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Alternative Billing:
Living With the Uncorked Genie

by John W. Toothman, Esq.

7(3) Accounting for Law Firms (Leader Publ. March 1994)


          As a litigation consultant, when I advise clients and the occasional law firm about value-billing, I face a dilemma. On paper, value-billing often looks advantageous, but clients accustomed to hourly billing are reluctant to experiment with alternatives, especially when they hear their lawyers grumbling.

          Hourly billing creates an environment governed by a corollary to Parkinson's Law that work expands to fill the time available: All too often, the bill expands to whatever the client can afford to pay. Hourly billing provides little incentive to settle early or to litigate cost-effectively. Instead, it rewards overstaffing and goldplating of cases. Even if counsel do not intentionally churn the case, their fees are open-ended and unpredictable.

    The drawbacks of hourly billing have put pressure on clients to find alternatives, but their fear of the unknown is even greater, which discourages them from trying alternatives. Meanwhile, most law firms see value-billing as a euphemism for aggressive discounting of legal fees, so they avoid it like the plague. Client anxiety and firm reluctance may slow the growth of value-billing, for now, but a body of experience and information about alternative billing methods is growing. Value-billing will never extinguish hourly billing, but it seems likely that it will become more common in the next several years than it is now.

Hourly and Value-Billing From
The Clients Perspective

          According to a 1992 ABA survey, in-house lawyers are much more enthusiastic about new billing techniques than are lawyers in private practice. From a client's perspective, hourly billing has major, often expensive flaws that can only be counteracted through aggressive, expensive case management by the client.

          While many clients are willing to give lawyers the benefit of the doubt on the quality of their work, it is extremely rare to find a client satisfied with the cost of legal services, even when the results are satisfactory. (Firms may think that their clients are happy as long as they are not complaining, but firms are likely to be the last to know when they are dissatisfied -- they fear that confronting their lawyers would only make things worse.) When "outside" lawyers are not around, e.g., at American Corporate Counsel Association conferences, it is rare to hear anyone sympathize with the plight of law firms or praise the virtues of hourly billing.

Client Bears Risk & Expense

          With hourly billing, the client bears both the risk and expense of litigation, and there is no inherent limit to the fees and litigation expenses, even if the risk posed by the case is limited by, for example, a finite ad damnum clause in the complaint. Hourly billing, even with a budget and extensive management, is a blank check from client to lawyer.

          The better value-billing techniques shift some of this risk and expense to the firm, with the firms compensation designed to create financial incentives to optimize the value of the case to the client (considering fees, expenses and the cost of a settlement or judgment).

          A value-billing technique is well-designed if the attorneys' net profit from the case will be maximized when the overall result for the client is optimized. By shifting some of the risk from fees and expenses to the firm (and even some of the risk of the underlying judgment in the case of contingent fees), value-billing tends to obey the Law of the Jungle -- survival of the fittest instead of Parkinson's Law.

Value-Billing as
Rational Discounting

          The concerns of firms that value-billing is just an excuse to discount bills are easily answered: Yes, value-billing is designed, in part, to make legal services cheaper, or more cost-effective. Firms correctly perceive that the objective of alternatives is to reduce legal fees as long as that is consistent with optimizing the net result of the matter from the client's perspective.

          Clients who consider value-billing are not, however, simply looking for a "discount." To obtain a discount, many clients know that all they have to do is refuse to pay the bill, complain or raise allegations of unethical or incompetent service. Indeed, many firms now show impromptu "discounts" in their original bills, a practice that makes even those clients who had no prior concern about their bills somewhat suspicious.

          Clients considering value-billing are looking for a means to make their legal expenses predictable and rational, in proportion to the value of the result to the client, and easier to manage -- if they can accomplish that, then the fees should also be lower.

          Unlike attempts to obtain "discounts," the objective of value-billing is not to skewer attorneys, but to avoid excessive fees, encourage necessary quality and obtain respectable results. In other words, the objective is to pay just enough in fees to obtain the optimal net result, considering both legal expenses and the amount at stake in the underlying lawsuit or business transaction.

          Attorneys who do well under value-billing will be rewarded, although many clients take this to mean that fees would then approach, but rarely exceed, what hourly billing might have done. Although it might still be possible to increase a firms gross receipts on a given matter through value-billing, perhaps with a contingent, bonus or enhanced fee, the most likely means for a firm to make more money in a value-billing situation is by controlling the firms expenses, especially labor. The primary means for accomplishing this is to examine the size and efficiency of the staff assigned to the matter -- this accounts for the vast majority of the expense incurred by the firm.

