Alternative Fee Structures: When Breaking the Mold Makes Sense

Alternative Fee Structures:

When Breaking the Mold

Makes Sense T he goal of alternative fee structures 1 in attorney engagement agreements is to give something to clients that they want, either a capped fee and cost certainty or a way to shift risk of loss to the attorney, while sharing some of the potential recovery. Most importantly, the goal of alternative fees is to align the incentives of the attorney and the client, while making legal fees affordable.

Alternative fee structures are generally defined as anything other than a pure hourly fee or pure contingency fee. A pure hourly fee structure entails a set rate per hour for each attorney and/or paralegal. The use of hourly fees is typically attributed to insurance companies that wanted to take more control of their legal bills. Law firms typically set an hourly rate, like the MSRP on a car, that is higher than they actually collect. A large defendant (such as an insurance company or Fortune 500 defendant) with market power—because that defendant has lots of legal work—will negotiate down the list rate. Many times, the actual rate may be well below the list rate. On the other hand, individuals and small clients end up paying at or near the list rate, which does not seem very fair. Law firms are willing to cut their hourly rates for large clients on the expectation of getting more work.

These billing dynamics can create both distrust and resentment between attorney and client at the outset of the relationship. Large clients frequently negotiate their bills by attempting to audit and cut the bills for the attorney allegedly taking too much time on tasks. Alternatively, a large client may simply exert their leverage for cost savings. Thus, for an attorney to safeguard from aggressive discounts, there is incentive to pad the bills by creating additional work tasks and tracking every waking moment spent on a file. This way, the attorney has room to negotiate the bill down.

In contrast, a pure contingency fee is where the attorney and client contract to pay the attorney a set percentage of the recovery if the case is resolved and paid prior to filing a lawsuit (at the demand and negotiation stage), a higher percentage if a lawsuit is filed, and a third higher rate if an appeal is filed. The attorney typically advances money for all expenses, which are paid back on recovery after the fee is calculated. If the case is lost, the attorney eats the costs. Contingency fee arrangements are most common for personal injury claims, where an injured client comes in the door, and there may be a police report from a car or truck wreck showing the potential defendant was at fault. For a contingency fee case to be viable for the attorney, the case requires three elements: (1) injury; (2) liability on the defendant, the clearer the better; and (3) a defendant with the ability to pay. If any of those elements is missing, a pure contingency fee is not viable for the attorney. Likewise, in business disputes, a contingency fee may be too expensive, risky, or time consuming. Alternatives to these traditional types of fee arrangements can thus be very attractive to give a worthy client access to the legal system.

Types of Alternative Fees, Where They Seem to Work Best, and How They Work Best Split-Structure: Hourly Transitioning to Contingency In a split-structure engagement, the client will pay an hourly fee for some portion of the work, and at a predetermined point, the engagement will transition to a contingency. The transition point is frequently after a demand letter is sent and no settlement is reached. This arrangement may work where a client has money to pay an hourly fee and where there is potentially a large recovery. For example, for an insurance claim arising from a severe personal injury, a split-structure engagement allows the client to not surrender a third of its recovery in what may be a quick settlement.

A split-structure engagement also makes sense for wrongful termination of a highly compensated employee or executive. The employee gets to keep the possibility of a larger payout (and less legal fees) when they think their former employer will pay rather than be sued, and the attorney gets paid before finding out what the company’s reasons for termination were. In the employment context, while there is usually a demonstrable injury (like a termination), liability is not clear until the employer comes back with their response to the demand. Sometimes the employer has a good reason for termination, or at least a documented reason that may stand up. This typically does not come out until after a demand letter has been drafted and sent—with usually a decent amount of work, making the contingency worth far less. Other times, the defendant’s liability is clear—or at least their desire to settle is clear—and settlement occurs. The lawyer is paid for his or her time—at the normal hourly rate—and the client keeps the settlement, which, after the legal work, is usually more than it would have been had there been a contingency fee.

