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Partner James Herschlein discusses how frank conversations about Alternative Fee Arrangements can help strengthen client relationships.
Despite all the ink that has been spilled about Alternative Fee Arrangements (AFAs)—broadly defined as any fee arrangement other than the traditional hourly rate—several fundamentals seem to have been obscured. The first is that AFAs are not all that revolutionary; some are almost as old as the traditional hourly rate itself. The second is that AFAs can be mutually beneficial for both buyers and sellers of legal services; they are not, contrary to popular opinion, the result of law firms reacting to market downturns. Finally, some GCs are unfamiliar with the full range of AFA options and how best to apply them in various litigation settings.
AFAs come in a range of forms, such as blended rates, contingency fees and fixed fees, and there are enough variations within these forms to merit being considered their own type of AFA. Among the multitude of AFAs being used in the legal industry today, we have identified 11 types that should be considered by GCs shopping for litigation services.
This article will discuss each of these 11 AFAs based on our experiences and findings over the past five years. The discussion will feature a brief description of each AFA, popular litigation settings for using them and the pros and cons for purchasers and providers.
The premise underlying each discussion is that AFAs are really about risk-sharing: they can provide a way for clients and law firms to better share – and thus manage – the risk inherent in billing by the hour. Thus, each party, prior to engaging in legal action, assesses the scope of the legal services required and then discusses and agrees on a fee for a specific matter. The benefits for purchasers are that AFAs can reduce legal fees and economic risks, while adding a level of predictability to budgets and future cash flow. For service providers, AFAs make it easier to forecast the firm’s revenue, motivate efficiency-improving measures and keep the focus where it should be—providing outstanding services. And both purchasers and suppliers benefit by sharing frank discussions of the goals and risks of the matter.
AFAs clearly can have advantages for both sides, although whether a particular matter is best handled through an AFA – and which AFA is appropriate – must be considered. One size does not fit all! But, when used correctly, AFAs can prevent the benefits from becoming too one-sided by aligning the purchaser’s objectives with the provider’s incentives, leading to the creation and maintenance of a long-term, mutually beneficial purchaser-supplier relationship.
- Discounted Rates: Often associated with high volume legal representation for a single client, discounted rates are just that: the application of a percentage discount to the traditional hourly rate. They typically operate on a “the more you spend, the more you save” basis, starting with no discount for legal services purchased under a certain threshold amount, before progressing on a sliding scale to larger percentage discounts for each incremental amount of services purchased (e.g., 0% discount for services under $1 million, 5% discount for services between $1-2 million, 10% between $2-4 million, etc.). The advantage to this AFA is that GCs are rewarded for expanding a relationship with a firm. The disadvantage is that the AFA requires subjective decisions on discount levels, the AFA is still driven by the billable hour, and the purchaser’s objectives may not align with the provider’s incentives.
- Blended Hourly Rates: This AFA bills the hours of all lawyers (partners, counsel and associates) at a single hourly rate. The blended hourly rate is typically a weighted average of the hourly rates of the entire team assigned to the matter (e.g., partners, counsel, associates and paralegals with billing rates of $180 to $800 per hour are all billed at a blended rate of $500 per hour). The advantages to this AFA are they are easier to negotiate and GCs receive a lower hourly rate for partner/counsel services. The disadvantages include the potential to create inadvertent incentives for the service provider to delegate larger portions of the matter to less experienced professionals, who are billing at a blended rate that is higher than their regular rates.
- Flat Fee (Per Matter, Per Phase, Per Unit): With this AFA, a single fee is agreed to for either the entire matter, each distinct phase of a matter (e.g., discovery, summary judgment motions trial, etc.) or each distinct task or unit (e.g., deposition, motion, expert, etc.). The advantage for GCs with this AFA is that purchasers will know their legal spend before the start of a matter (or phase). The disadvantage is that establishing the amount of the flat fee requires significant assumptions and analysis. Prior experience with similar matters, or perhaps a “ramp-up” period, can help inform the analysis.
- Contingency Fees: Often used in recovery situations, this AFA depends on the purchaser and supplier agreeing upfront on the desired results that need to be achieved. The result must be achieved for the supplier to get paid. The fee payment is often a predetermined percentage of the verdict, settlement or saving (for a defendant). Increasingly, a “mixed” contingency is being used, where the purchaser pays a small discounted hourly rate in exchange for giving a percentage of the verdict, settlement or saving. For instance, a contingency fee may be 30%, whereas a mixed contingency fee may be hourly rates at a 20% discount plus a contingent fee of 20% of the result. The main advantage to a full contingency AFA is that purchasers pay no legal fees if the desired outcome is not achieved. The disadvantages are that the AFA is not available for all forms of litigation due to ethical conduct rules, and the AFA could lead to divergent interests when settling a case.
