By David Smith
One of the revolutionary changes occurring in the legal industry in the wake of the 2008 financial collapse has to do with the pricing of legal services. For the entirety of the post-World War II period, legal services have been provided under an hourly rate structure (there are some limited exceptions such as personal injury contingent fee cases and fixed-fee bond financings). However, during the last four years, the percentage of legal work performed by the larger American law firms on some basis other than an hourly rate has more than doubled, and this trend will become, I believe, a permanent fixture in our industry.
Alternative Fee Arrangements (AFA) is the fashionable label for legal work done on some basis other than an hourly rate and the different permutations under that umbrella are limitless (a recent author enumerated something on the order of 35 different AFAs). The following is a simple description of AFAs divided between procedural and corporate practices of law:
Contingent Fee: From a plaintiff’s perspective, fees payable are a percentage of damages recovered through trial or settlement. A hybrid of this arrangement for many large firms like SKO is the performance of services on an hourly basis, billable monthly in the traditional manner, but at hourly rates substantially below the normal rates with a success fee premium to the firm in the form of a percentage of a successful recovery by the client.
Reverse Contingent Fee: In the context of defense litigation, an arrangement where the firm and the client agree at the outset upon the true exposure for the client from the subject litigation and the firm is awarded a percentage of the difference between that agreed upon exposure and the eventual outcome (assuming that the outcome results in damages paid by the client below the agreed-upon exposure).
Fixed Fee: A fixed-fee agreed upon at the outset of the engagement by the firm and the client which is payable irrespective of (a) the number of hours spent by SKO service providers in fulfilling the engagement and (b) whether the transaction closes.
Success Fee: Either a fixed dollar amount or a percentage of the value of the subject transaction is agreed to as the prospective fee which is paid to the firm only in the event that the transaction closes.
So, as they say, what’s in it for you? The immediate catalyst for the explosion of and, in the case of many corporate general counsels, insistence upon, AFAs was the financial collapse-triggered mania for the reduction of expenses in corporate America. While this may be a result (my expectation is a modest reduction in overall legal expenditures), two other rationale for, and benefits from, AFAs are equally profound:
First, clients welcome the clarity and transparency that result from AFAs as the uncertainty surrounding the cost of any particular legal engagement is reduced, if not eliminated. When the legal fees to be paid in a matter are fixed to a sum certain at the outset of the engagement or relegated to a percentage of damages recovered, the client can take comfort that the legal engagement will not drag on forever and in the process generate unquantifiable and burgeoning legal costs.
Second, apart from clarity, the risk allocation between the firm and the client is dramatically transformed in AFAs. For example, in the traditional hourly rate environment not only are there structural disincentives for law firm efficiency and project management, but the client is shouldering the majority of the risk of an unsatisfactory outcome. Where the client’s obligation to pay for legal services is tied to the result (either successful litigation or a transactional closing), then the firm is obviously working in collaboration with the client in terms of equally shouldering the risk attendant to the subject engagement.
While not a panacea for all of the frustrations clients encounter in dealing with legal difficulties, and while in many instances it is inertia on the part of clients that impedes the crafting of intelligent fee arrangements, AFAs do offer clients profound opportunities to assuage justifiable fears with respect to the management of expenditures and risk associated with legal challenges. I urge you to take every opportunity to broach the notion of AFAs with your SKO relationship attorney.