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Editor's note: This is the third part in a weekly series from The Legal Intelligencer examining the lasting effects of the current economy on the legal industry.
When Eli Lilly & Co. settled a whistleblower suit in January for $1.42 billion over allegations it improperly marketed an anti-psychotic drug, Duane Morris was in the unusual spot of representing the plaintiffs along with personal injury firm Sheller P.C.
While the clients may have been atypical for a large defense firm, Duane Morris has had plenty of experience working on contingency fee-based matters.
For at least the last decade, the firm has focused about 4 to 5 percent of its billable time on contingency fee or other matters with alternative billing structures. And throughout that time it has cultivated a process for assessing risk and potential rewards.
The firm will only take large commercial cases with a minimum fee of $1 million. There must be a 75 percent probability of success as determined by the firm's attorneys and contingent fee committee, and an opportunity to get three times the firm's recorded time.
Seasoned attorneys within the firm, generally in the trial practice group, review the cases and make a proposal to the committee, which then decides whether to take the case.
Firm Chairman John Soroko said earlier this month he is seeing increased calls from clients for this type of set up as they look for ways to move away from the billable hour.
"We have this in our DNA," he said. "We spent a long time getting good at evaluating" the cases.
That evaluation and projection process -- quite possibly the most difficult hurdle in moving away from the billable hour -- is something many Am Law 200 firms on down are beginning to consider as the lip service that has been paid to alternative fee arrangements for years starts to become reality in this buyers' market.
To be sure, even by accounts of alternative fee advocates, the billable hour is not dead and probably never will be. But a shift, slow as they go in the legal industry, is afoot in terms of how firms work to provide value for clients -- whether it be through contingency fees or any of the other multitude of alternative fee arrangements. And in this movement, the billable hour is seen as the antithesis of efficiency and value.
Nicky Mukerji is director of business intelligence for Legalbill, a company that audits corporate law departments and analyzes companies' legal spending.
Only about 1 to 2 percent of matters, he estimated, are done on an alternative fee basis, particularly at large- to medium-sized firms. In 10 years, he said, that rate might rise to 10 to 15 percent. Mukerji said the pace of change has been gradual but has gained momentum because of the recession.
The continued growth of alternative billing practices will depend on long-term commitment from law firms, he said.
To say the billable hour is dead implies the entire practice of law has changed, and Mukerji said he doesn't think the industry has gotten to that point. But alternative fee arrangements are a good way to start building relationships between firms and clients, he said.
The problem now is in the way they are planned, executed and monitored, he said.
Flat fees for certain services or the overall matter seem to be the most typical alternative billing method, he said.
"A lot of flat fee calculations for firms of all sizes are nothing more than just an educated gamble," Mukerji said. "What should be done versus what is done is a big difference."
Firms need to evaluate risk and have a deeper analysis of how to manage cases so that the firm is making money and the client is saving money, he said. Mukerji suggested that firms, at least in the beginning of this transition, continue what he called "shadow billing." Tracking hours becomes even more important because it allows a firm to compare its actual time with what it is earning in alternative fees. It can also allow the client to see whether it is incurring any savings.
'PENALIZING EFFICIENCY'
Dechert senior counsel William B. Lytton has held positions as general counsel for Tyco and General Electric Aerospace to name just two. While he switched back to law firm life last year, they still let him in to meetings of GCs of the Fortune 100 companies. At the latest one, he said that, for the first time, he heard a focused discussion on the use of flat rates. The group was surprised at the number of firms that were receptive to the concept. But Lytton said for the most part firms don't offer and law departments don't ask when it comes to anything other than the billable hour.
A "law firm guy" that was sitting in on the meeting, Lytton said, pointed out that discounted rates eat away at his firm's profit margins while alternative billing can up the profit margin through a focused effort on efficiency.
Whether this switch can last will depend on the data firms mine to understand how to best go about these arrangements, Lytton said. In looking at a pyramid in which the largest section at the bottom is "data" and the others moving up are "facts," "knowledge" and "wisdom," Lytton said firms are still at the data-gathering stage of this process and need to cull the countless billable hours they have logged in order to evaluate the risks taking on certain matters on an alternative fee basis. This is all "basic business stuff" that law firms, too, can figure out, he said.
"The hourly rate neither encourages nor rewards efficiency," Lytton said. "In fact the hourly rate penalizes it."
The larger firms will lead the way on this transition to alternative fees and it will be the ones that can get there first that will be best positioned in the market, he predicted.
For Susan Hackett, general counsel of the Association of Corporate Counsel, the large firms are definitely leading the way and she is already seeing significant increases in the percentage of cases handled on an alternative fee basis.
She has been working with firms as part of the ACC's Value Challenge and has seen in the last six months a move from almost no use of alternative fee arrangements to upwards of 20 to 30 percent. She admits, however, that she's talking about the choir since she's working with firms that are already receptive to the idea.
But even people who embrace the concept of alternative billing methods are overwhelmed and cautious by the required shift in law firm structures, she said.
"We're in that horrible middle stage," Hackett said. "As to whether or not it's inevitable, yes it is. For those who are saying the talk is because of the economy and that once things go back to normal we'll go back to billing as we used to -- wrong."
As mid-tier firms reap benefits during the recession by gaining clients dissatisfied with high rates at larger firms, alternative fees may be the only way those large firms can keep or get those clients back even once the economy turns around, Hackett said.
Ultimately, alternative fee arrangements are about good budgeting, she said. If firms are held to a budget, she said she doesn't care how many associates they use or whether they fly first-class.
A shift to alternative billing is going to take the focus off of hours spent in the office and put it on the efficiency with which a matter gets done, Hackett said.
"It's going to lead to lawyers going home for dinner again," she said.
The bottom line for alternative fee arrangements is trust, Lytton said. Not every matter will turn out how it is expected and if there is no trust between client and firm to renegotiate, then there will be no coming back for seconds.
The most successful use of an alternative fee arrangement Lytton ever had was admittedly an extreme situation, he said. As a GC, his company was looking to break up a merger deal that was already in place and buy the company itself. One firm offered to do the deal for a flat rate of $12 million and three others wanted four times their hourly rates.
Lytton went with a deal where he told the firm that at the end of the matter the attorney would say what he thought he deserved and Lytton would offer his own suggestion with Lytton's suggestion being final. Ultimately, Lytton paid the attorney exactly what he asked for.
"If trust is there, the opportunity is there so that neither side gets killed," he said.
The next installment of The Legal Intelligencer series will examine the impact of industry changes on small to medium-size firms. The first and second installments are available here, and here
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