Budgeting Is the Key to Effective Alternative Billing

10/01/2012
October 2012, Law Journal Newsletters

ABA Model Rule of Professional Conduct 1.5 states that lawyers cannot charge an "unreasonable" fee. Clients increasingly say that traditional billing by the hour for legal services is not particularly reasonable, because such billing does not convey either the specifics or the value of what their lawyer did for them for the billed hours. That has opened the door to the numerous alternative billing methods that firms use today. There is nothing magical about hourly rate alternatives — they all seek to achieve the same thing. Rather than setting price by a standard unit or result, billing alternatives focus on actions taken to benefit the client.

Billing alternatives can include a blended hourly rate, a contingent or percentage fee, a flat fee, or some combination of these and other approaches. No matter what alternative is used, it should reflect a highly interactive process: The lawyer takes a direct financial stake in achieving the desired results, and the client plays an active role in deciding whether those results have been met. No lawyer wants to lose control and direction of an assignment, but absorbing a degree of risk and accepting informed client judgment are often essential elements of a strong and growing lawyer-client relationship. The best way to balance the interests of both sides is by developing a budget at the start of an engagement where alternative billing is used.

Budget Elements

There are of course different kinds of budgets within any law firm: for the firm itself, for practice areas, for functions (marketing, technology), for specific matters. Too often when the lawyers do the budgeting they are not as detail oriented as they should be, both because they are not skilled in or oriented to financial specifics, and also because they are not convinced of the value of the process, preferring to adjust on the fly. Ultimately, a budget is a valuable discipline that can save lawyers from focusing on the task at hand without planning it beforehand or communicating about it after starting. Such tendencies can undermine a workable alternative fee arrangement.

In an economic environment that favors and rewards competitive performance, budgeting a representation does not automatically translate to a discounted or fixed fee. A budget can only be an estimate of what's going to happen. The lawyer should not strive for the highest possible fee; the client should not desire the cheapest outcome. Creating a budget shows clients that their lawyers are sensitive to their needs, and reinforces that they are receiving a service of value and not just a block of hourly time. Also, by making a budget that addresses events, time and money a part of every engagement letter, a lawyer stands a much better chance of collecting the fee because the client understands what to expect.

Budgeting begins by getting as much information as possible from the client about goals and expectations at the outset. Information should cover parties, claims, anticipated strategies and desired outcomes. "Winning" may not be one of them. A client may wish to delay the final outcome for political or financial reasons, believing that a continued threat of litigation may bring a settlement. Understanding the client's objectives is the prerequisite of the budgeting process. The key is not just preparing the budget, but involving the client in the preparation. The client should also formally approve the final budget. Without client buy-in, the process is meaningless.

Creating an effective budget using alternative fees epitomizes this kind of collaborative process. Effective communication to clarify the client's objectives should define four crucial budget parameters: terms, time, money and form.

Terms

Clients, including corporate counsel, are still not particularly knowledgeable about alternative billing. Their understanding of what equitable arrangements may exist is typically not substantial. Law firms must seize the initiative by working with clients to develop specific pricing alternatives based on each client's preferences. Being proactive avoids having the client fixate on fee alternatives that may be unworkable.

Time

Use common sense, be realistic and communicate accurately about the amount of time it will take to complete any work. Err on the side of caution, and be sure to build in more than adequate time. Except when dealing with statutory or deal-making deadlines, the client is typically less concerned with exact time and more concerned about being hit by surprises.

Money

Clients should have in mind how much money they want to spend in order to resolve a problem, just as they would know what they want to spend on a piece of equipment. In either case, a higher initial cost may be acceptable if the long-term return on investment justifies it. Sometimes a legal problem is large enough that spending big sums on it is justified. Most issues, however, involve everyday costs of doing business. It makes no sense to budget $2 million to try a case if a $100,000 settlement will meet the client's objectives.

Form

It's important to know the physical form in which a client wants to receive and monitor a budget. Some clients may prefer an Excel spreadsheet, others a simple text document. A good rule of thumb is to find out how the client's own operating budget is set up and then try to integrate with it. Providing budgets and budget communication in a format that's difficult for the client to use simply defeats the collaborative nature of the process.

Budget Operation

The more lenient the collection terms that the firm extends to clients, the more cash the firm will need while awaiting payment. This is particularly true when the alternative billing method involves contingency fees, which are only collected after the matter is complete. Conversely, tough credit terms (such as charging interest on unpaid balances) are likely counterproductive — clients who won't pay their bills won't pay the interest, either. Never give in to the temptation to extend credit in the hope that the client will give you more work. This strategy seldom works. Strive to get paid quickly for the work as it is being done — and document that in terms that are part of the initial budget agreement.

When budgeting for an entire matter, such as a lawsuit in an alternative fee arrangement, there should be different budget milestones tied to success. The budget can be for the entire case, or just to that point in the litigation where, if appropriate after a certain amount of discovery, a motion for summary judgment may succeed. The engagement goal is tied to that probability, as a success bonus can be if the firm has stayed within budget to get to that milestone. Different parameters define different success outcomes. For example, if the summary judgment motion is successful (even though the full case was budgeted), the client gets out of the lawsuit, and the firm gets a success bonus. It is a win-win situation for both the client and the law firm.

Of course, there should be provisions for approaching the alternative fee if success is less than complete. One way to deal with this issue is to use a success pool in conjunction with an hourly rate. In this arrangement, the firm and client jointly determine what percentage of the hourly rate goes into the success pool. For easy calculation, assume a billing rate of $200 per hour with 15% of that rate put into the success pool. Four hours of billing ($800), equates to $120 being put into the success pool. If the firm does not achieve success based on the previously determined definition, it does not get the bonus from the success pool.

There should be provisions for different degrees of success. Suppose firm and client initially agree that the case is worth X dollars. If the case is settled for that amount, the firm gets the success bonus in full. If the firm exceeds expectations and settles the case for 20% below what firm and client had thought was a reasonable amount, then a percentage bonus above that which is in the success bonus pool would be paid. Thus, there are success gradients beyond all or nothing. But it is absolutely vital that firm and client agree on these gradients or milestones before the engagement begins.

Budget Communication

Once the budget is set, all subsequent communication must be a collaborative effort. Collaboration means communication. Because lawyer and client will each have unique information at any given time, both must advance the process together. Honesty, openness and candor right from the start will make the entire representation easier and more successful.

The budget document should be periodically reviewed, with the client approving any necessary changes. Clients should also receive ongoing information of how much they have already invested in the litigation, negotiation or transaction.

Very often we find that law firms that have difficulty collecting their fees from clients have failed to schedule enough meetings at which the clients were apprised of what was happening in the matter. When the final bill comes, the clients may feel that the amount is not in line with their expectations or with what was established in the initial budgets. Lawyers may think they are communicating when they prepare the client for depositions and pleadings and ask for documents. But that's not the kind of interaction that gives clients a sense of what's happening in their matter.

Ultimately, alternative billing is a matter of trust and agreement between lawyer and client, such that they act as a team and create a budget for future services. When it is executed properly, the parties generally find that each will assume certain risks and that costs will go down. The mere process of budgeting will focus everyone on the goal line and how to get there most efficiently so that clients get the desired result at a lower cost. No matter what alternatives are used, firms should work with clients to measure the value desired and provide legal services accordingly. That way, "value" becomes the alternative billing message, not "lower price." Knowing they received value makes clients happy. And happy clients tend to pay their bills faster and in full, and they tend to bring the firm more work.

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