Are you considering alternative fee arrangements for your legal practice? If so, you're not alone. Alternative fee arrangements can offer a number of benefits for lawyers, both financial and professional. This piece will provide you with the information you need to make an informed decision about alternative fee arrangements and help you take advantage of all the benefits they have to offer.
What Are Alternative Fee Arrangements (AFAs)?
Alternative fee arrangements, known as AFAs, are pricing structures that do not rely solely on hourly rates and the number of hours billed to determine the overall cost to the client. The legal industry built its practice on the billable hour, so the usage of AFAs often meets resistance. While not every scenario is ideal for AFAs, in general, switching to alternative fee arrangements benefits both the firm and the client.
What are the most common types of alternative fee arrangements?
There are ten types of alternative fee arrangements:
Blended (hourly) rateThe firm establishes either a blended hourly rate for specific titles or one rate for every attorney who works on the matter
Collared fee/annual collared feeThe firm and client 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 exist for ad hoc matters.
Contingency feeThere are two types of contingencies: 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 that the client saved thanks to the firm’s representation.
Fee per trial day with success bonus for successful verdictThe firm and client agree on a set fee for each day of the trial. An additional fee gets paid to the firm should a favorable outcome occur.
Hybrid phased fixed fee with contingencyTypes of AFAs can combine for optimal results, such as when the firm and client price each phase of the matter, as well as agreeing to a contingency payment upon completion.
Matter flat/fixed feesThe firm and client agree to a total fee amount for the matter that does not change. This arrangement can apply to low-spend, high-volume matters and higher-spend matters without distinct phases.
Phased capped feesThe firm bills the client hourly until a cap, then ceases to bill for the hours worked beyond this point. Caps can exist per matter.
Phased fixed fee/phase-level fixed feesThe firm and client agree to a set fee for each phase of the matter.
Phased fixed fees with activity collarThe firm and client agree to fixed fees for each phase of the matter, as well as activity level pricing for major cost-driving activities, also known as an “activity collar.” If there is a 30% deviation in the quantity of the assumed major cost drivers, the firm can adjust the total fee up or down based on the agreed-upon price-per-activity.
Task-based fixed fees
The firm and client agree to set fees for specific tasks to perform, e.g., by local counsel.
The type of AFA utilized depends on the matter. Additionally, AFA types can combine.
What are the benefits of alternative fee arrangements?
Alternative fee arrangements cause hesitancy because the hourly billing culture dominates the legal industry. Yet, AFAs have the potential to deliver higher value to law firms and clients.
Spend predictabilityInstead of rate cards, you can negotiate with your panel firms the pricing for different phases of each matter. Clients won’t face an unknown number once the matter is complete.
Shifted focus to outcomes and deliverablesIn moving away from the billable hour, the focus of the work done on a matter shifts from how much ‘effort’ gets put in. In the legal industry, effort equates to time. Yet, time doesn't equate to quality. AFAs make the outcomes and deliverables matter more than the number of hours spent.
Formulaic method for adjusted fee amount when material deviation occursMaterial deviation clauses exist as the solution to the concern around accounted-for uncertainty. They define which events amount to a significant deviation from the assumptions contained in the AFA agreement. Should those events occur, the clause dictates how the parties will adjust prices.
Discouragement from overbillingWith AFAs such as capped fees, firms bill hourly until they reach the cap. Once the hours worked exceed the cap, the firm ceases to bill. The motivation lies in staying within the capped hours so that no work is done for free.
Incentivize efficiencySome AFAs include efficiency bonuses. For example, a collared fee sets a bonus for savings below the low end of the collar.
Stronger relationships between clients and firmsAlternative fee arrangements create a trust-based solution. Both client and firm share the risk and the expectation of working together in the future. Aligned incentives, candidness in defining success and expectations, and clear feedback create strong communications. A collective, long-term best interest gets supported.
Improved control over workflowsWhen setting AFAs, the major assumptions of each phase of the matter sets boundaries for the firm and its work. Changes can still occur — which is why material deviation clauses exist. The result is more control over the work that gets done. The focus is now on the quality of that work because payment is no longer contingent on time.
Enhanced firm performanceLawyers, firms, and their clients want successful outcomes. An option with alternative fee arrangements is attaching a success bonus to the payment structure. A bonus acts as a motivator to achieving a successful outcome — especially if the legal spend stays the same based on work done instead of time spent.
Increased ability to price
AFAs lead to cost predictability and lower your legal spend. With multiple types of AFAs to choose from (and the ability to combine them if needed), alternative fee arrangements increase the client’s ability to price out their legal matters.
What are the drawbacks of alternative fee arrangements?
The drawbacks to alternative fee arrangements shift depending on the type of AFA. For example: when it comes to contingency fees, there is no spend predictability. For capped fees, if the cap is set too high, firms will not be incentivized to be efficient. Capped fees still rely on effort as the barometer for value. This practice is tied to the billable hour – the precise system we are trying to kill. Even AFAs such as blended hourly rates rely on the billable hour and therefore lose spend predictability.
Each AFA is unique and comes with its own set of pros and cons. Assessing what works best for your matter and considering hybrid fees allows you to maximize the pros and reduce the drawbacks.
Choosing the correct oneEach AFA contains features that make it ideal for certain matters. Choosing the best alternative fee arrangement – or a combination of multiple – is critical to the success of the payment structure. On the front end, it can seem like drawing out the scope of work and assessing various AFAs creates more work. In reality, it creates efficiency as the matter progresses.
