Alternative Fee Arrangements: The Antidote to the “‘Poisonous”’ Hourly Rate Paradigm?

This article is based on a presentation delivered at the Northeast Corporate Counsel Forum held on April 7, 2017, in Atlantic City. Mari Henry Leigh, a Chicago attorney and advisor on alternative fee arrangements, assembled and moderated the session. Joining her on the panel were F. Samuel Eberts, III, chief legal officer, LabCorp, a $12.4 billion company based in Burlington, N.C., and Matthew A. Werbel, partner, Methfessel & Werbel, of Edison, N.J.

After an extensive examination of the 250 law firms in his company’s constellation of firms, F. Samuel Eberts, III said, “We found we had been locked into bad pricing models with law firms. Our interests were not aligned in what we were trying to achieve. The whole process of reviewing bills and arguing over hourly rates was fostering a poisonous relationship with our law firms.”

 Eberts, who is the chief legal officer of the $12.4 billion clinical diagnostics giant LabCorp, said they committed to moving away from an hourly-fee relationship with firms to one that is more of a value-based, portfolio-based, trust-based strategic partnership. They reduced that constellation from 250 law firms to just eight.

“We put less focus on individual matters and more on managing the total relationship and their representation of the company,” Ebert said. “In 2016 we finished with 70% of all our matters being on a non-hourly rate. The goal for 2017 is 98% of all legal matters will have no associated hourly rates.”

Goodbye RFPs

“We don’t do RFPs (requests for proposals) with law firms. We don’t competitively bid our work.”

At the beginning of the year, Eberts said they decide on which “partner law firms” they will use, sit down with them tell them: Plus or minus 10%, this is the amount of money you can expect we’re going to spend with you this year. “‘We’re not sure what we’re going to do it with yet,’” he tells them, “‘but we believe we have a good handle on our legal spend.’ That lets us focus on partnering with our law firms.”

Eberts said his company’s fee agreements are sometimes one page or even just two paragraphs. “We don’t do long letters or pages of contingencies. We have a value proposition that both parties have agreed to and we adjust it as we move along.”

He said a high level of trust is required. “If [the firms] lose money it’s not good for them and it’s not good for us. We actually want our law firms to make more money under this than they would under an hourly rate. We believe we can do that in a more efficient way. We believe in the end we will drive down legal expense.”

Many companies approach alternative fees with the wrong mindset. “The purpose of alternative fee agreements is not simply to save money. It’s to align the interests to promote greater efficiency in how we deliver our legal services.”

Measuring Value

 Mari Henry Leigh is a Chicago-based attorney and long-time expert on alternative fee arrangements and the attorney-client relationship. She formed Mari Henry Leigh & Associates in April, after many years with several national law firms.  Leigh is working with Eberts on his program at LabCorp, and hopes to turn the model he described into something the entire industry can use. “Part of that model is creating a performance metric other than referring back to the billable hour as to how you measure value,” Leigh said. 

The difference between the hourly fee paradigm and that involving alternative, value-based fees, she said, is that it requires a higher level of trust. The payoff is that it fosters a smoother relationship where the interests of the attorneys and client are aligned.

Matthew A. Werbel, partner, Methfessel & Werbel, the third panelist, said AFAs are here to stay and will be used more extensively. “You’ve got to be on the train. You can’t just put your head in the sand and say ‘this is just another trend.’ The best client for me is one who has that perspective of trust, and the relationship. And I understand [client companies] have to make money. I understand it’s about profit.” He said an element of trust is know that the fee arrangement is not just about cutting legal spend.

What's the Goal?

If you look to AFAs solely to save money, Werbel said you’re not looking at them in the right way. In fact, he added, AFAs work and work best when they are not implemented solely for the purpose of cutting expenses. Efficiency is a key goal, the panel agreed. With the billable hour arrangements, Werbel said it takes a lot of his time and that of several people in his office to go through the process of logging and reporting time, printing bills, reviewing them to be sure they meet client format and language requirements. Then, he said more time is taken up when the bills are sent out to be audited by a billing company, a process that involves the firm’s accounts payable department, and then someone else at the firm has to handle any appeals of the invoices.

“That process is exhausting,” Werbel said.

With that, Leigh said it is important for clients and firms to have a clear understanding of what they want to achieve with an AFA. She said both sides need to be willing to think differently—to think of legal services in terms of the value they bring, not the hours they spend.  To get started in the process, Leigh said having benchmarking data is important in the beginning. Attorneys are concerned about losing money and aware they will be measured against their peers who will be billing by the hour.  “You will be looked at differently. And you’re going to have to explain whether you’re making profit or not, so benchmarking will help you know your cost and mitigate your risk.”

But, what about the inventible comparisons between what a matter would have cost using hourly metrics versus the cost of a value-based AFA?

Eberts said that with their fixed-fee agreements, they have an explicit ban on law firms ever reporting what the firm would have billed on an hourly rate. “We encourage law firms not to compare invoices to the hourly rate. We urge them to think about the portfolio of work their law firm does with us.”

“We don’t expect that every transaction a law firm does with us to be profitable or to be as profitable as another transaction they are working on with us. I don’t understand this in the legal industry—that they believe every transaction they do is going to be profitable. No other industry in American business does that. We expect the portfolio of work they do throughout the year to be profitable. Very profitable.”

The Value of Predictability

“I put more value on the predictability of costs than spending the least amount of money possible,” Eberts said. “It is predictability of my costs I am willing to pay a premium for.”

He said that if during the course of the year they and the firm have miscalculated the costs, we will make a change and increase the fee. He said the reverse happens, too. “Law firms will come back to us and say a matter they were working on didn’t end up being a big deal and ‘we don’t want to charge you that much.’”

Eberts said they are transparent with their firms, and show each of them how much of the LabCorp legal spend they are getting.

An audience member said that, in the end, he is selling his time and he only has so many hours in the day.

The Poison Bill

Eberts responded, “I respectfully suggest, is that you’re not selling your hours, you’re not selling your time, what you’re selling to me, is you’re giving me a solution. Whether it took you 10 minutes or half a year, there’s a value on that.”

Lawyers only started charging by the hour in the mid-1970s, Eberts said, so it’s not how we started in the profession. “I think [hourly billing] is poisonous to the profession.”

He said the alternative to alternative fees is to have “more onerous RFPs, more onerous audits, piles and piles of adjudication and appeals of bills, and you’re going to get treated like a widget provider, and I am going to focus on the unit cost of what you deliver, and all I am going to do every year is figure out how to ratchet 5% down further on that. And it doesn’t focus on the attorney-client relationship, and it doesn’t focus on the professionalism of our profession, which I think we lose in an hourly rate environment and I think we foster that in an alternative fee agreement. “

X Marks the Spot

Leigh said it was like the old story (told many different ways) of the engineer who was asked by a businessman to identify the source of a problem with one of his machines. The engineer walked up to a wall of boilerplate and made a small X in chalk on one of the plates. The businessman was delighted, but when he received a $10,000 bill he asked the engineer to explain. The engineer said he only charged $1 to draw the X, but $9,999 for knowing where to put it.

To get started, Leigh emphasized the importance of conducting thorough analytics of data from past legal matters. She recounted how she painstakingly collected data from her own cases, as well as from her colleagues, to determine case values at their various stages. After this quantification process she moved to a qualitative one which involved factoring in the variables of each case. This big data analytics approach is key to coming up with the right budgets and benchmarks.

Werbel said that he, as outside counsel, wants to be the one to suggest AFAs, and not wait and have to react when the client proposes it. Leigh agreed, saying AFAs give law firms a new way to distinguish themselves from the pack.