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Article after article, panel speaker after panel speaker—in 2009, legal practitioners loudly proclaimed the death of the hourly bill, and its obituaries focused without exception on the new wave: "alternative fee arrangements."

Some law departments, confronting reduced budgets and increased litigation levels and looking to control cost by any means, are wading in for the first time. Others are enjoying unprecedented, recession-driven willingness from their outside firms to embark on alternative fee-based billing structures, sometimes on a broad scale. In any event, it’s clear that the unmanageable rate of inflation for legal services is coming under scrutiny.

"It used to be lonely out here on radical fringe—not so much anymore," says Jeff Carr, general counsel of FMC Technologies and a long-time proponent of value-based billing. "But there are also a lot of people who say, ‘I want to do this but I don’t know how.’"

Fulbright & Jaworski’s Litigation Trends survey of U.S. and UK corporate counsel, released in October 2009, found that the economic downturn had pushed 35 percent of corporate respondents to increase their use of alternative fees.

Across the legal industry, Nicky Mukerji, global director of LegalBill, a consultancy that provides help to clients structuring AFAs, estimates that only about 2 percent of total legal billings currently are being done on an alternative basis—but he contends it’s an increasing trend.

"If it continues, I’d expect that almost 20 percent of all billings would be on alternative billing in eight to 10 years—that’s really a lot of money," he says. "The question for in-house counsel and law firms is, are you ready for this?"

Whether the AFA trend will outlast the downturn is the wild card, but many law departments and their outside counsel are treating it as if it’s here to stay—and they’re finding the kind of success they want to shout about from the rooftops. Yet there is a sense among almost all of them that, in the legal arena as a whole, plenty of lawyers are talking the AFA talk without walking the walk.

Here, in-house players on the forefront of value-based or alternative fee arrangements talk about what’s worked best for them and the results they’ve seen. Next month, law firm leaders will give their side of the story and offer valuable advice to clients on proposing and using alternative billing structures.

First off, FMC Technologies General Counsel Jeff Carr wants you to know he refuses to use the term "alternative fees."

"It seems somehow unseemly," he says. "It’s not an alternative so much as it should be the norm. I prefer ‘value-based’ billing—what we’re trying to get to, many of us, is reconnecting what we pay for legal services to the value of what we get." The focus, he says, should be on that value and the relationship, not the fees.

Carr and FMC’s experience with value-based billing dates back to 1997, when FMC began using value-based fees. When Carr became GC of FMC Technologies, he ramped up their use. In 2006, he built use of value-based billing into his employees’ performance reviews.

"It’s funny," he says. "Once you tell people their compensation is dependent on following rules, they tend to start following them."

Carr used a similarly no-excuses approach with his outside firms.

"We simply told firms what we wanted them to do," he says. "There was some resistance, and over time those law firms don’t work with us anymore. It’s simple; it’s Darwinian. We’re not trying to change firms’ business models, but if they want to work with us they’ll work on our terms—there’s an inexhaustible supply of firms and of good lawyers."

Carr’s tough love has paid off for FMC. "It’s impossible to measure a voided cost," he notes. But the numbers seem to validate his approach: Since 2001, when FMC Technologies was created, it has tripled in size—but legal spending has stayed flat.

FMC TAKEAWAYS:

• Reward performance, effectiveness and efficiency. FMC Technologies’ preferred billing mechanism centers on a project-based fee with a hold back. (The company doesn’t have the volume of legal work to sustain a fixed fee arrangement, Carr says.) The amount of the hold back FMC rewards firms depends on a report card system Carr calls ACES (Alliance Counsel Engagement System), which ranks outside counsel on six equally weighted criteria: understanding FMC’s goals, expertise, efficiency, responsiveness, predictive accuracy and effectiveness.
• Process and matter management matters—there’s no use in overhauling a matter’s billing structure if the matter itself is being handled inefficiently. "The first pitfall is managing fees and not the process," Carr says.
• The vast majority of legal work can be commoditized or standardized. "It’s simply not true that all legal work has to be custom made," Carr says. "The current hourly-based business model of law firms tends to reward process and content, because those two acts result in the most hours. That’s what lawyers do all the time—instead of leveraging past work, they regenerate work to bill hours."

