Myths, Realities And Strategies Of Fixed Fees - Part I: Myths And Realities

Sunday, April 3, 2011 - 01:00

Introduction

Over the past few years, the recession has created a buyer's market in legal services, empowering clients to "push back on the billing scheme" and demand more value for their dollar. Most of the discussion on improving the value of legal services has centered on moving away from hourly billing toward alternative fee arrangements ("AFAs"), such as "fixed-fee" arrangements (also called "flat-fee" arrangements). Fixed fees have been celebrated for lowering legal costs, providing better incentives to outside counsel, simplifying the billing process, and giving clients more predictable costs. Surveys have found that the majority of law firms believe that non-hourly billing can improve efficiency and that fixed fees have become a permanent part of the legal landscape.1The billable hour, it seems, may be headed for retirement.

But will flat fees live up to their promise? There is no doubt that clients are looking for alternatives to hourly billing, and the potential shortcomings of hourly billing - overstaffing and working more hours than necessary - are frequently cited. But the shortcomings of fixed fees are less well understood, and the profession has been slow to adopt fixed fees. In Part I of this article ("Myth and Realities"), I discuss some widespread myths about fixed fees and hourly billing, and show that the relative merits of these fee arrangements are not as clear as they seem. A closer look reveals that both flat fees and hourly billing pose challenges for practitioners that won't disappear any time soon.

Yet client pressure for alternative fee arrangements will likely increase in the coming years. In Part II ("Strategies"), I show how understanding the realities of hourly billing and fixed fees can help both counsel and client to communicate more effectively with each other about billing and to determine the right billing method for a given engagement. No billing method is perfect, but a careful approach to legal billing can help generate greater value and satisfaction for the client.

Part I: Myths and Realities

Myth: Flat fees haven't replaced hourly billing because law firms are resistant to change

It is often noted that lawyers, as a profession, are resistant to change. Resistance to change seems a likely explanation for the persistence of hourly billing, and this is especially true because virtually all lawyers practicing today have spent their entire careers billing by the hour. Our generation of lawyers often assumes that hourly billing is simply how the profession has always charged its time, and that changing such an old tradition is difficult.

Reality: Law firms have rapidly adopted new fee arrangements in the past

Although fixed fees are often touted as a new way to bill, the reality is that fixed fees were the nearly universal form of legal billing long before hourly billing ever emerged. Until the 1960s, almost all legal work was performed on a fixed-fee basis, either through a single charge for a service performed, or through a monthly or annual retainer fee.2Over a period of two decades, the profession experienced a complete transformation in billing practice. By the 1980s, hourly billing had gone from virtually nonexistent to standard practice in corporate law.

If hourly billing is widely criticized today, how did it come to be so popular in the 1960s and 1970s? First, clients benefited. Clients who wanted greater accountability from their counsel were able to quantify each lawyer's effort using billable hours. Also, it was easier for clients to compare law firms by looking at hourly rates.

Second, outside counsel benefited. Estimating the total cost of an engagement ahead of time is difficult, and promising to charge a fixed amount per hour greatly reduces the effort required to propose a fee arrangement. Hourly billing also mitigated the risk that the engagement would involve unexpected (and time-consuming) complexity.

Finally, law firm administrators benefited. As firms grew, it became harder for law firm administrators to monitor the work of each lawyer on each matter. Hourly billing became a convenient method for tracking work within a firm.

Of course, today we realize that hourly billing also comes with its share of headaches, for both clients and outside counsel. But the advantages that hourly billing brought to the table a generation ago still exist, and these advantages must be weighed against the disadvantages of hourly billing when clients and counsel choose fee arrangements.

Myth: Flat fee arrangements lower costs

Often, one of the top priorities for in-house counsel is lowering the cost of outside counsel.In recent years, the recession has further empowered clients to push hard for ways to lower the cost of legal services. Much of the discussion of alternative fee arrangements has emerged out of this push to lower costs, and in a recent survey, 63 percent of U.S. and 74 percent of UK respondents said the primary reason for alternative fee arrangements is lower costs.3

Reality: Flat fees may raise costs but they do offer greater cost certainty

Flat fees often do lower costs. Often, however, they do not. In Fulbright & Jaworski LLP's Fourth Annual Litigation Trends Survey, nearly half of respondents who used fixed- fee arrangements said they paid the same for cases billed on a fixed-fee basis and cases billed on an hourly basis. In fact, a majority of respondents from the UK, where fixed fees are more common, said that they paid more with fixed fees.4

