a $500 an hour rate, it books five of those hours, for a total of $2,500. Law Firm B uses an AFA with a client that calls for a blended rate of $400 per hour, but it books eight hours of work, for a total of $3,200, or revenue that is 28 percent higher than Law Firm A. Although the reality of law firm billing is far more complex, the principles are the same. An AFA might mean (though not always) charging effectively less per hour than standard firm rates. But drive up billable time enough, and income and profit increase for the same matters. Structured correctly, AFAs will help a firm mitigate its risk of not being able to profitably use the time of its partners and associates. Given that many major firms continue to expand their use of AFAs, and assuming that the partners are no less interested in making money than others, one might conclude that using AFAs in a growing portion of their work actually delivered more financial value to the firms than straight hourly billing would have. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 15 Page 62

63 A report from ALM Legal Intelligence Software Not Sufficient One of the most challenging aspects of using AFAs for either department or firm is collecting, managing, and analyzing data. In the last six to nine months, we ve seen an accelerated interest in [AFAs], but it coincided with more tools in the firm and knowledge about it, says Miles Stockbridge chairman John Frisch. A majority of legal departments are now using ebilling software to plan, manage and track alternative fees. They are finding this to be more effective than matter management and accounting software, however, it does not facilitate the use of alternative fees in every case. Law firms are primarily using their accounting software for the management of alternative fees. These billing and timekeeping systems do not fully support AFAs, but there are some emerging financial planning software products that work with these systems and include functionality for evaluating and managing alternative fees, better meeting the need. Quality data for structuring more effective AFAs requires better software. Some firms, like Goodwin Procter, develop their own, but that has its own difficulties in attracting enough talent with the necessary expertise in analyzing large amounts of data. However, software by itself is not enough. Both law departments and law firms talk of a need for culture change, collaboration and the establishment of trust to have alternative fee arrangements work effectively. Even when we talk about billable hours and alternative fee arrangements, if your internal structure doesn t change, in the long run it s doomed to failure. Chief Counsel of outside counsel relations at a major banking institution CASE STUDY: Goodwin Procter (law firm) Goodwin Procter has used AFAs periodically for at least 20 years. But four or five years ago, some partners decided to examine what exactly made the agreements work. One of the most important elements would be to understand what it actually takes to do the things we do, says partner Laura Hodges Taylor. How much does it cost us in terms of hours to do a motion to dismiss, to take a deposition? The firm started tracking matters at a deeper level by developing custom software that works with its billing and time entry systems. If everyone enters their time properly then you can match it against budget and identify the minute things go out of whack, she says. We d ultimately be able to look and say, Is the right person doing this job? Could it be done just as well and cheaper by a paralegal? Would it be better done by someone senior? The best approach for Goodwin is to rely on data mining tools that analyzes information the firm currently has instead of pushing for real-time data collection by attorneys as they bill time on matters. The data should help with proper budgeting and staffing, but the worry is always that the firm will find that it has no place to go but down. There s a lot of inertia that pushes against any really meaningful use of alternative fees, other than discounts, Taylor says. [Clients] don t want to do fixed fees. They assume we ll set the price above what the cost would be so we make money. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 16 Page 63

64 A report from ALM Legal Intelligence Do you use software to plan, manage and track AFAs? If so, which? Check all that apply. Law Departments ebilling software 51% Matter management software 45% Accounting Software 15% Other (please describe) 24% Law Firms ebilling software 18% Matter management software 38% Accounting Software 46% Other (please describe) 12% Has the use of any of these software systems actually helped facilitate the use of AFAs with your law firms / clients? (Scale: Always=1, Often=2, Sometimes=3, Never=4) Law Departments Law Firms Mean Responses Mean Responses Matter management software Matter management software Accounting Software Accounting Software ebilling software ebilling software Other Other Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 17 Page 64

65 A report from ALM Legal Intelligence PART III: AFAs ARE here TO STAy (So WhAT TO Do?) As the survey shows, for ALL the RESIStanCE and inherent difficulties, AFAs are not just here to stay, but they will likely be active in an increasing amount of legal business. To that end, both departments and firms need practical ways to make AFAs work. One is to alternately take on the role of student and teacher, says D. Cameron Findlay, senior vice president, general counsel, and corporate secretary of Minneapolis-based Medtronic, Inc. We have learned a lot from a couple of our law firms who have suggested innovative alternative fee arrangements, and in that sense, they were far ahead of us, Do you think AFAs will remain a permanent part of legal matter billing? Law Departments 3% 9% Law Firms 2% 6% 88% 92% Yes No Not sure Yes No Not sure Findlay says. For firms that haven t been as advanced, we ve been the teacher instead of the student. One of our partners for internal purposes did a chart talking about alternative fees, says Gary Hoffman, partner at Dickstein Shapiro. Even with doing this at a somewhat high level, I think he had about 30 different combinations of things. When people ask what [AFAs are] limited to, it s creativity and what makes economic sense both for the law firm and the client. If it s one-sided, someone might do it, but they won t do it again. With the growing importance and pervasiveness of alternative fee arrangements, legal department and law firm respondents alike speak of the need for partnership and cooperation when structuring AFAs. Good intentions, however, are not enough. To what extent can firms and clients make that a reality when each side is looking to its own interests? An inherent symbiosis exists to the degree that neither side can ultimately recognize its goals without enabling the other. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 18 Page 65

66 A report from ALM Legal Intelligence As for entrenched resistance, Matthew Wagman, a Miles Stockbridge partner in the product liability department, remembers an AFA conference he attended. [Someone asked], How do you get a lawyer in your firm who has practiced for 30 years billing hourly to use alternative fee arrangements? The leader said, You don t. Your clients will. Or they might just do a worse job than you d like. Make sure you don t disincentivize outside counsel from doing the right thing, says David Shofi, chief intellectual property counsel of Danbury, Conn.-based ATMI. If they feel as though they re being asked to accomplish a task and they ll lose money on the case in terms of their time spent, they re just not going to spend the time that they should. Another way is to focus on legal areas or matters where structuring AFAs can be easiest the proverbial low-hanging fruit then advancing from there. In immigration law, it is not uncommon to bill primarily task-based, says Nancy-Jo Merritt, a director at Fennemore Craig. But the firm steers clear of AFAs in litigation matters. If we did a lot of it, maybe some of it we could routinize, because of course clients love to know exactly how much things are going to cost, she says. Pillsbury Winthrop s Wallan put it succinctly. They shouldn t think of how can I screw my lawyer to get lower costs, but how can we work together better to work more efficiently, he says. There is responsibility on the part of the law firm, as well: You don t need to gold-plate everything. You need to put the amount of resources that are appropriate to the case on the case. Both sides must work to learn more and consider the wide range of AFA structures that have proven themselves in such areas as litigation, patent prosecution, and mergers and acquisitions. Whether a structure such as partial contingency, monthly fixed fee, or caps on phases of litigation, the key to successful use of alternative fee arrangements is finding one that best fits the circumstances and the intent of the department and firm. Is cost containment of central importance to a client? Does risk sharing give the firm part of the reward in litigation? Relative to two years ago, do you think that law firms are making progress understanding and implementing AFAs in general? Law Departments A lot of progress 19% A little progress 59% Hardly any progress 18% Not sure 5% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 19 Page 66

67 A report from ALM Legal Intelligence CONCLUSION If LAw FIRMS and LEgAL DEPARtMEnts continue MIgRAting away FRom the billable hour model, both sides will need to embrace profound structural changes, such as training legal staff to manage matters within a budget while keeping an eye on profits. To do so effectively, they will need to develop or invest in pricing databases and other software that monitors the structure and profitability of AFAs. But the larger effort should always focus on the client-law firm relationship, the foundation of which is built on cooperation, honest communication, mutual flexibility, and openness to making tangible changes that ultimately will be to the advantage of both parties. ENDNOTES * Allies or Adversaries: Law Firms and Alternative Fee Arrangements ; ALM Legal Intelligence; April 2011 ** ACC Value-Based Fee Primer, Association of Corporate Counsel, July Retrieved at acc.com on February 7, Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 20 Page 67

68 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Do you negotiate, initiate or approve alternative fee arrangements in your legal department or law firm? Law Departments Law Firms.5% Yes 18% 11% No 14% 68% 89% Our legal department / law firm does not bill using methods other than the billable hour and/or discounts Which of the following describes your job responsibility or title? Law Departments General Counsel 42% Corporate Counsel 28% Staff attorney 9% Corporate Secretary 1% Other (please specify) 21% Law Firms Lawyer, Partner 51% Managing Partner or Chair 20% Chief Financial Officer 8% Firm Administrator 6% Lawyer, Associate 2% Other (please specify) 13% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 21 Page 68

69 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS In 2011, approximately what percentage of your legal work was valued through an arrangement that is not based solely on hourly rates? Law Departments Between 1% and 10% 38% Between 11% and 25% 25% Between 26% and 50% 19% Between 51% and 75% 4% Greater than 75% 8% Not sure 6% Law Firms Between 1% and 10% 30% Between 11% and 25% 37% Between 26% and 50% 10% Between 51% and 75% 2% Greater than 75% 4% Not sure 17% In general, what is your law department / law firm s philosophy when it comes to AFAs? Law Departments The law department 55% takes it matter by matter The law department 43% embraces AFAs The law department 3% tends to avoid AFAs Law Firms The law firm takes it 52% it matter by matter The firm embraces AFAs 46% The law firm tends to 2% avoid AFAs Between 2010 and 2011, what change did your law department/law firm see in the volume of AFAs? Law Departments % Increase: 50% % Decrease: 1% No change 49% Law Firms % Increase: 62% % Decrease: 2% No change 35% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 22 Page 69

70 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Of the alternative fee arrangements employed in 2011, which of the following does/ did your law department / law firm use? (check All that apply) Law Departments Flat Fee 89% Capped Fee 57% Blended Rate 47% Phased Fee 35% Contingent Fee 27% Partial contingency or success fee 22% Flat Fee with Shared Savings 19% Defense contingency fee 12% Holdback 10% Other 13% Law Firms Flat Fee 93% Capped Fee 83% Blended Rate 89% Phased Fee 66% Contingent Fee 74% Partial contingency or success fee 77% Flat Fee with Shared Savings 57% Defense contingency fee 23% Holdback 39% Other 7% Flat Fee: Client pays an agreed upon sum of money for an agreed-upon amount of work. Unlike hourly fee arrangements, flat-fee arrangements have the law firm assume the risk of cost overruns and the client assumes the risk of a bad result. Capped Fee: Client pays up to an agreed upon sum for an agreed-upon amount of work or for an engagement. Capped fees often are used in conjunction with an hourly rate agreement, but the total amount charged by the hour cannot exceed the cap. Blended Rate: A blended rate is an agreed-upon hourly rate that applies to all lawyers working on a matter. Some firms consider discounts to the hourly rate a form of AFA. Phased Fee: Law firm and the client agree upon fees for discreet phases of the work. Different phases might utilize different structures, including the hourly rate, a flat fee, a contingency fee, or an AFA. Contingent Fee: Law firm gets paid only if it achieves a financial recovery or other result for the client. Typically, the law firm receives a percentage of the total recovery. Partial contingency or success fee: Law firm might be paid a fraction of its fee under an hourly, flat, or capped-fee arrangement, and an additional amount if the result exceeds agreed-upon criteria. Flat Fee with Shared Savings: If at the conclusion of the work fees calculated on the basis of the hours worked would be less than the flat fee, the client and law firm share the savings. Defense contingency fee: Law firm defending a client against a monetary claim agrees with the client on an expected outcome. If the firm achieves a better result than the expected outcome, the client pays the firm a percentage of the savings. Holdback: Client withholds an agreed-upon amount or percentage of the fee until an agreed-upon milestone or result is achieved, or until completion of the engagement. The obligation to pay the amount withheld is triggered if the law firm achieves a result. Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 23 Page 70

71 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Has your legal department ever instituted / Has your firm ever been asked to bid on work via a reverse auction (or competitive bidding in an effort to get firms to lower prices on high-volume, repetitive work such as tax filings or IP transactions)? Law Departments 10% 20% Law Firms 31% Yes No Not sure 70% 36% 33% Has your firm bid on these reverse auctions? Law Firms 18% 7% Yes No Not sure 75% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 24 Page 71

