An Interview with Hugh Gottschalk

09/01/2004
Reprinted from:
September 2004

ED POLL: Our topic today is alternative fee arrangements, or as one attorney describes it, alternative pricing structure. In today's world the preeminent method of billing is based on the hour. Has this always been the way that lawyers have billed for their services, and if not, how did we get to where we are today?

HUGH GOTTSCHALK: I'm fifty-one, have been practicing since 1979, and it has certainly been the predominant method of billing during my career. I have heard folklore from older lawyers particularly in the younger days of my career that in times gone by, in the thirties and forties and fifties, it was not, and that it evolved in the fifties and sixties to the hourly rate being predominant. I'm not sure I know how it got to be that way. What I do know is, in the last few years it was clearly the predominate way that lawyers billed for their time.

ED: There's been a lot of dissatisfaction in recent times expressed with the methodology of billing by the hour. I know there's a lot of pressure on it particularly since bar associations can no longer be involved with the process. Is there anything right with this system?

HUGH: Clearly there is. There could be improvements. I guess my overwhelming reaction to discussions about types of billing is to recognize that it is a billing process, and any billing process covers engagements by lawyers to do small divorces, covers engagements by Wall Street to do mergers and acquisitions of billion dollar companies, covers engagements of lawyers to do personal injury litigation. It covers the gamut. Its obvious benefit is that it allows the client to purchase and pay for exactly the proportion of or the amount of work that is needed, and to not have to worry about overestimating or underestimating. So at a very functional level, I think it works fine for what it does.

ED: What's wrong with the system?

HUGH: The obvious problem with hourly billing is it incents the lawyer to increase the amount of time spent. Maybe a more fair way to say it is that it does not encourage the lawyer to look for ways to cut corners and cut time. The more time spent, the more money made. There is obviously a natural financial incentive, even if you assume good faith and fairness on all sides, (and an incentive on the margins) to do more rather than less and charge more rather than less.

ED: If it is inequitable as you're suggesting because it incentivizes lawyers not to look for the most effective or efficient way to practice, why is it that we're still using it, and why is it that it seems so many clients still prefer the old way or the hourly billing method instead of some new way?

HUGH: I'm not sure I would agree with your word "inequitable." I don't think it is inequitable. I think it works. I do not think most lawyers abuse or consciously overcharge clients. It just creates an incentive which across the gamut systemically can be criticized for encouraging unnecessary work at the margins. But going to your question, the alternate way of doing it is to fix a price, instead of a fluctuating price based on somebody keeping track of the hours and price per hour; there's your price. The alternative way of doing it takes work. It takes planning. It takes analysis. It takes agreement on both sides. In many cases where the amount and the nature of the work are not well defined, it is difficult to find agreement, to get the client and the lawyer to agree on what the fee will be in advance.

ED: I know these are not your words. Let me put it into my words. Because you talk about the requirement to plan, to budget, to really analyze the case before going forward if you're going to use some method other than the hourly billing, does that suggest that perhaps lawyers are either unable or lazy to sit there and do the planning? That of course is before we talk about the requirement for agreement that you suggested.

HUGH: I wouldn't use the word "lazy" but I'd say it is not normal for them. I do, for example, construction litigation. And in the construction industry contractors think nothing of spending hundreds of hours doing estimates and calculations and figuring out exactly what's going to need to happen in order to provide a fixed bid for the work they're doing. Now obviously there is more certainty in building a structure than there is in handling a lawsuit or doing a deal. But in addition to the uncertainty that's involved in the legal side of it, at least from where I sit, I don't think lawyers have the culture and comfort of spending a lot of unbillable time estimating fees and estimating work and doing calculations. So I'm not sure it's lazy as they're not comfortable with it.

ED: And of course, at least in my awareness, there's nobody teaching us how to do it.

HUGH: That's right. As you say that, I'm trying to think of people who you know would do the construction analogy of how you develop a bid and I guess I don't think I've ever heard of anybody doing that.

