Current Trends in Alternative Fee Arrangements

How Law Departments and Law Firms are receiving mutual benefit from value-based billing and alternative fee arrangements


 

The New Normal

Value-based billing and alternative fee arrangements are, arguably, no longer considered the “alternative” when it comes to law firm billing. It is increasingly becoming the new normal, or certainly heading in that direction. Note: for purposes of this article I am referring to value-based billing and alternative fee arrangements as any method of doing legal billing that is not paid for on an hourly basis. This trend is supported by hard evidence; although various forms of AFAs were used in the legal profession as far back as the 1950s, the value-based model started to gain traction in the mid-2000s. According to Fulbright & Jaworski’s 9th Annual Litigation Trends Survey, published in 2013, more than 50 percent of law department respondents used some form of value-based billing in 2012. According to Consero Group’s 2013 Spring General Counsel Survey, 61 percent of general counsel use AFAs, and 60 percent plan to increase their AFA use in the next year. Finally, when the same Consero survey found that more than 60 percent of Fortune 1000 general counsel are unsatisfied with the rates they pay to outside counsel, smart law firms continue to recognize that value-based billing must be an integral offering in their business model.

Indeed, the majority of law department clients report favorable experience with value-based billing and AFAs. Seventy-six percent of respondents to Fulbright & Jaworski’s study said they are satisfied with the quality of work provided through AFAs. Among the companies that use AFAs, 67 percent of U.S. respondents and 50 percent of U.K. respondents say they use AFAs for at least 20 percent of their total outside counsel billing.

Kim Townsan, recently retired senior manager of legal administration at United Technologies Corp., (UTC) says AFAs are “the rule, not the exception” for her company, which has embraced the concept since the late 1990s. She says AFAs comprise over 70 percent of her company’s outside counsel spend. “AFAs are the norm for us, and we continue to target increasing our percentage of spend under alternative fees each year,” she says, adding that she finds it refreshing that some law firms are taking more of a lead in the AFA discussion.

 

Additional Support for Value-Based Billing

Other factors at work today provide a sustainable foundation for value-based billing. The internet has made transparency a staple of today’s business, and has caused any mystery or uncertainty about VBB or AFA to virtually disappear. One need only perform a Google search for these terms to find a plethora of information related to these models. Progressive firms proudly display on their websites a willingness and ability to work with clients in structuring risk-sharing arrangements when taking on assignments. These firms provide many examples of various value-based models they offer. Several of these will be identified later in this article.

Another factor that supports the growth of value-based billing is the internal knowledge of the consumers of law firm services – i.e., the law department clients. More and more, law departments are collecting outside counsel billing information in commercially available spend management programs. These software tools enable law departments to quickly and easily “slice and dice” historical cost data. As a result, law departments can determine how much a particular matter is likely to cost by factoring in variables such as type of matter, location and even the phase of each step in the resolution of the matter. This gives the law department the confidence today to enter into AFA arrangements more readily than they would have in the past prior to having access to this historical data.

Finally, C-level executives in today’s corporation expect every department to be relentless in identifying opportunities to contribute to the bottom line. These executives know that there are tools available to increase departmental productivity and reduce cost. In the case of the law department, value-based billing supports both increased productivity and lower total cost of matters.

To Play, or Not to Play – That is the Question

Smart, progressive law firms recognize that AFA billing models provide an opportunity to grow their firm’s business, increase profitability, or both. Lisa Damon, partner at Boston-based Seyfarth Shaw, was recognized by the American Bar Association as one of the first attorneys in the United States to earn the distinction “Legal Rebel”. http://www.abajournal.com/legalrebels/article/making_it_lean_lisa_damon_seyfarth_shaw/

Lisa earned this accolade by changing the entire focus of her world-class law firm into one that embraced value-based billing. As a result, Seyfarth Shaw grew its business and increased its profitability. Lisa states, “Many of our most sophisticated clients are now using value-based billings for a wide variety of work. Our universal experience is that both the firm and the client benefit from working to together in a value-based billing relationship. Firms increase their business partnership with clients when they move beyond the billable hour.”

 

Seyfarth Shaw has clearly established itself over the last several years as a firm that “gets it” , but AFA models also provide an effective marketing vehicle for law firms that want to establish the kind of reputation that Seyfarth Shaw has already earned. Our law department clients tell us that they increasingly hear from their law firms a penchant for providing services on a value-based billing model as a way to gain new business or increase its existing portfolio of work with the law department.

