Are Alternative Fees Ethical?

I’ve wanted to post something on this issue for a long time but only recently came across some other blawg observations worth noting.

On David Giacalone’s f/k/a blawg, he recently posted about some Value Billing Issues for Today’s ABA Ethics Teleconference which he hoped would have some discussion about the ethics of “value billing” (for an explanation of value billing, see below.) David is clearly not a fan of value billing and he is correct that not enough has been written yet about the ethical aspects of using fee alternatives to the billable hour.

David’s post is worth reading in and of itself, replete as it is with links to many of his other posts and articles about the ethics of value billing.

I highly recommend reading his “smart clients care about . . . ‘marketplace value’” post, particularly the Comments at the end in which he and value billing advocate Allison Shields (her blog is here) repeatedly go back and forth. It’s very interesting reading. There is also a rebuttal to David on the Legal Ethics Forum.

My take on the David Giacalone v. Allison Shields debate is this – I think David is too hung up on his belief that some value billing proponents have allegedly suggested that value billing is a way to dupe clients into paying higher legal fees than they would ordinarily. Now perhaps David has read more widely on value billing than I have, but I have not seen this suggestion. What I’ve read, particularly on accountant and value billing godfather Ron Baker’s site, is that value billing’s proponents argue that in some situations, simply billing by the hour does not truly compensate the lawyer for what he or she has accomplished for the client.

Consider this hypothetical – a Fortune 500 company is being investigated by the Department of Justice. Assume that if DOJ ends up suing the Company and wins, it will cost the Company hundreds of millions of dollars. The Company can turn to the Acme Law Firm to defend it, which will put a team of 7 lawyers on the case ranging from junior associates to a senior partner, all billing by the hour. They begin gearing up and start billing thousands of hours at a blended rate of $400/hour for what looks like will be a long, protracted battle with DOJ.

Or, alternatively, the Company can retain the Zeus Law Firm who has as a partner John Doe, a former Deputy Attorney General at DOJ. Over many years at DOJ, Doe gained a reputation for integrity and brilliant legal work. He is respected by many at DOJ and has the ability to directly contact the senior decision makers at DOJ who will take his calls and his requests for meetings.

Let’s say that the Zeus firm has pegged Doe’s hourly rate at $750/hour and let’s further assume that after putting in 20 hours on the Company’s matter, he’s able to persuade the DOJ to drop it completely or to end it by allowing the Company to pay a minimal fine or penalty.

Question: what is a “reasonable” fee for Doe under the circumstances?

Hopefully they will correct me if I’m wrong, but I think Ron Baker or Allison Shields would argue that Doe simply billing the Company 20 hours x $750 grossly under-compensates Doe for what he did for the Company. The Company hired Doe precisely for his experience, reputation and contacts. He saved the Company hundreds of millions of dollars and did so very quickly and efficiently, not to mention also saving them millions of dollars in legal fees had they retained the Acme firm instead.

I certainly agree with David that no lawyer should ever use a fee arrangement that is designed to camouflage an undisclosed fee hike or an unreasonable fee.

But that’s not what Ron Baker and Allison Shields are saying. Are they saying that in certain circumstances a lawyer can properly charge a client more than y hours x z rate if that formula does not reflect the true value of the work? Yes, as long the fee arrangement is clearly understood by the client, is agreed to in advance, and reflects the value of the work to the client as evidenced by certain clear and agreed-upon value or performance metrics in the retainer agreement.

If all that is spelled out up front, then I don’t see what the ethical problem is even if the fee ultimately ends up being more than y hours x z rate.

The Financial Crisis & Alternative Fees (Continued)

Well, there's nothing like a financial meltdown to spur some discussion in the legal community about moving to alternative fees.

A recent New York Times article with the headline "Law Firms Feel Strain of Layoffs and Cutbacks" noted that with some large law firms "desperate for business," they "are more willing to accept less profitable payment arrangements that do not reward the firms for simply assigning more lawyers to spend more time on a project."

The NYT article goes on to cite a recent study in which 32% of 600 corporate executives surveyed predicted significant changes in law firm billing practices over the next two years. Wow, only 32%?! So in the face of what is likely to be the worst financial crisis in this country since the 1981-82 recession, two-thirds of these corporate executives expect to continue to be billed by the hour for legal services just as they have always been? Where are their shareholders?

At least one corporate executive gets it. In the article, Ivan K. Fong, General Counsel of Cardinal Health in my hometown of Dublin, Ohio, is quoted as saying "rather than having hourly rates, we are increasingly negotiating flat fees or fixed fees, or success fees.” Ivan is also the current Chair of the Association of Corporate Counsel (ACC) which has launched a new legal fee initiative called the "ACC Value Challenge" (you can read more about that here and here). Ivan gets it. (FYI -- Cardinal is not a client of mine.)

Over in Business Week, Cravath's managing partner Evan R. Chesler offered some advice to clients on how to cut legal costs in this troubled economy. One of his tips -- hire a lawyer who already has too much work to do (on the assumption that he/she won't spend a lot of billable time on your matter) -- is somewhat humorous. But it's his last suggestion that is surprising, coming as it is from one of the most elite Wall Street mega-firms -- "try to work out fees that are not based on the billable hour:"

"The billable hour can be a terrible thing," says Chesler. In litigation, he explains, "it creates all the wrong incentives," feeding a system "where it's more profitable to lose than it is to win." That's because when a corporate defendant loses a case, the process generally drags on with mounting legal fees.

Companies, of course, have been railing against the billable hour for decades. But particularly in litigation, it has persisted as the primary way big firms bill for their services. Chesler acknowledges that there "has been a one-way conversation" for years, but says Cravath now "is trying more and more to come to alternative fee arrangements that make the billable hour irrelevant." Generally, this means charging flat fees to handle cases, often with "success fees" for extraordinary results.

Flat fees may not always save clients money, but they do offer something of major importance to businesses: a measure of predictability in budgeting expenses. While Chesler thinks Cravath could do well under such arrangements, switching away from charging by the hour "is not intended to be a windfall for anybody," he says. "This is about trying to put some rationality in the system and come up with a better way of dealing with each other."

Interesting comments.

That the current financial crisis has prompted more of a discussion of alternative fees, particularly on the client side of the equation, is at least one positive outcome of what is for many people, both in the legal profession and beyond, a very trying time.

However, as I've discussed in previous posts, for there to be a true change in our profession in how we bill for our services, it will not be enough that more clients turn to alternatives to the billable hour. It will be necessary for the law firms themselves to come to the conclusion that the billable hour must go. And instead of being scared into using alternative fee mechanisms simply because current economic conditions might demand it, firms need to passionately believe there is a better way. When this financial crisis ends -- and it will -- it will be interesting to see if the clients and the firms who turned to billable alternatives during the crisis will revert to the old ways or if they will continue to see true value in a new way of providing legal services to clients.