          Unfortunately, thanks to the warped incentives created by hourly billing, most firms evaluate their inventory of time-keepers in terms of how many hours they can bill, not how efficiently they can work. Sure, they all pay lip service to quality and warn associates about the evils of overwork. But just drive by their offices after 9:00 p.m. any evening to see the associates voting with their kilowatt hours.

Cut Before the Work

          Value-billing recognizes that it is preferable to make sure that the staff is lean and efficient before performing the work, rather than cutting the bill after the fact, when all of the excess effort and expense become waste. The implications of this approach for a typical, pyramidally shaped firm, with lots of paralegals and associates, should be obvious. Instead of being assets, as they are in an hourly billing environment, inefficient billers who use scorched-earth litigation tactics become a firm's greatest liability.

          Billing alternatives seek to reduce waste by placing the burden for managing waste on the party with the best information and expertise to combat it -- the lawyer. Ideally, the attorney should be encouraged to move the case along, avoid unnecessary detours, forgo ego-driven cat fights with opposing counsel, maintain quality (without goldplating even the simplest matters), reach a reasonable settlement or resolution of the matter as soon as possible, but, if necessary, to see the matter through to the bitter end. Value-billing does not allow firms to rest on their laurels.

Risk-Free Implementation of
Alternative Billing

          Implementation of value-billing requires, first of all, that a reasonable, written agreement be reached. It also helps to have a trusting, communicative relationship between client and lawyer, especially if unexpected events cause the arrangement to become unsatisfactory from one party's perspective.

          The most important predicate for alternative billing, from the firm's perspective, is to have sufficient information about the firm's likely expenses and the path the matter will take, based on historical data and experience, to be able to predict with some certainty what a given matter will really cost. The firm is, of course, constantly encouraged to improve its performance, especially if historical data was skewed by irrational incentives produced by hourly billing, not efficiency.

          I usually recommend to clients and firms that they experiment with value-billing before implementing it, sometimes even without their partners knowing that an experiment is going on. For example, a firm can internally estimate how much a case will cost, even if it does not share the estimate with the client or agree to accept a fixed fee, and then see how close it comes as the case progresses. Fees and expenses billed on past cases can also be compared with results to see how well the firm might have done with a contingent or hybrid fee. Historical data already in the firms records should provide many case studies from which to choose, even allowing for fine-tuning the firms estimation techniques to account for the efficiency of individual attorneys.

Experiment With a Pilot Program

          Client and firm can also perform the same experiment together on current cases, by using estimates or budgets as hypothetical fixed fees or by using results as hypothetical contingent fees. Once both sides are convinced through this pilot program that value-billing would work, the hypothetical may become real, perhaps with a mechanism in place to protect both parties from windfalls or disasters.

          Each case must be evaluated before fixed fees or other alternatives can be designed. During that interim period, a client can pay its law firm by the hour for some period of time, perhaps a month or more, while the firm becomes familiar with cases that are unusual or complex or with a new clients expectations. This is not just the quick and dirty examination the firm might do as part of an audition or beauty contest to get the business, but the "due diligence" the firm must perform to become sufficiently comfortable with the case and client to render a reasonable estimate or value-billing proposal.

Reducing Value-Billing Risks

          Other means to reduce the risk of value-billing include the use of intermediate fixed fees, e.g., based on six-month or quarterly projections, rather than a fee for the entire case. This may still encourage firms to prolong the case, but it avoids some of the problems with predicting where a court or opponent may take the case, despite the best efforts of the firm. Similarly, fixed fees for components of a case, e.g., depositions, other discovery, specific motions and the like, avoid the problem of estimating how much the entire case will cost by establishing an la carte menu for services, without attempting to predict which ones may be necessary. Again, the firm still has an incentive to prolong and complicate the case, but, at least as to each event, it has an incentive to be efficient.

          By doing their homework and establishing a working relationship with their clients, firms can eliminate many of the uncertainties that cause them to shy away from value-billing. Once firms decide that value-billing is worth considering, the question is which of the many alternatives to consider.

Copyright 1994, 1998 John W. Toothman

 

 


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