Do They "Fix" Hourly Rates?

Reprinted from:

Published 6/07

Hourly rate alternatives are increasingly coming to the fore, and there is nothing magical about them – they all seek to achieve the same thing. Rather than setting price by a standard unit of time, billing alternatives focus on actions taken to benefit the client beyond the time of how that value is applied. Choosing the right alternative is ultimately a business matter for both the firm and the client. There is no universal best billing alternative. Client preferences differ, and each project or case may accommodate different billing options.

An increasingly popular alternative is charging a flat fee at a volume discount. With a fixed or flat fee, the billing rate is determined and stipulated in the engagement letter before the assignment begins. It will not vary no matter how much time the lawyer expends, or what the result. Flat fees are especially useful for routine legal services, and encourage the use of technology to streamline the delivery of those services. The challenge with this approach is that lawyers, generally, don't know their costs of operation. Thus, the fee figure chosen is often a "by guess, by golly" fee, not one based on a cost benefit analysis. Your firm cannot aspire to set an accurate flat fee unless you understand the operation of the firm as a business (budget, production, collections, profit, loss), the firm’s billing structure, and how each attorney determines firm profitability. A flat fee is only an acceptable billing alternative if the attorney knows the cost structure behind it, and if the client accepts the value that the fee represents.

Consider the example of a contract attorney, doing work for a large law firm. The firm proposed a new, higher fee schedule that included a volume discount based on a scaled number of hours per month. The client firm’s managing partner asked that the number of hours and the discount to be applied be reviewed retroactively at the end of each three months cycle. A retrospective review is a disaster to the lawyer because it fails to offer any security – you never know how much you will be paid until the end of the three months -- and makes planning impossible. Without the prospective assurance of volume, there is little or no benefit to the contract lawyer; there is every benefit to the client. Thus, a volume discount at a flat fee should be based on a prospective, rather than a retrospective, guarantee of work . This is analogous to the “play or pay” rule in the entertainment world. The fee is to be paid even if the work is not requested. That is the reason for the discount in the first place.

Flat fees are often considered to be a form of discount, but lawyers can negotiate against themselves by accepting them. Let’s use an example of a lawyer who is approached by a prospective client with the possibility of work in return for a discounted rate for a fixed volume of work. To avoid setting a troubling precedent for rate cutting, the lawyer should consider three strategies that meet the client’s request but protect the lawyer’s interests:

First, State that your billing rate is $295; you do not talk about discounts, reduction in fee, or any other modification of your hourly rate. To do so would be to negotiate against yourself and against your self-interest. If in the same breath you quote your fee, then start talking about discounts, you are saying that you are not serious about your own fee.

Second, if the client asks whether $295 is the least expensive rate you can charge, raise the idea of a volume discount. You are prepared to discount your rate from $295 to, for example, $270 – if, and only if, the client is prepared to guarantee 20 hours of work per month for a minimum period of time, say six or nine months. This is essentially a flat fee arrangement.

Third, if the client will commit to the amount of hours and the time period, they should pay the discounted fee of $5,400 (20 hours at $270/hour) at the beginning of each month. In other words they have to pre-pay that amount. If the client needs more than 20 hours of work in any given month, the additional work will be billed at the discounted $270 rate under billing terms the attorney typically uses (for example, payable within 30 days of the billing).

Approaching the idea of discounting this way says that you are willing to treat clients fairly when they treat you well. In other words, the quid pro quo for a discount is a guarantee with payment up front. It makes no sense to do business with a client who will not agree to do that.

But what about flat fees that don’t involve a discount – that, in fact, will pay the lawyer a premium for success? Such a billing approach is the oft-maligned contingency fee. Frequently used in personal injury and collection matters, this fee is a flat percentage of the value recovered for the client. It is particularly useful for the lawyer skilled at analyzing cases and accepting those with a high likelihood of success. However, it is also becoming an accepted alternative to give corporate firms a bigger payoff on “bet-the-company” matters for large clients, and to give those clients the assurance that their lawyer has some “skin in the game” in exchange for the predetermined percentage payout. Sounds intriguing but, as The Wall Street Journal recently noted, corporate firms that enter into contingency arrangements face increased problems from their use – particularly if the firm wins the matter.

Some problems crop up while the contingency matter is open. Normally, attorneys’ compensation is based on hours worked and dollars collected. How can you compensate lawyers who bring no money into the firm, and, in fact, are responsible for many dollars "flowing out of the firm" in the form of their compensation and expenses advanced to sustain the lawsuit. How can you determine bonuses? When millions of dollars are involved, the tension can become palpable.

Then, when the firm is successful, and many dollars flow into the law firm, who gets what? How much should the lawyers working on the matter receive? What kind of bonus should they receive, if any? Isn't the matter the "property" of the firm? Didn't the firm advance the costs, not the lawyers? What is fair? What will keep all the lawyers happy and in place? What will reduce the urge to leave and go to another law firm or start their own? And what should departed lawyers, who worked on the contingency matters, receive? A belated bonus? A payoff on their departure? How would you value the matter, before knowing even if the firm won the case?

These questions really have only one good answer. So long as any firm follows the “eat what you kill (EWYK)” compensation model, in which all attorneys are rewarded on how much business they personally bring in, contingency fees will cause problems. Any firm that encourages lawyers to maximize their individual compensation may have fast near-term growth. But approaching compensation as an institution makes for greater firm harmony and longevity. It also is the best foundation for non-hourly billing alternatives. If a firm wants to promote cooperative effort that ensures its survival, it must change to a more cooperative compensation model that depends on the success of the organization. That way the burdens and rewards of contingency billing are shared equally – and the firm benefits, along with its clients.