Nevertheless, flat fees have one overriding virtue over hourly billing: better predictability of costs. For some clients, this is as important, if not more important, than simply minimizing expected costs. Clients and law firms that have embraced fixed fees are quick to emphasize that their greatest merit is cost certainty, not cost minimization. For example, the chief litigation counsel at DuPont has noted that fixed fees provide good "certainty and predictability in billing,"5and law firms have emphasized "certainty" in their own marketing information.6

Myth: Hourly billing rewards inefficiency, while fixed fees encourage efficiency

The tendency of hourly billing to create an incentive for inefficiency is well documented. As one observer has put it, "fees based wholly on time spent can reward the lawyer for inefficiency and witlessness, at the client's expense."7If the client has no way of knowing how long a task should take, then hourly billing will provide more compensation to the slow and inefficient lawyer than to the innovative and efficient lawyer. One strength of fixed fees is that they give no incentive to spend more time than necessary on the case.

Reality: Both hourly billing and fixed fees reward inefficiency, but in different ways

The reality is that every fee arrangement between a client and outside counsel will create an incentive for inefficiency. Different fee arrangements, however, lead to different kinds of inefficiency. With hourly billing, the risk is that outside counsel will spend too many hours on the matter. With fixed fees, the risk is that outside counsel will spend too few hours on the matter. Because the fee arrangement does not depend on hours billed, outside counsel may be tempted to devote less time to the matter than they otherwise would. There may also be an incentive to staff the matter with more junior attorneys and staff and fewer experienced partners.

Myth: Flat fees reduce the need for the client to monitor outside counsel

Outside and in-house counsel can always agree that hourly billing is a hassle. The law firm attorney endures the endless treadmill of keeping time in six- or fifteen-minute increments. The in-house attorney must then review the law firm's bills, itself a tedious process. Based on the time and effort consumed by hourly billing, fixed fees seems like an easy improvement for everyone involved.

Reality: Flat fees place different burdens on the client to monitor outside counsel

Fixed fees do not eliminate the effort required for the client to monitor outside counsel. The client still needs to monitor whether outside counsel is devoting the right amount of effort to a matter. With fixed fees, however, the concern is too little effort. This may mean that timesheets and budgets are still necessary to keep track of who is working on the matter, what they have done, and how much time they have worked on the matter. Or it may mean that the client simply focuses on the outcomes of cases; but this task is complicated by the fact that it is often hard to tell whether an adverse outcome was due to shirking or due to factors beyond outside counsel's control. Even in the context of routine litigation (where fixed fees are most common), the client can only set benchmarks for performance by studying outcomes across a large number of cases.

Also, hourly billing does have one substantial advantage over fixed fees when it comes to effort on the part of the client. An hourly billing arrangement requires only a basic understanding of the matter when the engagement letter is signed. Setting a realistic fixed fee, by contrast, requires an estimate of the degree of complexity of the matter, the time and staffing required, and the likelihood that unexpected contingencies may arise.Accounting for these factors at the outset of a case may be a difficult and time-consuming process.

Myth: Hourly billing will soon be a thing of the past

With the groundswell of support for alternative billing arrangements, it is natural to expect a "tipping point" in the trend away from hourly billing. In 2011, you might not be surprised to read quotes like: "The restructuring of the legal industry is at hand . . . . Hourly billing by law firm lawyers . . . is insupportable." But would you be surprised to find that this quote is from 1992?8

Reality: Fixed fees will grow in popularity, but hourly billing is here to stay

Since at least 1989, when the ABA published Beyond the Billable Hour: An Anthology of Alternative Billing Methods , there have been several waves of interest in alternative fee arrangements, each of which fostered hope that the demise of the billable hour was not far behind. The reality, however, has been slow change in billing practices. A 1998 article reported that "only 25 percent of corporate legal work is performed through alternative billing arrangements, a small increase from prior surveys."9Ten years later, a different survey indicated that this number was essentially unchanged.10Other studies show little change as well.11As Professor Charles Silver has argued, "Flat fees are not one-size-fits-all compensation formulas. . . . It is impossible to predict how large a fraction of legal work will one day be done for flat fees, but there is no reason to fear the imminent demise of the hourly rate."12

In Part II of this article, I will turn to the strategies that clients and law firms can take in choosing between hourly billing, fixed fees, and other fee arrangements. 1 2010 Law Firms in Transition: An Altman Weil Flash Survey at 4 (http://www.altmanweil. com/LFiT2010).