Incentives for poor performanceA common misconception is that without the incentive of time to make greater money, poor performance is the result. In reality, the shift to outcome enhances performance. With alternative fee arrangements, you can attach a success bonus to your matters. The only way to obtain that bonus is with a successful outcome for the client. The financial incentive for the firm leads to better performance — one that is reached more efficiently because time is not the qualifier.
What are some common incentives for alternative fee arrangements?
Shifting to alternative fee arrangements requires change management with firms and clients. In an industry known to lag when it comes to change, incentives help not only enact the move but keep the change.
Incentives for firms
AFAs can result in increased profitability for the firms. If matters take less time to complete, that extra time transfers over to other cases and increased businesses.
Alternative fee arrangements additionally can give the firm a clearer understanding of the client’s expectations when it comes to the number of major tasks to be performed. Better alignment of expectations leads to better firm-client relationships.
Incentives for clientsAlternative fee arrangements hold the ability to reduce costs for clients and decrease their legal spend. More efficient firms can induce lower fees. In an economy where there is pressure to reduce legal spend, this is an immense benefit. Regardless of whether there is a difference in fees per matter, AFAs bring about budget predictability.
Incentives for employeesOn a micro level, alternative fee arrangements benefit employees in a key way — by giving them back their time. The amount of billable hours that lawyers are meant to achieve is astronomical and takes a toll. If firms focus on effort instead of time, employees can devote maximum energy to accomplishing matters well. The time back can go towards other cases.
When it comes to clients, administrative work gets reduced by utilizing tools such as single-live invoicing.
What are some common ways to price alternative fee arrangements?
Alternative fee arrangements work best when customized to your situation. The firm and client have multiple options.
The pricing structure is not broken out by phases when it comes to fixed fees. Instead, the firm and client agree to a total fee amount that does not change. The idea behind this is that the firm and client share the risk that more or less work may be required. The result is encouragement for the firm to attain a speedy resolution and/or to be more efficient and leveraged as it can improve its profit margin by doing so.
Contingency feeContingency fees can generally be divided into two groups: ‘pure’ and ‘reverse.’ In a pure contingency fee agreement, the firm receives a specified percentage of the damages recovered in its representation. Meanwhile, in a reverse contingency relationship, the firm receives an agreed-upon percentage of money saved for the client in the representation. Contingency fees create a strong incentive for the firm to achieve wins for the client and advocate vigorously on their behalf.
Hybrid fees occur when more than one type of AFA gets combined. Phase-level fixed fee AFAs are common, but many times a hybrid structure brings better results for the client as well as the firm.
Multiple examples exist for hybrid fees. A fixed fee can get negotiated for each matter. Upon completion, a success-based bonus can get paid out. A fixed fee can also be used for earlier phases, while a capped fee can be used for later phases.
Two major questions that get posed when it comes to alternative fee arrangements are:
- How can you be assured that you’re scoping the correct work for the matter?
- How do you know you’re getting a good deal?
When it comes to value pricing, there is a system to ensure that the scope of work is correct. By leveraging and analyzing data, you can scope matters correctly. The addition of a material deviation clause ensures that if the scope of work deviates by a large enough percentage (which gets defined), then there is a reassessment.
To ensure you’re getting value pricing, you can once again utilize the scope of work and the data of what matters such as those costs in the past.
What are some common performance issue concerns with alternative fee arrangements?
Alternative fee arrangements bring with them concerns surrounding performance issues and risk. What if the price quoted doesn’t align with the work performed? Here is how to solve for them.
Incentives are not properly alignedAFAs give a clear alignment for firms on how much work is to be done within a certain matter. The work within each phase falls within the predetermined scope. Matters are not volatile, but the work needed can shift. AFAs recognize and allow for this change. They hold space for the ability to change the scope of work with a material deviation clause. If there is a large change in percentage, the AFA and pricing get reassessed. In this case, the incentives and reality differing do not hurt the client or firm.
Billing is not transparent
When it comes to hourly billing, there is no predictability on what the legal spend might reach. Firms give clients their rate cards. Hourly rates can only go so far when it comes to knowing the total cost for a matter.
Alternative fee arrangements lend to transparency when it comes to legal spending.
Shift control to the client
Using alternative fee arrangements gives control to the client when it comes to their legal spend. Before, clients were at the mercy of their firms. However many hours the firm decided to bill is what the client had to pay for a matter. Now, the client can set what kind of work is done per matter. In this way, control shifts to the client while benefiting firms by setting assumptions.
Find an AFA That Works for You
AFAs are often misunderstood. Clients and law firms default back to the billable hour because it seems easier and the only way to price certain matters. There is a method to successfully utilize alternative fee arrangements.
- Begin with a win-win mindset that AFAs produce a greater outcome
- Select the right AFA based on your goal and the matter involved
- Research the market price as a baseline for negotiations
- Use material deviation clauses to account for uncertainty
- Quantify major expenses for each phase of work
- Agree on a midpoint review to decide whether any events occurred that triggered the material deviation clause
- Include a success bonus to ensure everyone benefits
- Be clear on the administrative portion with tools such as engagement letters and invoicing within your eBilling system
If you follow these 8 steps, you can employ alternative fee arrangements to your advantage.
Moving to AFAs holds benefits for the entire legal industry. Whether it aids in firm-client relations, increases business for both parties, or gives everyone predictability and transparency, AFAs are the new defining change of the profession.