Today, the number of law firms offering fixed fee arrangements is on the rise. With the option of an alternate billing structure, there is growing curiosity among our clients about the efficacy of using the fixed fee approach for billing.
A quick internet search will bring up articles espousing the benefits of flat fee versus hourly billing and others illustrating valid reasons for the use of both hourly billing and fixed fee billing in certain circumstances. But what are the real issues behind the shift away from hourly billing? Is hourly billing really the villain it is made out to be in many articles? In order to answer these questions, this article will first look at the basic pros and cons of fixed fee and hourly billing, the times when one type of fee arrangement works better than the other, and finally a look at the real issues behind the debate of fixed fee versus hourly billing.
The pros and cons of fixed fees and hourly billing
The following is a brief overview of some of the arguments for and against the use of fixed fees and hourly billing:
• Increased efficiency (reduces inefficiencies and increases law firm productivity)
• More predictability in the cost of a matter
• Simplified billing process
• Reduces the need to monitor law firms
• May not necessarily lower the cost of matter
• Increased incentive to staff the matter with junior attorneys or settle matter quickly if matter is over budget
• Stronger understanding of complexity of case by client (client needs more knowledge of the matter in order to estimate a fair cost)
• May result in too few hours spent by law firm on matter (if matter extends beyond scope)
• Ability to quantify the efforts of each timekeeper
• Easier to compare firms by reviewing hourly rates
• Lessens need to understand complexity of the case
• Rewards expenditure of time versus outcomes
• Possible overstaffing
• Incentive to work more hours than necessary
When is it appropriate to use hourly fees or fixed fees?
There is no winner or loser in the debate between fixed and hourly fees. Valid arguments exist for and against the use of either billing method. When clients inquire about the use of fixed fee arrangements versus hourly billing, we encourage them to examine the types of engagements they encounter. Some matters lend themselves to using fixed fees. Routine matters that are repetitive, predictable work such as real estate transactions or patent applications work well with fixed fee arrangements. With these types of matters, both the client company and the law firm have an understanding of the work and the amount the work should cost. Hourly billing works better for more complex, litigated matters where the scope of the matter is often hard to predict. Many cases fall in-between these types of repetitive, predictable matters and the more complex litigated cases. When these types of matters arise, it is important to examine what is at issue when contemplating a fixed fee arrangement as opposed to an hourly billing rate.
What is the real issue behind a request for alternative fee arrangements?
When clients inquire about fixed fee arrangements, it is almost always surrounding the need to cut costs and to some extent, a need for certainty. We remind clients when evaluating fixed fees that moving to a fixed fee arrangement is not necessarily a panacea for cost control. First of all, with cases that fall in the gray area between repetitive tasks and complex litigation, implementing fixed fee arrangements isn’t always easy. It is a big commitment on the part of the client and the firm. It will take time to understand the needs of each party and to structure a fixed fee arrangement that makes sense for both. With clients struggling to do more with less in their departments, many do not have the time or the resources to dedicate to developing a fixed fee pricing structure. Clients need to take the time to look at the performance across several cases in order to come up with some type of average cost based on an established history. A client also needs to keep in mind that detailed scopes of work must be put in place. In order to avoid misunderstandings, a scope of work for a fixed fee arrangement must be very clear about what it covers and what could lead to additional fees for the client.
If cost savings and predictability are really the issues for the client, the solution is not necessarily a new type of billing arrangement. Reducing costs can be achieved regardless of how a law firm bills for the service. Hourly billing is still a good option in that it provides the client with a breakdown of time for each timekeeper and allows them to see value for their money. With hourly billing, neither party is assuming the risk that a matter will fall above or below a pre-set cost. Clients have many tools at their disposal to control costs under hourly billing rates. For example, our insurance clients often use panel firms (the client selects law firms in certain regions to potentially perform work and the firm agrees to billing guidelines and reduced billing rates) that usually offer discounted rates. Clients concerned with predictability require firms to budget for each matter and if the matter goes over budget, the firm must send in a new budget. The use of a legal auditor to review hourly billing is another way the client can keep costs in check. Law firms send invoices to a third-party auditor and fees are reviewed against the client’s billing guidelines before the invoice is paid.
When considering an hourly rate versus a flat fee with a law firm, remember that a flat fee structure isn’t always best in those matters that fall between routine tasks and complex litigation. If cost savings is your main goal, changing to a flat fee structure may not be worth the effort or the risk. Weigh out the pros and cons of each option and take a realistic approach to whether your organization has the commitment and resources to put a strong fixed fee program in place.