Legal industry moves away from billable hour to alternative fee arrangements

For decades, the typical fee structure between law firm and client was the billable hour. Things started to change around seven years ago. That's when general counsels from companies around the country began seeing a "disconnect between value and the services delivered," says Russ Dempsey, chief legal officer at United Retirement Plan Consultants, a retirement plan provider for employers around the country.

Attorney concerns led the Association of Corporate Counsel, a global bar association for in-house counsel, to create the ACC Value Challenge. The initiative would aim to reconnect value with legal services.

The financial collapse of 2008 threw the legal market into disarray, furthering the fee discussion. "General counsels at large companies were facing significant expense pressures," says Dempsey.

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Over the past five years, the billable hour has declined, and alternative fee arrangements (also known as value-based billing) have become a rising national trend. Alternative fee arrangements include any payment structure that is not the billable hour. The most popular include fixed fees, capped fees, success fees and holdback fees.

Research shows that the alternative fee trend has merit. Altman Weil, a consulting firm for the legal industry, reported in 2009 that 28 percent of managing partners and chairs at national firms believed non-hourly billing to be a permanent trend. In 2014, that number has spiked to 82 percent.

In 2012, a separate report issued by ALM Legal Intelligence found that between 2010 and 2011, 62 percent of national law firms polled saw an increase in the volume of alternative fee arrangements.

Opinions vary among local legal professionals, however. "My sense is that any trend toward alternative fees has plateaued," says Quintin Lindsmith, a partner in Bricker & Eckler's Columbus litigation group. "AFAs will always be with us, (but) they will be a limited part of the local legal billing landscape."

On the other hand, Thompson Hine is embracing alternative fee arrangements firm wide, including its Columbus office. Deborah Read, the firm's nationwide managing partner based in Cleveland, asserts that alternative fees are not only permanent, but "will continue to grow at the expense of hourly billing arrangements."

Consequently, Read says that Thompson Hine is "proactively offering alternatives to hourly billing arrangements" to better align with clients' business goals. While the firm does not track fee data by office, there are more than 1,100 matters currently subject to alternative fee arrangements firm wide.

Corporate counsels appear more aligned in their perspective, says United Retirement Plan Consultants' Dempsey. "(There are a) higher percentage of firms using value-based billing," he says. "That's a national trend, and the local trend is following."

Dempsey says the three reasons for using alternative fees over billable hours are managing expenses, achieving predictability in legal expenses and improving legal outcomes.

Bill Jordan, general counsel for Columbus-based DSW Inc. is optimistic about alternative fee arrangements. "I do see AFAs taking hold in Columbus. It makes good business sense for both firms and clients. They align interests, expectations and enhance communication between lawyer and client." Jordan says DSW likes the model so much that most of its legal matters are billed through alternative fee structures rather than billable hours.

Fixed Fees

Among local law firms and clients, one of the most popular alternative arrangements is the fixed fee, which is a set fee charged for specific services that can be used for litigation, transactional and retainer purposes.

Litigation, long viewed as unpredictable, can be managed through the phased fixed fee. The matter is broken out by phase--such as discovery--with the flat fee calculated by identifying the probable tasks associated with that phase. Dempsey says an added bonus is that it "helps build a roadmap to manage the process of litigation."

Nevertheless, Bricker partner Lindsmith cautions that phased fixed fees require a "narrow type of litigation comprised of cookie-cutter cases." Otherwise, there can be unfavorable surprises based on poor predictions.

Lindsmith notes that a flat fee can be used in conjunction with the hourly model, too. "In a very specific category of litigation, we have negotiated a flat fee up to the point of trial. When the matter moves into the trial phase, the engagement switches to the standard hourly rate," Lindsmith says.

Regarding retainers, whether litigation or transactional-based, DSW's Jordan prefers to pay firms flat monthly fees for ongoing litigation and transactional matters. "It gives us the comfort of predictable spend(ing), and the firm has a predictable income stream."

Success and holdback fees

Another common approach is using a fixed fee as a base and then adding other alternative components, such as success fees or holdback fees.

For example, Jordan states that after choosing a fixed fee, DSW will pay its law firm 80 percent of that fee when owed. The 20 percent outstanding is a holdback fee, which DSW will only pay upon satisfactory completion of the project. If the law firm exceeds expectations, however, the firm has a chance to collect an additional success fee of 20 percent.

Lindsmith and Dempsey also pursue the same approach, often called the holdback with success fee, in their litigation billing.

Capped fees

Capped agreements are another common alternative. This fee involves a client paying a budgeted hourly rate with a collar, or capped amount, for legal services. Generally, the firm and client agree on a percentage to be reimbursed if the law firm exceeds or delivers below the collar. Dempsey admits this is an "hourly arrangement in disguise," and says he prefers the flat fee.

The value menu of legal services

Alternative fees are often just one offering of a full menu of value-enhancing services law firms are now implementing for clients. Common initiatives include legal-project management, knowledge management and process-improvement services.

Thompson Hine has devoted time to innovations in people and tools. Managing Partner Read hired a pricing manager who is responsible for aligning the best fee arrangement for clients, and a director of legal project management who keeps projects on track. The firm created a centralized depository of alternative fee arrangements, instituted a mandatory task coding system which is plugged into a predictive-pricing database, and developed proprietary software for budgeting each matter.

When Dempsey negotiates with outside counsel for a series of commercial lease reviews with a fixed fee, he uses something he calls a risk chart, which outlines the probabilities of certain risks occurring with corresponding litigation strategies, among other things. While the law firm was initially hesitant, the risk chart sufficiently alleviated concerns, and Dempsey secured a fixed fee.

In addition to Thompson Hine, Dempsey mentions several Columbus firms that are willing to work on a wide variety of alternative models and legal management initiatives, including Ice Miller, Porter Wright, Dinsmore & Shohl, Barnes & Thornburg and Jones Day.

Alternative fee challenges

Alternative arrangements are not immune from challenges. "The biggest obstacle to AFAs is fear or lack of trust. If both parties don't trust each other, AFAs will be hard to implement," says Jordan. "The hourly billable rate came from clients who didn't trust their lawyers."

Lindsmith says that alternative fee agreements work well only with the right ingredients. These ingredients include a "large institutional client that has a steady stream of litigation in a particular area that allows for predictable pricing based upon an established history of costs. To these must be added the key ingredient of trust."

Other challenges include patience and openness to change, says Lindsmith. "Firm management and the partners need to understand that with AFAs in the form of flat fees, the billable hour is no longer the measure of profitability." Instead, "the measure is revenue versus the amount of time spent to earn that revenue."

Dempsey adds that a common situation is where an in-house attorney has lamented the billable hour, and tries an alternative that doesn't work out as planned. The problem stems from operating the same way as the client and firm did under the billable hour. The model is different, he says, and both clients and law firms need "the tools or experience to get started successfully."

Adapting to alternative fees

Since 2010, Altman Weil's survey reports a decline by almost a third in the number of firms that are "proactive in their use" of alternative fees. Nevertheless, Altman Weil maintains that the potential payoff for proactive firms is substantial, in that "non-hourly work is three times as likely to be more profitable than hourly work in proactive firms."

Thus, law firms that embrace the change may find themselves ahead of the game. As Dempsey observes, alternative fees are the "new normal," and are here to stay.

Paige Kohn is a freelance writer.