Law Firms Need to Embrace Alternative Fee Arrangements

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As professionals who revere precedent, lawyers are not traditionally well known for innovation. Since attorney Reginald Heber Smith first conceived of the billable hour in 1914, billing clients on an hourly basis has been the dominant method by which law firms collect fees. However, as the nature of business becomes increasingly global, more law firms need to adapt to their clients’ business models — some of which do not lend themselves to the traditional hourly billing structure.

As a law firm that represents many international businesses, we at Foley & Lardner LLP have found that alternative fee arrangements, which provide for compensation to the law firm based on a structure that suits the client’s business needs rather than strict hourly billing, are a good way to keep up with the demands of the global business market.

As an international law firm, we have learned that there are countries where billable-hour-based fees are uncommon or even treated with suspicion by clients. Many foreign companies dislike the billable hour because of the uncertainty such a fee arrangement creates, instead favoring fixed fees or fee cap arrangements. Similarly, many domestic companies prefer alternative fee structures because they provide predictable expenses and facilitate budgeting.

Looking through the lens of economics, shifting the fee risk to the law firm ensures that the law firm’s incentives are parallel to those of the client. In addition, clients who lack significant financial resources but have high potential for future earnings (such as technology start-ups) may prefer an arrangement where fees are capped but the company shares a portion of future profits with their law firms. In general, corporate counsel look for alternative fee arrangements that meet three primary objectives: transparency, cost certainty, and flexibility.

What, precisely, are these alternative fee arrangements? In survey after survey, the fixed fee arrangement is one of the alternative arrangements most favored by corporate counsel. In a fixed fee arrangement, the law firm offers its client an upfront or monthly fixed flat fee for each defined project, subject to mutually agreed-upon parameters and expectations. This arrangement achieves all three of the objectives set forth by in-house attorneys. Fixed fee arrangements also facilitates budgeting and provides predictability.

The second most popular option — according to surveys of corporate counse l—  is blended hourly rates. In this arrangement, the client is charged one fee per hour regardless of who in the law firm works on the matter — a senior partner with a relatively high rate or a junior lawyer with a lower one. This option aligns the law firm’s incentives with those of the client by motivating the law firm to delegate work to the most efficient attorney for each particular task. Furthermore, this approach removes some uncertainty over the cost of legal fees.

The capped fee arrangement represents the third most popular option.This arrangement involves a maximum fee for a particular matter or task, generally billed on an hourly basis up to the maximum amount. Usually, this arrangement is coupled with an agreement to mutually split or share any savings generated below the cap. While this approach does not truly involve removing the billable hour from the fee arrangement, it provides the client with predictability of legal expenses and aligns the law firm’s incentives with those of the client.

In addition to these three approaches, other, more creative alternative fee arrangements may be a better match for the client’s objectives and risk profile. For example, law firms may want to consider accepting equity from a client who has a modest budget but may potentially have higher future profits. While this approach may be preferred by both the law firm and the client, caution is advised.

Investing in or doing business with clients raises concerns about ethics and attorney liability. Under the professional ethics rules, attorneys investing in or doing business with a client must send the client a “Rule 1.8 letter” that explains the investment or the business transaction and the attorney’s role to the client in terms that the client can understand. The letter must also advise the client to review the investment or transaction with other counsel before entering into it. As a rule of thumb, law firms should take care to ensure that all professional ethics rules are strictly followed, both in creative fee arrangements and in everyday practice.

Businesses and business models have undergone tremendous changes as we move toward a truly global economy. Law firms must recognize and adapt to these changes in a number of ways, including, perhaps most significantly, adopting new billing arrangements that align with clients’ objectives and continue to add value.

Daljit S. Doogal is a partner with Foley & Lardner where he is managing partner of the Detroit office and chair of the firm’s business law department.

 

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