ED: By virtue of our having this interview today suggests that you have done that. My question would be how did you learn how to do it? Is this all an OJT kind of a thing, on the job training, and you've spent many mistakes getting to the point where you can do it now?

HUGH: It's clearly on the job training. I know I certainly didn't learn anything about it in law school, and can't think of any CLE I ever attended that helped me do it. I have developed budget forms that lay out litigation tasks in great detail. Again if you go back to the construction industry analogy, contractors have computerized forms that lay out every possible thing that can happen on their type of construction and when they do a bid they simply go through their checklist on the computer and the computer generates what the ultimate cost is going to be. I have a similar form that I've developed over the years and I literally go through and figure out how much discovery hours and how many case planning hours and how many airplane tickets and all that I think will necessarily go into the litigation we're talking about.

ED: Well other than doing the budgeting that you're talking about and coming up with a flat fee or a fixed fee, however we might describe it, what are some of the other alternatives to hourly billing?

HUGH: Well, let me break it down into two pieces. One is the alternate to the hourly rate, which allows you to jump into the matter without really much ability or need to predict. The thing we've been talking so far is when you need to predict, what's the process you go through to identify the tasks and the work and the time and the cost? Once you've done that, I may come up with a budget form that says two hundred thousand dollars.

But then there is a completely different task. Now that you know or you think you know what it's likely to cost, what is the client willing to pay? Are they going to do a two hundred thousand dollar fixed fee agreement? Do they want to do some incentivized thing? Once you've figured out the cost, or what you think is the cost, you move into something completely different, which is how does the client want to structure a fee agreement in light of what everybody now thinks it's going to cost?

ED: Well that's interesting that you talk about cost in that context. When you say that, what comes into my mind is the idea of how many hours is this going to take, times whatever billing rate I want to charge, and that comes up with a quote cost. Is that what you're talking about?

HUGH: Ed, it's funny you would mention that because that's precisely what I'm talking about. And I suppose, given the topic of this conversation, that shows sort of a subconscious holding on to the hourly rate even though you're overtly not holding on to the hourly rate. If I do a fixed fee contract with a client, it will be measured by me and my partners as whether I did better or did worse at the end of the day with a fixed fee, with an hourly rate engagement. Quite frankly, I think that's exactly right. I can tell you from my experience at two law firms, in particular, where I have been in management, that as law firms are managed and partners are compensated, and money is distributed, how profitable you are and how much work you're bringing in is a significant element of that. On a fixed fee basis, if you can do better than your brethren are doing in bringing in their hourly rate work, that's a feather in your cap. If you do worse, then it's something that will be a detriment to your compensation. I'm not sure whether it's sort of a psychological anchor to hourly rates or whether it's just a realization that if most people are still doing most of their work on hourly rates, when you do something alternative, that alternative will ultimately be compared against an hourly rate engagement.

ED: I'm not sure anchor's the right word, but the underpinning to the success of any method in the larger matter, where you're dealing with the more sophisticated corporate America, is that you've sat there and you've planned it. You've analyzed it. I think that may be one of the differentiating factors, would it not, to the earlier or current method of just hourly billing, where you just, what's the expression, fire and aim?

ED: Rather than fire and aim, what you're talking about is really aiming and then firing.

HUGH: I think that's right.

ED: Well how does our discussion today play in comparison to the ABA model rules of professional conduct and similar rules across the country, Model Rule 1.5, where we talk about the fee being reasonable? Is this impacted one way or the other depending on which method of billing we use?

HUGH: I don't think so, at least in the kind of work I do. I tend to deal with very sophisticated clients. Most of the individuals I am dealing with as clients are lawyers themselves, are very well versed in all these issues. They know exactly whom they're hiring, what they're hiring them for, what the marketplace is. They know what I charge. Even if I do it on an hourly rate, I'm typically giving some sort of budget estimate even if it's not binding. For complicated legal problems, if a sophisticated corporation through its corporate counsel decides what I'm charging is what they need, whether it's an alternate fee or an hourly rate, I don't think that really implicates 1.5 at all. I think 1.5 is more directly applicable to when you're dealing with less sophisticated customers and the lawyer has an obligation not to take advantage of their lack of sophistication.