As director of legal employment services at Cisco Systems, the three-person team Roxane Marenberg works within is responsible for engaging lawyers at approximately 100 firms handling employment law work covering 64,000 employees in 200 countries. Even with such a scope, and with a caseload that can vary greatly, Marenberg manages to deliver cost predictability to Cisco through alternative fee arrangements—mainly fixed fees based on the project, with monthly payouts and potential bonuses.

"Budgets are top of mind to in-house counsel now, and by keeping within the budget, I’m providing the highest level of service to my clients," Marenberg says.

Her goal is eventually to handle all day-to-day advice or counseling on an alternative fee basis. So far, focusing on value-based billing has paid off.

"I have predictability and the ability to respond to questions as to where I am in my budget," Marenberg says. "I’m also incentivizing the early resolution of matters."

Marenberg works to maintain constant communication with her firms and to properly tailor fee agreements to avoid unpleasant surprises.

"The worst thing that could happen in any company is to be surprised at the end of the month or the year or the project," Marenberg says. "The relationship is important because that is what drives the ability to have open communication so you’re setting expectations properly. The firm and company have a relationship and don’t see it as a one-shot engagement but as a longstanding relationship."

Litigation is unpredictable, so in keeping with its goals of open communication and achieving the win-win, Cisco might write in the opportunity for a renegotiation if a court, say, triples the amount of depositions the original agreement took into consideration. In that way, Marenberg says, alternative billing may not be the panacea. But her goal still is to have all her lawyers working under alternative fee arrangements with a few exceptions, such as a lack of familiarity with the legal area or a brand new firm.

CISCO TAKEAWAYS:

• It’s easy to tell if firms are pleased with arrangements. "The success is evident in the number of firms that continue to want to work with us," Marenberg says. "We haven’t had any difficulty in finding a firm to engage in a fixed or alternative fee."
• Tough breaks on either side tend to even out over time. "The longevity with which you have the fixed fee arrangement with the firm is key to mitigating any kind of loss that a law firm might have in one month," Marenberg says. "Next month, it evens out. Both firm and company are sharing risk, and that’s at the heart of the relationship when law firms and clients embark on fixed fee arrangements."
• The economy certainly is driving AFAs. But having AFAs already in place when things went south helped Marenberg’s team better weather the economy, she says.

DuPont has been working at alternative fees for a long time. Eighteen years ago, the company’s law department started by streamlining its firms from 350 to 34. That network has been the foundation for creative, trust-based partnerships, many of which are not based on an hourly billing model.

"We have a belief that, in most cases, hourly rates are destructive and inefficient and they don’t really equate to value," says Andrew Schaeffer, managing counsel, operations and partnering. "Just because something takes longer to do doesn’t mean it brings more value to a client. The idea was to come up with alternatives to the straight hourly rate that would align with client’s interest and also promote efficiencies so you would get it done faster."

Now about half of DuPont’s legal spend, both defense and recoveries, is done on an alternative fee basis.

Although Schaeffer believes the hourly bill will never die because it’s still useful for certain things, he has lofty goals for expanding the company’s use of AFAs.

"I could see a day when maybe 80 to 90 percent of our work is tied to an AFA," Schaeffer says.

The law department continues to experiment with different models, such as a hold back/bonus model, contingency arrangements on recoveries and an umbrella AFA for work not already based on alternative rates.

Alternative fee arrangements, along with the law firm convergence process and efficiencies in e-discovery, have helped DuPont’s law department consistently maintain budget and achieve legal spend that is at the same level as 10 years ago. In a world where legal inflation has far outpaced other professional services, that’s an achievement.

DUPONT TAKEAWAYS:

• A tight, long-term network of firms ensures trust that goes both ways. "It’s easy to have discussions with our firms regarding alternative fee arrangements because they know we’re not out to use our leverage to make them take a bath," Schaeffer says. "I think one reason [AFAs] have been so slow to catch on is lack of trust between the client and the law firm."
• AFAs take effort. "You have to think about it, negotiate it, make sure it continues to make sense," Schaeffer says. "A lot of people aren’t willing to do that, but now times are awfully tough and it’s forcing people to look at AFAs."
• Contingency fee arrangements for recoveries can be a bonus for companies with less capital. Although DuPont has some leverage, Schaeffer says smaller companies have an additional incentive to use contingency fee arrangements because the billing model means fewer out-of-pocket litigation costs up front for the client–they don’t pay up until they win.