72 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS In some cases, AFAs are isolated to certain legal practice areas. In which of the following practice areas do you work to arrange AFAs? (check all that apply) Law Departments Litigation 67% Transactional 49% Intellectual Property * 46% Employment/Labor 42% Real property 27% Corporate law 24% Corporate governance 22% Regulation/Compliance 17% Other (please specify): 14% Law Firms Litigation 13% Transactional 13% Intellectual Property * 8% Employment/Labor 8% Real property 7% Corporate law 8% Corporate governance 5% Regulation/Compliance 1% Other (please specify): 1% *(copyright, licensing, trademark, patents) Thinking about the majority of matters billed using an AFA in 2011, how were they generally initiated? Law Departments We initiated 81% Mutually initiated 14% They initiated 5% Law Firms We initiated 13% Mutually initiated 50% They initiated 37% In general, how do you approach law firms when requesting AFAs? Law Departments Informally with preferred law firms 83% Formally with an RFP 12% Other (please explain) 6% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 25 Page 72

73 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS In approximately what percentage of matters did you discuss an AFAs with a law firm / law department but end up reverting to a billable hour model or billable hour with discounting? Law Departments Never 31% 10 percent 28% 25 percent 18% 50 percent 15% More than 50 9% percent of matters Law Firms Never 13% 10 percent 37% 25 percent 21% 50 percent 12% More than 50 17% percent of matters Thinking about firms / law departments with whom your law department / law firm negotiates and institutes AFAs, what percentage of AFAs are on a per matter basis vs. a portfolio of matters? Law Departments 30% Law Firms 26% Matter by matter A portfolio of matters 70% 74% How often does your legal department / law firm make specific suggestions as to how to structure an AFA? Law Departments Most of the time 39% Some of the time 52% Rarely 6% Never 3% Law Firms Most of the time 18% Some of the time 54% Rarely 25% Never 3% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 26 Page 73

74 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Does your legal department demand that first- or second year associates not bill time on matters? Law Departments 7% 15% Yes No Not sure 78% How often do clients demand that first- or second year associates not bill time on matters? Law Firms Never 40% 10 percent of the time 46% 25 percent of the time 12% 50 percent of the time 0% More than 50 percent of the time 2% Compared to five years ago, is your legal department working with more or fewer outside law firms? Law Departments We are working with more firms 25% We are working with fewer firms We are working with the same amount of firms but they 16% are different ones than the firm employed 5 years ago We are working with about the same amount of firms 13% 46% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 27 Page 74

75 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS What role did receptivity to AFA pricing play in any changes your legal department has made to its roster of outside counsel? Law Departments It played a minimal role 42% It played a significant role 38% No affect on our choice of outside counsel 20% Who approves alternative fee arrangements in your company? Law Departments AFAs are approved by the General Counsel 57% AFAs are approved down to the Associate General Counsel level 30% AFAs are approved by the CFO 4% Other (please specify) 9% Who approves alternative fee arrangements at your firm? Law Firms AFAs are approved by a committee or relationship partner 55% AFAs are approved by the managing partner 34% Partners are at liberty to negotiate their own billing structure 12% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 28 Page 75

76 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS If your company puts pressure on the law department to demonstrate value, do they request that the law department use AFAs, discounting, both or do they even have a preference? Law Departments They don t have an opinion 73% They ask that we use both AFA and discounting 17% They ask that we discount 7% They ask that we use AFA pricing 3% What do you believe to be the major benefits of using alternative fee arrangements for a legal department? Law Departments Cost predictability / transparency 87% Cost savings 68% Increased efficiency (e.g. quality and value for legal service) 44% Risk-sharing 35% Ease of comparing law firm cost-effectiveness 11% Other (please specify): 2% What are the major benefits of using alternative fee arrangements for the law firm? Law Firm Attracting or maintaining clients 91% Simplified billing and operations 50% Increased billing realization 43% Cost predictability 37% Ease of comparing law firm cost-effectiveness 23% Cost savings 11% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 29 Page 76

77 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS What do you believe to be the biggest obstacles to the growth of AFAs? Law Departments Law firms are more comfortable with the billable hour 61% Firms have insufficient experience defining or managing work on an AFA basis 51% Absent better metrics and data, it is difficult to determine AFAs 36% Law firms resist alternative fee arrangements 32% Corporate law departments have insufficient experience defining or managing work on an AFA basis 25% There is not sufficient billing history or pricing methodology to know how to bill AFAs 25% Corporate law departments are more comfortable with the billable hour 15% Legal department personnel lack the time to structure AFAs 13% Alternative arrangements are too difficult to negotiate or hold to 10% There is insufficient technology to analyze billing history or pricing methodology 9% Other (please specify): 9% Law Firms Law firms are more comfortable with the billable hour 52% Firms have insufficient experience defining or managing work on an AFA basis 54% Absent better metrics and data, it is difficult to determine AFAs 34% Corporate law departments have insufficient experience defining or managing work on an AFA basis 26% There is not sufficient billing history or pricing methodology to know how to bill AFAs 32% Corporate law departments are more comfortable with the billable hour 40% Alternative arrangements are too difficult to negotiate or hold to 13% Compensation models at the firm are still based on hours billed 24% AFAs are too risky for the firm s overall revenue 10% Partners object or refuse to cooperate 4% Other (please specify): 5% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 30 Page 77

78 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Is there an effort underway at your law department to train legal staff in requesting or implementing AFAs? Law Departments 6% 22% Yes No Not sure 72% Is there an effort underway at your firm to train associates and/or partners in implementing AFAs? Law Firms There is no real AFA training effort for attorneys at the firm 37% We train both associates and partners 36% We train partners 24% We train associates 0% Not sure 3% Thinking about project management (the process of tracking, controlling, analyzing, and reporting on work flow), does your legal department train staff in improving efficiencies and understanding costs per matter? Law Departments 44% 7% Yes No Not sure 50% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 31 Page 78

79 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Thinking about project management, does your firm train attorneys in improving efficiencies and understanding costs per matter? Law Firms We train both associates and partners 50% There is no real project management effort for attorneys at the firm 34% We train partners 11% We train associates 3% Not sure 3% Do you use software to plan, manage and track AFAs? If so, which? Check all that apply. Law Departments ebilling software 51% Matter management software 45% Accounting Software 15% Other (please describe) 24% Law Firms ebilling software 18% Matter management software 38% Accounting Software 46% Other (please describe) 12% Has the use of any of these software systems actually helped facilitate the use of AFAs with your law firms / clients? (Scale: Always=1, Often=2, Sometimes=3, Never=4) Law Departments Law Firms Mean Responses Mean Responses Matter management software Matter management software Accounting Software Accounting Software ebilling software ebilling software Other Other Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 32 Page 79

80 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Has your legal department / law firm studied past expenses on outside counsel billing in an effort to learn how costs should be structured for matters or ongoing legal work? Law Departments Yes, we ve studied internally 61% No 26% Yes, we ve used a consultant 8% to help us figure that out Not sure 6% Law Firms Yes, we ve studied internally 74% No 12% Yes, we ve used a consultant 3% to help us figure that out Not sure 10% Does your legal department / law firm have measures in place to determine the value or ROI / financial success realized from an AFA? Law Departments 12% 20% Law Firms 3% 7% Yes No Not sure 68% 90% When your department has used AFA pricing structures, has your department realized value or ROI than matters with costs structured strictly on the billable hour or with discounts? Law Departments Yes, in all cases 30% Yes, in some cases 45% No 5% Too soon to tell 20% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 33 Page 80

81 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS With what frequency does your firm monitor the profitability (or loss) of alternative fee arrangements? Law Firms Weekly 5% Monthly 48% Quarterly 26% Annually 19% Never 1% Does your firm record and code hours spent on a task or matter so that the firm understands how long similar tasks might take in the future? Law Firms 10% 21% Yes No Not sure 70% In your best estimation, are matters structured with AFAs more or less profitable to the firm than matters with costs structured strictly on the billable hour or with discounts? Law Firms Depends on the matter or client 55% Less profitable 13% More profitable 9% Too soon to tell 8% The same 7% ROI is in client relationship/loyalty or 7% increased volume of work Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 34 Page 81

82 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS What kind of cost savings / profit or losses has your law department / law firm realized as a result of AFA billing? Law Departments Cost savings / profit of 0-5% 17% Cost savings / profit of 6-10% 28% Cost savings / profit of 11-20% 37% Cost savings / profit of 21-50% 11% Cost savings / profit of 50%+ 2% Loss of 0-5% 3% Loss of 6-10% 1% Loss of 11-20% 0% Loss of 21-50% 1% Loss of 50%+ 0% Law Firms Cost savings / profit of 0-5% 40% Cost savings / profit of 6-10% 21% Cost savings / profit of 11-20% 8% Cost savings / profit of 21-50% 5% Cost savings / profit of 50%+ 4% Loss of 0-5% 14% Loss of 6-10% 4% Loss of 11-20% 2% Loss of 21-50% 1% Loss of 50%+ 0% What are your timing needs for billing information in order to manage matters around AFAs? Law Departments Monthly billing is okay 80% Need for real-time billing information 15% Other 5% Law Firms Monthly billing is okay 43% Need for real-time billing information 53% Other 4% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 35 Page 82

83 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS How do you foresee the volume of alternative fee billing changing in the next year? How about 5 years from now? Law Departments 2011 to 2012 % Increase 55% Average percentage change 14.6% 2012 to 2016 % Increase 70% Average percentage change 28.9% 2011 to 2012 % Decrease 7% Average percentage change 20% 2012 to 2016 % Decrease 4% Average percentage change 18.8% Law Firms 2011 to 2012 % Increase 74% Average percentage change 11.9% 2012 to 2016 % Increase 82% Average percentage change 23% 2011 to 2012 % Decrease 2% Average percentage change 5% 2012 to 2016 % Decrease 3% Average percentage change 11.7% Do you think AFAs will remain a permanent part of legal matter billing? Law Departments Law Firms 3% 9% 2% 6% Yes No Not sure 88% 92% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 36 Page 83

84 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Relative to two years ago, do you think that law firms are making progress understanding and implementing AFAs in general? Law Departments A lot of progress 19% A little progress 59% Hardly any progress 18% Not sure 5% Relative to two years ago, how well are law firms cooperating with legal departments on structuring and implementing AFAs? Law Departments Law firms are more cooperative now than 2 years ago 55% Law firms are just as cooperative than 2 years ago 31% Laws firms are as uncooperative as 2 years ago 13% Law firms are less cooperative now than 2 years ago 1% Assuming AFAs become a more significant form of legal fee arrangement, how well would you say your firm is equipped to embrace this paradigm shift? Law Firms 5- Extremely well 20% 4 42% 3 26% 2 11% 1-Not at all 1% Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 37 Page 84

85 A report from ALM Legal Intelligence APPENDIX: SURVEY RESULTS Overall, how satisfied is your law department / law firm with AFAs? Law Departments Law Firms Very Satisfied 26% Somewhat Satisfied 58% Neither 11% Somewhat Dissatisfied 6% Very Dissatisfied 0% Very Satisfied 11% Somewhat Satisfied 61% Neither 15% Somewhat Dissatisfied 10% Very Dissatisfied 2% How large is your organization? Law Departments employees 22% % % % 10,000+ employees 37% How many lawyers are in your law firm (nationwide)? Law Firms % % % % Speaking Different Languages: Alternative Fee Arrangements for Law Firms and Legal Departments ALM Legal Intelligence 38 Page 85

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87 About ALM Legal Intelligence ALM Legal Intelligence offers detailed business information for and about the legal industry, focused on the top U.S. and international law firms. The division s online research web service ( provides subscribers with direct, on-demand access to ALM s extensive database of surveys, rankings, and lists related to law firms and the legal industry. The site also includes an online store where non-subscribers can, on an individual basis, purchase and download preformatted individual law firm reports, ALM Legal Intelligence research reports, and selected current-year survey data. Page 87

88 Legal pricing in transition: How client demands and alternative fees are changing the way that law firms price their services A LegalBizDev White Paper by Jim Hassett and Matt Hassett TRAIN Page 88

