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Lawyers despise it, and clients loathe it along with all things billing-related – so what’s with the billable hour and why haven’t we reinvented ourselves yet? We’ve been examining this hairy beast for years, but the farthest we seem to have come is merely to utter the notion of alternatives in Requests for Proposals (RFPs) when our pens are forced.
American lawyers and firms are now undeniably called upon to introduce more creative approaches to billing by in-house legal departments and we are feeling the pressure, too. A few firms have jumped aboard and, further yet, some will be paid bonuses on positive outcomes, rewarding the creative and efficient. After many years of mumbling by lawyers and clients alike, one must wonder: will we look beyond the billable hour in light of the current economic bellyaching and slashed budgets of virtually every U.S. corporate legal department and many Canadian clients?
Are client demands increasing for alternative billing options? Colin Cameron affirms, “They are, and I understand why they’re asking for it. When the economy is bad, clients will push to reduce legal fees, and firms should be cautious about changing billing systems to accommodate a temporary situation. Instead, offer to reduce rates with a corresponding reduction in value.”
The management consultant and chartered accountant says, “Stick to your business plan, don’t change in the middle of turmoil – you will regret it … Try to keep rates where they are, because once we get past this economic situation, it’ll be difficult to return to your regular rate if you drop your rate now.” At the same time, be sensitive to client needs. If necessary, offer clients a lower rate, but with lower value provided.
Ironically, the biggest push for alternatives must come from clients who want increased value for fees, although clients want their lawyers to initiate this conversation. But law firms require incentive to offer creative solutions that place them at greater risk. This was the message heard recently from a corporate counsel panel event hosted by the Legal Marketing Association (LMA), Vancouver Chapter, where four in-house counsel from large public and private enterprises were asked for their views on alternative billing arrangements.
Billing Models
Particularly during challenging times, clients want to pay for results, not time. They want predictable fees, not surprises. This has never been more important than today, when every dollar counts, and requires justification. Stakes are higher now. Consider whether you can better satisfy client needs with one or more of the following alternatives:
Hourly fee – the most common and basic of billing methods. The bulk of billing in Canada is still on an hourly basis, backed by an agreement. The corporate counsel panel felt that hourly rates must be locked in for the duration of the file unless a previous exception is negotiated. Even if the original lawyer leaves the firm, the rate must hold for the replacement in order for the client to keep to a budget.
The hourly rate actually penalizes the efficient lawyer but, as years of experience are accumulated and expertise mounts, a higher hourly rate is arguably justifiable. Regardless of the model, the billable hour serves as a benchmark to gauge how expensive a lawyer is going to be. The billable rate is still the default model for almost all billing.
Blended rates – usually based on the average rate of two or more lawyers who will work on a file. All time is billed at this hourly rate, regardless of which lawyer is doing the work. A blended rate is best applied to matters that are narrow in focus and can be predictably handled by a few lawyers.
All general counsel on the LMA panel wanted lawyers to initiate a blended rate arrangement. Clients have some comfort that a senior lawyer is overseeing the file, but they aren’t always paying at the high rate. However, blended rates can encourage too many juniors on the file, and in-house counsel wondered whether a blended rate would motivate senior lawyers.
If you propose a blended rate, take some time to assure the client that a senior lawyer will be responsible for the file, and will spend the necessary time on the matter, then follow through.
Capped Fees – here the client pays up to a defined maximum amount, but no more. Capped fees are advantageous to law firms that know how to leverage their efficiencies and expertise. They also work for clients because they are able to predict maximum costs and shift some of the financial risk to the law firm.
Capped fees are understandably attractive to clients when budgets are tight and work best with high volume, routine commodity work, where costs are easy to predict and surprises are rare. It’s important to include a safety valve that allows the law firm to revise the agreement should the matter take an unpredictable turn.
Contingency – fees are paid on a completed matter and are usually outlined as a percentage of monies recovered or saved for the client. The client only pays if there is a successful outcome.
Clients like it because they only pay when their lawyer achieves a successful result. There is no financial risk for clients and it allows them to access legal advice when they may not otherwise be able to. This model can be risky to the firm, however, as there is no guarantee the firm will be paid, or exactly how much.
Contingency fees are best applied when the firm is experienced in the type of matter, and has a high expectation of a positive outcome. A screening process for each potential contingency matter should be in place to increase the likelihood the firm receives a fee for services.
As with all contingency work, ensure the terms are clearly set out in the fee agreement and both client and lawyer will know at the outset how the fee will be determined.
Fixed fees – the client pays a set price for a discrete piece of work, either as an isolated matter or part of a larger file. General counsel at the LMA panel were in favour of fixed fees because theyhelp them budget their legal expenses.