Value-based Billing – Not Just Litigation

While value-based billing was traditionally associated with litigation, that is no longer the case. As law departments and law firms are able to analyze historical spend management data, each side is more able and willing to structure work inspired by the value-based model.

Wilmer Hale, an award-winning global law firm located in Washington, D.C., currently employs AFAs in matter types such as regulatory, intellectual property, transactional (corporate, real estate and labor and employment) in addition to its litigation practice.

Kirkland & Ellis, recently named “Law Firm of the Year” in Mergers and Acquisitions by U.S.

Media Group, states that as long as the risks are fairly balanced between Kirkland and the client, there is no type of matter that cannot be structured as an alternative fee arrangement matter.

Shadow Billing

I mentioned earlier in this article that a basis for establishing a value-based billing model is the ability to analyze historical data. Another component of value-based billing that will help sustain an ongoing “win-win” relationship is shadow billing. This is the process of submitting a “shadow” invoice that shows the actual time spent on a matter. The firm still gets paid based on the prior AFA negotiated at the outset of the matter. However, the shadow invoice enables the law department and the law firm to analyze results at the conclusion of matter to see how close or far the two sides were to the actual cost when the AFA was established at the outset of the matter. This information can then be used to further refine a mutually beneficial relationship going forward.

 

This process requires reciprocal trust and an understanding that at the end of the day, it is in the interest of both sides to get the best result for the client while still enabling the firm to earn a profit. Townsan of UTC stated that shadow billing is particularly useful when first embarking on the implementation of an AFA billing model to aid the firms in the validation of their cost assumptions; she believes it plays less of a role once firms gain experience with billing for work in this manner.

Numerous Different Models

Proponents of value-based billing recommend that law departments that have not yet begun to use AFAs meet with some of their primary outside counsel to discuss those matters in their portfolio that might make sense with which to start. There are many different models from which to choose. The table below represents several different ways that law department and law firms are using alternative fee arrangements today.

AFA Type Examples of When to Use It
Fixed or Flat Fees Best-suited where time and effort are highly predictable – can be used in either litigation or transactional matters. This is the most widely used AFA type today.
Phased Fee Works well where defined segments can be estimated and scope is well delineated.
Success Fees Payment is contingent on a successful pre-defined goal being achieved – e.g., early motion to dismiss.
Multiple Matters Can apply to either plaintiff or defense-based matters. Can be either contingent or fixed fee. Law department gives the firm a group of similar matters. All matters are handled at the same cost.
Fixed Fee for Accounting Period An annual agreed upon fee is paid in twelve monthly installments.
Appeals The firm’s compensation rests on the success of the appeal.
Budget-based Fees Both parties agree to establish a budget for the work to be performed. This model works best when both sides have an understanding of fees and costs involved.
Retainer Fees The firm agrees to provide general advice within specific subject areas regardless of actual time spent.
Pure Contingency Fees (typically plaintiff-side) Compensation to the firm is based solely on the results achieved, often expressed as a percent of recovery, settlement or amount saved.
Partial Contingency The client pays a portion of the hourly rate plus a smaller percentage of any recoveries – used more in plaintiff matters.
Holdback/Success Fee Similar to partial contingency fee, except used more in defense cases.
Blended Hourly Rates All time is billed at the same rate regardless of who works on the matter. Used where it is easy to predict required tasks.
Collar Arrangements Work is billed hourly, with a percent +/- “collar”. Fees above or below the collar are shared on an agreed upon basis in savings or additional expense. Risk collars are a good way to get started with AFAs.
Menu Pricing Most suitable for high volume routine projects or “per task” basis.
Tiered Volume Discounts Reduced hourly rates as volume of legal work increases.
Broken Deal Discounts Discount of fees if project did not proceed beyond a certain stage of the transaction.
Hybrid Fee Arrangements Combination of fixed fee for some matter phase(s), holdback on hourly rates for other phases, and success fees for other phases
“Credit” Discount Reduction in fees in one matter for client commitment to work in a new area of the law not previously serviced by the firm.

 

Summary

Alternative fee arrangements and value-based billing are trends that will continue to be used more, rather than less. AFAs enable law firms to grow their business, increase profitability and increase the probability of establishing long-term client relationships. Law departments are able to avoid surprises, increase predictability and reduce unnecessary costs. The key for both sides is to communicate in a spirit of mutual self-interest and exert the effort up-front – some short-term pain will help achieve long-term gain.

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