89 Legal Pricing in Transition Page 1 Contents Executive summary...2 Why law firms are changing their approach to pricing...3 The cost-plus approach...5 Price competition, discounts, and loss leaders...8 Value pricing basics...10 Ron Baker s eight steps to implementing value pricing...13 The rise of the pricing function...15 Using metrics to define value...19 Where firms are today...23 Predicting the future...24 Appendix A: Case study showing the difficulty of calculating cost per hour in advance...29 Appendix B: The mathematical relationship between hourly discounts and profits...34 About this white paper...37 About the authors...38 About LegalBizDev...39 Copyright 2012, LegalBizDev. Brief excerpts or quotations may be reproduced without advance permission and should be credited to LegalBizDev. This document may be freely copied and distributed. For more details, see Page TRAIN

90 Legal Pricing in Transition Page 2 Executive summary Legal pricing is changing as a result of client pressures for efficiency on both hourly and non-hourly matters and the increasing use of alternative fee arrangements. Law firms are being forced to rethink their approach to two very fundamental questions: 1. When bidding for new work, how do I set a price that is high enough to protect profits, but low enough to get the work? 2. After winning the work, how do I manage the matter so that I make a profit (or at least break even) at that price? Answering these questions will require lawyers to develop many new skill sets, including project management to deliver high quality legal services within limited budgets, and better bidding in the first place. Of the pricing strategies that other businesses use to maximize profitability, the two that seem most relevant to lawyers are cost-plus pricing, in which a profit margin is added to the cost of delivering a service, and value pricing, where the client s perception of value is the most important factor. True cost-plus pricing would require firms to perform much more detailed projections and analyses of actual costs than the current hourly billing model. The cost of each billable hour ultimately depends on a number of factors that are difficult to predict, including the exact number of hours billed and paid in a given year. The most common response to client cost pressure is to simply discount the hourly rate, but most lawyers do not understand that a small discount can lead to a large reduction in profits, as illustrated in a number of examples in this white paper. A better understanding of true costs will help law firms to make better business decisions and to protect profitability. In cost-plus pricing, cost is known before you set the price. In value pricing, you start with the price the customer is willing to pay and control your costs to live within that price. Many lawyers believe that value pricing will lead to higher prices and profits, and sometimes it can. However, the intense competition in today s legal marketplace is reducing the number of clients who are willing to pay a premium for value. In response to these challenges, many firms are now creating pricing committees and directors to focus on this critical function. This paper includes interviews with pricing leaders from a number of large firms that are working to better understand their costs, improve value creation, measure value, and apply project management techniques to control both cost and value. The paper ends with eight predictions, including a continuing increase in competition and that to succeed in the future law firms will be required to put more emphasis on both initial pricing and subsequent project management. Page TRAIN

91 Legal Pricing in Transition Page 3 Why law firms are changing their approach to pricing Some law firms are going to large companies and offering to do all their legal work for one fixed price, but the firms don t know how it will work out in the long run. I suspect in some cases it will come out really ugly. This prediction was made in 2009, by a senior partner from an AmLaw 100 firm who took part in our LegalBizDev Survey of Alternative Fees. 1 In the years since, this prediction has become a reality and many fixed price legal deals have indeed turned out badly. In the 2011 Law Firms in Transition Survey, Altman Weil asked managing partners and chairs, Compared to projects billed at an hourly rate, are your firm s non-hourly projects more profitable or less profitable? 2 Thirty-two percent said non-hourly matters were less profitable. Of these 32%, there is no data on how many turned out really ugly. But based on many stories I have heard off the record, I would guess quite a few. I also suspect that the true number of less profitable deals is much higher than 32%. In college, I had a friend who spent a lot of time at the race track. He seemed to remember the times he won much better than the times he lost. I suspect many lawyers have a similar talent for forgetting deals that turned out badly. Especially when they answer questions in a survey. In the survey results, 12% said non-hourly arrangements were more profitable, and 36% said they were about the same as hourly. The remaining 20% were not sure. Apparently, their accounting systems weren t set up to analyze mere details like the profitability of individual fixed price engagements. Would you invest in a company that didn t know which deals were profitable? Of course not. But if you are a partner in a large or mid-sized firm, there s a good chance you already own one. How did this happen? The answer can be traced to too many years of good news. For the last few decades, the law firm pricing model could be described as cost plus a lot. Just keep raising prices until the overhead is paid and key partners make a lot of money. But now the game is changing, and clients are resisting rate increases. 1 Jim Hassett, The LegalBizDev Survey of Alternative Fees (LegalBizDev, 2009). See Page TRAIN

92 Legal Pricing in Transition Page 4 When money is flowing freely, everybody thinks they are smart, and nobody has to count too carefully. As Warren Buffett famously put it, It s only when the tide goes out that you learn who s been swimming naked. Many lawyers would like to believe that the tide will come back in soon and the good old days of raising prices every year will return. But, as Barbara Boake and Rick Kathuria noted in their book Project Management for Lawyers, The recession was merely a catalyst for an inevitable shift in the balance of power from seller to buyer that will have a long-term impact on the way lawyers work. 3 Very simply, clients are demanding more value for their legal dollar, and that is not about to change, no matter what happens to the economy. In the foreword to our LegalBizDev Survey of Alternative Fees, Bruce MacEwen wrote that this type of sea change in law firms fundamental revenue model is a once-in-acareer event. 4 When law firms begin offering non-hourly alternative fee arrangements (AFAs), they must address two fundamental questions: 1. When bidding for new work, how do I set a price that is high enough to protect profits, but low enough to get the work? 2. After winning the work, how do I manage the matter so that I make a profit (or at least break even) at that price? Answering these questions will require lawyers to develop many new skill sets, including project management to deliver high quality legal services within limited budgets, and better bidding in the first place. For the average partner, learning more about pricing must start with a very simple insight. As Bruce Clearing Sky Christensen, Executive Director of Warner Norcross & Judd put it, Lawyers must understand that client perceptions of value may have nothing to do with the hours it takes to do the work. But don t feel bad; lawyers are not the only ones who could be better at pricing. In the fifth edition of one of the most widely respected texts in this field, Thomas Nagle, John Hogan and Joseph Zale noted that: In many business-to-business markets, where high-volume repeat purchasers negotiate their purchases, buyers are ahead of sellers in thinking strategically.buyers have goals and a long-term strategy for driving down 3 Barbara Boake and Rich Kathuria, Project Management for Lawyers (Ark Group, 2011). 4 Hassett, Survey, 2. Page TRAIN

93 Legal Pricing in Transition Page 5 acquisition costs, while suppliers rarely have comparable long-term strategies for raising or at least preserving margins. 5 Wikipedia lists 21 different pricing strategies suppliers use in other businesses, ranging from loss leaders to premium pricing. Two of them are of special interest to lawyers: cost-plus and value pricing. Cost-plus pricing is similar to the traditional hourly billing approach, and is exactly what it sounds like: a price is based on the cost of delivering a service plus a markup or profit margin. But that is much harder than it sounds, and not necessarily a good idea, as we will discuss in the next section. The most popular alternatives are built around the idea of value pricing, where the client s perception of value is the most important factor. The best known proponent of this approach is Ron Baker, author of several books on the topic, including Pricing on Purpose. In practice, this too can be harder than it sounds, as we will also discuss below. In a highly competitive marketplace like legal services, where some firms these days seem downright desperate for new work, there is also a giant complication: price competition. So, that too will be discussed in this white paper. The legal profession is changing rapidly, and law firms are just starting to apply experts insights into pricing, so there is controversy about what will work best. But on one point everyone can agree: law firms could make more money if they got better at setting their prices. The cost-plus approach In the fall of 2011, when I gave a speech at the retreat of a 1,000-lawyer firm, a senior partner asked, In your experience, how do large firms determine costs? I replied, Mostly, they don t. Until recently, most firms were making so much money they didn t need to precisely calculate their costs. Many lawyers seem to think of their standard hourly rates as being equal to the firm s costs. But traditionally, rates have actually been based on cost plus a lot, and no one was quite sure which part was the cost and which part was the plus a lot. One underlying problem is that the compensation of equity partners typically is based on dividing the firm s profits at the end of the year. To cite an extreme example, 5 Thomas T. Nagle, John E. Hogan and Joseph Zale, The Strategy and Tactics of Pricing: A Guide to Growing More Profitably, Fifth Edition (Prentice Hall, 2010), Page TRAIN

94 Legal Pricing in Transition Page 6 consider Wachtell, Lipton, Rosen & Katz, which had the highest profits per partner in the AmLaw 100 in 2012: Some equity partners were paid more than this average, some were paid less. But let s consider a lawyer who was paid exactly that amount. He may think of his $4.46 million annual draw as a cost of doing business. But the chances are Wachtell Lipton could stay in business if he were forced to scrape by on $3 million, or even $2 million. What fraction of his draw is a true cost and what part is his share of the profits? Until the day that Wachtell Lipton guarantees equity partners a baseline salary, and identifies the rest as a discretionary profit-sharing bonus, the line between cost and plus will remain arbitrary. Despite this lack of precision, most law firm pricing has traditionally been based on the cost-plus model. As Ron Baker points out in his influential book Pricing on Purpose, it seems fair to start from costs and add a reasonable markup for profit. But Baker strongly favors value pricing over cost-plus. After listing numerous bullet points that people use to argue in favor of the cost-plus approach, and explaining how they are wrong, he noted, It is amazing how many businesses still cling to the costplus pricing method Doing something stupid once is just stupid. Doing it twice is a philosophy. 6 The authors of The Strategy and Tactics of Pricing were a bit gentler when they said: Cost-plus pricing is in theory, a simple guide to profitability; in practice, it is a blueprint for mediocre financial performance. The problem with cost-driven pricing is fundamental: In most industries it is impossible to determine a product s unit cost before determining its price. Why? Because unit costs change with volume. 7 In traditional legal work, the unit you are selling is the billable hour. To see how the cost per hour depends on several variables, we have provided a detailed hypothetical example for a solo practitioner in Appendix A. For the reader who does not want to go through all the math, suffice it to say that until you get to the end of a year and know exactly how many hours you have billed and been paid for, and how much you spent on everything else, you can only estimate the cost per hour, and your initial estimate will almost certainly be wrong. Now take the uncertainties for a single lawyer, and multiply them by 100 lawyers or 1,000, with laterals coming and going, and client needs constantly changing, and you will begin to get an appreciation for how difficult it would be to accurately predict the cost per hour at the beginning of the year. Any cost estimate at the beginning of the year will depend on a number of assumptions. And when some of those assumptions inevitably turn out to be incorrect, the cost numbers will need to change. 6 Ronald J. Baker, Pricing on Purpose: Creating and Capturing Value (Wiley, 2006), Nagle, Hogan and Hale, Strategy, Page TRAIN

95 Legal Pricing in Transition Page 7 However, that is not to say it is impossible to estimate costs in advance. Government contractors who work under cost-plus contracts are required to estimate their costs at the beginning of each year, bill the government all year long at the estimated rate, and then do a reconciliation at the end of the year to determine actual reimbursable costs. If actual costs exceed the original estimate, contractors typically must request permission to exceed the contract limit, giving the government 90 days advance notice. If costs are lower than the original estimate, at the end of the year the government gets a refund. To make money within these rules, contractors set up elaborate financial reporting systems to provide early warning of variance from their projections, and they change their spending at the first sign of a problem. So it is certainly possible to run a company within narrow cost limits, but it requires a degree of financial analysis and control that would be a revolutionary change for law firms. These days, many partners in large firms do not understand even the rough costs of each billable hour. Does it matter? Yes it does. As one AmLaw 100 decision maker put it in the LegalBizDev Survey of Alternative Fees: Our partners are the salesmen as well as the producing managers on a lot of this work, so they ve got to be armed with our own internal costs and how we can adjust those internal costs. If somebody comes back and says [that they d] like to do this work, and [they know] what [they] need, but [that they] can only get $150,000 for the project, then we have to say [whether we can make it work, or] if we re doing it with no profit margin or as a loss leader. There need to be people in the organization that can sit down with the partners and talk to them about costs and [then] arm them to talk to the general counsels. 8 Cost-plus may or may not be a good basis for setting prices. But if law firms want to stay in business in an ever-more competitive world, they must ultimately charge at least as much as they spend. And that starts with understanding their costs. 8 Hassett, Survey, Page TRAIN

