Using Alternative Fee Arrangements to Redefine Your Bottom Line
December 07, 2016
In 1958, the American Bar Association (ABA) published a pamphlet recommending that attorneys track and keep detailed records of their time. For better or for worse, legal work has since been measured by the “billable hour”—the established practice of breaking down an hour’s work into six-minute increments. This metric appeared unassailable until the economic downturn of 2008. Companies of all sizes began to reevaluate their legal spend, and clients turned a critical eye to the billable hour. As a result, law firms began to widely adopt alternative fee arrangements (AFA), previously used by only a select few firms, as a creative way to tailor legal spend to their clients’ needs.
Unfortunately for clients, many law firms are still not comfortable championing AFAs. A recent survey, Altman Weil, 2016 Law Firms in Transition (2016), found that only 28 percent of law firms using AFAs initiated those arrangements—compared to the 72 percent who only adopted an AFA after a request from a client. Underscoring the importance of AFAs, the survey also found a “7-year trend of compelling success enjoyed by firms that take a proactive approach to alternative fee arrangements.”
Benefits of Alternative Fee Arrangements
AFAs allow for greater control over legal spend, allowing growth-stage companies, for example, to keep more funds invested in the organization. Additionally, AFAs may mutually benefit clients and law firms as follows:
- Where both parties have “skin in the game,” outside counsel is motivated to champion the client’s cause efficiently, and clients appreciate that perspective.
- AFAs provide certainty better than the traditional billable hour system as they are structured directly to the client’s budget.
- AFAs allow billing to reflect sophisticated strategic concerns. For example, a client expecting multiple or concurrent litigation may cap one case for all fees yet establish a larger contingency fee in another.
- AFAs provide access to the legal system for clients with worthy claims but insufficient funds to sue.
Choosing the Right Alternative Fee Arrangement
The key to every successful AFA is a joint effort to create mutual value. Choosing the right AFA requires a robust conversation about the client’s goals and expectations at the outset.
- Pure contingency AFAs place all risk for success on the law firm. Many law firms tend to avoid these AFAs since they are risk averse themselves. Such contingency terms are best handled by firms with extensive experience in gauging value in similar cases.
- Modified contingency AFAs apportion costs and a per diem fee. Such arrangements often include “kicker” paid to the firm if the client prevails. Others may include a “hold-back” arrangement that not pay some amount if the case is not successful, as defined.
- Capped fee AFAs cap the amount payable by marker points in the litigation or for the entire litigation. Such AFAs provide the ultimate certainty for budgeting purposes but require extensive communication as to what assumptions are built into the proposed caps (number of experts, prevailing at certain stages of the case, etc.). Often, such AFAs include a provision allowing both parties the ability to revisit caps in the event of an unexpected event materially changing the litigation.
- Fixed fee AFAs describe increasingly popular agreements using a fixed monthly or annual amount. A 2015 survey, Norton Rose Fulbright, 2015 Litigation Trends Annual Survey (May 2015), found that life sciences and healthcare companies used such AFAs 13 percent more often than their peers (79 percent vs. 66 percent). Again, clients and law firms need to describe expectations and options in the event of material, unexpected changes. Fixed fee arrangements are most appropriate for cases with predictable costs and timing where the client has a clear goal.
Before selecting any AFA, both parties should conduct extensive due diligence. The selection process should include as much historical data as possible, as well as room for the experiential wisdom of the seasoned trial lawyer. Likewise, due diligence requires both parties to fully disclose any information that might affect the outcome. These arrangements, when carefully crafted, can strengthen and bring additional value to the attorney-client relationship.
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