ED: Hugh, many lawyers believe that corporate counsel are merely trying to lower their legal costs, and that there's no benefit to the lawyer. Can you describe what some of the benefits might be to the lawyer as well as to the corporate world?

HUGH: The primary benefit to the lawyer is you don't lose your client.

ED: That suggests that corporate America is moving rather quickly toward something other than the hourly. Am I correct in understanding the sub text of your comments?

HUGH: I would say they are moving; I would not say they are moving quickly. I think that there is no doubt that corporations are trying to take a more rigorous business-like approach to legal fees and looking for other ways to measure performance of outside counsel on matters to generate compensation consistent with results. I have personally worked on relatively small matters for a longstanding, corporate client where they are very cost conscious and I've worked on very large matters that are of interest to the board of directors where cost is really not a consideration. I don't know that you can make a general statement across the board, but what I do see is that in most areas of the corporation, getting "bang for your buck," deciding what you want to purchase, what the parameters of the product you're purchasing are and paying a fair price for that is a fundamental business philosophy. I think that is clearly being injected into legal departments in ways that it hasn't been in the past.

ED: And when we talk about fair, I suspect we're talking about the competitive fairness. Am I correct?

HUGH: Competitive fairness, but also I go back to commensurate with the task at hand. If you know you've got a relatively small product liability case, you know the corporation looks at that as a cost issue. They want to manage that cost. There's no strategic significance. They want to manage that as cost effectively as they can. If they're doing a IP or trade secret case where the core technology of the company is at risk, they may pay a whole bunch more for legal services and consider it eminently fair, if they're getting the best representation possible. I really think it's not so much fair in the sense of what do I charge, compared to what the guy across the street charges, it's fair in the sense of what do they think they're buying? Do they think they're buying the very best trial lawyer for their most serious problem? Or do they think they're buying a good competent lawyer to help cost control lawsuits as they come up in the company?

ED: One of the critical elements of alternative billing, as I hear it explained, and as you discuss it now with the client understanding what they're buying, is that the more important the issue is to them, the less they're going to worry about what the cost of the legal service is. That the lawyer has to move away from his or her attempt to be perfect which is counterculture to what we've been taught in law school. It talks then about not leaving any stone unturned philosophy. How is it that the lawyer can work in this environment and not be subject to a malpractice suit?

HUGH: Again I think there are different strata. I think you and I are talking about primarily representing sophisticated, significant corporations on the legal matters that they have. In that world, I think the answer is communication. Quite frankly, I think malpractice is much less of a risk than just making or leaving the client unhappy and losing a client. Theoretically, even in a cost conscious environment, you're going to do the things that you know provide minimum competent representation; neither you nor the client would think you'd expose yourself to malpractice. But the question you're asking, I think, more directly is within the bounds of competent representation, are there things you could or could not do that are really a matter of cost efficiency? I think the answer is communication. I've had this conversation many times with clients, it's a risk. We can turn over all the stones and have a ten percent better chance of winning. Do you want to spend another hundred thousand dollars for a ten percent better chance of winning? If you don't, let's identify the stones we're not going to turn over, and let's jointly recognize that we have created some risk that one of those stones may cause us some problems. That's a risk that we have jointly agreed we're going to take. If the lawyer makes those decisions all by themselves, I think they do take the risk of a client who's unhappy with those decisions. If the lawyer involves the client and it is a joint risk in pursuit of cost effective legal services, I think that risk is very small.

ED: When you talk about joint risk, what's the risk to the lawyer?

HUGH: I probably misspoke. I don't mean joint risk. I mean jointly decided. Joint decisions about the risk.

ED: The way I heard it the first time, I get scared. As the lawyer, I don't want to take any risk.

