Reduce your reliance on hourly billing

Alternative Fee Arrangements (AFAs) FAQs, Guide, and Resources

Alternative fee arrangements are becoming more common than ever. If your team needs to reduce your reliance on hourly billing, PERSUIT has resources that can help.

Alternative Fee Arrangements FI
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There are many misconceptions about alternative fee arrangements (AFAs). In this expert-written guide, you'll learn how to create and implement AFAs successfully. 

Seven Types of Alternative Fee Arrangements

The term “AFA” can be used to describe a wide variety of fee models.

Some AFAs remain closely tied to the traditional billable hour (ex: capped fee AFAs). Other AFAs (including fixed fee AFAs) sever the link between price and the billable hour completely, incentivizing the value and results delivered rather than the amount of time spent working on matters.

1. Capped fee or phased capped fees

Capped fee AFAs place a cap on the amount a firm can bill for a matter or for each phase of a matter. While capped fees are common, they are not the most effective type of AFA.

2. Overall fixed fee

Fixed fee AFAs use a predetermined fee that does not change during the life of the matter. Fixed fee AFAs require that the corporate legal team and their law firm have a clear scope of work to define what’s expected of the law firm. Fixed fee AFAs include material deviation clauses, which are used if something unexpected happens that changes the pre-agreed upon scope of work and allows for the fees to be adjusted accordingly

3. Structured fixed fee

Corporate legal teams and firms can also agree to fixed fee AFAs with prices agreed upon for a particular structure. These structures are typically fixed fees broken down by phases, key activities, or distinct deliverables. These are especially useful for matters that may be resolved or settled at various phases of the legal process (lawsuit dismissed, lawsuit settled, etc.).

4. Contingency fee

This fee structure establishes fees which are contingent on a particular trigger and the value of the fee is tied to some financial figure at stake for the matter. The law firm and the client will typically agree on the requirements for the trigger and a percentage share of the value at risk associated with that trigger. Two common types of contingencies are pure and reverse. In a pure contingency fee agreement, the firm receives a percentage of the damages recovered. In a reverse contingency relationship, the firm receives a percentage of money saved in the matter.

5. Success fee

This fee structure establishes a fee which is contingent on a particular trigger. Unlike a contingency fee, this fee structure does not have to be tied to a particular financial figure at stake for this matter. This could be a success fee for a motion to dismiss for example or achieving a particular milestone in a matter.

6. Collared fee or annual collared fee

The firm and corporate legal team agree on a price for a matter as well as a collar surrounding this amount (e.g., 10% above and below). The firm bills hourly. A penalty usually exists for billing above the high end of the collar. Plus, a bonus is in place for billing below the low end of the collar.

Annual collared fees operate in the same manner across the course of a year. They are most often used for ad hoc matters.

7. Hybrid structures

Hybrid structures are a combination of two or more AFA structures. An example of this is a phased based fixed fee combined with a contingency reward. A corporate legal team and their law firm may agree to price each phase of the matter using a phase-level fixed fee arrangement along with a contingency payment of a percentage of any recovered amount.

FAQs about alternative fee arrangements (AFAs)

When should I use an AFA instead of traditional billable hours?

AFAs can be used with any type of legal matter. On the PERSUIT platform, we regularly see in-house legal teams use AFAs in a wide variety of situations, including litigation, IP, HR, M&A, and many more. 

There are two rare situations where an AFA is impractical. Both relate to a situation where an in-house team either cannot provide a scope of work — or is unwilling or unable to.

  1. You need to retain a firm to ask questions infrequently, but you have no idea how frequently you’ll need to ask the firm questions. In this situation, you want a firm to be pre-selected as preferred counsel, but you cannot provide a specific scope of work. 
  2. You have no ability to (or are unwilling to) perform the steps necessary to determine an appropriate price. If your goal is to contain the cost of ever-growing legal work with some type of AFA with the firm currently doing the work (e.g., legacy litigation), but you do not intend to consider switching firms, you cannot get around conducting some data analytics to determine an appropriate fee amount for the work.
Which AFA type is right for my situation?

AFAs come in different types, and each AFA type comes with its pros and cons. An effective AFA negotiation starts with an alignment on the optimal pricing strategy based on your goals and the type of matter at hand. In general, we recommend using AFAs that are not dependent on the billable hour to determine the value of the work you’re receiving, including value-based AFA types such as fixed-fee AFAs or phase-level fixed fee AFAs. Doing so will help you ensure you’re receiving the benefit of using an AFA and not just repeating hourly billing in a different form.

