In last month’s blog post, we reviewed an increasingly common practice in alternative fee arrangements (AFAs): the request by the client for firms to submit “shadow bills.” “Shadow billing” is a practice where a firm submits a fee for an alternative billing arrangement along with invoices outlining the actual hours and work performed. Our last post revealed why shadow billing tends to be controversial and gave a scenario where shadow billing is necessary. This portion of the article will review another fee arrangement where shadow billing is necessary and how to get the full benefit from shadow billing.
When you need shadow billing with an AFA
Fee collars allow for a lawyer to be paid a set amount if the hours come in on target or at a certain percentage above or below the set target. If the hours come in below the fixed percentage, the savings are shared between the client and the lawyer. If the hours are above the fixed percentage, the lawyer is paid only a percentage of the additional amount billed. Fee collars are often used in scenarios where outcomes are unpredictable. For example, let’s assume a client and an attorney agree to a fee of $100,000 for a project with a 20% up and down collar. If the lawyer’s billing comes in at an amount between $80,000 and $120,000, the attorney will be paid $100,000. However, if the billings come in at $60,000, the $20,000 difference is split between the client and attorney (the client receives a $10,000 credit, so the attorney is paid $90,000). If the attorney’s time amounts to $140,000, the attorney is paid 50% over the $120,000 collar (the final fee to the attorney is $110,000). Again, this is another situation where the firm has an incentive to try to bill at the cap or at the collar around the cap, if the fees are below the collar. As with the capped fees with sharing, the benefit to the client is a more predictable fee structure.
Getting the full benefit from shadow billing
With both types of alternative fee arrangements, capped fees with sharing (mentioned in Part I) and fee collars, there is a need for shadow billing in order to calculate the final cost to the client. The problem with shadow billing is that it can cause a disincentive for law firms. Firms may begin to worry that if the billed hours come in significantly lower than the fee caps, the client may feel like they are not getting a “good deal,” even if the amount paid is appropriate for the value delivered by the law firm. With this in mind, it is important to remember that shadow bills have their maximum value only when they are reviewed for billing guideline violations, consistency with ethical rules of professional responsibility, industry standards, and other relevant authority. This type of review will keep the law department on track and also benefit the client by giving them a more accurate view of their data. With the shadow bills available, clients also gain the benefit of using the data to track and report on the data found in the invoices.
Alternative fee arrangements have the benefit of providing predictability and, in some scenarios, cost savings for the client. However, if a legal department decides to shift to using some form of alternative fee arrangement, it is important to require shadow billing, at least in the beginning of the program. Shadow bills give the client a gauge to measure if the program is successful by allowing for full transparency. But, along with a request for shadow bills, comes the incentive for law firms to create shadow billing that comes close to the fixed fee in order to make the client feel they are getting a “good deal.” The best way to maximize the use of shadow billing is to review the bills for accuracy. This will give the legal department clean data to measure for reporting and analytics, and the client will have a more accurate picture of true costs when negotiating fixed fee arrangements in the future.