The pros and cons of 5 popular alternative fee arrangements

AFAs are an extension of the partnership between in-house and outside counsel

When most in-house counsel describe their job, the description usually includes language to the effect of: “No two days are alike and I never know the next surprise that will come across my desk.” There are, of course, nice surprises and unpleasant surprises. Of the unpleasant surprises, perhaps none is more unwelcome than a larger-than-expected legal bill. To minimize these surprises, corporate legal departments are increasingly using alternative fee arrangements (AFA). 

The ABCs of AFAs

AFAs generally fall into one of five basic categories: contingency, flat fees, capped fees, blended fees and holdback. 

  1. Contingency. This is the oldest and most well-known form of AFA. In a “pure” contingency fee arrangement the client only pays the law firm if it obtains the agreed-upon result. While contingency usually occurs in the context of representing a plaintiff, it can also be useful in defendant cases or for determining fees in transactional matters. When used with a defendant, the company and law firm agree upon an expected damages amount. If the damages are equal to or lower than that amount, then the firm receives a fee, which grows in proportion to the extent that the damages are under budget. In the transactional context, the firm’s fee, which is generally a percentage of the size of the transaction, is dependent on completing the transaction. This arrangement usually includes a “broken deal” fee that provides some protection for the law firm.
  1. Flat fees. This is the most common AFA. In a flat fee arrangement, the firm agrees to represent the company in exchange for a specified fee, regardless of the number of billable hours. While this provides cost certainty for the company, if the firm quickly resolves a matter, the company may end up paying a higher fee than if it paid an hourly rate. The AFA can be structured so that the law firm earns a flat fee on a task-by-task or stage-by-stage basis within a single matter, or in a broader approach, for all of the company’s legal needs across the board or in a given practice area. A flat fee, of whatever sort, is usually most appropriate for repeat or repetitive engagements where both the company and law firm have a similar understanding of the necessary work and the amount it should cost.
  1. Capped fees. Under a capped fee agreement, the company pays on an hourly basis, but the law firm agrees that the total bill will not exceed the capped amount. A cap is often accompanied by a minimum fee, which together are sometimes referred to as a “collared fee” agreement. A capped fee provides the company with cost certainty, but, particularly for the law firm, may not be appropriate for cases in which the scope of the engagement is unpredictable. The parties can agree to use a “soft cap” in these more amorphous representations. With a soft cap, the parties agree on a maximum fee based on specific agreed-upon assumptions. If the assumptions turn out to be wrong, resulting in a cap that is substantially less than what the work would otherwise cost, the law firm and the company agree to adjust the fees accordingly.
  1. Holdback. Under a holdback arrangement, the company agrees to pay the firm a specified percentage of the firm’s standard hourly rate. Based on agreed-upon criteria, at the end of the matter, the firm is entitled to receive anywhere from $0 to an amount exceeding the amount of the holdback. The basis for determining the additional fee can be subjective or objective. This approach links the law firm’s fee to the client’s satisfaction with the representation. 
  1. Blended fees. Under a blended fee arrangement, the company pays the law firm a specified hourly rate, regardless of the individual lawyer’s hourly rate. This incentivizes the firm to appropriately delegate to less expensive attorneys rather than have its more expensive attorneys working at substantially reduced rates. 

In addition to the categories above, in-house and outside counsel often work together to develop a hybrid fee arrangement that tweaks and combines elements from several types of AFAs to create a bespoke solution that meets their mutual concerns and interests for that particular engagement.

AFAs, friend or foe?

Are AFAs good or bad? More and more lawyers on both sides are recognizing that AFAs are not entirely boon or bane. Many factors go into determining whether or which AFAs are appropriate and the circumstances in which they are most likely to create a “win-win” situation. Echoing the views of several in-house counsel interviewed in connection with this article, Tara Martin, deputy general counsel for Travelex The Americas Inc., an advocate of AFAs, stated that she firmly believes that AFAs will only succeed “when you have a true partnership between the company and the law firm.”  When the company and firm do not communicate with each other, at least one of the parties is dissatisfied with the AFA, according to Martin. She has found that “fee agreements do not work where one party is trying to get a ‘deal.’ In a successful fee arrangement, both the company and the law firm are satisfied with the overall bill.” 

If a law firm is not responsive to a company’s business objectives, it may raise a red flag as to the nature of the relationship. Instead, the law firm should seek to create a symbiotic relationship, working to understand the company’s concerns and designing, in a collaborative manner, the appropriate fee arrangement that is consistent with the law firm’s goals, while also providing in-house counsel with the assurance they need in an already volatile business environment.

AFAs and third-party funding – A broker’s comment

James Delaney, a specialist in litigation funding brokers and director at TheJudge, provides a broker perspective.

As described in my earlier article for Inside Counsel, the external litigation funding market is adapting to the needs of larger corporate enterprises. Where funding is secured, it will often be in tandem with one of the AFAs described above. Approached properly, a funding package can create a symbiotic relationship between client, law firm and funder, each with risk alignment to the other. The level of risk/reward is a matter for open and transparent negotiation, since there ought not to be competing or conflicting interests. The multitude of available AFAs and tailored litigation funding/insurance products provide enormous flexibility to in-house counsel in their bid to achieve cost certainty and avoid unwelcome legal bill surprises.

Contributing Author

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David Liston

David Liston is Counsel with the litigation practice of Hughes Hubbard & Reed LLP. He can be reached via email at listond@hugheshubbard.com.

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Contributing Author

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Alex Patchen

Alex Patchen is an associate with the litigation practice of Hughes Hubbard & Reed LLP. He can be reached via email at patchen@hugheshubbard.com.

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Contributing Author

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James Delaney

James Delaney is a director at TheJudge, and a specialist in litigation funding brokers. www.thejudge.co.uk 

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