- Hold Backs and Success Fees: This AFA is a form of a contingency fee in which the purchaser pays a portion of the agreed-upon fee and retains (holds back) the remainder (usually between 10–50%), which may be paid following a future milestone (e.g., year-end, conclusion of discovery or conclusion of the matter). Payments in addition to the hold back can be made, based upon the level of success. Typically, the hold back amounts are to be paid if the purchaser believes it has received satisfactory performance, and the “success fees” are used by the purchaser to reward the supplier for extraordinary service/results (e.g., obtaining reversal on appeal of state jury verdict against purchaser/ company; winning summary judgment; obtaining order excluding testimony of a key plaintiff expert with likely spillover benefits in other jurisdictions; or obtaining “nuisance” value settlements as a result of strategic positioning that eliminates exposure). The advantage to this AFA over a straight contingency fee is that the interests of the purchaser and provider of legal services can be better aligned. The disadvantage is there is a potential for conflict if the standards for payment of the hold back or success fees are not precise. Note that this AFA could result in the supplier receiving more than its standard hourly rate, should the purchaser decide to pay a success fee because of extraordinary results.
- Single Law Firm Flat Fee: In areas where the purchaser’s annual amount of work is fairly predictable, the supplier agrees to take on all work in a given practice area for a single set fee. This approach can be applied to a specific practice area or across the full complement of the purchaser’s needs. Similar to the flat fees discussed in item 3, the advantages to GCs of this AFA include easier budgeting, fewer bill reviews (because no billable hours are recorded) and secure, continued representation across a fixed period of time. Similarly, as a variant of fixed fees and retainers, the disadvantage of this AFA is that it does not align purchaser-provider interests very well.
- Hourly Minimum/Maximum: A variant of hourly billing, this AFA sets a predetermined maximum amount of money or hours that can be billed for a project or specified time period. A minimum amount of hours or money can also be set. The advantage to this AFA is that the purchaser knows upfront the maximum amount that the legal work will cost. The disadvantage is that there is no potential saving for the purchaser if the service takes less time and, in a worst-case scenario, the purchaser may overpay if the supplier took less time than the guaranteed minimum.
- Budgeted/Capped Fees Per Phase: Similar to an hourly maximum AFA in item 7, this AFA enables the purchaser and supplier to agree upon a budget or a cap for each phase of a matter. By focusing on the smaller unit of a phase, rather than the entire project or time period, there is more potential accuracy to forecasting and budgeting the fees. The advantage to capped fees is that GCs get predictable pricing for legal fees. The disadvantage is there is no incentive for the supplier’s efficiency while within the budget or below the cap.
- Partner-Based Billing: As the name implies, this AFA is based on only the work billed by a partner. The work of other members on the supplier’s team (counsel, associates, paralegals) is not billed. GCs benefit with this AFA because they pay only for experienced lawyers. Additionally, the purchaser’s bill review is easier because there are far fewer timekeepers to track. The disadvantage is that purchaser and supplier objectives are unlikely to be aligned, especially because purchasers are likely to be charged partner fees for lower-level tasks that would otherwise be delegated.
- Retrospective Based Billing: Similar to the success fees described in item 5, this AFA depends on the supplier and purchaser determining upfront a minimum price to achieve the client’s objectives. At the conclusion of the matter, the supplier determines the fee based upon the supplier’s performance and the satisfaction of the client’s objectives. The advantage of this AFA is its ability to establish clear guidelines for objectives. The downside is the potential for disputes that arise from billings based on the supplier’s self-assessment.
- Sliding Rates for Work: With this AFA, the fees or hourly rates vary depending on the phase of a matter and the desired business outcome. For example, there would be a decrease in hourly rates coupled with premiums for events like winning a motion to dismiss or for summary judgment. The value to GCs with this AFA comes from the focus it creates on the supplier to add value to the purchaser’s business. This AFA aligns the provider’s and the purchaser’s objectives by providing incentives to the provider to achieve results that truly benefit the purchaser. The downside is there can be consistent pressure to drive prices down to such a point that success milestones may be compromised.
There are myriad forms of AFAs available today. To incorporate them successfully, it is important to remember that one size does not fit all. AFAs work best when the outcomes and contingencies are situationally defined. As a result, a clear understanding and assessment of the matter prior to agreeing on an AFA is crucial. So is truly aligning the objectives of the legal services purchaser with the provider’s incentives. As with any transaction that needs to be negotiated and agreed upon, clear communication, trust and flexibility are key.