When lawyers first adopted an hours-based billing model in the mid-twentieth century, most lawyers billed around 1,300 hours per year at modest rates. No one foresaw logging 2,000+ hours per year at fees of $500, $1,000, or more per hour, which has become the norm at most large and mid-sized law firms. There’s a limit, however, to rates the market will bear and how many hours lawyers can work.
The recent recession exacerbated matters as law firms encountered increased resistance to high legal bills from their clients. In response, they developed new billing models—"value-based billing" or "alternative fee arrangements" (AFAs)—which reward value received, not necessarily hours logged. These new billing arrangements better align the interests of the lawyer and client and incentivize law firms to work more efficiently. Furthermore, they increase predictability not only of costs to clients but also of fees to lawyers.
The Association of Corporate Counsel initiated its Value Challenge in 2008 "to reconnect value and costs for legal services." They recommended a move away from traditional hourly billing and, today, corporate clients continue to push their outside counsel for even more use of alternative fee arrangements. Most lawyers believe the use of non-hourly billing is a permanent change in the legal marketplace. Nevertheless, hours-based billing still accounts for the vast majority of law firm revenues.
The American Lawyer’s annual surveys of leaders at the top 200 firms show increasing receptivity to alternative fee structures. But, moving from a billable hour model that rewards inefficiency to an alternative pricing model that promotes the opposite isn’t easy. Successfully employing alternative billing methods requires major modification in how law firms estimate, price, plan, staff, and deliver matters, and how they evaluate and reward attorneys. Firms must create and implement systems for tracking the progress of a matter against schedules and budgets to detect any problems and correct them before matters go expensively astray. Although alternative arrangements don’t require lawyers and firms to record hours for billing purposes, timesheets may not become obsolete as firms still must monitor time to determine efficiencies and work done by each lawyer in the firm.
In this increasingly competitive environment, rival law firms can use alternative billing methods as a marketing advantage to land new clients and matters. These arrangements take a myriad of forms, but include any agreed-upon billing scheme for legal services not based on hourly charges. They don’t, however, include fee discounts or blended rates where there’s still incentive to bill as many hours as possible.
Alternative fee methods include:
- Fixed fee/flat fee - a set amount for whole matter.
- Unit pricing - a set fee for each stage of the matter.
- Success fee/bonus/incentive fee - a standard fee plus additional fees for specified success targets such as resolving a case for less than a stated amount; resolving a matter within a certain time frame; or obtaining a defined result. Some law firms use a "value adjustment line" on bills which allows clients to adjust the agreed-upon fee up or down to reflect the client's satisfaction.
- Holdback - withholding a percentage of the set fee until the conclusion of the matter or upon reaching a defined goal. If not successful, the lawyer doesn't get the held back portion of the fee.
- Retainers - lawyers provide particular services for an agreed upon period for a set price. Clients also may agree to pay a reduced hourly fee for services over and above those covered by the retainer.
- Contingent/value billing - the fee is directly related to the result obtained.
Variations on the hourly rate model (not truly AFAs) include:
- Blended rates - one hourly rate for all billers on the project regardless of their various standard rates.
- Discounts/volume discounts.
- Fee caps.
- Per diem or daily rates rather than hourly rates for travel time or specific legal procedures.
A hybrid fee structure can involve any combination of the above. All alternative billing engagements require that the client clearly defines its expectations and scope of work, the law firm gives its best estimate of the cost and timeline for delivery of its services, and all elements be accurately memorialized in a written agreement.
When parties act reasonably and clarify their goals, value-based billing works well and eliminates many criticisms associated with the billable hours model. Moreover, when not paid by the hour, lawyers usually work more efficiently so the effective hourly rate often is higher than standard hourly rates. This is a win-win: the firm makes money and the client is happy with the value received.