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Client-Directed Billing: Shifts in Who Defines the Value of Legal Services

By Jim Calloway and Mark A. Robertson

More and more, clients are directing how the value of the legal services they use is determined and many of them are looking at alternatives to hourly billing.

This article was originally printed in The Oklahoma Bar Journal (Vol. 80, No. 33, 12/12/2009). Reprinted with permission of Oklahoma Bar Association.

Certainly the last two years have seen a lot of movement around alternative billing for law firms. In the last 60 days, more than 88 articles in both legal and general circulation publications have appeared discussing alternative billing and how to appropriately value legal services. From BigLaw to Main Street lawyers, many are struggling to address the increasing demands by clients to use some measure other than the billable hour to value legal services.

Even the label has changed! What we lawyers have discussed for years as “alternative billing” is now often called “alternative fee arrangements” (AFA). That, too, seems like a term coined by clients rather than law firms.

Are we seeing a shift in how and who defines value for the work we do? Consider the following items.

Evan Chesler, in the January 12, 2009, edition of Forbes magazine, wrote a piece titled “Kill the Billable Hour”. This was particularly noteworthy because Chesler is a presiding partner at Cravath, Swaine & Moore, one of the most elite of the mega-law firms. He says lawyers should bill like Joe the Contractor does.

He writes:

“Clients have long hated the billable hour, and I understand why. The hours seem to pile up to fill the available space. The clients feel they have no control, that there is no correlation between cost and quality….

“The billable hour makes no sense, not even for lawyers. If you are successful and win a case early on, you put yourself out of work. If you get bogged down in a land war in Asia, you make more money. That is frankly nuts….

“Contractors bill a lot, too. Last year my wife and I decided to put in a new kitchen. We called in a contractor (let’s call him Joe). Joe arrived with a clipboard, measuring tape and calculator. We told him what cabinets and appliances we wanted. He measured and calculated. A few days later he came back with a price. We thought the price was fair and agreed to it. We didn’t care how many hours Joe, or his electrician or his plumber, would be running their meters. That was Joe’s problem; we had our price.”

On Monday, August 24, 2009, the debate about alternatives to the billable hour in the legal industry became even more high-profile as articles appeared about the topic in both the Wall Street Journal and Corporate Counsel. The Wall Street Journal piece, “Billable Hour Under Attack” began:

“With the recession crimping legal budgets, some big companies are fighting back against law firms’ longstanding practice of billing them by the hour.

“The companies are ditching the hourly structure—which critics complain offers law firms an incentive to rack up bigger bills—in favor of flat-fee contracts. One survey found an increase of more than 50 percent this year in corporate spending on alternatives to the traditional hourly-fee model.

“The shift could further squeeze earnings at top law firms. The past 18 months have been brutal for some big law firms…”

On December 1, 2009, coverage of a survey in Corporate Counsel magazine supported the idea of change. “Just over half of the 231 companies surveyed by the Hildebrandt consulting firm said they either have started or will start negotiating non-hourly billing arrangements with their outside counsel. Just over a quarter said they are considering them. And only 18 percent said they have no plans to abandon the billable hour.

“The American Lawyer and the Association of Corporate Counsel jointly surveyed 587 general counsel and chief legal officers in October, and found that 39 percent paid law firms more money this year under alternative fee arrangements than they did in 2008. Meanwhile, just over half, 53 percent said spending on alternative fee arrangements had stayed the same. Only 8 percent said it had fallen.” (From “The Bell Is Tolling for the Billable Hour: ‘Change Is Here to Stay.’”)

Bruce MacEwen on his well-regarded Adam Smith, Esq. blog responded with a great analysis of this discussion in his post “The Billable Hour Debate Is Not About the Billable Hour.” We encourage you to read his thoughts online at tinyurl.com/nnyw9j, where he writes:

“What’s wrong with the billable hour?

“From my fundamental economic perspective, all you need to know is that it starts and ends the pricing determination based on ‘cost of production’ rather than ‘value to client.’ In my book, that’s per se irrational….

“It’s just plain a weird way to price products or services, because it fundamentally disconnects price from perceived value in the eyes of clients.”

From Fortune 500 companies to Main Street shops and individuals needing legal help, the economy is forcing everyone to look at the costs they incur in hiring lawyers. More and more, clients are directing how the value of the legal services they use is determined and many of them are looking at alternatives to hourly billing. This issue may represent one of the greatest future challenges to our profession. But, of course, we have both thought that for several years now. Our latest book, Winning Alternatives to the Billable Hour: Strategies That Work: Third Edition, was published by the American Bar Association in the summer of 2008.

Are hourly timesheets going away? No—we still need to keep track of our time to know what it costs us to deliver the services. (Although alternative billing guru Ron Baker says this is pointless “cost accounting.”) Are hourly billings going away? No—there are still matters that will be too complex to adequately estimate or budget, too many variables to consider and too many in house bean-counters out there that want to see the time records, still believing that it is a sound way to measure value. Having said that, some law firms state they have done that very thing.

Lawyers on Wall Street and on Main Street need to look at how they bill and be proactive in providing clients with choices on how to be billed for legal services that meet their definition of value.

