Alternative Legal Fees: Myth or Reality?

Even though the cost of many things is going down, legal costs seem to climb every year. Clients have begun to realize that in many law firms, the billable hour is an impediment to efficiency.  It creates a counter-incentive to efficiency: to some extent, it encourages lawyers to re-invent the wheel. All too often traditional hourly pricing results in inefficiencies, overruns, complexity and unpredictability, resulting in excessive need for administrative supervision.  As a result, clients have started asking for "alternative fees"  for legal services to be delivered at prices that are predictable and make business sense.

Some of the press about alternative fees sounds a bit like a child describing Santa Claus:  like alternative fees will fix everything, make excellent legal work cheap and deliver all sorts of good things instantaneously.  Alas, alternative fees are not quite the panacea envisioned in the glowing press.  Nor will they work for every legal matter.

However, understanding how to use alternative fees is like understanding Christmas as an adult:  both can be wonderful and yield happiness all around, but neither is magical -- both require adult work (rather than belief in a mythical magic that works on its own) to get to the desired outcome, and neither is perfect.  Wisely used, alternative fees can help businesses meet their risk management and other goals more cost-effectively.  They are, however, very difficult to use effectively – partly because lawyers are not trained to think about the process of delivering legal services in a systematic and predictable way, and partly because most law firms are not used to pricing or billing for services this way, nor to paying their lawyers based on the lawyers’ efficiency.  In addition, many clients are not used to assessing what they really need in legal services nor to considering changing their own inefficiencies in order to achieve cost predictability and savings.

What’s an alternative fee?  Any deal struck for the payment of legal services other than on an hourly basis.  Such fees can be structured as a fixed fee for a specific scope of work, a flat fee with a premium if certain standards are met, a contingency fee where the fee paid is a percentage of the recovery (if any) or the transaction (if it closes),  a bulk fee or retainer (an agreement to do all or a large amount of work that is generated by a client over a set period of time for a set monthly payment) or other such arrangements.  These alternatives are all desirable because each incentivizes the law firm to be efficient in handling the legal matters: to do the level of work needed to get to the desired business goal, but not vast amounts in excess of that amount. In addition, each of these pricing models gives clients predictability:  they should allow the client to predict its legal spending and to make sure it is proportionate to the value of the transactions undertaken or risks averted in litigation.

(What’s not an alternative fee?  An agreed discount to an hourly rate. This is simply an agreement to conduct business as usual – billing by the hour.  This appears to be the most common form of non-standard billing concession made by most law firms, because in house counsel can demand a discounted rate, and law firms will typically provide it – after raising their hourly rates sufficiently to cover the expected discount.  This exchange allows both sides of the negotiation to have the appearance of victory, but makes no real change.)

So, how can a client benefit from a true alternative fee? Properly understood, an alternative-fee arrangement works a bit like a construction contract: the law firm agrees to perform certain tasks for a set fee.  Some advantages of a true alternative fee are: 

• The price of the legal work is more predictable than with an hourly rate arrangement, so the client can determine in advance if the legal work will be cost-effective for its business goal, exercising better cost control and improving resource allocation; 
• If the law firm is well-managed, the firm will use forms, checklists and other systems to prevent needless duplication of effort and to ensure consistent work quality by helping its lawyers not to miss issues; 
• Billing is simpler: the irritation of second guessing whether too much time was spent doing a task goes away when the bill is for a previously agreed amount when the task is done, and the administrative time needed to review bills (and the number of billing disputes) decreases radically; 
• The client’s and the law firm’s interests are aligned: a well-designed alternative pricing structure creates incentives for a law firm to control costs and create efficiencies consistent with its clients’ strategic goals. 

How to get a good alternative fee arrangement.  A good alternative fee arrangement works for both the client and the lawyer. While a client should be able to obtain greater predictability of fees – though probably not 100% predictability – such an arrangement won’t provide magically free or cheap legal services.  Good lawyers are highly compensated because they provide value in much the same way insurance does: by mitigating risks.  A good alternative fee arrangement pushes a law firm to be efficient and effective, but also is profitable for the law firm.  If it is not, the client will ultimately be hurt, as a lawyer who is losing money will typically give a matter short shrift.  In addition, some clients have a tendency to treat a lawyer on an alternative fee arrangement as being on call for free at all times, expanding the scope of work without increasing the amount of fee. This can -- and must -- be addressed by delineating the scope of the work to be done and by honoring that agreement, or else if unchecked such "mission creep" will ultimately will harm the attorney-client relationship too. 

The key to understanding and negotiating these deals is to deal in good faith with your lawyer and to understand three key things (all of which can be negotiated):  

1. what is included in the price (the scope of the work to be done); 
2. what is excluded from the price (what work and risks are not covered); and 
3. what risks the client and the lawyer are agreeing to bear, and who is in control of what decisions. 

The scope of work to be done should be clearly defined in the agreement between the client and the law firm. Getting to a clear definition of the scope requires both an understanding of the legal processes involved, and an understanding of the client’s priorities and style of negotiation.  Ideally, the scope of work should be defined so that it is likely to cover most or all of the work the client needs.

