"Audit" Your Law Firm's Bills
Before Your Client Does by John W. Toothman
9(11) Accounting for Law Firms (Leader Publ. Nov. 1996)
WHAT LAW FIRM does not have its share of partners too busy to submit their time records or examine their draft bills, associates trying to impress others with lots of billable time, Pyrrhic victories, over-optimistic estimates, unexpected losses, clerical staff looking for overtime and so on? Yet each of these may become significant liabilities if the firm's bills are audited.
These days, most law firms of any size are bound to encounter an occasional "legal bill audit." Though bill audits are more similar to what accountants would call a "review" or a "performance audit" than to the exhaustive financial statement audit, they can nevertheless be an uncomfortable and costly experience, even for careful, ethical law firms.
Part of Quality Control
Many institutional clients, especially insurance companies, now review all or some fraction of their bills as part of their cost and quality control programs -- the audit may be nothing personal or the firm's bills may have been specially flagged for review. The initial negative reaction of many firms to notice of a proposed audit only makes things worse if they refuse to cooperate with the audit. In addition to triggering potential ethical violations, especially if the audit is requested by a current client, resistance leads many people to conclude -- rightly or wrongly -- that the law firm has something to hide. Yet, for lawyers in shaky financial circumstances or whose lifestyles require them to bill incredible amounts year after year, resisting the audit may seem like the only hope. Audits have uncovered, for example, everything from firm-wide fraud to schemes within a firm that the firm's own accounting systems failed to catch.
Firms managing their billing systems to minimize self-inflicted wounds prefer to avoid future problems by identifying and remedying their causes within the firm. Some firms have even found it helpful to audit themselves or consult with an auditing firm as a prophylactic measure or to substantiate their fees either in a fee dispute or when the opportunity arises to shift fees to an opponent.
What to Expect
There is no single method or procedure by which legal bill audits are conducted. They may range from a simple review of the bills alone -- which can be accomplished without the knowledge, let alone cooperation, of the law firm -- to a full-scale audit, with verification of expenses, on-site examination of firm systems and records and examination of work product and underlying records to substantiate time and expense entries. The scope and depth of the audit depend on such factors as the firm's cooperation, the records available for review, the client's objectives (management information for future decisions versus substantial billing disputes) and the client's budget.
In addition to considering the bills themselves, our reviews typically include examination of the published credentials of the lawyers, review of published information on local hourly rates, review of work product (quality as well as quantity) and consideration of legal performance, strategy, tactics and results.
Standard of Measurement
In a typical audit, the primary standard against which the law firm's bills will be measured is the lawyer-client retention or billing agreement, if there is one. This may be affected as well by the course of their dealings, such as client instructions and lawyer estimates. Billing agreements are subject to more judicial or bar second-guessing than most commercial contracts anyway, especially if entered into or modified after the lawyer-client relationship exists, but a lawyer's failure to adhere to the agreement will catch an auditor's eye. In other words, it is necessary but not necessarily sufficient for the lawyer to comply with the billing agreement.
With or without the agreement, another layer of standards against which to audit is provided by law, including common law and the lawyer's professional ethical duties. These may vary slightly from jurisdiction to jurisdiction, but are surprisingly uniform. See, e.g., Model Rule of Professional Conduct 1.5 (stating a laundry list of subjective and objective factors). There are also standards provided by statute or regulation, e.g., in fee-shifting statutes or with regard to compensation of bankruptcy lawyers. Ultimately, the lawyer has the burden to properly document his or her bills and demonstrate that the agreement and resulting fee are both reasonable. If the auditor cannot verify each entry, the lawyer may be denied payment.
While the entire list of problems identified by one authority or another would be prohibitively long, some of the most common problems are outlined in the accompanying chart (see below).
Sometimes two or more problems may exist within the same entry, e.g., because there is duplication of effort and the work was clerical in nature. In those situations, we normally code the entry for all problems and count each nonsegregated entry in the subtotal for each issue. Timekeepers who fail to break time down by task or mix various tasks risk disallowance of the entire entry.
This list is not exhaustive, but elimination of these problems would save 90 percent of the law firms we review 90 percent of the problems they might encounter. Catching these problems before they leave the office should therefore limit the impact of an audit.
Aside from minimizing the impact of audits themselves, many of these problems are the ones that clients notice on their own. Clients who hire an auditor are just the tip of the client-dissatisfaction iceberg -- the rest simply take their next piece of legal business elsewhere or refuse to pay the last few bills.
What To Look For
Copyright © 1996, 1998 John W. Toothman
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