We are living in a time of great change—both economic and client driven. We see the successful businesses. We know that they embrace the efficiencies of technology, they adapt to changing consumer needs and demands, they provide good customer service and they continue to improve and evolve. They are demanding we do the same if we are going to be their trusted advisors.

If it were easy, all the smart lawyers would have already done it. But there are smart lawyers and smart clients who are using alternative billing methods. How do you start? Let us suggest modest steps. You recall the old saying “How do you eat an elephant?” Answer: “One bite at a time.”

So litigators, are there some routine tasks that should be billed on a task completed basis rather than an hourly basis? What about filing documents with government clerks? Hourly or fixed? Consider this and revise your policies accordingly.

It’s All About Risk

One of the business principals at work in the consideration of billing methods other than a strictly hourly basis is the allocation of risk. In hourly work, the client assumes all of the risk of a project taking more time than anticipated. In a personal injury contingency fee situation, the attorney assumes the risk of not being paid if there is no recovery.

Just as much as the lawyer does not wish to work for free, the modern client does not wish an open-ended unlimited commitment either. The traditional hourly model shifts all of the risk of unanticipated demands or complications to the client, with the lawyer being in the position to bill and collect more in that event, subject only to the risk of client nonpayment. Any alternative billing strategy will entail the law firm assuming some degree of risk of complications. But if implemented correctly, fixed fees can combine with improvements in delegation and use of technology to free up the lawyer’s time to do the more complex and interesting legal work while increasing firm revenues.

Task-Based Billing as Opposed to Flat Fees

Some lawyers think of a flat fee for an entire matter as the only alternative to hourly billing. But the more fair and workable plan is likely some hybrid arrangement that includes flat fees for certain tasks and perhaps even some limited hourly charges. Most lawyers would be unlikely to agree to an unlimited number of depositions for a fixed fee at the beginning of an uncertain matter, for example, and some might argue that such an arrangement has the potential to create a conflict of interest between lawyer and client. It could be agreed, however, that preparation for and taking of each deposition would be charged at a “per deposition” fee, with one rate for in-state and another for out-of-state.

Employing Change Orders

Suppose a lawyer was building a home and, in early construction, the lawyer (or spouse) decided granite countertops were needed in the kitchen instead of the material specified in the contract. What would the builder do? The builder could say, “No, too late. You signed the contract.” Or the builder could say, “Well, that’s a lot more trouble and expense for me, but I’ll do it. No charge.” But only a soft-hearted lawyer would agree to do extra work for no charge.

In reality, the builder would figure out the costs of the modification and some additional profit and give the customer a form called a “change order” that specified additional charges and/or delays and required the customer’s signature.

Lawyers who enter into alternative billing arrangements would be well served to follow the builder’s example. First, the original agreement should specify in detail everything that the lawyer is obligated to do under the fixed-fee or task-based billing arrangement. Then when the client decides something else is needed or there is a change in plans, the lawyer provides a change order for the client to sign, specifying the additional steps and additional attorney fees.

Not all clients will willingly and immediately sign the change order, but as we lawyers like to say, we now have framed the issues for discussion.

Your Fee Agreement Should Evolve Over Time as You Learn From Experience

Unknown contingencies can increase the cost of legal representation. The lawyer with experience in the type of matter is often in a better situation to anticipate these contingencies and provide for them in a task-based attorney-client agreement. Sometimes a corporate client or insurance company may have a better understanding of the possibilities than the lawyer. But there is always the possibility of unusual events that were not anticipated. In that case, one will turn to the language of the original attorney-client agreement. Sometimes the client will be obligated to pay more and sometimes a fair reading of the contract will require the attorney to handle the complication for no additional payment.

Rather than rail about the unfairness of working for free, the lawyer is well served to just do the work and inform the client that there will be no additional charge. Hopefully the client will be impressed with the lawyer’s integrity.

But the lawyer may take this opportunity, if needed, to modify the template for the attorney-client agreement for future matters and provide how this situation will be handled next time. Hopefully, over the years, the contract will evolve so that unforeseen complications will be much less likely to occur.

Go “Cisco” on Your Fee Proposals

Cisco Systems is a builder of computer network equipment. All of Cisco’s outside legal work is handled under alternative agreements reported Neil Rubin, its vice president of litigation, in a recent Corporate Counsel article. Two models are used. Simpler or routine matters are bundled together, and firms are invited to bid, on a flat-fee basis, for the work. For more complex or protracted claims, Cisco pays a flat monthly fee, plus a bonus for a favorable result. “These days everyone’s talking about this,” says Rubin, “but we’ve been doing [alternative fee agreements] for a long time now.” Cisco has been using these alternative fee arrangements since 2002.

“Our goal [with novel fee arrangements] isn’t for firms to be less profitable,” says Rubin, “It’s to tie [Cisco’s] success to the law firm’s success.” Paying successful firms a bonus on top of a flat monthly fee does just that, he says. What’s more, the bonus Cisco pays decreases over time to further incentivize outside lawyers to get good results quickly.

