Seeking alignment with your fee model

Last month, Microsoft Corp. announced a new “Strategic Partner Program” designed to deepen and enhance its relationship with the many law firms it engages every year (see New York Times, “Microsoft Shifts From Paying Outside Lawyers by the Hour,” by Elizabeth Olson, Aug. 3, 2017). In doing so, Microsoft expressed its “hope to move 90% of [its] work to AFAs [Alternative Fee Arrangements] within two years,” with the intent to “encourage a stronger alignment between Microsoft and its firms on the scope and goals of an engagement.”

That’s a laudable and appropriate goal, assuming the objective of “stronger alignment” remains primary. It is one that may help force a slow-to-change legal industry to focus on the “value” of the services it provides and not just on the time it allocates to deliver those services. And, perhaps more importantly, the acclerated shift towards alternative fees may offer the best means for achieving a more critical, longer-term objective — the effective “strategic alignment” between lawyer and client.

The key to effective counsel, to value-driven engagement, and to collaborative, sustainable lawyer-client relationships, is alignment. Alternative fees, if properly understood and effectively implemented, can, and should, be helpful in achieving an alignment that inures, over the long-term, to the mutual benefit of both lawyer and client.

Where there may be little or no incentive under a “metered” compensation scheme for outside counsel to seek and implement efficiencies, a well-constructed alternative fee arrangement will address that structural “inefficiency.”

Where there may be little or no incentive with hourly billing arrangements to ensure a predictable client billing pattern, or to mitigate billing surprises, a thoughtful alternative fee structure will address those important client interests.

Where there may be little or no downside risk or upside potential for a law firm operating under standard time-based billing terms, a creative fee arrangement ideally will offer the client downside protection and reward the highly-performing outside counsel with upside opportunity for a job well-done.

The hourly billing model, as historically applied, has generally failed to drive efficiencies, to incent or recognize superior performance or to ensure credible risk allocation between lawyer and client. That being said, if proper alignment is not readily achieved through a proposed alternative fee arrangement, the hourly fee may yet retain its relevance for designated engagements.

Alternative fee arrangements can take myriad forms. Any billing structure that diverges from the prototypical hourly model is likely classified these days as “alternative.” But is that divergence, in and of itself, really helpful? Alternative fee arrangements for alternative’s sake serve no purpose. Fixed fees, where a set fee applies to a specified project, may work well when project parameters are well understood, fairly standard and predictably routine. Employment law advice, patent filings and global equity planning, for example, may afford appropriate opportunities for a fixed rate schedule. While uncertainties could arise that affect the scope of those engagements, such as employment-related class actions, subject matters like these are generally susceptible to a steady, consistent, routine approach by outside counsel. Within that context, the fixed fee should serve to create greater efficiencies, to incent more interaction between lawyer and client and to enable enhanced budgeting by a client more knowledgeable of future legal expense.

And yet, that should not end a constructive analysis. Effective alignment demands further consideration of whether the fixed fee should adjust during the year to better track seasonally adjusted client revenues or whether the fixed fee should be modified, whether up or down, at agreed intervals based on actual workloads experienced during prior periods. For alternative fee arrangements to make sense, ongoing critical assessments must continue throughout the engagement by both lawyer and client, and appropriate adjustments should be undertaken to ensure continuing alignment.

Success fees may be appropriate when a “good” outcome is easily defined. To share in the “success,” these arrangements may also require the law firm to assume some degree of risk if the matter concludes unfavorably for the client. A sense of shared risk must underlie this model. Merger and acquisition transactions offer a framework for success-oriented arrangements, when the desired outcome of the engagement is generally understood by both client and outside counsel. There may be a premium paid to the law firm for a successful closing, and a discount applied to its bills for a failed transaction.

But what is the “good” outcome in a patent litigation? Success at trial? If the trial costs millions, but the litigation could have been settled at an early stage for just a modest payment, does that result reflect a “successful” outcome? Is it a “good” outcome if the client’s motion to dismiss is granted even if an early settlement would have cost one-tenth the amount billed for the allegedly successful motion to dismiss?

Defining the “good” outcome may not always be easy. In fact, it may lead to endless discussion between lawyer and client and significant differences of opinion. The attempt to define success, and relate it to compensation, may lead to strife. Discussing future engagements that might allow a law firm to “recover” for a failed transaction may engender disagreement. Unless there’s a “meeting of the minds” regarding a “successful outcome,” or an understanding regarding potential future engagements that may offer opportunities to reclaim “lost fees” on a failed matter, it may be difficult to reach consensus on “success-based” arrangements. Alternative arrangements like these demand a business-like approach by both law firm and client, one that is less “transaction-focused” and more relationship-focused. “Fairness,” and a level of trust between lawyer and client, must prevail for these forms of alternative arrangements to gain traction.

What about “fee holdbacks,” where a client withholds 5 or 10 percent of fees charged by its outside counsel pending satisfaction of some specified milestones? If most billing rates reflect 30-40 percent embedded profit margins for the law firm, what does a 10 percent holdback achieve? Nothing. Similar criticisms may apply to standard fee discounts or blended rate arrangements. Does a 5 percent fee discount achieve real strategic alignment? Although withholding and discounting mechanisms may sound like “alternatives,” they may be nothing more than disguised forms of “tails we win, heads you lose” fee propositions. They are not likely to enhance strategic engagement and should be critically evaluated to determine whether they achieve mutually desired long-term objectives.

Alternative fee arrangements should only be pursued and implemented if they help to achieve something that the simple billable hour does not. While a short-term discount may offer something of a near-term “sugar high,” and may address immediate client concerns, it is not an arrangement that, standing alone, is likely to strengthen lawyer-client relationships for the longer-term duration.

Absent a proper alignment between lawyer and client, any form of fee structure, whether hourly, contingent, discounted, blended, fixed, success-based or otherwise, will lead to less than optimal outcomes. Efficiencies, shared risk allocation, billing predictability and effective collaboration — the things that can lead to stronger lawyer-client relationships — result only when the interests of lawyer and client are properly aligned. To achieve proper alignment, lawyer and client must engage in a substantive, business-focused discussion about proper compensation models and apply a creativity of thought commonly lacking in those types of conversations. Detailed, understandable objectives, deliverables and expectations must inform any dialog. Law firm compensation should be based on the value the firm delivers, should be fair to the lawyers and client involved, should reflect and incorporate performance standards and aspirational targets and should be crafted with the intent of developing, enhancing and sustaining the lawyer-client relationship.

Thoughtful, intelligently designed alternative fee arrangements can help realize these objectives and can address deficiencies inherent in traditional hourly billing models. The importance of Microsoft’s announcement was not its intent simply to shift to alternative fee arrangements, a shift, frankly, late in coming; rather, the importance of Microsoft’s announcement was its recognition that billing arrangements, and external counsel compensation models, must serve more directly and effectively to align lawyer and client interests than standard hourly billing arrangements. Without a proper alignment of lawyer and client interests, no compensation model, whether innovative or commonplace, will offer mutual satisfaction to the parties involved or prove truly effective in achieving favorable results.