When clients seek alternative pricing strategies these days, it’s often fixed fees that most interest them. Fixed-fee proposals typically include adjustment mechanisms, so neither the client nor the law firm is improperly penalized or rewarded if workloads vary considerably from initial expectations.
Fixed fees work well for commodity work where firms have established a predictable routine for certain matters, but the vast majority of work is not suitable for fixed fee arrangements. If you propose this alternative, it is imperative the firm scope out the work in detail to ensure all parties are clear about what the fixed fee includes (and doesn’t include).
Retainers – clients commit to a down payment and all legal fees are deducted from it. When funds are depleted, clients are asked to replenish the retainer or settle the balance due.
Retainer fees give clients a predictable expense each month, while law firms get paid quickly and thus avoid collection issues. This model can be used in conjunction with any other fee structure and in almost all matter types.
Under the present economic constraints though, prepaying for legal services is unlikely to appeal to clients, and the firm that suggests this model could be viewed as insensitive.
Success fee – this model is one that places a degree of risk on law firms. A success fee is based on the result. For example, if you win in court (or close a deal by a deadline) your firm receives 130% of fees, but if you lose, you get only 70 per cent. Some say it’s fair for firms to adopt a certain degree of risk, but each firm will assess what’s acceptable for themselves.
The risk involved has two inherent elements: matter completion and cost overrun. While risky, commercial completion is an important consideration if firms want to get closer to clients and see them through to success. Limiting potential budgetary overruns will depend on effective file management.
Some clients might be keen to consider a success fee on a “bet the company” deal or matter, but firms should be very cautious about accepting risky terms that place fees in serious jeopardy.Cameron chimes in on alternate fees, “Commodity legal matters don’t work well for alternate billing situations. Accounting firms learned this lesson in the early ’80s when they used audits as loss leaders and tried to get work. They had their heads handed to them. They lost a lot of money with audits, and had to make up for it with other areas of work such as tax or consulting work, etc.”
This is not the time to start taking too much risk. About 95% of total billings for all firms in North America use the hourly rate model, leaving just a few firms testing alternative fees. Some are experimenting with large litigation files that have fixed-fee phases. But, if things go sideways, you’ll want an escape valve for the firm where the arrangement will default to an hourly rate. Cameron cautions, “There’s a high level of risk for firms in these times.If you haven’t established a successful alternative billing practice already, you should continue billing by the hour.”
Hourly billing remains the sure thing for both client and firm, but today the risks are felt with every legal dollar spent. Legal budgets are smaller, and there is less that’s discretionary, while more depends on a positive outcome of each legal matter. It’s increasingly important – perhaps critical – to keep clients informed about their mounting fees.
“When giving clients online access to their accounts, your communication with the client is what makes up for all these issues. Things go off the rails when lawyers don’t communicate with clients,” says Cameron. When clients are intimately aware of their fees, there are fewer surprises when the bill arrives, and you’ll have fewer issues collecting on your bills. You may even find they are paid more quickly, since clients don’t need to contemplate the details as closely.
Legal Fee Budgets
LMA panellist opinions varied on the subject of budgets provided by outside counsel. One panellist, a large electronics retailer, uses budgets on large litigation files or where files run on for years and need updating. The challenge is for external lawyers to adhere to the budget provided. When they don’t, in-house counsel have to report to the finance department about overruns and explain overages. “Don’t hang your client out to dry with respect to budgets,” said another panellist.
Important considerations when setting a budget are the level of effort required by outside counsel, timing of the issue, the response required and phasing of the work. Outside counsel need to work hard to stay on budget and communicate the status to their clients. Another panellist added, “Upfront thinking is needed by counsel.”
None of the panellists used billing auditors, like Catalyst or its competition, and most agreed it could seriously damage their relationship with their lawyer to do so. Lawyers should be having their own conversations with clients during tough economic times to appreciate budgetary constraints. It’s an opportunity to gain a critical – and competitive – understanding of your client’s environment and needs.
An annual retainer is another model Cameron has seen adopted, usually by insurance companies as a value-added service to their members. “They pay a flat annual rate and the law firm would answer member questions on legal issues. No hourly charge is applied, and a smart firm would track time to review the ultimate cost of providing that service. They might want to revisit the arrangement after a year or two.”
Clients agree that the hourly rate should continue, but they are keen for their lawyers to initiate conversations about alternatives. Beyond cost savings, another benefit to some billing models is budget certainty – a significant plus for clients. In every instance though, alternative fee agreements should always include an escape route to permit you and your client to revamp the agreement should unforeseen circumstances occur.
Whichever billing method you and your client choose, do your own due diligence first, communicate clearly with your client, and then measure the results.
Susan Van Dyke, Principal, Van Dyke Marketing & Communications is a law firm marketing consultant based in Vancouver, B.C. She can be reached at 604-876-7769 or svandyke@telus.net.