Managing Your Legal Spend, Part 3: Alternative Fee Agreements

Managing legal spend when firms bill on an hourly basis can be challenging, and companies are more frequently using alternative fee agreements (AFAs) to deal with these challenges. To better understand how AFAs contribute to effective management, it is important for in-house counsel to consider why and when to select AFAs.  

AFAs offer the following advantages to legal spend management:

• Control over the final cost. From the beginning, the law firm and in-house counsel determine what work will be performed for a set price, whether that price is fixed or capped. This level of control is difficult to achieve under hourly billing because hourly billing is based on total work done not necessarily its value.
• Predictability of the final cost. Even though outside counsel will create budgets based on the anticipated work for the case, budgets are often updated and revised. By setting the final cost, in-house counsel is able to create more accurate budgets and can allocate funds in advance.
• Shared risk of the final cost of the case. AFAs balance the risk between the law firm and the company more equitably. Under AFAs, the total amount to be paid is determined by the overall value of the work performed and the eventual resolution of the legal matter; whereas the focus of billable hours is the specific work performed in its entirety.
• Better relationships with outside counsel. The structure and focus of AFAs as well as the clear communication required to enter into AFAs create deeper, more long-lasting relationships between companies and outside counsel. By establishing the terms of the agreement at the outset, expectations are communicated clearly from the beginning. Clear communication prevents fee disputes later on in the case and sets the tone for a more positive working relationship. Because AFAs are based on the value received by the company and reward the firm’s expertise and efficiency, AFAs inspire confidence within the in-house counsel that the company’s money is being well spent.

In-house counsel should also take a close look at the common types of AFAs (see our post next week) and when the agreements are most advantageous.

When should you use AFAs?

AFAs can be structured to manage spend for a variety of legal services, but AFAs are frequently used for short-term legal services or transactional work. For example, fixed fee agreements are often used for drafting contracts and other documents.  Contingency fees are not used very often for transactional matters, but you might consider entering into a contingency fee agreement for certain transactional services, such as the success or failure to obtain funding for a loan.

AFAs can also be structured to accommodate more long-term, complex legal services. Fixed fees for litigation matters should be structured on a phase-by-phase basis throughout the course of the entire case. Contingency fees also work well for litigation. While contingency agreements are most common on the plaintiff side, the agreement can also be structured for defense work. For the plaintiff, the agreement is often that the attorney will only get paid if the plaintiff wins. For the defense, the parties might agree on a specific end result (e.g., damages would not exceed $500,000). If the attorney is able to successfully achieve the end result, the attorney is paid the agreed upon fee.

Blended hourly rates can also be used for more long-term legal services regardless of complexity. In-house counsel can assign a specific blended rate for an entire section of the company’s legal department or for certain firms. Less complex matters will often have a lower hourly rate while more complex matters might warrant a higher hourly rate.

Which firms do AFAs work best for?

In general, AFAs work best between companies and law firms that have a long-term relationship. When law firms and companies have been involved with prior legal matters, a foundation of trust has already been established and each party is familiar with the amount of work needed for a specific matter. Even if law firms have not been retained by the company for very long, firms are often open to AFAs because of the opportunity to build better relationships and to grow business.

How can legal data help determine when to use AFAs?

Firms often track the amount of time it takes to perform certain legal services and use this data to determine which AFAs are to the firms’ advantage. While clients do not have direct access to the firms’ data, in-house counsel can collect data, as well, by requiring firms to include a shadow bill that details the specific work performed and the hours spent for each task. Companies can also use their legal spend management provider to view the cost incurred for certain types of cases handled by certain firms. The company can use this data to decide which agreements might work best for certain types of case and which firms should be retained, as well.

The benefits that AFAs offer for managing legal spend will be best realized when companies take into account the factors outlined above.