HUGH: I don't want to take a risk that my client hasn't agreed upon. For example, there may be third party witnesses on the East Coast and we want to depose them. I've interviewed them and I've found out they don't have a lot to say. But you know once I get them under oath, I may find some good stuff. Should we spend ten thousand dollars to depose the witnesses on the East Coast. Let's not do that. Okay. It's a joint decision. If at some point it explodes and turns out one of those witnesses really did know something, if the client is honorable and recalls this was a joint decision, it's a risk the company took based on a joint decision between the client and the lawyer as to what were the elements of cost-effective representation.

ED: Hugh, if one of the principal ingredients of alternative billing is that fees are paid by value rather than by time, who sets the value? And if the client sets the value, how does the client get educated to understand what the value is and for that matter how does the lawyer get educated to understand what the value is?

HUGH: That is one of the impediments to moving away from the hourly rate. When you said corporations are moving quickly, I said, "I didn't think they are moving quickly." This is one of the reasons. I think it is very difficult for either side. I mean it's very difficult to predict given the nature of litigation, which is what I do, to really make those judgments in any sort of objective way. It is probably more difficult for the corporation. I think that a corporation has some hesitation to make binding fixed fee type commitments when the case could settle in the first three weeks. And then all of a sudden the corporation's paying way more than it should. It is just very difficult to determine value. It is very difficult to determine that sort of thing objectively, which is an impediment to going to these alternative methods.

ED: You said if the matter settles in the first three weeks on a fixed price matter, then the thought is it's sort of buyer's remorse in that the company is paying too much because they could have settled it, in fact did settle it, early. But didn't they get value?

HUGH: In the big picture, they certainly did. Let me give you both sides of the answer. One side is, yes, they clearly got value because they got rid of a lawsuit that could have gone for years; they could have spent hundreds of thousands of dollars; they got rid of it quickly; they saved management administrative time; and they got certainty. It was a great outcome.

ED: And the bottom line is they actually did get what they want.

HUGH: Right.

ED: They got extricated from the matter.

HUGH: The opposite side of the argument is I paid this lawyer a gob of money and he didn't really do anything. It may have settled for circumstantial reasons unrelated to the value that I contributed to the process. It may have been completely fortuitous. In fact, on a fixed fee arrangement, I had a client where one of the other defendants filed a personal jurisdiction motion in a case filed here in Colorado. We sat around, didn't do anything for a couple of months while that was being decided. It was granted. That defendant was dismissed. The plaintiff then decided they were going to go to that defendant's home state, but then decided, because it was not a favorable forum, to drop the whole case. We got rid of the case, from my client's perspective, for virtually nothing. I did almost no work in the case. It wasn't a fixed fee, but under our schedule of fees, I probably made a hundred times my hourly rate on that. We talked and negotiated and we compromised. I thought the fee as scheduled was grossly unfair. That particular case had nothing to do with my talents or the value I added to the engagement; it just worked out that way. I would have been a huge fortunate beneficiary of circumstance.

ED: You describe your own psychological feeling of guilt in taking so much money. On the other hand, if it had worked out the other way and you were upside down in the matter, you wouldn't have felt guilty, you would have felt resentful that you're doing it for something less than what you, "should have gotten." Would you have been able to go back to the client and say, "You know this just isn't fair on the other side of the ledger, and you should be paying me more money than what we agreed to?"

HUGH: I think the short answer to that question is it depends on the agreement that the parties have. I mean I think you can agree with a client that it's airtight, each side agrees to take the risk of fortuities and third party events, and whatever happens happens. Or you can agree that this is a semi-airtight thing, but both parties will reconsider if circumstances really work out differently. If somebody files an antitrust counterclaim to a product liability case, we're going to renegotiate. And almost all of the alternate billing arrangement I've done have that element to them. The expectations of the parties are not that this is airtight, no matter what. The expectations of the parties is this is an alternate way to price and value the services; we both think this'll work out fair. We'll both take a risk plus or minus thirty percent, but if it's more than that and it's more than that for external reasons, we'll renegotiate.