96 Legal Pricing in Transition Page 8 Price competition, discounts, and loss leaders Law Firm Price Wars Break Out as Some Try Loss Leader Bids for Work said a November 2009 headline in the ABA Journal. 9 The article was based on a post from my blog quoting AmLaw 100 senior partners who said things like: I have become aware of a large number of bids by competitors which I don t think are sustainable. Some firms are bidding alternative projects at very low costs. These are loss leaders which cannot survive in the long term. Many firms are willing to discount their fees in order to keep people busy...it s a jungle out there. 10 Since this piece appeared, in many markets legal price wars have evolved from front page news to a way of life. In a survey published in the December 2011 issue of the American Lawyer, 81% of law firm leaders said that more clients are requesting discounts, and 55% said clients are requesting deeper discounts. In a separate survey conducted by Altman Weil, 90% of managing partners and chairs said that increasing price competition is not temporary, but rather a permanent change in the legal marketplace. The economic balance of power has shifted to clients. Just a few short years ago large law firms reigned supreme. Now it seems that almost all large corporations and their in-house counsel are asking for some sort of price break from their lawyers even from firms they have used for decades. Many general counsel are seeing their legal budgets reduced, and they are passing the pressure along to their outside law firms. As Peter Zeughauser noted in The American Lawyer, The Achilles heel of many firms is that they use discounting to achieve high levels of client satisfaction without focusing their partners on improving profit margins. 11 This problem is familiar in other businesses. The Strategy and Tactics of Pricing noted that: Customer satisfaction can usually be bought by a combination of over delivering on value and under pricing products The purpose of strategic Peter Zeughauser, Stuck On You, The American Lawyer (October 2011), Page TRAIN

97 Legal Pricing in Transition Page 9 pricing is to price more profitably by capturing more value, not necessarily by making more sales. 12 Discounting can have a much bigger effect on profitability than you might think. If you want to work through the math, see Appendix B for a discussion of formulas relating hourly discounts to profits. Or you can skip the math and take our word for it: the relationships are complex, and what may seem like a small discount can have a large impact on profits. Our appendix starts with an example in which a 10% discount reduced anticipated profits by 80%. When law firms calculate their partner compensation these days, many are seeing all too clearly how last year s discounting reduced their income much more than they expected. Lawyers often justify discounts as loss leaders, under the theory that low prices will start a new relationship and later lead to more profitable work. But will it? Once clients become accustomed to low rates, it will be very difficult to get them to pay more. As Ron Baker noted in Pricing on Purpose: Purchasing agents have been rewarded for demanding low prices by getting discounts, concessions and other price decreases, thereby creating little Pavlov s dogs. If you subsidize something, you get more of it, including lowprice buying behavior. 13 If you do decide to use loss leaders to build new work, it might be wise to make sure the first job is a large one. A few years ago, Ron Paquette published an article in the September 2007 issue of Strategies: The Journal of Legal Marketing describing research conducted by Redwood Analytics to evaluate the widely held idea that small jobs often grow into big clients: It s called the acorn theory from a tiny seed of work in one legal area can grow a mature oak of a client, which provides work across many practices. Nice theory. But how often does it happen in practice? We thought this theory was largely a myth We ve observed that regardless of the firm involved, most large clients appeared to have retained the firm for significant matters from the start of the relationship. 14 So Paquette and his colleagues looked at the top five percent of clients at one AmLaw 100 firm, and went back 23 years to see whether these clients had started large or small. More than 90% had started large (that is, already in the top 20% of the firm s clients in their very first engagement). When Paquette analyzed similar data from an 12 Nagle, Hogan and Hale, Strategy, Baker, Pricing on Purpose, Ron Paquette, Cracking the Acorn Theory, Strategies: The Journal of Legal Marketing (Sep 2007). Page TRAIN

98 Legal Pricing in Transition Page 10 AmLaw 200 firm, they again found that today s large clients had been large right from the start (in this case 84% of the clients). They concluded that: Firms should be highly selective with regard to small clients. It is commonly held that small clients are on average less profitable than large clients. If your firm s growth strategy depends at all on growing small clients into larger and more profitable clients, think hard about the likelihood that this will happen. 15 So what should law firms do? Many believe that law firms should turn to a different approach: value pricing. Value pricing basics Almost all law firms currently use variations on cost-plus pricing. But anyone who has ever heard of the ACC Value Challenge knows how important perceived value is to clients today. If you have thought about applying value pricing with your clients, you have probably read about the work of Ron Baker. His most recent book, Implementing Value Pricing: A Radical Business Model for Professional Firms, provides an excellent overview of the theory of value pricing, and how it applies to accountants, lawyers, and other professional services firms. As Baker defined it: The word value has a specific meaning in economics: The maximum amount that a consumer would be willing to pay for an item. Therefore value pricing can be defined as the maximum amount a given customer is willing to pay for a particular service, before the work begins. This is not to suggest we can capture one hundred percent of maximum value, but rather that we have the potential to access some of it utilizing strategic pricing. 16 Does that sound like price gouging? It s not. As Stanley Marcus (former president of Neiman Marcus), put it, You re really not in business to make a profit, but you re in business to render a service that is so good people are willing to pay a profit in recognition of what you are doing for them. 17 In cost-plus pricing, cost is known before you set the price. In value pricing, you start with the price the customer is willing to pay and control your costs to meet that price. 15 Paquette, Acorn Theory. 16 Ronald J. Baker, Implementing Value Pricing: A Radical Business Model for Professional Firms (Wiley, 2010), Baker, Implementing, Page TRAIN

99 Legal Pricing in Transition Page 11 Baker summed up the difference in these two diagrams: Cost-Plus Pricing Services» Cost» Price» Value» Customers Value Pricing Customers» Value» Price» Cost» Services Baker felt strongly that value pricing should be embraced by lawyers, and that timesheets and hourly billing should be eliminated. Baker s web page bio begins with this mission statement: To, once and for all, bury the billable hour and timesheet in the professions. Chapter 17 of Implementing Value Pricing is titled The Deleterious Effects of Hourly Billing and describes numerous disadvantages including misalignment of interests, a focus on effort instead of results, hoarding of hours, leaving money on the table, and diminishing the quality of life. Chapter 18 explains why timesheets should be eliminated. Its title indicates the strength of Baker s feelings on this issue: Why Carthage Must Be Destroyed. Baker also emphasized that value pricing can sometimes produce far more revenue than the hourly approach. He gave the example of an accounting firm that was engaged to develop an exit and management succession strategy which produced substantial tax savings. Initially the CPA billed at standard hourly rates, but at some point he said to the client, I don t believe hourly rates [are] appropriate [in this case] You tell me what all the value of this is to you I know I will be happy with whatever you come up with. Ultimately he was extremely happy, because the total payment was a little bit over $1 million. 18 By then, he had stopped tracking time on this engagement, so it is impossible to say exactly how much he would have gotten on an hourly basis. However, he did say his prices had skyrocketed and reading between the lines our guess is that hourly rates would have totaled less than $100,000. Any lawyer would love the concept of value pricing if it meant that she could get paid 10 times what she would earn for billing hours. And many law firms see value pricing as a ray of hope in a troubled marketplace, an opportunity to increase profitability at a time when there are unrelenting competitive pressures to charge less. Baker noted that, These types of engagements are certainly not the rule in any firm, they are the exception. Nonetheless, they do arise, and when they do it is critical to recognize the value you are creating and to utilize innovative pricing strategies to capture it. 18 Baker, Implementing, Page TRAIN

100 Legal Pricing in Transition Page 12 Companies like Apple have become very profitable by creating consumer perceptions of value, and pricing products like the ipad and iphone accordingly. But there is only one Apple, and there are dozens of companies like Dell, HP, Samsung, Lenovo, and Asus who find themselves competing on price. A small number of the most profitable law firms in the world have been using value pricing for years, just as Apple has. But they are at the top of the profession and specialize in bet the company work. If a client is defending a billion dollar law suit, or acquiring a powerful rival, or being accused of a white collar crime, she will care much less about the price than about the outcome. When Jim Durham published The Essential Little Book of Great Lawyering, he estimated such bet the company matters at only about 5% of all legal work. The rest he classified as important matters (65-70%) or commodity work (25-30%). In the seven years since Durham published this book, all signs are that legal commodity work is growing, and bet the company and important work is shrinking. 19 In my Legal Business Development Quick Reference Guide, I ve written about the traditional marketing implications of these three different types of legal work, as summarized in the following table: Type of legal work Value s significance in marketing Bet the company High Low Important Medium High Commodity Low Low 20 Relationship s significance in marketing But the world is changing, and when it comes to getting new business, the marketing significance of providing value is going up, and the importance of prior relationships is going down. The next section discusses the nuts and bolts of Ron Baker s eight steps to implementing value pricing. As we see it, the problem with value pricing is an expectations gap. Law firms want to believe value pricing will lead to higher prices and profits. Sometimes it can. But in most cases these days, when legal clients say value what they mean is I need to pay you less. 19 James A. Durham, The Essential Little Book of Great Lawyering (James A. Durham, 2006). 20 Jim Hassett, Legal Business Development Quick Reference Guide, Second Edition (LegalBizDev, 2012). Page TRAIN

101 Legal Pricing in Transition Page 13 Ron Baker s eight steps to implementing value pricing The first four sections of Ron Baker s influential book Implementing Value Pricing: A Radical Business Model for Professional Firms review a great deal of interesting theories and a number of arguments against hourly billing. But if you want to focus on the how to, you can jump directly to Part V of his book, which describes Baker s Eight steps to implementing value pricing : Conversation. Talk to the client to determine her wants and needs. This requires genuine communication, so you must listen actively and comprehend what is on the client s mind. Pricing the customer: Questions for the value council. Pricing is of such importance that Baker says each firm should have a value council which studies the results of the value conversation, and considers the best strategy for pricing each matter. Developing and pricing options. The analysis in steps 1 and 2 can lead to an internal discussion of several different options to offer a client, at different price levels. According to Baker, this can help the client think about what is really of value for him and help the firm close a deal. Presenting options to the customer. Then it is time to effectively present the options to the client, and address any objections. Customer selection codified into the fixed price agreement. Baker assumes this conversation will lead to a fixed price agreement, which must be written carefully to memorialize the meeting of the minds between the firm and the customer. Chapter 32 includes a sample fixed price agreement. Proper project management. Once the agreement is signed, the firm must manage the matter to live within the agreed-upon price. (If you are familiar with our Legal Project Management Quick Reference Guide and our nine project management training options, you may not be surprised to learn that we stress the importance of this step.) 21 Scope creep and change orders. In today s dynamic business environment, changes in requirements are almost inevitable. The firm and the client must have plans in place to decide when changes in scope lead to a change in price, and to resolve any problems or disagreements. 21 Jim Hassett, Legal Project Management Quick Reference Guide, Second Edition (LegalBizDev, 2011). See Page TRAIN

102 Legal Pricing in Transition Page 14 Pricing after action reviews. The US Army has a policy of after action reviews to evaluate missions after the fact and learn from what happened. This same type of retrospective review is helpful for setting future prices. 22 Each of these eight steps is described in depth in its own chapter. For example, in the chapter on Step 1 s conversation, Baker talked about: Twenty-seven questions you could ask the client. How to start the conversation and effectively point it in the right direction. How to listen carefully and hear what the client wants without dominating the conversation. How the firm should deal with clients who try to conceal information about how much your services are valued or what other firms may charge. How should you discuss risk with the clients? 23 Whether you agree with Baker s rejection of hourly billing or not, the information in this chapter can be very useful in finding the best price. Similarly, Chapter 29 goes over the key elements of Step 2 what to do when you get back to the office and work on your pricing strategy based on that conversation. Again, there are long lists of useful tips. What constitutes a good price? On page 245, there is a list of 16 items to consider, including: Not allowing your dumbest competitors to set your price, which is related to the issue of avoiding price wars, as discussed previously. What questions should you ask yourself before setting the price? There is a list of thirty-five questions on page 247. Four types of buyers price buyers, value buyers, convenience buyers and relationship buyers and how to deal with each. What are the psychological factors that affect the price sensitivity of the client? 24 Every lawyer can find valuable ideas and tools in this book, whether you agree with Baker s rejection of hourly billing or not. However, you may question his optimism about what the market will bear for value pricing. In the section on Dipping your toe into the water for fixed pricing, Baker suggested calculating your initial fixed price estimate with a budget based on what you think your normal billable hours would be and then adding a premium of 50% to 90%. 25 That would be great way for law firms 22 Baker, Implementing, Baker, Implementing, Baker, Implementing, Baker, Implementing, Page TRAIN