“Rubin acknowledges that novel fee agreements require more up-front work than simply negotiating an hourly billing rate. Outside counsel and in-house lawyers need first to sit down and discuss what’s most important to the client, not just decide when the check will arrive. But it’s been Rubin’s experience that firms are getting more and more receptive to his flat fee/incentive-based model.”

Consider investing some time reviewing filings for a firm client over several years and ask yourself—can I propose a flat fee to this client for this type of work? How can we measure value to the client and a reward for the lawyers if there is a successful outcome?

Solo and Small Firms Representing Consumer Clients Face Different Challenges and Opportunities

The majority of lawyers in the United States practice in a solo or small firm setting. These lawyers often face different challenges concerning pricing for their services. Yet, in many ways, a smaller-sized practice—with its lack of bureaucracy and certain institutional traditions—allows lawyers to move more nimbly in adopting changes.

Solo and small firm lawyers often represent individual consumers on personal and small business matters. Clients who are often cost-conscious, often expect a flat or fixed fee or a contingent fee rather than the billable hour. Their experience with lawyers is usually very limited.

For consumer legal services, fees are often based on market forces and lawyer experience, rather than negotiation with prospective clients. But these “inexperienced” clients are those who might most appreciate the clarity of many alternative fee arrangements.

For many consumer clients, a statement of the lawyer’s hourly rate—the cost per hour—is not sufficient information. Almost immediately, the next question is, “How many hours will it take?” or, “What will the total cost be?” This is when lawyers often give a most unsatisfactory answer: “It depends.”

It is not surprising that this can be a source of frustration for the potential client. After all, most consumer purchasing experiences do not work this way. Even a car dealer will make a firm offer. In fact, the Main Street lawyer has a fairly accurate mental understanding of what an average fee for this matter will total. But the estimate communicated to the client is often couched in broad terms, with many disclaimers. The lawyer cannot give an exact quote when the number of total hours to be expended is unknown to the lawyer, as well as the client.

Although some may view this reluctance as an attempt to conceal something from the consumer, in reality, the lawyer is exercising time-tested judgment. The experienced lawyer knows that if an average fee is mentioned, the client may focus on that number as “the fee.” If the lawyer quotes an estimate of $2,000, the lawyer will view a final total billing of $2,165 to be right on target. But too many clients would respond with, “No, wait, you said $2,000.” So the lawyer learns to express the estimate as a range, with plenty of room at the top end of the range to ensure that the total fee will almost certainly be less than the highest number mentioned. In this example, the lawyer, if pressed, would quote a range from a low of $2,000 to a high of $4,000 or $5,000.

Imagine how much more consumer-friendly and non-threatening this transaction would be if the lawyer simply said, “This probate case can all be yours for the low price of $X.” Many lawyers will object that there are many variables, and many contingencies.

But the lawyer does understand the variables—far better than the client. Lawyers know they will treat a client fairly, but they also want to make sure they are not treated unfairly by working many extra hours without additional compensation.

The alternative fee arrangement need not be based on only one flat fee. The fee agreement may cover numerous contingencies: if event A happens, one fee will be charged; if B happens, then another fee. The most important thing is for the client to be able to understand and comprehend fees quoted in this manner. Written materials for the client to take home and review are extremely important in these situations.

Hourly billing may be simple for the lawyer, but a consumer will appreciate the clarity and certainty of a fixed fee—even if that certainty is embodied in a road map with a dozen possible total fees, depending upon future variables.

Conclusion

If 2009 is any example, we are going to see a lot more interest in alternative fee arrangements in 2010. Both lawyers and clients are engaged in this and it seems extremely doubtful that we will return to business as usual.

TIPS FOR IMPLEMENTING ALTERNATIVE BILLING

1. Take your time, using “bite-sized” steps.
2. Mine your closed files for objective data. Your recollection may be a bit biased.
3. Start with things that make sense to you and the client—e.g., a flat fee for courthouse filing, no matter who does it.
4. Written agreements and documentation are keys.
5. Pay special attention to areas where you can delegate and automate better.
6. Look at the goals from the client’s viewpoint; predictability is at least as important as cost.
7. Do other aspects of firm management need to change to reflect this reality?
8. If your firm rewards based on billable hours, change the focus to dollars billed and received.
9. Could one aspect of your practice be transformed? E.g., corporate formation, minute book and first year’s minutes, up to two hours of phone questions answered, running your new business advise letter, all bundled together? The client gets predictability and “free” calls to lawyer. You get a year to prove how valuable you are.
10. Keep reviewing and improving the process.

About the Authors

Jim Calloway is the director of the Oklahoma Bar Association Management Assistance Program. His award-winning blog is Jim Calloway’s Law Practice Tips at http://jimcalloway.typepad.com. He co-authored Winning Alternatives to the Billable Hour, Third Edition with Mark Robertson.

Mark A. Robertson is a partner in the Oklahoma City law firm Robertson and Williams. He is a Past Chair of the American Bar Association Law Practice Management Section, currently a Delegate to the ABA House of Delegates and co-author of the book Winning Alternatives to the Billable Hour.