ED: Well, Hugh, one of the things that is underlining here is the aspect that we're talking about litigation. And just as a side note, do you see this working in transactional matters, or is it still just for the moment limited to litigation matters?

HUGH: My expertise and knowledge in transactional matters is very limited so I have almost a casual normal citizen's view rather than any unique lawyer point of view. I read a variety of materials about Wall Street M & A deals, and the Wall Street law firms who make millions and millions on those kind of deals are incredibly resentful of the investment bankers who take ten percent or eight percent. The New York and the Wall Street law firms walkaway with eight million dollars, and the investment bankers walk away with a hundred and ten million dollars. They're roughly doing about the same thing, putting the deal together. I guess you could certainly go to it. I don't know what the pros and cons of it would be.

ED: If the client says that the value of the service to the client is priceless, or if the client says that it's inestimable, and you get the desired result for the client, how do you determine the fee to be paid? Is it based on a percentage? And if so, what would that percentage be?

HUGH: The only real answer to that is it's got to be by agreement. I just finished handing a lawsuit for a huge multi-national company where the issue at hand was something of board of directors level of concern. By any stretch of the imagination, the outcome was worth hundreds of millions, if not billions of dollars, for this company over the next ten years. You know the other wasn't any serious consideration, that if I won I would get a hundred million dollars. You just can't look at it like that. They can say we're willing to pay your rate or we're willing to give you a premium. But, just because I achieved a result that resulted in the benefit of a billion dollars to a company, that doesn't immediately tell me at all what my fee should be. What my fee should be is whatever we agreed to. And so in that particular case, we had a fixed fee agreement for the litigation, and a bonus of agreed amount if I won. And we did. And I got a bonus that was what we agreed. It was a pittance compared to what was at issue in the case, but it was what we agreed.

ED: So, you're saying that the mortgage bankers might be able to get a percentage of a result, but lawyers still are not in that position?

HUGH: One of the problems of getting a percentage of the result is when you're on the plaintiff's side, there's a number at the end of the day, six million four hundred twenty two thousand, three hundred eighty-one dollars. In a Wall Street merger, the deal has a value of thirty eight million dollars, or thirty eight billion dollars, or whatever it is. So there's a number, and it's a relatively visible and objective number, that you can apply a percentage against. Although I tossed around in my prior comment that this was worth hundreds of millions, even a billion dollars, to my client. That is a very nebulous sort of calculation. It had to do with the operational efficiencies. There really wasn't a number that you could see on any piece of paper that would be the outcome number you could apply a percentage against. Particularly on the defense side, that's true. You can talk about saving the client tens of millions of dollars, that's true. But if you really got right down to it, it would be very difficult to pick a number against which you could factor some percent.

ED: Hugh, if beauty is in the eye of the beholder, and in this case, we're talking about value, and assuming that you have the client, so we're not talking about the competitive bid here, what would the process look like? How could you reconcile the differences in opinion of value between the client and the law firm?

HUGH: I think that's simple. That's a deal. Somebody wants to buy widgets and somebody wants to sell widgets. And they either agree that the widgets are worth four cents apiece or there's no deal. I've had lots of clients who come to me and say I have this big huge case and I want you to represent me and I say I charge what I charge. And they go holy cow, I'm not paying that. And they go to somebody else. The answer to your question is if we agree on what I'm going to charge either by hourly rate or by alternative method, we have a deal. If we don't agree, then we don't have a deal, and they find somebody else they can do a deal with. I'm literally right now with a long-time client going to do apiece of litigation on a fixed fee basis subject to fairness reopeners that I mentioned before. We've talked about it and because we have a track record, I think it's very likely we're going to reach agreement. But it's always possible I could negotiate too hard or ask for too much, or they wouldn't value my services or contribution as much as I think they should, and they go someplace else.

ED: Underlying what we're talking about is the need for the lawyer to really understand what the client wants, not what they say they want, but what they really want. Secondly, there is the need for the lawyer to create a time line both of costs and events to understand what this really looks like or what's going to play out, at least as best the lawyer can understand the future. Yet we were never taught this in law school, at least I wasn't. I don't think they're teaching it today, yet, in law school. How, do lawyers intuitively know, in your experience, how to do this? Or where do we go to school to figure this out?