How do I know if an AFA is a good price?

From the perspective of an in-house legal team, an optimal outcome for an AFA negotiation is one in which you agree to pay an overall price for the matter that is in line with the market price for the work.

So how do you determine what the market price is for the work? There are three methods we see being used most often, which are:

  1. Review historical billing data
  2. Purchasing benchmarking reports
  3. Assessing the market in real time via competitive bidding or tendering.

There are pros and cons for each approach, and a combination of multiple approaches will yield the greatest level of confidence in what a fair price would be for the matter.

What happens to an AFA if the situation changes?

Every AFA should include a material deviation clause that defines what events can trigger a material deviation and how the parties will proceed to adjust the fee amount if a material deviation does occur. 

While legal services have built in forks in the road that can lead to a significant increase or decrease in work, many of these forks are themselves predictable, and you can ask firms to price each path that they could conceivably walk down. 

For example, many litigation matters settle before trial, so it makes sense to have a price that represents what will happen in that situation.

Further, the type of matter or project can speak volumes about the likelihood of material deviations and the process of aligning the AFA type with the matter type has already progressed us towards a viable solution for changes in scope.

When using a material deviation clause, here are several key principles:

  • Seek to limit renegotiation as much as possible. A good material deviation clause sets boundaries such that the parties do not need to renegotiate the AFA frequently.
  • Do not leave it open ended. If you want to limit renegotiation, you have clearly defined events that can trigger a change in price. Leaving it open ended based on what is fair and reasonable could cause either party to have free reign to ask for frequent adjustment.
  • Keep it simple. If the clause is too complicated to understand, both sides will opt to resort back to the billable hour the next time around.
  • Make it formulaic if possible. While (most) lawyers dislike math, it can certainly be helpful to use a simple formula for pre-determining how the price will change if there is a material deviation. The more we can align on preset mathematical adjustments, the less need there will be to have lengthy AFA renegotiations later.

Learn more about developing material deviation clauses: How to Marry Fixed Fees with Changes in Scope for Legal Services.

Can an AFA be used for complicated legal situations?

Absolutely. Even complicated legal matters often have a few common ways they tend to progress. You may not know exactly how many steps you’ll need to take to resolve a matter, but in most cases, you (or your law firm) have a good idea of how “matters like these usually go.” For that reason, a phased-based fixed fee AFA could be a strong option.

For example, for a complicated M&A deal, you won’t know if the deal will be agreed to or not ahead of time. You may also be concerned that regulators will want to review the deal at some point. Pricing your matter by phase would allow you to use an AFA with pricing for each scenario you believe has at least a realistic chance of happening.

If something completely unexpected happens, that’s when the material deviation clause described above will trigger.

Can AFAs be used for litigation?

Yes. Many in-house legal departments use AFAs for their litigation matters — including complex matters. In fact, litigation matters are among the most common matter type sourced on PERSUIT using alternative fee arrangements. 

Do AFAs incentivize firms to lower the quality of their service?

No. As with any professional service provider, a law firm must deliver quality work to earn repeat work from a client and protect its reputation in the market. Whatever the pricing model, if a law firm doesn’t deliver a quality product, it won’t receive more work from its client. 

What’s the best negotiation strategy for AFAs?

The best way to negotiate a fair AFA is to find the true market price through a competitive, transparent process, where you can consider proposals from multiple law firms. The best AFAs are win-win situations for in-house legal teams and firms.

Can AFAs help me lower my outside legal spend?

Yes. A key goal of moving towards AFAs is driving towards paying for value rather than paying for effort. As such, both parties should strive to find win-win opportunities when negotiating. For instance, for firms, a fixed fee AFA presents a clear revenue opportunity in which the firm is freed up to provide a more discounted price because it can control its staffing mix in a way that maximizes its profitability. 

Are AFAs primarily a way to force law firms to lower their costs?

No. Alternative fee arrangements are best used as a way to realign the incentives between in-house teams and firms, with the in-house team incentivizing value and results instead of billable hours.

For example, it is common in M&A transactions to include a pre-agreed broken deal discount such that the parties know that the fee amount will be reduced significantly if the deal falls through. 

In a litigation context, if a client is asking for a more aggressively discounted fixed fee, the firm could consider providing a fixed fee that is 15% lower than its anticipated budget in return for a success bonus of 25% in the event of a successful verdict or early case dismissal. In this way, clients and firms can create win-win scenarios and negotiate in a way that incentivizes the right outcomes.

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