Estimating Legal Fees:
A Primer for Law Firms
by John W. Toothman
10(11) Accounting for Law Firms (Leader Publ. Nov.1997)
INCREASING attention to legal expenses has caused sophisticated clients to request their law firms to provide estimates for legal fees. In response, some lawyers protest that legal services, especially litigation, are too unpredictable to be estimated. Avoiding the client's request may be a mistake: Lawyers who claim to be unable to estimate legal fees are perceived by a savvy client as either too inexperienced or too evasive to be trusted. Clients who routinely get price quotes and estimates from every other source see no reason to make an exception for lawyers.
To replace the perceived "blank check" that hourly fees entail, clients are also asking for flat, contingent or percentage fees, plus hybrids combining various fees, designed to shift some of the risk, including the risk to the lawyer's own fees and expenses, to the lawyer. A lawyer who fails to understand what his or her services will cost in comparison with the likely outcome cannot survive or profit in an alternative fee environment. The lawyer should, in fact, be in the best position to predict and control fees -- alternative fees just force lawyers to shoulder that responsibility by shifting to them some of the risk.
Firms considering themselves lucky because they thus far have not run into this new breed of client should still be creating estimates for internal use, e.g., to allocate resources, measure attorney performance and manage costs. For example, many firms now reward two partners equally if each bills 2,000 hours and originates $1 million worth of business, but what if one did so using half the resources of the other or produced three times as many successful results using the same resources -- isn't that lawyer ultimately more valuable to the firm? There are uncertainties in many legal matters, but that is no excuse for lawyers to abdicate responsibility for guiding their clients. Experienced, competent lawyers can narrow and focus uncertainty -- or at least provide a range of possible outcomes and probabilities -- even if they are not psychic. Consider the client's perspective on litigation: A client cannot wait until the trial or transaction is over to understand what it might cost, the risks involved and the options. Without a realistic plan and estimate, the client cannot make rational judgments about whether to pursue the matter in the first place (if that is optional), to negotiate (and on what terms) or to seek other options.
Billable Culture Shock
Estimation comes especially hard for lawyers spoiled by unmanaged hourly billing, who must therefore be most careful when finally forced to give an accurate, binding estimate. Many such lawyers give absurdly low estimates because they are genuinely oblivious to what their time costs in the aggregate they just see a succession of monthly bills. The hourly fee environment may actually reward a lawyer for his own detours, mistakes and inefficiency, which can be costly in an estimated fee or alternative fee environment.
Indeed, a firm's billing environment has an impact on how it approaches the work its does, including its staffing and investments in overhead. Compare the lean staffing and heavier investment in technology of many contingent fee firms with the larger staff and relatively smaller investment in time-saving technology of many larger firms, which are largely dependent upon hourly fees.
Nowhere is the contrast starker than when the two types of firm are deployed on opposite sides of the same case, yet hourly lawyers will still insist to their clients that the only "right" way to staff the case is with two or three attorneys at every meeting, deposition and hearing. Living in a regime controlled by estimates will also cast inexperienced associates and marginal partners, formerly valuable for their billable hours if not their intrinsic value to the client, in a new light.
Estimates are not just a cost-management tool. Without the incentive to analyze costs that estimating their fees and expenses creates, lawyers may even fail to plan ahead in their strategy. Either they follow their "usual" path or they react to whatever the opponent does. The estimation process forces both lawyer and client to analyze goals and options, not just costs, and can provide a reality check for client expectations. Thus, a valuable byproduct of building a realistic estimate is a step-by-step plan for handling the matter, usually in the form of a list of likely tasks, to which the lawyer then attaches expected costs to build the estimate.
One reason lawyers are reluctant to give clients a brutally frank estimate at the threshold is that this may scare the client away, with the honest lawyer losing out to lawyers willing to bait the hook with something more palatable to land the client. Another drawback is the expectations the step-by-step plan gives clients about the path the matter should take, not just its cost. For example, even if legal fees are on budget, the client may become perplexed if the lawyer's predictions about the matter's likely path turn out to be misguided. If the lawyer predicted that the court would block discovery on the XYZ issue, which the court then declines to do, not only is the lawyer going to have to explain the new discovery expense, but seeds of doubt about the lawyer's judgment have been planted.