103 Legal Pricing in Transition Page 15 to do it, if they could find clients who were willing to pay 50% to 90% premiums in the current marketplace. A few firms may. But from what we ve seen, most clients are looking to cut costs, and the firms that win fixed price deals these days often get no premium at all. While we are not aware of any AmLaw 100 firms that have gone so far as to appoint the value council mentioned in Step 2, there are a number of interesting changes going on in how firms handle pricing, as explained in the next section. The rise of the pricing function The most famous pioneer in the alternative fee movement is Bartlit Beck, a Chicago firm of about 70 trial lawyers which The American Lawyer named Litigation Boutique of the Year in As their web page explains: Our approach to fees is unique, but simple. We believe our interests should be aligned with our clients. To that end, we think we should get paid more if we win and less if we lose. We do not bill by the hour. A law firm should not get paid more the longer it takes it to do the same task. Yet that is exactly the incentive hourly billing promotes. As the New York Times recently recognized, the practice of billing for each hour worked can encourage law firms to prolong a client s problem rather than solve it. Our approach to fees is different. Our fees don t depend on how long we can spend on a task or how many associates we can put on it. Our fees depend on our success. We employ a variety of fee arrangements, including flat monthly fees, partial contingency fees, and similar alternatives. In virtually every matter, some portion of our fee is based on the outcome of the case. In a 2009 online panel discussion I conducted for West LegalEdcenter, Fred Bartlit explained how his firm had centralized both pricing and project management. 26 At Bartlit Beck, there is no management committee: One guy, Skip Herman, runs the entire firm, from deciding which cases to accept to setting the price and staffing each matter. We have no firm meetings and no conferences; Skip runs everything. Other firms have not gone this far, but a number of large firms are centralizing the pricing function in a variety of ways Page TRAIN

104 Legal Pricing in Transition Page 16 Stuart Dodds became Baker & McKenzie s first Director of Global Pricing in July 2011, after serving for three years as Global Head of Pricing at Linklaters. His job includes four main components: We help set the price in a proposal, help get the price, help our fee earners manage the price through project management, and then review how effective the pricing approach taken has been on a long-term basis for both our client and our firm. We are building a whole infrastructure within the firm with pricing do s and don ts. Much of Dodds time is focused initially on the firm s larger clients, and one key goal is to help ensure pricing consistency and rationality for a firm with 70 offices around the world and over 3,800 lawyers. In April 2012, Toby Brown was hired by Akin Gump to serve as its first Director of Strategic Pricing & Analytics. He had previously filled a similar role at Vinson & Elkins, where the firm s leaders put out the word that whenever pricing is an issue with an important client, Toby should be consulted early and often. One of the most important aspects of his job was to create a culture of having conversations about value. Lawyers are really good at talking to clients about legal issues, said Brown. Now, however, they need to add another dimension to the conversation to include value, pricing and efficiency Sometimes I think my job is almost 100% business development. Others with related titles also emphasize how pricing is tied to client satisfaction and new business. Matt Laws, senior manager of alternative fee arrangements and head of the pricing group at Reed Smith, said, I see myself as working for the firm and for the client at the same time. I try to find that middle ground, a mutually beneficial arrangement. Similarly, Brown said: I like to walk the client through a whole list of questions. Sometimes, they won t immediately understand what their own price sensitivity is. My job is to get them thinking about what matters most to them. I can be seen as an internal consultant to the lawyers in the firm, and also to the clients. Although at this time only a small number of firms have a separate pricing director or department, many see it as the wave of the future. I find it hard to see how major firms could not organize themselves this way, said Michael Byrd, assistant director of pricing strategy and analysis at Mayer Brown. What we do fits somewhere inbetween finance and business development. It s at the same time both numbers-driven and creative. Byrd sees the main benefit of a proactive pricing strategy as increased competitiveness to keep us in the forefront of the market. Both Byrd and the partners he works with believe that in his 18 months at the firm, the new emphasis on pricing Page TRAIN

105 Legal Pricing in Transition Page 17 has helped increase responsiveness to client needs, increase client satisfaction, and add value. One key factor that is driving the pricing movement is the new emphasis on alternative fee arrangements (AFAs), including fixed and contingent fees. According to Altman Weil s 2011 Chief Legal Officer Survey, AFAs now account for about 14% of all legal fee revenue. This figure is still small compared to the 86% that is hourly, but it is measured in the billions and all of the forces of change are headed toward more AFAs. In the good old days of hourly arrangements with rates that went up every year, it did not require sophisticated financial analysis to send a bill that multiplied each lawyer s hourly rate by the number of hours spent. But to make AFAs profitable, law firms now need to spend more time thinking about pricing. At Winston & Strawn in early 2012, the pricing strategy role was shared by the coleaders of the firm s AFA initiative: Kathrine Cain, the manager of business intelligence, and Keri Gavin, the controller. Cain reported to the firm s Director of Business Development, and Gavin reported to the firm s CFO, but they worked closely together to analyze the information that the firm needed for competitive pricing. The partners are encouraged to reach out to us for assistance with requests for alternative fee arrangements and budgets, Cain said. Some partners were already very good at defining budgets and pricing strategies, while some were new to the concepts. We coach them through the process of defining a budget and identifying pricing options that align with their client s needs and expectations. In the two years since starting the formal initiative, we have made significant strides in providing the tools and techniques to support our lawyers and clients. Cain said she and Gavin always consider a wide range of options for AFA proposals, based on the client s expectations and goals as well as the projected internal rate of return, the anticipated level of staffing for the matter, benchmarks based on previous matters, the firm s history with that particular client, and other factors. Fish & Richardson uses a somewhat different model. There, the AFA group is led by Kurt Glitzenstein, a firm partner and patent litigator. Glitzenstein says that since his firm specializes in intellectual property law, many of his firm s cases fall into just a few categories, such as patent litigation. Fish & Richardson is able to ask the same questions in nearly every case and obtain useful answers that will help in its pricing. We prefer to price on an AFA basis, he said. Page TRAIN

106 Legal Pricing in Transition Page 18 To do that, my staff goes through a case and interviews the lead attorney about the details. Is it a judge whom we know well? How many patents are under litigation? What is the technology? How complex is it? As a result of inquiries like this, we can put together a litigation budget and use it as a guide for pricing. By asking the right questions, we can predict which cases will be more challenging to handle. We think that the fixed fee arrangements that Fish & Richardson often proposes improve aspects of the lawyer-client relationship. Fixed fees allow lawyers and clients to focus on the merits of the case so that they can reach the best result, without the same level of concern as in a traditional hourly fee arrangement, that changes to the case strategy, or unexpected developments, will significantly increase the cost to the client. Of course, in every firm, ultimately the success or failure of this new pricing movement will depend on buy in from the partners. Mayer Brown s Byrd said that although it is not required that partners consult him when they need to respond to an RFP or develop an AFA proposal, it is highly recommended, and that his plate has been full. Matt Laws, head of the pricing program at Reed Smith, where just about 20% of the annual revenue comes from AFAs, said his role has been very well received Partners do tend to call every time a potential engagement comes up. Laws said Reed Smith does not have any strict guidelines about what we can or cannot do to win a client s business. Any proactive approach to meeting a client s needs is likely to be approved. In fact, Laws said, he sometimes finds himself and his team having direct contact with the clients financial officers during the bidding process something that would have been unthinkable only a few years ago: In the old relationship, partners would work with corporate general counsel. Now, we see finance people and CFOs from the client companies. The process of online bidding, which has become more and more common, reduces the importance of the historical relationship between the firm and the client. Another interesting trend in this area is a growing emphasis on project management. According to Baker & McKenzie s Dodds: Over the last 18 months, the biggest change in the legal pricing field is a greater emphasis on project management and how we deliver services. Law firm clients are now looking for demonstrable value and efficiency, and we should not shy away from this challenge. Page TRAIN

107 Legal Pricing in Transition Page 19 This should not be surprising, given that once a firm is committed to a fixed price or an hourly fee cap, the most important determinant of profitability is being able to meet the client s needs within a predetermined budget. That s why efficiency is on everyone s minds these days. In the 2011 Altman Weil Law Firms in Transition Survey, managing partners reviewed 15 current trends, and gave their opinions about which were temporary and which were permanent. Price competition was number two on the list, with 90% saying it was permanent. The only trend rated higher was the related idea of improving practice efficiency; 94% saw that as a permanent change. Firms are responding to these changes in a wide variety of ways, depending both on the firm s culture and available talent. Practice management staff are often involved in planning how to price proposals. To cite just one example, Womble Carlyle has identified Bill Turner, the director of practice management, as an internal point person to evaluate every significant price proposal in the firm and to analyze the pricing on every large RFP response. The trend of appointing specialized pricing officials and devoting more effort to analyzing pricing is expected to increase. ILTA the International Legal Technology Association recently formed a Financial Management Peer Group to support this movement. Pricing is both an art and a science, said Akin Gump s Brown. We need to focus on both if we are going to grow our business. There are a host of pricing strategies out there, and lawyers are now just touching the surface. This is a dynamic world and my job is changing on almost a daily basis. The heat is getting turned up on law firms, and the pace of change is accelerating. Using metrics to define value In the legal profession, everybody s talking about value, but nobody seems to know how to measure it. In September 2009, the Association of Corporate Counsel announced the creation of the ACC Value Index, a client satisfaction measurement tool that helps ACC members to share meaningful information about the law firms they engage. 27 Clients were asked to rate law firms on a 1 to 5 scale on six key factors: Understands objectives/expectations Page TRAIN

108 Legal Pricing in Transition Page 20 Efficiency/process management Predictable cost/budgeting skills Legal expertise Responsiveness/communication Results delivered/execution Then they answered a single summary question: Would you use this firm again? The idea of Zagat-type ratings of law firms was controversial from the start. In November 2011, ACC announced that the Value Index had been closed because ACC members voted with their feet by continuing to use the egroups for law firm referrals, instead of the Value Index. 28 While the idea of a Zagats of law firms has disappeared for now, the six key factors in its rating system remain a great starting point for defining value. The key phrase in that sentence is starting point. In a panel discussion at a March 2011 Georgetown Law School Symposium entitled Value: How do we define it? How do we measure it? Susan Hackett, then head of the ACC Value Challenge, noted that Value is hard to define The ACC Value Index offered an early set of categories of common interest to examine but it needs to move to the next level of assessment. The future of value assessment will be data-driven. 29 Thought leaders are beginning to discuss exactly what value metrics should look like, and how they should be related to prices. In February 2012, Paul Lippe listed several value metrics that might be used to evaluate sales contracts: o How quickly did the contract get done? o How favorable are the terms to the company (opportunity gained and risk avoided)? o How easy are the terms for other parts of the company (finance, manufacturing, sales, etc.) to understand and perform? o How satisfied were the true business clients? o How satisfied was the counterparty? o How much did the contract cost? o Did the contracting process improve? Page TRAIN

109 Legal Pricing in Transition Page 21 If you want to explore just how complicated this type of measurement can get in the real world, see the series entitled A Value-based Client-firm Relationship on the ACC s web page. 31 It includes 16 posts in which a client Ken Grady, general counsel and secretary at Wolverine World Wide and his law firm Seyfarth Shaw, represented by Lisa Damon talk through the details of how they defined value metrics and determined cost for work on a trademark portfolio. Here is one list of possible value metrics from the law firm side early in their negotiation: o Success rate, measured by things like first action allowance, watch hit outcome o Overall satisfaction o Timeliness of communication o Effectiveness of lessons learned sessions o Strategic participation/understanding of Wolverine business o Proactive issue identification o Budget variance o Cost management effectiveness 32 Here are a few of the value metrics that the client proposed: Trademark Risk Rate (total dollars spent defending trademarks, divided by total number of trademarks defended) Counterfeit Recovery Rate (total dollars spent on anti-counterfeiting actions, divided by total number of units seized) Specimen Response Productivity (days from first request for specimen to receipt of acceptable specimen, divided by number of trademarks for which specimens requested). 33 On the positive side, if you read all 16 posts about the details of this relationship, it is clear that the two sides developed a very trusting relationship, and that Seyfarth went the extra mile to be a proactive strategic partner that puts its money where its mouth is. On the negative side, this is uncharted territory, and it took months of discussion to come up with metrics that enabled both sides to measure how the process was going Page TRAIN

