The Basis of the Billable Hour and Why Clients Benefit From a Fixed Price Arrangement

Well I hope you are as happy as I am that the December holidays have ended.  Now some real work can get done.

The dilemma: If you have any of your firms on an hourly fee basis, then you might notice an uptick in associate hours in December as the associates struggle to meet their hourly billing minimums for the year, just one of the many evils of an hourly billing system left unchecked.  On the other hand, if you were paying a fixed fee on a monthly basis you might be feeling like a chump as you write the check for December recognizing that a lot of partying and little litigating actually occurred in December.

So what is a client to do to strike the proper, fair and economical basis between hourly billing and an alternative method? Importantly, if you understand how the billable hour is constructed, you should be able to better evaluate if hourly billing is appropriate for your matter, if the amount billed is fair and whether annual requests for across the board rate increases will be approved or disapproved.

Anatomy of the billable hour: Years ago, law firms wrote a quarterly or annual bill “for services rendered” for a fixed amount and the client paid the bill without question.  Clients thought they were being overbilled so they pushed for the hourly billing system.  The result was that law firm profits rose!  Certainly not the result the clients intended.  But it was the result of lawyers being notoriously bad at estimating how much time they spent in total on a matter.  (I have found from comparing litigation budgets to actual billings that law firms underestimate their actual time spent 50-66% on a frequent basis.)

Nonetheless, the billable hour was born.  Now the law firms had to set a rate per hour per lawyer that encompassed a number of factors.  This blog speaks generally to the factors considered at the outset of a new client engagement and not to any one client, firm or matter.  The rate typically is set first for the highest, most experienced ranking member of the team.  Factors include the senior lawyers experience in the particular matter at hand, the complexity of the matter, whether the senior lawyer will be actively involved or will merely supervise a team of junior partners and associates, whether travel is involved, whether office costs like postage, copying and research are itemized or included in the rate, the economics of time and availability of the senior lawyer and his/her track record in successfully concluding the type of case.  Of course, the rate also allows for reasonable overhead such as salaries, rent and overhead, and a profit factor for the law firm.

The rates of lawyers assigned to a matter in descending order of seniority (junior partners, senior associates, junior associates, contract lawyers, paralegals, clerks) are billed at rates based on the senior lawyer’s rate.  Unfortunately, this system does not mean that the subordinates’ rate structure bears any relationship to experience or fairness.  These younger lawyer rates will fill up most of the legal bill yet they are merely puffed up based on the senior lawyer rate and other factors internal to the firm which the client cares nothing about.  For example, the “overhead” included in the rate may include the summer associate recruiting and entertainment fund, the office renovation, the holiday party, staff bonuses and other expenses that may help the law firm run harmoniously but do nothing to contribute to the advancement of the client’s cause.

So is hourly billing or fixed rate billing better for the client? If you consider that lawyer rates are rising without relationship to the economy or the actual costs of litigation and that lawyers notoriously underestimate the time they will spend on a matter, then the fixed rate alternative is preferred from the client perspective.  The law firm is likely to underestimate its budgeted amount of hours and, therefore, is likely to underestimate the total cost of the matter.  The client then saves money.  However, the lawyer-client relationship is not about taking advantage of one party over the other when it comes to getting paid.  (Although law firms posting 10% plus profits are not known for giving refunds to clients when this occurs.)

What is a client to do? A client can address the billing method issue several ways.  First, always, always, always insist on a budget that explains the tasks to conclude a matter and the time estimated to conclude the matter plus the level of personnel who will be assigned to complete the tasks.  Second, evaluate whether the rates for the team below the senior lawyer are fair given the lawyers’ experience and expected contributions to the outcome.  Third, evaluate whether the number of people is necessary to the matter, for example is it time sensitive such that ten people must be assigned?  Then, multiply the rate times the expected hours and divide over the estimated time that the matter will likely be pending.  Armed with this total cost, the client can then evaluate whether the cost appears appropriate for the matter.  A particular vulnerability is the high rates charged for the lower level personnel that are not supported by experience or effort.  Another vulnerability is the amount of time spent on routine tasks as a result of the training of junior associates or the filing function of paralegals; this is often a black-hole of billing.  Cut out the costs that serve the law firm’s interest and not the client’s interest and the overall cost becomes more fair.

After analyzing the total cost based on the law firm’s given budget and rates, the client can evaluate if fixing the cost of the matter at that price makes economic sense.  If the law firm will not agree to a set rate, one must ask why?

Finally, the client agreed to a rate and budget at the outset.  I have yet to see in 26 years of practice, a budget that includes annual increases in the hourly rate.  Why should the law firm be allowed to annually increase the rate when it didn’t budget for this cost?  The client is well within its rights to hold the law firm to its contract, to bill a set rate for designated lawyers for the matter.  Of course, in certain economic times it is fair to adjust for inflation and cost of living increases related to law firm expenses but short of these reasons, why should a client pay more to the law firm every year just so the partners can take home more profits that year?  Adjustments can always be made during a matter if it is pending longer than predicted or is more complicated than it initially appeared.

Clients, it’s a new year.  Open your files and look at the requests for rate increases.  Don’t automatically grant them.  Look at the engagement letters from your law firms and see if the law firm has built in an “automatic rate increase” clause into the letter and if so, write a letter rejecting that approach.  Look at the budgets on your files and take the start of the New Year as the time to start a new approach to evaluating whether the hourly rate fairly charges your company for the work done or whether it is time for billing on fixed rate cost based on the law firm’s predicted time and rates.