Estimates do constrain the lawyer's fees, but within boundaries set by the lawyer's own expectations. Estimates thus make managing the lawyer easier for the client. The client need not speculate about what to expect or how much it should cost once the lawyer, who is supposed to be an expert in the field, creates his or her own roadmap.
The estimate also makes fee management easier for the client by placing psychological pressure on the lawyer to avoid breaking the estimate. Lawyers often discount fees before sending the bill, to avoid confrontation with the client.
Aside from the subtle psychological effects of the estimate and underlying plan, there is nothing subtle about the direct effect of exceeding an estimate. Once a budget or estimate has been communicated to a client, the lawyer has a continuing duty to update it, especially when new events make the old estimate misleading. A comment to Model Rule of Professional Conduct 1.5 states: "When developments occur during the representation that render an earlier estimate substantially inaccurate, a revised estimate should be provided to the client." The consequence of exceeding the estimate can be disallowance of the extra fees or a substantial portion of them.
To reinforce the importance of the estimate, client-drafted retention agreements frequently provide either that fees over-budget will not be paid or may be deferred until the matter is over, when the client will assess whether further payments should be made. These agreements also provide that any changes to the estimate must be approved by the client.
Creating an estimate leads to a dilemma: If you estimate too high while the client is shopping around, you will probably lose the business, but estimate too low to cover profits and unforeseen events and you'll be sorry you got the business. This tension creates two phenomena, at different ends of the estimation spectrum: The unrealistically low estimate, designed to underbid the competition then be forgotten (often called a low-ball estimate), and the inflated or padded estimate, designed to build in lots of profit and minimize risk resulting from unforeseen events.
At first it might seem to be in the client's interest to accept a low-ball estimate, to save the money. In practice, though, the lawyer has either given an entirely fictional number or assumed ideal circumstances to create the estimate, and the lawyer may plan to jettison the estimate at the first sign of trouble. The low estimate benefits the client only if the estimate is binding and if the lawyer will still provide services of adequate quality while losing money by exceeding the estimate.
Low-ball estimates typically come with a dozen or so caveats attached, which the lawyer assumes will make the estimate nonbinding under less than ideal circumstances. Even without the caveats, some lawyers simply ignore their estimates once the client has made the choice of counsel -- competitive pressure, and with it the client's leverage, evaporate as soon as one firm is selected and replacing it would be inconvenient.
Clients concerned about low-ball estimates will insist that estimates be binding and in writing. Critical scrutiny of the estimate is also part of evaluating the law firm's credentials -- it may be that the low-ball estimate is betraying incompetence or dishonesty, which the client might otherwise not discover until it's too late to change counsel. This critical analysis can be made by in-house counsel or another experienced lawyer giving a second opinion. Playing one firm's estimate against another as part of the selection process may have the same effect.
Caveats added by the lawyer to subvert the estimation process or minimize risk due to a low estimate will either be removed or ignored by the client or all competing lawyers will be given the chance to comment upon or estimate based on the same assumptions. Clients are likely to reject estimates with unrealistic or excessive caveats. The attorney-client agreement may also provide mechanisms for controlling additional fees allegedly excused by a caveat, e.g., by limiting overruns to a certain percentage of the total fee or by requiring prior notice and an updated estimate whenever the lawyer intends to argue that a caveat has undermined the original estimate.
There are three ways clients can avoid the tendency of lawyers to undermine estimates by inflating them. First, clients can make estimates part of the selection process, when firms know they are competing and competitive pressure will keep estimates down. Second, as with the low-ball estimate, clients can analyze the estimate critically, but this time for signs of fat. Third, if the estimate provides a ceiling, clients may still manage fees to keep them below estimates.
Lawyers who approach the estimating process cynically or dishonestly by providing unrealistic estimates can expect to be disqualified on that basis alone.
Copyright © 1998 John W. Toothman
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