110 Legal Pricing in Transition Page 22 When the time came to tie the metrics to a portfolio price for the year, Grady proposed, One way to set the new fee relationship for year one of the relationship would be to: Adjust the baseline based on what we know about the business (that is, increase, decrease or the same amount of portfolio activity) Adjust that amount to account for improvements in the processes to handle the portfolio using lean activities we will undertake with Seyfarth Adjust that amount to build in whatever cost-sharing is appropriate for Seyfarth to get up to speed on our business as reflected in the portfolio We then could agree on a base price to handle the portfolio work. We can gainshare on additional improvements we get part of the benefit (lower costs) and Seyfarth gets part of the benefit (we don t get 100% of the lower costs). We could add a topper fee: depending on performance against certain other metrics (e.g., increase in average mark value using the equation I showed in the last post), Seyfarth gets an additional payment for helping to drive the increased average mark value. 34 Here is one small part of how the payment system actually worked: To measure Seyfarth s systemic improvements, we will use two metrics: time to process an application, and time to receive a useable specimen (we have to file specimens in certain countries to show we are still using the mark). We need one score across both metrics to determine Seyfarth s bonus, so we will combine the results on the two metrics by weighting them 80% on trademark applications and 20% on specimen gathering. We calculate the trademark application improvement metric, multiply it by 0.8, calculate the process improvement on specimens metric, multiply it by 0.2, and add the results. For every X% of weighted process improvement, Seyfarth will earn $ This example is much more sophisticated, complicated and demanding than the simple value pricing example quoted above from Baker s book, in which a client simply paid a hefty premium because he felt that he had received value in excess of hourly rates. 36 There can be little doubt that in the current environment, some clients will continue to look for metrics that allow them to precisely define value and tie it to payment. But we predict that many lawyers will see the example above as excessively complicated, with a whole lot of arithmetic and price uncertainty. So it is far less certain how many clients and law firms will ultimately develop and use metrics like this Page TRAIN

111 Legal Pricing in Transition Page 23 Where firms are today As we noted at the beginning of this white paper, when law firms begin offering non-hourly alternative fee arrangements (AFAs), they must address two fundamental questions: 1. When bidding for new work, how do I set a price that is high enough to protect profits, but low enough to get the work? 2. After winning the work, how do I manage the matter so that I make a profit (or at least break even) at that price? To be honest, when we started writing about pricing we thought that our research would be limited to the first question: picking a price in the first place. This requires external knowledge about your client and the marketplace, and internal knowledge about your own cost structure. But the more we talked to people and reviewed the literature, the more obvious it became that the two questions are so wrapped up in each other that they are very hard to separate. Add in the fact that most firms don t even understand their own costs of doing business and that price wars are forcing bids down for many practice areas, and you have the makings of a very confusing situation. Many lawyers would like to believe that if they could master the art of value pricing, they could make more money than ever before. Maybe some can. But with competition constantly forcing prices lower, we have not seen much evidence for that yet. Some believe that pricing will become more sensible when lawyers learn how to develop value metrics, but we remain to be convinced. The two questions above are so difficult that firms like Baker & McKenzie, Akin Gump, Mayer Brown and others are setting up pricing directors and committees to help answer them, case by case. Responsibilities and methods varied for the people we heard about and interviewed, but we are aware of only one who had independent decision-making power. And that one was Skip Herman, whose name is on the door at the pioneering 70-lawyer firm Bartlit Beck Herman Palenchar & Scott. Partners are ultimately responsible for pricing, so they must understand the principles before they will accept help from a pricing director or committee. Some firms are moving to develop policies which limit partners power to set prices depending on their training and experience, but these policies are very much a work in progress. No matter how a firm is organized, pricing analyses inevitably get pulled into the question of how to manage matters. To set the right price, you must know what the Page TRAIN

112 Legal Pricing in Transition Page 24 work requires. In the good old days when lawyers did not have to worry about how much things cost, that was relatively straightforward. But now that so many clients are demanding efficiency, the work must be done differently. That will inevitably change the cost of delivering a quality service, and ultimately its price. Which takes the pricing discussion right back to a topic we have been talking about for years: legal project management (LPM) and process improvement. The best way to implement LPM varies from firm to firm, and even from one practice group to another within a firm, depending on its culture, clients, and goals. In our experience, the approach that works best most often is to start with just-in-time training for a small group of influential partners who are open to change. We introduce LPM basics very quickly and then get them to immediately apply key concepts to actual matters. The focus is on changing behavior to produce tangible results. When these lawyers are successful, they can motivate other partners to embark on the same journey. Case by case, lawyer by lawyer, the firm begins building its experience in LPM and AFAs, and gradually changes the way it meets the needs of its clients. For an example of how this worked in one firm, see our recent post entitled Legal project management in the real world: The case of Williams Mullen. 37 One key to profitability is continuing business from a firm s most important clients. For clients who demand AFAs, it helps to work in an atmosphere of mutual trust on a portfolio of matters. The firm may lose on some matters but with the right strategy and tools it can offset the losses with enough wins to profit overall. For some real world examples of this, see Rachel Zahorsky s ABA Journal article Facing the Alternative: How Does a Flat Fee System Really Work? 38 If we needed to summarize where legal pricing stands today in a single phrase, it would be in transition. Predicting the future Clearly, legal pricing is changing as a result of the increasing use of AFAs, and client pressures for efficiency on both hourly and non-hourly matters. So what does this mean for the next 10 years, or the next 10 months? Nobody knows. As Niels Bohr, winner of the 1922 Nobel Prize in physics famously said, It is very hard to predict, especially the future Page TRAIN

113 Legal Pricing in Transition Page 25 In a blog post entitled Staying Relevant, Toby Brown recently put it this way: We have reached a point in human history where predicting the future beyond a few years is quite a challenge. A perfect example is that of Facebook, which grew from zero to 100 million users in less than two years. What things will look like in five to ten years is anyone s guess. So the best we can do now is keep a vigilant eye on the storm and stay prepared to constantly alter course. 39 While we don t know exactly how things will turn out, it does seem safe to predict that changes in pricing will be driven by eight key trends: 1. Alternative fees will continue to increase. According to Altman Weil s 2011 Chief Legal Officer Survey, 14% of fees are currently non-hourly. 40 This percentage has gradually been increasing. Conservative clients often require a long time to take the leap to try non-hourly fees, but this particular change is a one-way street. Tucker Ellis was one of the first midsized firms to derive more than half of its revenue from non-hourly fees, and managing partner Joe Morford, has noted that, Once we started working for a client with AFAs, not a single one has ever wanted to go back to hourly Lawyers will develop new metrics that measure value. Sophisticated clients want to measure what they are paying for, and a sophisticated law firm should be able to measure its own results. Above we gave an extended example of the challenge of one past attempt to define value metrics. For an interesting discussion of why there is resistance to this idea, see Paul Lippe s blog post entitled, What If Someone Could Measure What Lawyers Do? and the comments written by various lawyers at the end of that piece Leading firms and clients will place increasing emphasis on aligning their interests. One key to success for AFAs is creating a genuine sense of partnership by aligning interests. As one AmLaw 100 decision maker put it in our LegalBizDev Survey of Alternate Fees: The firm and the client must have a very transparent conversation about the process. [It is important to discuss] how [the fee structure] will be mapped out and who will do what. [It is vital] to look at the delivery of services holistically, and to look at how the team in-house and the team outside can work together to deliver value for your shared client. That s a real challenge, because it is tricky to transition from a negotiation Page TRAIN

114 Legal Pricing in Transition Page 26 process to a collaborative process. If you can get into a collaborative discussion, you can get good results that work for both organizations. 43 This requires some sharing of risk. Another participant in our survey put it this way: GCs should be thinking about what kind of risks they are willing to take early on in the life of a particular matter. Right now, they want firms to take all the risk and they are reluctant to take risks themselves The distinction between bet the company, important and commodity work will be reflected in different pricing strategies. In The Essential Little Book of Great Lawyering, Jim Durham estimated that about 5% of legal work fell into the bet the company category, 65-70% was important and 25-30% commodity work. There is every indication that the percentage of commodity work is going up, and the other two categories are shrinking. To be price competitive, it will be crucial to keep up with the process improvement and outsourcing alternatives for commodity work. As Toby Brown noted in his blog series Staying Relevant: An emerging and compelling reason for lawyers to make different business decisions is coming from new breeds of competitors. One example is the Legal Process Outsourcer (LPO) market. These companies started as off-shore (typically India) based providers for first document review in litigation. They hire English speaking, American law trained candidates in other, lower wage countries. These much lower-costing, well-enough trained lawyers were appropriately suited for this level of work. So well-matched to the tasks, that in very short order, these document reviewers became viable competitors. Most lawyers glossed over this market encroachment, seeing it as commodity level work no longer worthy of their skills. In reality, this meant millions in fees were no longer going to US lawyers Law firm profitability will be squeezed harder than ever before. According to the 2012 Client Advisory from the Hildebrandt Institute and Citi Private Bank: Many firms will need to work harder to maintain profitability at levels that meet the expectations of their partners. Indeed, we expect that 2012 may prove to be even more challenging than 2009 in terms of profitability across the industry, not because revenues will be as 43 Hassett, Survey, Hassett, Survey, Page TRAIN

115 Legal Pricing in Transition Page 27 depressed in 2009 but rather because of the combination of slow revenue growth and rising expenses Hourly billing and high partner profits will be questioned more and more in the future. Clients generally do not live in an hourly billing world. They know their actual costs of doing business and plan to make a profit above those costs. They have pricing risks and plans to manage those risks. Clients often wonder why their law firms cannot do the same. Many corporate counsel started their careers as associates at large firms, and they know all too well how the profit model works for firms. Many are asking why partner compensation is so high. As Susan Hackett put it: Surveys such as these from Corporate Counsel and Empsight are coming out. They usually confirm that the average in-house counsel who hires outside firms makes only slightly north of what a bonused first- or second-year associate in a big law firm makes. There are a few hundred large law department top leaders who haul in comparable returns for their work usually through non-salary comp but nowhere near the number or percentage of highly compensated partners that we find in the ranks at big firms where entire equity partnerships pull in hundreds of thousands or over $1 million a year in profit per partner. The average in-house lawyer is well aware that he shares with those high-profiting partners the same schooling, sophisticated law firm background, and top-flight experience on his resumé. He s made his choice, but please remember that he will more likely identify with the 99 percent and not the partnership when he s assessing who s getting coal this Christmas Competition on price and value will increase. The Hildebrandt/CitiBank 2012 Client Advisory also notes that, [There is] continuing client resistance to fee increases [and] it is unlikely that the demand for legal services will grow robustly for the foreseeable future The legal industry will be forced to live with uncertainty for some time to come. 48 With some law firms aggressively providing more value at lower prices, the competitive bar is going up. Whatever else may prove to be true, it seems clear that cost will remain a major issue. As Mark Smith put it in a blog post entitled, Excuse me, I think your pricing is broken: The common refrain from private practice lawyers is that in-house lawyers who talk about value based billing really just want to pay less, 46 Hildebrandt Institute and Citi Private Bank, 2012 Client Advisory, Hildebrandt, Client Advisory, 5. Page TRAIN

