One participant at a recent HBR Consulting corporate law department roundtable expressed his frustration during an alternative fee arrangement (AFA) discussion by scribbling on a napkin, “AFAs are dead.” Contrary to his belief, AFAs are on the rise. Why then is there frustration on both the law department and law firm side when discussing AFAs?
This article continues the series on how a general counsel can create and foster a law department culture that excels in the business of practicing law. Implementing an effective AFA program and managing AFAs are important components of outside counsel management cost containment.
Corporate law departments desire more alternative fee arrangements
Since the early 1990s, AFAs have been in existence in certain industries, starting with the insurance industry. Many insurance industry law departments required fixed fee arrangements up until the time of trial for certain types of defense matters. Around 2005, many manufacturing corporate law departments adopted Six Sigma light and started requiring a percentage of AFA matters in order to test efficiency savings. What then is contributing to the most recent rise of AFAs? The recent AFA wave is attributable to stagnant legal budgets, law firm rate escalations, client efficiency concern, and an increase in non-traditional legal service vendors.
According to 2013 HBR Law Department Survey, law departments are expanding the use of AFAs. Survey participant data revealed:
- 82% of the companies reported the use of AFA (non-hourly) in 2012
- 65% of the law departments plan on increasing the use of AFAs
The most frequently utilized AFAs include:
- Fixed-fee per matter: 42%
- Value or incentive billing: 20%
- Flat fee by matter stage: 16%
- Volume discount: 7%
- Contingency: 5%
- Flat fee for portfolios of work: 4%
- Other: 7% (rounded)
AFA primary challenges
Many corporate law departments have a relatively small number of AFA matters as they feel challenged in defining or managing the work required for an AFA. Other corporate law departments are concerned about whether AFA matters have negative substantive outcomes and unfavorable windfall fee arrangements. Trust, collaboration and effective communication between the law department and the law firm is essential for any matter handling but even more so for an AFA matter. Regardless of where they stand on the AFA continuum, most corporate law departments struggle in identifying the characteristics of matters amenable to AFAs and determining how to manage an AFA matter. Perhaps that is why the 2013 HBR Law Department Survey data revealed that only 10 percent of total current outside counsel spending in 2013 was subject to AFAs.
Law departments and law firms share the same two primary challenges when it comes to implementing and managing an AFA matter. First, implementing an AFA arrangement is more of an ad hoc exception to the traditional hourly billing arrangement. Second, managing the AFA matter is performed the same way as if it was a traditionally hourly billing arrangement.
Challenge 1: Implementing an AFA program
Implementing ad hoc AFA arrangements with law firms does not, on its own, create an effective AFA Program. Rather, law department leadership must invest in the resources, time commitment, training, and technology to create a strategic AFA Program. An effective AFA Program contains the following steps:
The value derived from the AFA program steps
Exploring the primary value behind just three of the steps helps identify why an AFA Program must be comprehensive and planned for well in advance.
- Data analysis step:Conducting a data-driven decision based, in part, on historical data comparisons helps establish baseline metrics and determine patterns of expected future matters.
- Scope step: Providing as much structure on specific terms, staffing, pricing and matter assumptions helps eliminate any unintended fee consequences.
- Evaluate Step: Measuring quantitative and qualitative outside counsel performance metrics helps identify necessary AFA Program and process improvements.
Challenge 2: Managing an AFA matter
If the internal lawyers in a corporate law department are ineffective in managing the business of practicing law skills for traditional hourly billing matters, they will be equally ineffective in managing AFA matters. There is a direct correlation between how well the internal lawyers manage their traditional hourly billing matters — especially with budgeting and staffing models — to how well they manage their AFA matters. Once an AFA matter’s terms have been carefully memorialized, the work of managing to those terms while maintaining a high quality of legal service begins. Training on managing to budget, staffing models, project management, invoice review, and performance metrics and measurements — all business of practicing law skills — helps ensure quality AFA execution.
Having a strategic program and ensuring that the law department lawyers are effective in the business of managing the AFA matters is essential to AFA effectiveness. Corporate law departments need to invest in the necessary planning, resources, training and technology to ensure AFA success and cost containment.