In 2004, Tyco International set about narrowing down the law firms it used on its product liability docket. The downsizing was major, to say the least, with Tyco going from 168 firms nationwide to just one—Shook Hardy & Bacon (SHB). Although the firm had used alternative fee arrangements before, it was the first time SHB had used fixed fees on a docketwide basis, taking on 450 Tyco cases.

It was a bit of a leap of faith. "We were a new firm [for Tyco], but in-house counsel has to be willing to shake it up," says Paul Williams, products liability partner at SHB.

The partnership is based on yearly negotiations of their fixed fee arrangements, which are usually paid in 12 annual installments with incentives for quick and successful resolutions. Both in-house and outside counsel are committed to the idea that even if one party comes out on top one year, over time the benefits will even out.

Tyco senior litigation counsel Dave Nicholas says using a single firm is the preferred model for Tyco. "There are a lot of benefits," he says. "You’re reducing the number of vendors, so when you partner with a firm like SHB, it becomes a partnership between client and law firm. The fixed fee makes the goals of both parties congruent."

The close partnership is even more remarkable considering Nicholas had just joined Tyco during the convergence process, and SHB was a new firm. So trust had to be the name of the game as Nicholas and SHB set out to learn about Tyco's product liability docket on the fly.

TYCO TAKEAWAYS:

• Know your docket. "As a litigation lawyer, are you walking into a docket where it’s going to be high volume, a predictable type of exposure? Is the volume predictable? What type of billing has there been? I think there’s room in any docket to work with AFAs," Nicholas says.
• The moment is now. "Given the state of the economy, if a company came to a law firm and said they have a number of cases on an annual basis, ‘Give us a proposal’—I think any law firm right now will look at those programs and see what they can do," Nicholas says.
• The billable hour is the comfort zone—and a rut. "There’s great reluctance among in-house people to look at whether a case or a docket can be handled on an alternative fee basis because they haven’t done it before and it’s a change, it’s new," Nicholas says.

Rich Baer isn’t convinced that alternative fees are the solution to the legal industry’s woes. As general counsel of Qwest Communications, Baer efficiently runs the legal department of a Fortune 200 company. He’s experimented with value-based billing models, and his experiences range from OK to, well, not OK. So for now, he’s sticking with the billable hour.

"We’re willing to explore them as the whole area evolves," he explains, "but I don’t think they are the panacea or sea change that a lot of folks are saying they are."

He takes issue with claims that the hourly rate gives outside lawyers a financial incentive to bill as many hours as possible.

"Assume I’m wrong," he says. "A fixed fee may solve that [supposed incentive to overbill], but it creates other misalignments, and those are the ones I’m more concerned about than a lawyer overbilling me by a couple of hours."

Baer says moving to a fixed fee arrangement makes keeping large margins and resolving matters as quickly as possible a law firm’s main goals. "They could advise me to pay more than we need to be paying just to get the case resolved," he says. "And then there are no incentives not to do as much work, not to be as thorough, not to take a necessarily aggressive stance—because the more time they put in, the narrower the margins become for them."

QWEST TAKEAWAYS:

Instead of using AFAs, Qwest has controlled spend in other ways:

• Highly engaged, active strategic management of cases. In-house lawyers should work closely with outside counsel to make sure the case is being handled efficiently. Is that 10th deposition really necessary? It’s the in-house lawyer’s job to make that risk-benefit analysis, Baer says.
• Unbundling and IT. "Everyone’s focused on billing structure as being the panacea," Baer says. "I think you’re going to see much greater change as a result of more sophisticated use of technology and the outsourcing of a lot of work that’s typically being done by law firms."
• Wiser selection of outside counsel. You can find great litigators at much smaller firms, Baer says, and technology and legal process outsourcing mean going up against a big firm is no longer a drawback. For in-house counsel this means being a sophisticated consumer of legal services and knowing the marketplace.