It’s easier to define the scope of work if the work to be done is either (a) repetitive transactions or litigations that are generally similar and done for the same client (these can be highly customized); or (b) transactions or litigations that are predictable in scope because the procedure for doing such transactions doesn’t change all that much from one matter to another.  The things that are hardest to predict are "one-off" matters -- and alternative fees may not be available for such unpredictable matters. 

Other challenges to coming up with a reasonable estimate are the parties’ tendency to negotiate in transactions, the parties’ general willingness to fight over important and unimportant issues in litigations, and judges’ decisions and actions in litigations. For this reason, one size doesn’t usually fit all in alternative fees: to work well for both client and lawyer, some very careful scoping work must be done by both parties working together.  For example, a client may overestimate its market position or negotiating power; this issue can be addressed by adjusting the amount of the fee upwards or downwards depending on the actual work done based on some specified measure.

The exclusions must be carefully defined.  They should make sense.  And they should not be too broad. Basically, the scope should cover the most likely scenarios, and the exclusions should cover unusual contingencies. However, in ill-considered proposals, the fine print of the exclusions frequently excepts out of the deal many of the issues that should be covered for the alternative fee to have its desired effect: for example, some law firms are happy to provide fixed fees for undisputed litigations, but exclude any disputed claims – which means their offers aren't really worth much.

Another issue we’ve seen in alternative fee proposals are "look back" provisions that essentially give the client and the law firm the right to revisit and renegotiate pricing retroactively – sometimes by comparing the prices actually paid to those that would have been charged if the work had been done on an hourly basis.  While such terms may sometimes be advisable, frequently they indicate that the parties have not really thought through what they were doing – and sometimes this provides law firms with the ability to pretend they are providing "alternative fees" without having to really do the work to make their provision of legal services cost-effective and efficient.  These exceptions are often so broad you could drive a truck through them.

General caution about exclusions.  At the risk of stating the obvious, some law firms willing to provide fixed fee quotes for legal work, especially those relatively new to alternative billing methods, will submit very low bids in order to bring in new legal business, and then rely on many vaguely worded exclusions in their bids to effectively raise the fees they can charge.  (This is not unlike the pattern of a construction contractor who bids low, then attempts to make up its lost profit through change orders).  A law firm’s proposal should spell out what work is included and what work is not included in the alternative fee with specificity, based on deep experience in the relevant specialties.  If anything in a law firm’s proposal is not clear, the law firm should clarify it in writing for its client.

The risks each party will bear need to be understood.   By agreeing to provide a specified scope of legal services for a particular fee, the law firm is bearing the risks of its own inefficiency and ability to estimate:  if the agreed scope of work takes longer or is harder than anticipated, the law firm will absorb the overage.  However, the law firm typically does not guarantee the result of its work, just as it does not do so in work done for a standard billable hour fee.  Spelling out who bears what risks can avoid misunderstandings later.

In addition, it is important to state who is in control of making the relevant legal and business decisions.  Unfortunately, many poorly considered alternative fee arrangements require a client to cede control of fundamental business issues.  For example, an aggregate bulk price or retainer for all work in a division of a loan collection company, if the amount of work is not clearly defined, may risk the company’s ultimate collection on the loan assets, because it may create incentives for its lawyers that may not be aligned with the company’s business goals:  if the alternative fee is not well structured to allow for such contingencies, once an all-in price is set, the law firm may be incentivized to minimize use of resources, regardless of impacts on quality or collection results.  By contrast, a well-designed alternative fee arrangement aligns the law firm’s cost control incentives with the client’s interest in maximizing its legal position.  In a  well-designed fee arrangement, the client retains the ability to make the needed strategic decisions, and the law firm provides the client with pricing and other information needed at key decision points to realistically assess whether more legal work will be cost-effective.  While such decisions will affect the amount of the fee, because the client knows in advance what the cost of each option is, he or she can choose to take the option that makes sense both on a business level and as a legal matter.  Ultimately, such designed-in flexibility leaves the client with the ability to control all-in costs by assessing whether it makes business sense to take certain steps in a particular transaction or litigation.

The more collaboration, the better the deal.  For any alternative fee pricing arrangement to work well, in practice, the law firm and its client’s management must manage efficiently using a standardized and collaborative approach.  A law firm that is experienced in handling such deals will typically set up streamlined processes to make sure that needed information is transmitted quickly; that analyses of matters and reports to the client are done on a consistent basis (which makes them faster to manage and review); and that its services and relationship mesh well with its client’s systems across all of the areas being serviced. Instituting such an approach allows a client to move quickly and effectively to manage large numbers of legal matters. For example, in one such alternative fee arrangement I structured, we systematized our client’s and our approach to a set of retail store site acquisitions to meet the client’s goal of a very fast rollout of a new retail concept. This allowed our team to close in excess of 150 store sites in a landlord’s market in 18 months.  Application of these principles -- using good forms and processes -- can work for handling distressed real estate loans also: standardizing an approach to defaulted loans from initial document transmission and review through ultimate disposition, allows lenders and special servicer clients to enforce, work out or foreclose on real estate collateral quickly.

Bottom line, alternative fees are one tool, and an increasingly useful one, for proactively managing legal decisions and costs – IF you know what you are doing and are willing to spend some time working through the issues involved in such approaches with your law firm so that you end up with a win-win situation.