HUGH: It's on the job training as you say. I think it would be hard to teach in a law school. You could do a little bit of it. But at the end of the day, this is a process about predicting. I predict that future events in my client matter, my lawsuit, are going to go this way and that way, and they're going to last about this long, and these are going to be the constituent elements, they're going to take about this much time. Because I've done lawsuits for twenty-five years, I have some high degree of confidence that we'll have a couple of motions to compel and there will be thirty depositions. It is that ability to look forward and see the process that is the foundation of saying this is what I think the process will cost, or this is what I think the value is going to be to the client. I don't even know how you can begin to embark on that process until you, have a rudimentary knowledge of lawsuits and depositions and how they work and not in the sense you learn in law school. I don't really see how you can be in a position to quantify value or predict the course of lawsuits or transactions until you've done them for a while.

ED: In other words, you're not going to build the Chrysler building as an architect or as a contractor until you've built a few buildings that are twenty and thirty stories high to get the experience.

HUGH: Exactly. And you're not going to know the approximate cost of building the Chrysler building until you've done it a few times in the past.

ED: So, all of this comes back to the fact that a new lawyer couldn't do this. There's got to be an experiential factor. With the pressures today, the competitive pressures today on the law firm, where clients are not willing to pay for the learning curve of newer lawyers, how is it that we can teach our newer lawyers the skills they need to know to get to the point where they're in your seat with your knowledge to be able to do these kinds of things for the kinds of clients that you have?

HUGH: Ed, I think that is a classic conundrum faced by all businesses. It's short-term yield versus long term investment. I can work an hour today on a billable matter and earn whatever I earn, or I could spend time training younger lawyers in this skill or any other skill or taking my secretary out to lunch, or doing other management things that don't earn me any money in this hour. But they are good uses of my time in investing in my enterprise. I don't think the dilemma lawyers are facing in the training of young lawyers in this or any other skill is any different than any business faces. You can spend a lot of time earning money right now and not investing in the future, or you can find the balance in your enterprise of current yield versus long-term investment. We do it a certain way. I do it a certain way, but I'm not sure there's any formula.

ED: What kind of advice might you give to a newer lawyer so that they could be prepared for the kinds of changes in our profession that you might see on the horizon?

HUGH: You know, it's funny. I don't think I'd need to give them any advice because I think it's the old dogs like me that are sort of stuck in the past and resistant to change. Every new client or corporate demand is an aggravation that needs to be dealt with. Younger lawyers are much much less hide-bound to the ways things have been. I think my only advice on this issue is my advice in general to younger lawyers which is the customer is number one. The customer is always right. If you're in the consulting business and you're a highly paid lawyer, you can forget that and think the world revolves around you. But whether it's the definition of their legal needs or meeting their budgetary constraints, recognizing that the customer is always right is the most important issue. One of the things that I have always tried to do and tell the people around me to do, when some client comes to you with some budgetary administrative documents, or some new way of billing, or an alternate fee arrangement or some arcane proposal that's new and different and your first reaction is "Oh my God, I've got to figure this out," and "I've got to do this differently," and "it's more complicated than hourly billing," and "I haven't done this before," and "it's sort of a minor aggravation," the way I look at it is this is a competitive advantage. If I can do this task, if I can respond to this change in process and procedure, if I can meet my client's needs at this administrative level better than my competitors because I'm faster on my feet, I'm more responsive, I'm more flexible in how I meet the need that's being expressed, that's a competitive advantage I have. I look at that flexibility, that creativity, that responsiveness the client needs as a competitive advantage, just like giving a better closing argument than the guy across the street.

ED: Hugh on that positive note, I want to thank you for joining us today and sharing your views with a proposal for the future if not already here in the present. Thank you very much.

HUGH: Thank you very much Ed. It's a pleasure talking with you.

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