In an effort to step away from the orthodox method of working via billable hours, software giant Microsoft announced last month they are planning to shift 90% of their legal work to retainer-based models, flat fee, capped fee and performance-based models. Microsoft hopes that alternative fee arrangements (AFAs) will encourage deeper partnerships between the company and its outside legal advisors by adopting this ‘on-call’ mode of functioning, which eliminates charging on an hourly basis. Fourteen law firms, including K&L Gates, Latham & Watkins and Sidley Austin, working with Microsoft have agreed to this change and are a part of their renewed program. This measure from Microsoft is expected to spike adoption and implementation of AFAs with other corporations as well.
According to a survey by Aderant, a software service provider for law firms, almost 26% of outside counsel work is currently structured under AFAs, a significant jump from a meager 9% only three years ago. Key drivers affecting this rise in adoption include deeper engagement between a firm and outside counsel, savings on the overall cost of services and a reduction in timeline for some milestone-based cases. Also, AFAs help companies bring in a performance-based system for critical matters and the perception of higher bargaining power for clients. These are desirable pros if law firms are hesitant to move toward AFAs.
An AFA can be defined as a fee plan completely different from the traditional mode of hourly billing. Some key AFAs include fixed/flat fee, retainer fee, success/contingency fee, blended fee and capped/collared fee. These fee models can be used depending on the specific types of practice areas or legal requirements. For example, in flat/fixed fee, the price is pre-negotiated and clients pay the entire amount upfront. These are generally adopted in transactional legal matters such as reviewing contracts, compliance, or practice areas repetitive in nature, so both the law firm and client are in a win-win situation. The length of these matters is predictable and it’s simple to estimate a flat fee pricing model.
Patent litigation cases and transactional cases would use the success fee and flat fee pricing models respectively, as in both cases clients receive savings and higher quality of service, while the law firms are motivated to provide successful results to receive their paycheck. The fixed fee model is the most adopted model among AFAs, preferred by 60% of clients. Adoption rate for the fixed fee model is three times more (60%) than the next in line – capped fees, accounting for 20% of overall AFAs. The remaining 20% is made up by fee models such as performance-based, retainer-based and blended fee. Flat fee is when a specific amount is assigned to a case and cannot be adjusted later, while capped fee sets a ceiling price on what the client will pay the law firm.
Adoption of AFAs is quickly growing in the industry. Pfizer recently selected a small group of law firms as preferred providers for most legal matters, including litigations requiring representation of the company using the fixed fee model. In another example, Levi’s negotiated a fixed annual fee for worldwide representation in all legal matters (excepting their intellectual property assignments) with one of their vendors. If the law firm does not have an office in a location requiring representation, they are required to hire local counsel to handle it, with services remaining within the agreed fixed fee. It is estimated that companies can save as much as 25-35% based on the type of AFA adopted.
A key challenge while drafting an AFA is in implementing a program where proper investment of resources, time, commitment, training and technology is implemented by both outside and in-house counsel. Frequently, in-house counsel finds it difficult to plan and budget a case with an AFA model and recommends the staff required to work on the case. Guidance on managing the budget, staffing models to adopt, project management, invoice review and, above all, methods to measure performance will help ensure successful execution of AFAs. With AFAs becoming a substantial part of the legal industry, law firms should nevertheless expect to receive pushback from clients as they slowly but surely move toward adopting AFAs in contracts.