Legal Commentary

Legal Community Veterans Continue Attack on Billable Hour

By Patrick J. Lamb

In two separate articles, long-time law firm consultant Joel Henning and former GE GC Ben Heineman, Jr. and William Lee, co-managing partner of WilmerHale, have highlighted the plight of the profession borne of the billable hour and the model that creates a ponzie-scheme-like need for ever increasing revenue in law firms.

Henning's article, A Broken Business Model,begins with this observation:

Law firm economics are pretty simple. There are only a handful of drivers of law firm profitability: productivity (billable hours), leverage, realization, expenses and rates. It's self-evident that — for the past decade — law firm profitability increased by upwards of 10 percent annually and even more in some firms. But only one profitability driver was operating: unrelenting annual increases in hourly rates.

Henning then takes the bold step of advocating for opening the legal profession to outside investment, as has been done in the UK:

Moreover, the case against our retrograde regulatory environment is relevant to our hand-wringing about legal costs and the lame law firm business model. University of Southern California Gould School of Law Professor Gillian Hadfield, a lawyer and an economist, argues that regulatory barriers keep us from reducing the high cost of corporate legal services. She suggests that — but for proscriptions against the unauthorized practice of law and our monopoly over certain legal matters — other professionals trained in a variety of disciplines could offer innovative and efficient methods of managing business relationships that now can be handled only by lawyers.

But that's not all. Regulation also keeps us from bringing in outside investors who would cast a cold eye on the inefficient and costly ways in which we deliver legal services. Although such a transformation in the American legal profession seems revolutionary, it is already taking place in Commonwealth countries including Australia and England.

If we moved to such a system, the current model would simply fade away.  As Henning concludes:

If this were to happen, the billable hour and the lawyer compensation systems grounded upon it would largely become anachronisms. Savvy outside investors would find that too many smart lawyers and too few smart systems currently inhabit our law firms.

Heineman and Lee are not as visionary in their piece, Two Veteran Lawyers Say Now Is The Time For Fixed Fees. Their point is simple if not especially novel:

Seen in its best light, fixed fees thus have significant benefits for both in-house and outside counsel: reduced billing hassles, more predictable cost to the client, more predictable and timely payments to the firm, and, ultimately, better alignment between the cost and the value of the legal service. The credit meltdown and the deep global recession may provide the impetus for real change in this corner of the economy, as in so many others.

Recognizing that results matter, Heineman and Lee suggest a Valorem-type holdback bucket:

Even with good processes, law firms under fixed-fee regimes will, of course, also be judged by the quality of their results. The fixed fee can make incentives or demerits easier to design and implement. For example, the monthly payment in a litigation could be 80 percent of the fixed fee. If a satisfactory settlement (defined at the outset) is reached, then the firm receives the withheld 20 percent. If the matter goes to trial with a positive result, the firm receives 125 percent of the fixed fee. If neither a good settlement nor a good trial outcome occurs, then the firm receives the original 80 percent of the fixed fee.

Similarly, some part of the fixed fee can be held back until after a deal is completed and acquisition integration occurs. Then the client can see if the due diligence done by the outside firm properly identified problems. A bonus could be possible if corporate performance is better than the pro forma projections. Moreover, if a law firm is managing a book of business, like labor arbitrations, as well as preventative measures inside the company, a bonus payment can be designed if the number of labor disputes declines year over year.

As I have said many times in many places, the best fee agreement for a client is one that rewards those things most important to the client and does not reward those things the client wishes to avoid.  And since no client ever goes shopping for hours, hours is the one thing that should never be rewarded.  This message gone from cacophony to symphony.  Are clients listening?

Full post as published by In Search of Perfect Client Service on August 24, 2009 (boomark / email).