The Intractable Hourly Rate (Perspective)

Editor’s Note: This article is the second installment in a recurring series in which Cravath partner David R. Marriott will write on topics of interest to in-house and outside counsel in partnership with a GC co-author.

Over the last few years, a number of surveyed general counsels and law firm leaders have said that alternative fee arrangements (“AFAs”) should displace hourly rates. Yet AFAs are still not as widely used as all of the media hype around them would suggest. According to a BTI Consulting survey released in April of this year, hourly billing arrangements still account for nearly two-thirds of outside counsel spend.

The billable hour would make a fascinating case study for a textbook on behavioral economics. It persists despite decades of criticism and a Great Recession that has put significant power in the hands of clients who, at least in theory, have the greatest ability and motivation to force change. So, why haven’t clients like GE wielded their power to greater effect?

One reason is that both clients and law firms evaluate the benefits and costs of AFAs by comparing them to the fees that would have been generated under hourly billing. When viewed this way, AFAs seem like a zero-sum game. If the law firm spends more time working on the matter than it projected at the outset, the client is happy and the law firm is displeased about having given a “discount.” If the law firm spends less time than it estimated, the law firm is happy and the client is displeased about having paid a “premium.” This win-lose mentality can create hard feelings. And so long as this “hourly thinking” remains the dominant frame of reference, many clients and law firms will prefer to avoid AFAs rather than risk damaging their relationships.

This is the wrong way to think about AFAs. Fundamentally, AFAs should be more about pricing legal services according to the value of those services to a business enterprise than the time spent delivering those services. For starters, value-based pricing is usually the right thing to do. “Legal is different” are no longer magic words that can be recited to dodge difficult conversations (for law firms with clients and for in-house counsel with business leaders) about the value law firms deliver for the money paid to them. Many non-lawyers manage to set value-based prices for any number of multi-faceted and remarkably sophisticated products and services that do not lend themselves to the type of certainty upon which lawyers ordinarily insist. To be sure, there are some assignments that are sufficiently complex and open-ended as to make it difficult to determine a fair, value-based price at their inception; but many law firm engagements are not so unique or unpredictable in scope or complexity that they should defy attempts to arrive at a mutually satisfactory price that is not tethered to hours and rates.

Shifting the emphasis away from hours worked toward the value lawyers create also has the potential to reduce what some call the legal “grind.” A lot has been written about the negative consequences of outside lawyers feeling compelled to bill 2200+ hours per year. What gets less attention is the grind that the billable hour imposes on in-house lawyers. It has been said that some lawyers believe the most important legal writing they do for clients is not their briefs, contracts, or research memos, but their billing narratives. This bit of hyperbole underscores the reality that clients may not always have the time to read lawyers’ work product as carefully as they’d like, but they have no choice but to make the time necessary to pore over their bills (or to hire others to do so).

Many in-house lawyers spend a great deal of time reviewing descriptions of time and haggling with law firms about suspicious-looking entries. Not only are these activities time-consuming, they are time-wasting in the sense that they do nothing to increase the value of the underlying legal services to the business. Worse still, the billing review process itself breeds mistrust. Clients tend to see any push back from a law firm as confirmation that a bill is padded while firms view a client’s questioning as a failure to appreciate and value the firm’s skill, expertise, or professional judgment.

AFAs are not a panacea for what ails our profession. But by providing an incentive for productivity, AFAs will force clients and firms to eliminate some of structural challenges that impede successful partnership between lawyers and their clients. Sometimes a five-minute phone conversation is just as good as a five-page legal memo. And not every litigation matter requires full-blown privilege reviews or pre-trial depositions of every potential witness. In a world where costs are carefully controlled, conventional strategies like these must be reconsidered. AFAs can open our minds to new (and better) possibilities.