116 Legal Pricing in Transition Page 28 and are not really interested in concepts like sharing risk. Opening a dialogue about pricing is simply an exercise in getting the law firm to do the same work for less money... Of course they want to pay less! The fact that the firm hasn t developed a model that really meets their needs does not turn this into the client s problem. It s the private practice lawyer s problem. It s the firm s problem. It s the profession s problem. The market has changed. Forever Law firms will continue to put more emphasis on pricing and project management. In 2009, I conducted in-depth interviews with chairmen, senior partners and C-level executives from 37 AmLaw 100 firms for the LegalBizDev Survey of Alternative Fees. The final report included hundreds of quotes about what works, and what doesn t. The precise wording of every quote we published had been approved by the interviewee, but every statement was also anonymous. This confidential approach encouraged senior decision makers to speak frankly and openly, and provided a platform that made it easy for firm leaders to say what they really think, without being quoted by name. In our personal opinion, the most insightful quote in the survey dealt with pricing, and came from a senior partner who had previously worked in house: For most of the past decade, I was a senior executive at a publiclytraded real estate company, and I like to say that the two most important people we had in the company were the estimator and the project manager. Law firms historically have had no one play either of those roles. It s very dangerous to move into a world of fixed fees if you don t have somebody who s capable of estimating and you don t have somebody who s capable of project managing it. In the three years since that survey was conducted, law firms have begun working to fill both those roles, sometimes with individuals, sometimes with departments, and sometimes with entirely new ways of doing business. All signs point to an ever faster pace of change Page TRAIN

117 Legal Pricing in Transition Page 29 Appendix A: Case study showing the difficulty of calculating cost per hour in advance To see how cost per hour changes with volume and other factors, consider the hypothetical case of Beth, an AmLaw 200 senior associate who specializes in labor law and is considering going out on her own. Last year Beth billed 2,000 hours at an average rate of $300 per hour. Since the firm charged $600,000 for her time, and Beth was paid a salary of $250,000, the firm s share of her billings was $350,000. It seems obvious to Beth that if she hung her own shingle, she should be able to charge less and make more. Her first question is what she should charge per hour. She goes on the web and finds this cost-plus formula: Average Billing Rate = (Expenses + Desired Profit) / Realized Hours Realized hours, of course, are the hours which are not only billed but also paid. Since she will be a solo practitioner, the desired profit equals the amount she would realistically expect to take home in addition to her salary at the end of the year. The table below shows Beth s first take on the finances of going out on her own. Projected expenses and revenue Desired salary $250,000 Overhead (fringe benefits, taxes, rent, phone, etc.) $100,000 Total expenses $350,000 Realized hours (billed and paid) 2,000 Break-even hourly rate or cost per billable hour (Expenses/realized hours) $175 per hour Total revenue (Realized hours x hourly rate) $350,000 Profit (loss) for end of year bonus or correction $0 At the beginning of the year, Beth s salary is only an estimate, since she will be her own boss, and what she earns will depend on her revenue and expenses. Page TRAIN

118 Legal Pricing in Transition Page 30 Although her calculations suggested an hourly rate of $175, Beth decides to start by charging $200 per hour to leave a safety margin in cases expenses are higher than predicted, her billable hours are lower and/or some clients fail to pay their bills. Beth asks a CPA friend to review her thinking. He says that he would like to see more details about exactly what she will spend on rent, insurance, payroll taxes, and everything else, but the analysis is basically sound. However, he says that Beth needs to factor in one more thing: the non-billable hours (indirect labor) that she has to work to set up the office, send out her bills, and find new clients. Consultants often don t track the unbilled time they spend on marketing and administration. But from a CPA s point of view, that time has a value, and is a cost of doing business, so it should be included in the cost analysis. This may seem like hairsplitting to a new solo, but as Beth s firm grows it will be extremely important to track. Beth estimates that she will have 500 unbilled hours in addition to her 2,000 billed hours, for a total of 2,500 hours. After talking to the CPA, Beth does not change her projection for the bottom line, but she does add a few lines to her chart: Page TRAIN

119 Legal Pricing in Transition Page 31 Projected expenses and revenue Salary $250,000 Number of hours worked 2,500 Salary per hour $100 Direct labor ($100 salary per hour x 2,000 realized hours) Indirect labor overhead ($100 salary per hour x 500 unrealized hours for administration, marketing and unpaid bills) Other overhead expenses (malpractice insurance, health insurance, fringe benefits, taxes, rent, phone, etc.) $200,000 $50,000 $100,000 Total expenses $350,000 Overhead rate ((Indirect labor + other overhead)/direct labor) Break-even hourly rate or cost per billable hour (Expenses/realized hours) 75% $175 Actual hourly rate $200 Total revenue (Realized hours x hourly rate) $400,000 Profit (loss) for end of year bonus or correction $50,000 Note that she has used the cost-plus equation. She raised her hourly billing rate so as to add to her expenses an amount for desired profit. So Beth goes out, rents an office, and gets started. At the end of the year, her big picture projections turn out to be close, but of course many details turn out to be different. On the negative side, her clients don t give her quite as much work as she expected, one client fails to pay a small bill, and it takes more time than she predicted to start the business. She ends up with only 1,500 realized hours instead of 2,000, and she worked 550 unrealized hours instead of 500. On the positive side, she controls other expenses like a hawk, and is able to spend approximately 14% below her initial budget. At the end of the year, her figures look like this: Page TRAIN

120 Legal Pricing in Transition Page 32 Actual expenses and revenue Salary $250,000 Number of hours worked 2,050 Salary per hour $ Direct labor ($ salary per hour x 1,500 realized hours) Indirect labor overhead ($ salary per hour x 550 unrealized hours for administration, marketing and unpaid bills) Other overhead expenses (malpractice insurance, health insurance, fringe benefits, taxes, rent, phone, etc.) $182,925 $67,073 $85,642 Total expenses $335,640 Overhead rate ((Indirect labor + other overhead)/direct labor) Break-even hourly rate or cost per billable hour (Expenses/realized hours) 83.48% $ Actual hourly rate $200 Total revenue (Realized hours x actual hourly rate) $300,000 Profit (loss) for end of year bonus or correction (35,640) All in all, it was a reasonable first year. She lost $35,640 (that is, she had to reduce her desired salary) instead of making a profit of $50,000, but she also worked 450 hours less than planned and covered most of her salary while working independently. Most new solos would be happy with this result. In terms of our example, however, the point is that the only way to truly know her costs was to wait until the end of the year, see what she actually spent, see how many hours were actually billed and paid, and then do the math. When her sales volume changed, her unit costs changed as well. It could have turned out very differently. If she had been able to bill the full 2,000 hours and all were paid (realized) as originally planned, her cost per direct labor hour Page TRAIN

121 Legal Pricing in Transition Page 33 would have been $ If her billable hours had declined to 1,000, the same expenses would have led to a cost per direct labor hour of $ Page TRAIN

122 Legal Pricing in Transition Page 34 Appendix B: The mathematical relationship between hourly discounts and profits In Appendix A, Beth s planned profit at the beginning of the year was $50,000. The table below shows that this reduces to $10,000 if the hourly billing rate of $200 is discounted 10% to $180. No discount 10% discount Salary $250,000 No change Number of hours worked 2,500 No change Salary per hour $100 No change Direct labor ($100 salary per hour x 2,000 realized hours) Indirect labor overhead ($100 salary per hour x 500 unrealized hours for administration, marketing and unpaid bills) Other overhead expenses (malpractice insurance, health insurance, fringe benefits, taxes, rent, phone, etc.) $200,000 No change $50,000 No change $100,000 No change Total expenses $350,000 No change Actual hourly rate $200 $180 Total revenue (Realized hours x hourly rate) $400,000 $360,000 Profit (loss) for end of year bonus or correction $50,000 $10,000 In other words, in this case a 10% discount in hourly rate led to an 80% drop in profits (from $50,000 to $10,000). If you read widely on this topic, you are sure to see hypothetical accounts where the same 10% discount reduces profits by a smaller or a larger percentage. Why the differences? It all depends on what the costs of the firm are. Page TRAIN

123 Legal Pricing in Transition Page 35 So when you ask a math question about what losses will be, the answer is always It depends. To analyze this further we will look at a simplified version of the spreadsheet which introduces algebraic variables for the quantities of interest. The two spreadsheets below show that in Beth s case, the same 10% reduction would reduce profit by 80% if her overhead was $100,000, but only by 50% if her overhead was $70,000. This makes sense, since with lower overhead the profit is larger and the percentage loss through discounting is a percent of a larger number. 80% Loss in Profit Discount 10% Variable Description Budget Actual S Salary $250,000 $250,000 RH Realized Hours 2,000 2,000 O Overhead $100,000 $100,000 E Total Expense $350,000 $350,000 BR Actual Hourly Rate $200 $180 TR Total Revenue = RH x BR $400,000 $360,000 PR Profit = TR E $50,000 $10,000 Profit Reduction 80.00% Page TRAIN

124 Legal Pricing in Transition Page 36 50% loss in profit Discount 10% Variable Description Budget Actual S Salary $250,000 $250,000 RH Realized Hours 2,000 2,000 O Overhead $70,000 $70,000 E Total Expense $320,000 $320,000 BR Actual Hourly Rate $200 $180 TR Total Revenue = RH x BR $400,000 $360,000 PR Profit = TR E $80,000 $40,000 Profit Reduction 50.00% Below we give a data table that shows a range of losses in profit based on various combinations of discount rate and overhead in Beth s case. Discount Rate 5.00% 10.00% 15.00% 20.00% 50, % 40.0% 60.0% 80.0% Overhead 75, % 53.3% 80.0% 106.7% 100, % 80.0% 120.0% 160.0% 125, % 160.0% 240.0% 320.0% Raising salary would also increase expense, lower profit and make the effect of a discount on profit larger. We can do some simple math to sum this up for Beth. We will use the letter d to represent the discount rate. Then we have: Original planned profit is total revenue less total expense: Page TRAIN

125 Legal Pricing in Transition Page 37 Pplan TR E RH BR E Profit after discount changes the billing rate to BR 1 d P RH BR 1 d E disc Then the change in profit is: so we have: Pplan Pdisc RH BR E RH BR 1 d E RH BR d The percentage change in profit is the change in profit divided by the profit: RH BR d RH BR E This formula implies that if Beth keeps her realized hours as planned: 1. Any increase in the discount rate will increase the percentage loss in profit. 2. Any increase in total expense will increase the percentage loss in profit. 3. Beth could offset the effect of the discount (d in the numerator) above by lowering expenses (E) so as to increase the denominator. But for most lawyers, the main implication is simpler: these relationships are complicated. It may be wise to get more help from the trained professionals in your accounting department. About this white paper This white paper is based primarily on a series of blog posts that appeared in the Legal Business Development blog at between November 2011 and April It also includes material from the article The Rise of the Pricing Director by Jim Hassett and Jonathan Groner, Copyright 2012 Bloomberg Finance L.P. That article was originally published by Bloomberg Finance L.P. Reprinted with permission. The opinions expressed are those of the authors. This material will be updated and expanded, and included in the third edition of the Legal Project Management Quick Reference Guide, which is scheduled for publication in June Page TRAIN

126 Legal Pricing in Transition Page 38 About the authors Jim Hassett is the founder of LegalBizDev, which helps law firms increase profitability by improving project management, business development, and alternative fees. Before he started working with lawyers, Jim had 20 years of experience as a sales trainer and consultant to companies from American Express to Zurich Financial Services. He is the author of 10 books, including The Legal Project Management Quick Reference Guide, The LegalBizDev Survey of Alternative Fees, and The Legal Business Development Quick Reference Guide. He has also published more than 80 articles in the New York Times Magazine, Of Counsel, Legal Management, Strategies: The Journal of Legal Marketing, and other publications. Jim is a frequent speaker at law firms and at bar associations (including the New York City Bar, the New York State Bar, and the Massachusetts Bar), Harvard Law School, the Association of Corporate Counsel, the Defense Research Institute, the Ark Group, and at Legal Marketing Association meetings in Boston, New York, Philadelphia, Washington, Savannah, and Vancouver. He has conducted webinars through West LegalEdcenter, the National Law Journal, The International Lawyers Network, TAG Academy, and the Legal Marketing Association. Jim writes the blog Legal Business Development which was featured at the ABA TECHSHOW in 2009 and again in 2010 (in its list of 60 Sites: Latest and Greatest Internet Hits ) and by TechnoLawyer (in its list of the most influential legal blogs in BlawgWorld). He earned his Ph.D. in psychology from Harvard University. Matt Hassett was convinced by his brother to begin research on legal pricing, alternative fees, and risk management. He has a Ph.D. in mathematics from Rutgers, and is the co-author of several textbooks and study guides in statistics and actuarial science, including Probability for Risk Management. Matt taught Mathematics at Arizona State University for over 30 years. As a consultant, he helped set prices for mortgage-backed securities (for American Southwest Financial) and for Medicare supplement insurance (for Oxford Life Insurance). He has also served as an expert witness on financial calculations, developed educational programs for actuaries, and worked at CVS Caremark as a director of experience analysis for health plans. As a Principal at LegalBizDev, Matt is currently developing new techniques to enable law firms to reduce risk and improve the pricing of alternative fee arrangements. Page TRAIN

