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November 14, 2012

Ten years later: A look back and ahead, a decade after the ABA Commission on Billable Hours Report (Part 1 of 3)

Legal Management, the magazine of the Association of Legal Administrators, recently published this article, which I wrote with my brother, Matt Hassett. To download a pdf of the complete article, click here.

In August 2002, the American Bar Association published its influential ABA Commission on Billable Hours Report summarizing the research of a distinguished panel of experts. The report highlighted many disadvantages of hourly billing and said that “the overreliance on billable hours by the legal profession:

  • Results in a decline of the collegiality of law firm culture and an increase in associate departures
  • Discourages taking on pro bono work
  • Does not encourage project or case planning
  • Provides no predictability of cost for client
  • May not reflect value to the client
  • Penalizes the efficient and productive lawyer
  • Discourages communication between lawyer and client
  • Encourages skipping steps
  • Fails to discourage excessive layering and duplication of effort
  • Fails to promote a risk/benefit analysis
  • Does not reward the lawyer for productive use of technology
  • Puts client’s interests in conflict with lawyer’s interests
  • The client runs the risk of paying for:
    • The lawyer’s incompetency or inefficiency
    • Associate training
    • Associate turnover
    • Padding of timesheets
  • Results in itemized bills that tend to report mechanical functions, not value of progress
  • Results in lawyers competing based on hourly rates” (p. 5)

Although the report generated a great deal of discussion, for several years it seemed to have little impact on behavior.  A small percentage of clients and firms continued to use non-hourly billing (as they had for years before the report), and the talk gradually faded away.  Then, in 2008, two things happened: the economy declined, and the Association of Corporate Counsel announced its Value Challenge, mobilizing action around its declaration that “Many traditional law firm business models...are not aligned with what corporate clients want and need: value-driven, high-quality legal services that deliver solutions for a reasonable cost.” 

In 2009, when the alternative fee arrangement (AFA) buzz was still building, we interviewed chairmen, senior partners and C-level executives at 37 AmLaw 100 firms for our LegalBizDev Survey of Alternative Fees.  Since we assured participants that all quotes would be anonymous, many of these law firm leaders spoke frankly and openly about the uncertainties that surrounded non-hourly work:

In-house counsel are just as nervous and as scared about alternative fees as the law firms are. 

General counsel really don’t know exactly what they’re trying to achieve. They just feel like everything has gotten very expensive [and that] the structure of the law firm promotes inefficiency.  I don’t think they’ve really thought through what would work well for them.

I think [clients] don’t know yet how to evaluate [alternative fee] proposals.  Our long-term clients are honest with us [and] say, “I have no way to measure this, no way to know which of these deals you are offering us is the best deal, and no way of comparing your alternative fee arrangement with the simple discount off of standard rates that the other firm has offered us.” 

When it comes to alternative billing arrangements, a number of clients are just not sure yet what it is they are looking for. They are feeling their way through this paradigm shift, just as we are.

In the words of another senior partner in our survey, the whole discussion was also “like a junior high dance. There’s a lot more talking than dancing.” 

While that comment still rings true today, several recent surveys have found that about half of law firms and law departments report that they have increased the use of AFAs in the past twelve months.  (In Altman Weil’s 2012 Law Firms in Transition survey, 47% of firms reported that their AFA revenue had increased in the past year.  In an ALM Legal Intelligence survey published this July, 50% of law departments and 62% of law firms reported that there was an increase in the volume of AFAs between 2010 and 2011.)

Lawyers have been very creative in coming up with a variety of AFA structures.  In the LegalBizDev survey, we classified the most commonly used AFAs into nine types: risk collars, fee caps, fixed fees for a single engagement, fixed fee menus, portfolio fixed fees, retainers, success fees, holdbacks and full contingencies.

When the ALM Legal Intelligence Survey asked law departments which types they used from a slightly different list, the most common were flat fees (89%) and capped fees (57%), followed by blended rates, phased fees, contingent fees, success fees, flat fees with shared savings, defense contingency fees and holdbacks.

The most important difference between the two classification schemes is the fact that ALM included blended rates – a single hourly rate that applies to all lawyers on a matter – and we did not.  This reflects a philosophical difference between two types of AFA definitions: narrow and broad.  Our survey used the narrow definition which reserves the term AFAs for fees that are fully or partly non-hourly.  The broad definition used by ALM and others also includes arrangements that are 100% hourly but include certain types of discounting.

The fact that two conflicting definitions of AFAs are in wide use adds considerable confusion to an area that was already confusing enough.  If a firm claims that 50% of its work is performed on an alternative fee basis, that could mean that they are moving away from the billable hour (under the narrow definition), or it could mean that they are engaging in some creative hourly rate discounting (under the broad definition).

Some have a vested interest in maintaining this confusion.  Announcing that a firm offers 50% of its work on an alternative fee basis sounds much more thoughtful and less desperate than saying, “Half the time, we have to slash our hourly rates because we need the business.”

Next week, in part 2, predicting the future.

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