Alternative Fee Agreements In Practice

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Alternative fee agreements can increase firm profitability and client predictability.

Lawyers have been traditionally trained to bill by the hour, putting efficiency and profitability in direct conflict— and creating endless fodder for lawyer jokes. The legal industry’s initial resistance to technology and the efficiencies it created made clients further wary of the billable hour model. As a result, corporate client demand (and the related rise of the legal operations function) is now forcing a change in the industry towards predictable billing structures that encourage and reward efficiency.  

With this trend, some firms have proactively offered alternative fee arrangements  (AFAs) as a business development tool, shifting the perception that lawyers are just racking up hours and giving clients a predictable structure to manage costs.

This doesn’t and shouldn’t mean charging less for services— 54% of projects billed as AFAs are as profitable or more profitable than traditional billing arrangements. Done well, AFAs use data, project planning, and collaboration between firms and clients to promote predictability and to stabilize costs with a sound financial result for both sides. This collaboration can also further develop and strengthen long-term client-attorney relationships.

We’ve put together a (not exhaustive) primer on the most common alternatives to hourly billing  below:

  • Success or Contingent Fee

Contingency fees are typical in plaintiffs’ claims and personal injury cases, where the lawyer takes the risk of loss in exchange for a hefty percentage of the settlement or judgment. But increasingly, law firms are adopting this strategy to other types of matters, like transactional work where the firm receives a percentage of a closing when the deal gets done.

In practice: Byrd Campbell, a commercial litigation firm, offsets the risk of taking matters on contingency, by spreading its risk across its portfolio of commercial cases. This allows them to work with others lawyers whose clients want a contingency fee, but are unable or unwilling to take on all the financial risk.

  • Fixed Fee + Success Fee

A firm can use this arrangement when it can predict the time it will take to provide the services required, and the client and the lawyer are willing to share in the risks associated with a case. Typically, the firm charges a fixed fee for more routine services like documentation and charges a success (contingency) fee if the subsequent litigation is successful. This arrangement does require the lawyer to be very familiar with the matters covered by the fixed portion, so as not to acquire any additional financial risk for the firm.

In practice: Kathryn Abernathy, a solo practicing out of North Carolina, offers judicial review litigation services for Medicare appeals on this basis. Because her practice is limited to this one specialized area, she can reasonably predict the time it will take her to conduct an appeal, and charge a fixed fee for it. She only takes a success fee if the court overturns the agency decision.

  • Fixed Fee + Collar

A more complex arrangement, fixed fees with a collar are a way to establish an effective hourly rate based on a client’s budget. Once the fixed fee is determined, the firm negotiates a "collar" around the fixed fee amount of the acceptable outer bounds of the fee arrangement based upon current expectations. If the fees are less than the lower collar, then the client pays the difference; and if the fees are higher than the upper collar, the client receives a discount. This arrangement encourages long-term relationships, gives clients greater certainty, and protects both client and lawyer from unreasonably high or low hourly rates.  

In practice: California business transactional firm Archer Norris handles a bank’s litigation matters on a fixed fee basis, covering all of the services to be rendered with any claims that should arise. They identified the most common lawsuits and tasks for each one and proposed a menu of services for each category of claims. To protect themselves and their clients from any unanticipated costs (or savings), they proposed a "collar" to establish a floor and a ceiling on the effective hourly rate. They perform an annual review to confirm that the effective hourly rate falls within the agreed-upon range. If it does not, Archer Norris refunds the fees in excess of the range, or the client pays additional fees to meet the floor of the fee agreed upon.

  • Reduced Hourly + Reduced Success Fee

Perhaps the most common of all alternative fee agreements, this pricing method allows the client to pay a lower hourly rate or upfront rate than the firm would typically charge, in exchange for a percentage of the recovery if the firm is successful. This type of arrangement allows clients to reduce their costs and encourages more risk-sharing between the client and the firm.

In practice: Albertson & Davidson is a small will and trust firm that uses this arrangement for inheritance litigation. It offers the client a lower hourly rate up front to stay operational through litigation and takes a success fee on the back end if they are ultimately successful. The client has the benefit of a more substantial award than a straight contingency, and the firm can cover its cost through the process.

  • Reverse Contingency

A firm can use a reverse contingent fee agreement when a client is a defendant and has a potential exposure that is specified and understood. Typically, the client agrees to pay a contingent fee that is a percentage of the difference between their vulnerability and the amount of the final judgment or settlement.

In practice: Susman Godfrey is a medium-sized firm that litigates IP cases, where the cost of defending a patent can be high for corporate clients. Through a reverse contingent fee, the firm is incentivized to limit the client’s exposure, and Susman takes a percentage of the savings on the liability. For example, if a client’s financial exposure is $5 million, and the firm negotiates a $4 million settlement, the client pays a percentage of the $1 million savings as the reverse contingent fee.

Good pricing strategy takes time to develop, and firms should do so carefully and analyze the profitability of their business. AFAs require honesty about utilization and productivity, and how the firm can improve efficiency over every hour billed. Ironically, time-tracking is essential for successful AFAs, as the data will point to which fee agreements make the most financial sense.

Still, the days are numbered for billables as we knew them. Clients are looking for the efficiencies they see technology creating everywhere else — where they expect the cost to be lower and the products and services to be better. Presenting an AFA strategy to your clients before they ask, will position your firm as one that places value over fees.

Think any arrangement should be added to the list or would you like to share how you’ve had success with AFAs in practice? Leave a comment below or send us a tweet and join the conversation.

Natalie Kovacic