127 Legal Pricing in Transition Page 39 About LegalBizDev LegalBizDev helps law firms increase profitability by improving project management, alternative fees, and business development. We offer coaching, webinars, workshops, retreats, train the trainer programs, publications, and more. We help each individual identify the action items that are most likely to produce immediate and practical results for their practice, their personality and their schedule. Our proprietary process helps lawyers to make the best use of their limited time by building on best practices from other law firms and other professions. Before we started working with lawyers, we had 20 years of success developing award-winning training programs for such clients such as American Express, Bank of America, Bank of New York, JP Morgan, State Street, TIAA-CREF, TD Waterhouse, Zurich Financial Services, and many others. In 2005, in response to the enormous changes and opportunities in the legal profession, we decided to limit our services exclusively to the needs of large and mid-sized law firms, and renamed the company LegalBizDev. For more information on the programs that could be of the greatest benefit to you, call us today at TRAIN or LegalBizDev 225 Franklin St., 26 th Floor Boston, MA TRAIN Page TRAIN

128 12/4/13 The Case Against the Law Firm Billable Hour - NYTimes.com March 28, 2013 The Tyranny of the Billable Hour By STEVEN J. HARPER WILMETTE, Ill. THAT bill shall know no limits, wrote one DLA Piper lawyer to another in 2010 in what the firm is now calling unfortunate banter between associates about work for a client. But what is truly unfortunate is the underlying billable-hour regime and the law-firm culture it has spawned. Lost in the furor surrounding one large firm s current public relations headache are deeper problems that go to the heart of the prevailing big law-firm business model itself. Regrettably, as with previous episodes that have produced high-profile scandals, the present outcry will probably pass and the billable hour will endure. It shouldn t. The billable-hour system is the way most lawyers in big firms charge clients, but it serves no one. Well, almost no one. It brings most equity partners in those firms great wealth. Law firm leaders call it a leveraged pyramid. Most associates call it a living hell. In a typical large firm, associates earn far less than the client revenues they generate. For example, a client receives an invoice totaling the number of hours each lawyer spends on the client s matters, multiplied by the lawyer s hourly rate, say $400 for a junior associate. Most big firms require associates to bill at least 1,900 hours a year, according to a survey last year by NALP, the Association for Legal Career Professionals. In 2009, DLA Piper announced that it had eliminated associates billable-hour requirements in favor of a performance-based reward system. However, the firm s submission for the association s current NALP Directory of Legal Employers reports that it has a minimum billable hour expectation. In 2011, DLA Piper s average annual associate hours worked (both billable and nonbillable) was 2,462; the billable average was 1,831. At $400 an hour, a hypothetical 2,000-hour-a-year associate generates $800,000 a year for the firm. But the firm typically pays the salaried lawyer one-fourth of that amount or less. MORE IN OP Opinion Intermi Lincoln For associates, the goal is simple: meet the required (or expected) minimum number of billable hours to qualify for annual bonuses and salary increases. Billing 2,000 hours a year isn t easy. It typically takes at least 50 hours a week to bill an honest 40 hours to a client. Add commuting Read More Page /3

129 12/4/13 The Case Against the Law Firm Billable Hour - NYTimes.com time, bathroom breaks, lunch, holidays, an annual vacation and a little socializing, and most associates find themselves working evenings and weekends to make their hours. Most firms increase financial rewards as an associate s billables move beyond the stated threshold. For partners, billable hours are a key measure of associate and partner productivity. More is better. The resulting culture pushes everyone harder. Meanwhile, each partner strives to maximize individual client billings that he or she controls. Those billings in most cases determine a partner s annual share of the firm s profits. Their clients also become tickets to other firms. That makes partners reluctant to share too many important client responsibilities with their associates and fellow partners. For clients, the consequences of the billable-hour system can be absurd. Fatigue through overwork can produce negative returns the critical document missed during a late-night marathon review; the error in the draft of a corporate filing that goes unnoticed. Why do clients tolerate this perverse system? Periodically they rebel, especially during economic downturns, but those revolutions have been short-lived and unsuccessful. A 2011 survey by ALM Legal Intelligence, an online data service, found that alternative fee arrangements accounted for only 16 percent of revenues at the nation s largest law firms in Despite outcries for reform, the billable hour remains entrenched and the barriers to change are formidable. In many practice areas, including large and lucrative bankruptcy cases, prior court rulings (including the United States Supreme Court s 2010 opinion in Perdue v. Kenny A.) essentially require lawyers to use the billable-hour approach if they want to assure approval of their fee petitions. There s a way out of the mess. But it requires clients to press harder for alternative fee arrangements, courts to back away from policies that embed the billable hour, law firm leaders to stop rewarding excessive associate hours and senior partners to consider the deleterious consequences of their myopic focus on short-term profit-maximizing behavior. However it comes out, DLA Piper isn t the first law firm to endure a client billing controversy. While at a big firm, Webster Hubbell, a former Arkansas Supreme Court justice and associate attorney general for President Bill Clinton, was caught billing clients for time that he never worked. He went to prison. A partner in a prominent Chicago law firm got into trouble when someone wondered how he could bill almost 6,000 hours annually over four consecutive years. He couldn t. In fact, a cottage industry has now developed in auditing outside law firm invoices to clients. Even so, as the deceit associated with the billable hour continues undetected, equally insidious consequences of the entire system endure. The episodes of public embarrassment will remain Page /3

130 12/4/13 The Case Against the Law Firm Billable Hour - NYTimes.com infrequent, and the triggers producing them will be idiosyncratic. DLA Piper s current notoriety began when a former client refused to pay his roughly $675,000 bill. The firm sued him last year, and its internal s about the matter became subject to discovery. Before long, they landed on the front page of The New York Times. DLA Piper said that the comments of its lawyers were an inexcusable effort at humor. What s really not funny is the toll that the flawed system is taking on a vital profession. Steven J. Harper, a former partner at the law firm Kirland & Ellis and an adjunct professor at Northwestern University, is the author, most recently, of The Lawyer Bubble: A Profession in Crisis. Page /3

131 12/4/13 Why clients fear alternative fee arrangements - ABA Journal ABA Home Join ABA Calendar Web Store About ABA Contact ABA search HOME NEWS TOPICS MAGAZINE NUMB#RS REBELS PODCAST BLAWGS STAY CONNECTED Home Legal Rebels Why clients fear alternative fee arrangements The New Normal Why clients fear alternative fee arrangements Posted Feb 27, :30 AM CST By Patrick J. Lamb Print Reprints I was catching up on a pile of reading when I was confronted with a piece about the fear among general counsel of alternative fee arrangements. Just a few days before, I had highlighted a piece in Richard Susskind s new book, Tomorrow s Lawyers, where he observed that in truth, hourly billing is simply a way of pricing and billing legal work; it is a mindset and a way of life. Find us on Facebook ABA Journal Like 14,609 people like ABA Journal. Susskind s observation goes a long way to explain why GCs and so many others fear alternative fee arrangements. Disagree? Then bear with me through these few questions: Facebook social plugin How hard is it to recite the alphabet? How fast can you do it? For everyone, the answers are easy and really, really fast. But what if the questions were changed by adding just one word? How hard is it to recite the alphabet backwards? How fast can you do it backwards? For virtually all of us, the answers change to really hard and really slow. Welcome to the world of change, where lawyers are being forced to change work habits from reciting the alphabet to reciting it backwards. The change of a mindset and a way of life is much harder than learning to recite the alphabet backwards. Still not sure? Think about changes you have tried to make in your life. For many, dieting and exercise are on the list. How successful were you making permanent changes in your prior behaviors? When change is hard, many people default to change lite. Lawyers are no different. When the marketplace suggested that clients hated the hourly fee billing system, lawyers began to offer what they called alternatives to the hourly rate. But rather than making the structural changes to their business models needed to extract maximum value for themselves and provide maximum value for their clients, lawyers opted for change lite. What does this mean? Again, Susskind s book succinctly states the answer: Alternative fee arrangements seem to be failing to deliver significant savings for clients for at least two reasons. The first is that most AFAs are derived from hourly billing thinking. For Page /9

132 12/4/13 Why clients fear alternative fee arrangements - ABA Journal example, the starting point of many law firms is the amount that would have been charged on a conventional hourly basis. Susskind describes what is, at its core, surrogate hourly billing. Several years ago, I labeled this a wolf in sheep s clothing approach to value fees. It is common, and it most definitely is change lite. After all, what firms expect to be paid is the same or nearly the same as what they would be paid if billing by the hour. How big a change could that possibly be? Clients fully know of the difficulty of organizational change, and there is an understandable tendency to look at change from a cost/benefit standpoint. What incentive is there to make the massive effort to change to learn the alphabet backward if there is no payoff in savings? If clients were looking at 30 to 50 percent savings, however, the incentive to invest in the change is profound. But clients are not seeing the 30 to 50 percent savings or even the promise to get to that level, so they are understandably unimpressed with what they see and hear from most of their law firms. So is that the end of the game? I believe not. Much has been written about clients learning that they are in a position of power, that it has become and will remain for the foreseeable future a buyer s market. Clients must direct outcomes and force their lawyers to engineer solutions. There has always been a bit of engineering required to be a lawyer, but the traits of engineering discipline and creativity make achieving material savings a real possibility for clients. This requires no sacrifice in work quality or outcomes. Better outcomes are not only possible but likely as you engineer solutions, since many of these solutions will take work out of the hands of inexperienced lawyers and put it into the hands of more experienced lawyers. When clients receive the benefit of experience, they also gain the benefit of efficiency. Like Schrödinger s cat, the answer is in the client s hands. Patrick Lamb is a founding member of Valorem Law Group, a litigation firm representing business interests. Valorem helps clients solve their business disputes and coping with pressures to reduce legal spend using nontraditional approaches, including use of nonhourly fee structures, coordination with LPOs or contract lawyers, joint-venturing with other firms and implementation of project management tools to handle lawsuits or portfolios of litigation. Pat is the author of the the book Alternative Fee Arrangements: Value Fees and the Changing Legal Market. He also blogs at In Search Of Perfect Client Service. Related Topics In-house Counsel, Legal Rebels, The New Normal, Trials & Litigation, Attorney Fees Comments Tweets Kevin Seattle Restaurant Bans Google Glass And Wearer bit.ly/1bgzrdo Retweeted by LegalRebels Expand Above the Biglaw Firm To Farm Out Real Work To Contract Attorneys By Associate Request: bit.ly/1exfofv Retweeted by LegalRebels Expand Blawg 100 is up! Congrats to all of the nominees! Vote at this link: abajournal.com/blawg100 See the alpha list here: abajournal.com/magazine/artic Retweeted by LegalRebels Expand New Normal: Latest data reveals growing problems for OldLaw dlvr.it/4kj9vl Expand Tweet Follow 7h 26 Nov 25 Nov 14 Nov Reddit Links for ABAJournal.com 1. Calling it like it is Feb 27, :43 AM CST I m ba-ack. And sorry to see that the quality of this column has not really progressed. Where to start? Schrodinger s cat - really? Even if the reference was correct and not an apparent attempt to put a intellectual sheen on a fatuous bit of writing, it is simply poor writing to throw a reference in as the last line of a piece without tying it back. Much more importantly, the column is typical of the insulting approach that Lamb and his acolytes take. All that it takes to implement alternative fee arrangements is a change of mindset. If you don t do it, you are either inflexible or stupid - really it is not harder that reciting the alphabet backwards. Are website founders 'pirates' and 'thieves'? Not in this judge's courtroom 3 points comment Judy Clarke has a knack for keeping her notorious clients off death row 22 points 1 comment The 2013 ABA Journal Blawg point comment Chimpanzee habeas suit seeks declaration of 'legal personhood' based on cognitive abilities 0 points 1 comment Madoff's $17B fraud began in 1970s, witness says in testimony against former colleagues 4 points comment What are other reasons that a company would not use AFAs? One - it doesn t apply to the type of work (like transactional work.) Page /9