After a demand has been sent and negotiations have failed, the facts establishing (or negating) liability will usually be clearer, and the attorney and client can then transition to a contingency fee, if it still makes sense based on the risk of liability and possibility of collection. Hybrid Contingency Fees In a hybrid contingency fee structure, the law firm combines a percentage of its hourly fee and a proportionate reduction in a contingency fee on the outcome. For instance, the law firm will charge half of its hourly fee and will receive 20% of the settlement of verdict. Hybrid contingencies are most often used in business litigation, but can also be used on behalf of a personal injury plaintiff who has the funds to pay a smaller hourly fee to retain more of the settlement or verdict result.

A pure contingency fee is used in most personal injury cases because most personal injury victims do not have the money to fund a lawsuit when they are injured, out of work, and have to pay medical bills. When an injured person has a high net worth and the ability to pay hourly fees, particularly when liability is clear and there is a serious injury, it makes sense for the injured person or their family to pay either hourly or on a hybrid contingency. 2

In business litigation, it is often appropriate to insist on a hybrid contingency, rather than a pure contingency. In these cases, the first two elements of a successful contingency case are not clear—injury and liability. Business litigation is rife with bad emails that can turn the tide of a case half-way through or establish counterclaims. Clients are far more likely to disclose bad emails or bad facts early if they are paying fees throughout. Clients, knowing the attorney is on a hybrid contingency, are less likely to feel that an attorney is over-billing.

Who pays expenses depends on case complexity. In a typical business dispute, if deposition and expert expenses are split, there is a discussion of costbenefit of the action or expert. Both the client and lawyer have skin in the game, ‘‘

Alternative fee structures are generally defined as anything other than a pure hourly fee or pure contingency fee. A pure hourly fee structure entails a set rate per hour for each attorney and/or paralegal.”

sharing responsibility and risk. Alternatively, in a complex intellectual property case, hybrid fees provide risk management of the fee structure, and the client weighs the cost of litigation against its business goals. Flat Fees Flat fee or “fixed fee” arrangements are typically arrangements where the attorney agrees to handle a matter or group of matters for a sum certain for the total matter, or for a certain amount of money per month. Monthly flat fees are best used for clients with steady legal work that want a lawyer on call and legal expense assurance that the client can budget each month, and the lawyer wants guaranteed income each month.

The difficulty in any flatfee arrangement is determining pricing that makes both the attorney and client happy. Clients wants to know that they are not overpaying, and the lawyer wants to be sure that while there is steady income, the client’s legal demands will not eat up too much time. Where the attorney has done work for the client for a while and has a pretty good idea of the time commitments required, the attorney and client can agree on a monthly price based loosely on the average amount of attorney time the client has used in the past. A way to formalize the cost process and balance the risks is for the attorney and client to agree to a set amount of money each month. The attorney keeps his or her time each month. At the end of a fixed period (usually a year), to the extent that the attorney has billed more than double the budgeted amount of hours, the client pays for the extra time. To the extent that the client has not used more than half the amount of hours, the attorney will refund a set percentage. In this way, if the client does not have many legal issues, they are not greatly over-paying for legal services they do not use—and the money paid is for the peace of mind of having an attorney ready for them, and if the client unexpectedly has more legal work than usual, the lawyer does not eat the extra time. At the end of the year, the monthly legal flat fee can be reset based on the prior year’s billings and the next year’s expected needs.