2 For a discussion of these transitions, see Ed Wesemann, "Managing Your Practice: Alternative Pricing: Full Circle," 70 Or. St. B. Bull. 38 (May 2010).

3 Pam Easton, "U.S. Companies Experiencing New Litigation Wave, Anticipate More to Come in 2010," 11 No. 25 Lawyers J. 5 (Dec. 4, 2009).

4 Fulbright & Jaworski LLP's "Fourth Annual Litigation Trends Survey Findings," http://www.fulbright. com (2006).

5 Russ Banham, "Lawyers for Less: Large companies are opting for cheaper, more-predictable alternatives to the traditional billable-hours approach," CFO.com (Oct. 1, 2005) (http://www.cfo.com/article.cfm/4443639/ c_4448927).

6 Erin Fuchs, "Come Out Of The Shadows About Alt Billing: Experts," Law360.com (June 18, 2009) (http://topnews.law360.com/articles/107096) ("This week Saul Ewing posted to its home page a link to a page outlining a 'cost certainty commitment.'"); Leigh Kamping-Carder, "Alternative Fees Gain Sway With Corporate Counsel," Law360.com (Oct. 12, 2010) (http://topnews.law360.com/articles/200735) ("'Clients like to be able to predict with some level of certainty what their legal costs are,' Jack Allender, the global head of Fulbright's tax department, told Law360.).

7 John A. Beach, "Symposium on Business Dispute Resolution: ADR and Beyond: The Rise and Fall of the Billable Hour," 59 Alb. L. Rev. 941, 947 (1996).

8 Charles H. Carman, "Your Role in Restructuring the Legal Industry," Corp. Legal Times 4 (March 1992).

9 ABA Committee on Lawyer Business Ethics, "Report: Business and Ethics Implications of Alternative Billing Practices: Report on Alternative Billing Arrangements," 54 Bus. Law. 175 (Nov. 1998).

10 Pam Easton, "U.S. Companies Experiencing New Litigation Wave, Anticipate More to Come in 2010," 11 No. 25 Lawyers J. 5 (Dec. 4, 2009) ("69 percent of respondents say that, of the money spent on outside counsel, only 25 percent or less is billed via alternative fee arrangements.").

11 From 2004 through 2010, studies such as Fulbright & Jaworski LLP's Annual Litigation Surveys found that the number of companies that never use alternative fee arrangements has consistently hovered around 50 percent, although the number may have fallen slightly over the six-year period. See "7th Annual Litigation Trends Survey Report," http://www.fulbright.com (2010); Fulbright & Jaworski LLP, "6th Annual Litigation Trends Survey Report," http://www.fulbright.com (2009); Fulbright & Jaworski LLP, Julie Zeveloff, "In-House Counsel Tightens Grip On Law Firms: Study," Law360.com (Oct. 21, 2008) (http://topnews.law360.com/articles/73515); Fulbright & Jaworski LLP, "U.S. Corporate Counsel Litigation Trends Survey Findings," http://www.fulbright.com (2004).

12 Charles Silver, Flat Fees and Staff Attorneys: Unnecessary Casualties in the Continuing Battle over the Law Governing Insurance Defense Lawyers," 4 Conn. Ins. L. J. 205, 221 (1997/1998).

Ashish S. Prasad is Founder and CEO of Discovery Services LLC and is widely regarded as among the leading experts on discovery in the United States. He has served as Litigation Partner, Founder and Chair of the Mayer Brown LLP Electronic Discovery and Records Management Group, Executive Editor of The Sedona Principles: Best Practices Recommendations and Principles for Addressing Electronic Document Production (2004), Co-editor-in-Chief of the Practising Law Institute treatise Electronic Discovery Deskbook: Law and Practice, Adjunct Professor of Law at Northwestern University Law School, Chair of the Defense Research Institute Electronic Discovery Committee and Chair of the Advisory Council of the National South Asian Bar Association.

Please email the author at aprasad@discoveryservicesllc.com with questions about this article.