If not now, when are you going to reset the balance between legal services and fees?  It will affect your company’s bottom line.

Client Salaries Stagnating; Associates Getting Frozen Out; Who’s Making All The Money?

Client, remembering meeting that highly personable, well-established trial lawyer on your recent trip to the law firm? The one with the corner office and custom suit? He’s not in his office today because there is no other new client seeking a law firm to hire and he has no intention of working on your matter. Did you call the team of lawyers you ended up with? Could they answer any of your questions directly or did they need to “check with someone (i.e. senior partner)” before answering your question?

This week’s news reported that in-house counsel salaries over the past two years have frozen yet the companies are requiring those counsel to take on more work. This week’s news reported that one BigLaw firm, Reed Smith cut the pay of first year lawyers, the very crop of talent they expect to make their margins on in two to three years.  I have yet to see a story where any BigLaw or other firm announced hourly fee cuts or even freezes on rates for the coming year to ease the burdens on clients.

What is the irony and similarity in these stories? The people working the hardest have the most to do and are being paid the least amount of money. This inequity can only result in the following: exhaustion, burnout, fatigue, illness, lack of motivation and the overwhelming feeling that there is no way out.

Why do I paint such a bleak picture? Because I have seen too many clients think they are selecting the best counsel only to have the work land back in their lap along with legal bills that are far too high for the value transferred to the company. The law firm always rolls out the A team to land the business. Rarely does the client meet the team let alone meet the person/partner (maybe) who will lead the team. Rarely is the client even told it will take a team of up to ten attorneys, meeting together at least one hour per day, to stay abreast of the legal matter.

How do you put a stop to this? Ask a few questions during the hiring process, assuming you have been given any control over this process, before the legal engagement begins:

1. Who will lead this case from start to finish? What percentage of time do you expect the leader to put in?

2. What is the trial experience of that person? Number of trials as lead lawyer, to a conclusion, the result and the offer and demand headed into trial.

3. How many assistant lawyers or paralegals should be expected to be assigned to this matter and who are they (ask for resumes). Make sure the bill contains only their names and not other strangers. How many meetings and when are they likely to be held to advance the matter?

4. Does the firm bill in minimums? For example, it is highly common to read BigLaw bills where a paralegal bills 8 hours a day for managing the case file. What this means, how many documents are processed and how it advances the legal status of the case is anyone’s guess.

5. What is the overall case plan based on what little is known at the outset? What is the estimated budget for that plan? What variables could affect that budget? How many first and second year lawyers will be part of the plan?

6. What work is expected/required by me, in-house counsel, to advance this legal matter to a conclusion. Estimate the hours and time frame.

What good will it do you to ask these questions? At a minimum, you will approach the matter with your eyes wide open as to what type of hit your annual budget will take and what type of hit your own personal schedule will take to support the matter. Of course, the turnkey firm that can give you personal service, from a trial partner (if it is a dispute) with a reliable budget will beat almost any other offer you hear.

In the end, you will know what you just signed on to if you hire that firm. If you pick the firm where your frat buddy works, or is nearby, or just happened to be the last firm you hired, you get what you deserve. But then again, the choice of outside counsel is not always yours to make or veto. But if costs, efficiencies and results are important, along with morale, and a balanced life, you need to be more vocal about the process. After all, if you’re in-house counsel, it’s your life that will be affected along with the outcome.

Do You Have Your Case Budget Yet?

Clients, can we speak frankly?  Do you have your budget for your most recent piece of legal work yet?  Did you ask for one?  Now is the time to insist on a detailed litigation budget.

The case budget is an essential tool for litigation management.  It forces your lawyer and you to carefully examine what is in dispute, what is required to prove or disprove the allegations and the costs associated with this process.  The best example I’ve heard to analogize to the need for a budget is to compare a house rehab project with a budget and plan and one without.  Under each situation, the rehab job will eventually get done.   But with the budget and plan in hand at the outset, all parties know what it will cost to a reasonable degree of certainty, the right parts are installed at the right time and the outcome usually matches the plan.  The rehab project that is done on an “as you go” basis usually finds that steps were missed, costs are surprisingly high and some essential component is missing or incorrectly installed.

Requiring a budget from a lawyer is not asking for rocket science.  The lawyer will resist the effort, will delay or ignore the request and fill the budget with assumptions and disclaimers.  But think of it this way, if a doctor can create an annual budget for his research to cure cancer, or a scientist can prepare a budget for the cost to launch the shuttle on its next trip, then a lawyer should be able to calculate the costs to bring the litigated matter to a conclusion.  A lawyer familiar enough with the litigation process, and the billing process should be able to estimate the costs in a matter.

Plus, no one says a budget is set in stone.  Of course, a case changes course due to other parties, court rulings, the court calendar, and the behavior of one’s opponent.  But these events occur in all cases and should be taken into account in a budget.

Creating the budget should not be the end of the process though.  It is essential on at least a quarterly basis to compare the actual bills to the budget to determine if the case is following its predetermined course or is off-track.  This short review should tell the client if the case is progressing as anticipated and at the cost projected.

Clients, you have a right to know what the litigation is going to cost.  Lawyers have the knowledge and ability to complete this task.  You should insist on a detailed budget that itemizes the activities expected to be undertaken, the attorneys (by name and rate) who are expected to perform the activities, and allow for a category on the budget that covers case reporting and correspondence.  Whether you use a form your company designed or use the ABA Billing Codes, or allow the lawyer to explain the activities and cost in his own form, it behooves the client to insist on a budget before proceeding with any activity.