Flat fees also work for smaller corporate matters that a law firm has done many times in the past or does on a regular basis and can utilize prior forms or prior work to benefit newer clients. In this case, the law firm does not charge the first client the lion’s share of the legal fees, and have subsequent clients—if they are on an hourly fee—get the benefit of prior work without paying for it. For very simple things, setting up simple single-member LLCs, a low flat fee can be used, particularly as a way to get a client in the door. For more complicated, but still smaller, corporate work, the flat fee should price in legal counseling. No flat fee should be agreed, even for single member LLCs, without first learning about the client’s industry, goals for the future—bringing in partners or investors, and business experience. This is because certain industries are regulated, an attorneys’ forms may not be useful, and the matter may take longer than budgeted. When contacted about flat fee work for smaller corporate matters, a good practice is to allow a halfhour consultation, in person or on the phone, to learn basic facts to see if the flat fee will be viable. If it is not, it is important to explain that to the client, so they do not think it is a bait-and-switch, and to make sure they do not go to an online legal document repository and set up an illegal business. My firm has been contacted by doctors who want to go into a ‘‘ Flat fee or ‘fixed fee’ arrangements are typically arrangements where the attorney agrees to handle a matter or group of matters for a sum certain for the total matter, or for a certain amount of money per month.”

business that, on first glance, did not appear to violate the law on doctors being in medical businesses with non-doctors, but after a few questions, realized it definitely would violate the laws. We were still able to work for these clients, but it was a more complicated endeavor that was not subject to a flat fee.

Flat fees are not the best option for single litigation matters. Flat fees in litigation tend to discourage settlement and can create friction between client and attorney over things like the number of depositions to take, experts to hire and motion practice. Because the client has already paid, or agreed to pay a certain amount, the client wants the attorney to do everything possible. The lawyer has financial incentives to do as little legal work as possible on the case. Even if the lawyer is not doing the bare minimum, the client may perceive that the lawyer is not doing enough. The only time a flat fee should be used in litigation is: if the attorney and client agree in writing on the desired outcome; if the lawyer can get the outcome at any point, the lawyer can settle the case for the pre-determined desired outcome; and if the attorney retains the authority to settle based on these parameters. All such agreements must be in writing. Further, if it is the type of case that will require experts or depositions, there should be an expense agreement whereby the client will begin paying expenses above a certain point.

Non-Negotiable Hourly Rates and Non-Negotiable Bills While still an hourly rate, an alternative to the common practice of higher list rates, negotiation of rates, and negotiation and discounting of bills is a non-negotiable hourly fee. This practice, which my law firm uses and is very upfront about with clients, is to charge an hourly rate that we believe is fair in the market at the price that it is set, without an expectation for discounting. We audit ourselves and show the client anything we write off, but we do not discount the bills on a percentage basis, nor do we discount

the hourly rate for any particular clients. Everyone pays the same rate, and nobody negotiates the bill.

If you are very up front with clients about this approach, they appreciate it. Clients get a fair bill, which eases much of the tension when the bill goes out and at inception. Smaller clients know that they are not being charged more than large clients. Larger clients know what the billing rate is going to be and what the bill is, and there is no incentive for the billing manager, inhouse counsel, or accounting department to try to negotiate the bill or have to answer to a higher-up about why the bill was not negotiated. The bill is the bill.

Conclusion Clients frequently say that they want an alternative fee arrangement. However, the traditional hourly fee and pure contingency fee still dominate legal billing. For an alternative fee arrangement to work, it has to align with both the goals of the attorney and client, and their incentives. Alternative fees can work well, and have worked well for my law firm, but only when discussed early and honestly. Seek what is best for the client in the fee arrangement, but make sure that it still protects the law firm’s interests. An open and frank discussion of the risks and benefits of each type of fee arrangement, done in conjunction with the initial consultation, adds value to the representation .

Joseph M. Schreiber is a founding partner of Schreiber | Knockaert, PLLC. His practice focuses on personal injury, business litigation, and employment disputes.

Endnotes 1. This article addresses fees primarily in the civil litigation context, the primary area of my law firm’s practice. I do not have experience in criminal law, large deals, tax work, immigration, or family law. Those areas may have different fee practices that

I cannot and do not address 2. My firm has represented high-net worth individuals on hybrid contingency fees in personal injury litigation, usually in cases where we would rather have had a pure contingency for our own financial reasons, but for the same reason, it was in the client’s best interest to retain some of the risk and pay fees up front to receive a