Unocal Corp.’s lawyers had good intentions. But after losing millions of dollars in a recent lawsuit, they may have learned the true gravity of ensuring due diligence when it comes to contracts.

In late 2003, the oil and gas company’s in-house legal team was seeking creative ways to cut costs in the legal department. One of the company’s biggest legal expenses—with regard to both money and time—was environmental litigation. At the time, an average Unocal environmental case took three years to resolve, cost $500,000 in legal fees and typically settled for $1 million or more.

So Unocal approached eLawForum (now known as Drystone Capital Corp.), a litigation portfolio outsourcing company that promised to connect it with a law firm that could handle its environmental litigation for a fixed fee that amounted to a fraction of what it had been spending. eLawForum hosted a competitive reverse-auction online-bidding session among prospective law firms, and after eight rounds of bidding, Unocal chose the now-defunct law firm Howrey in August 2004 to take on 200 of its environmental matters during a five-year period for a fixed fee of $15 million.

Unocal also agreed to pay a total of $6.9 million to eLawForum for its services in quarterly installments. The amount approximated the savings Unocal would realize by using eLawForum’s reverse-auction service as opposed to searching for and hiring outside counsel on its own.

The match between Unocal and Howrey was seemingly made in heaven. Right off the bat, the firm began resolving the company’s environmental cases faster and more cheaply.

But unfortunately, the relationship didn’t last.

Breaking Up

In August 2005, Chevron Corp. acquired Unocal for approximately $18 billion. Soon after, Unocal terminated its contract with Howrey.

Up to that point, Unocal had paid eLawForum in two installments adding up to $4.6 million. But once its contract with Howrey ended, Unocal said eLawForum wasn’t entitled to any additional payments because the company wouldn’t be realizing any further savings through the relationship eLawForum had arranged with Howrey. Additionally, Unocal argued that based upon the work that Howrey had so far completed, eLawForum had only earned $3.1 million, so it wanted eLawForum to pay the difference back.

But eLawForum disagreed. It claimed Unocal still owed it for the full $6.9 million outlined in the contract because it was a fixed amount. It sued Unocal in February 2008 for breach of contract.

A trial court granted eLawForum summary judgment in June 2011, saying the company’s interpretation of the contract was stronger and more logical than Unocal’s interpretation. The court awarded eLawForum the full $6.9 million outlined in its contract with Unocal.

Clear Obligation

Unocal appealed to the D.C. Circuit, arguing that eLawForum’s contract was ambiguous. The company said it had interpreted the contract to mean that the $6.9 million fee was not fixed, but was instead dependent on actual cost savings realized through its partnership with Howrey.

But a three-judge panel for the D.C. Circuit sided with eLawForum. The court wrote in an Aug. 30 opinion “that the contract’s meaning is clear” and that Unocal owed eLawForum the full $6.9 million even though it had prematurely ended the five-year contract with Howrey. The court reasoned that eLawForum earned the full amount outlined in the contract “on the date that Unocal retained Howrey as outside counsel by way of eLawForum’s services,” and “Unocal’s obligation to pay eLawForum this agreed upon fee is not altered simply because the agreement allowed for the payments to be made in installments.”

Lessons Learned

Experts say the lesson from the Unocal case isn’t that legal departments should avoid working with litigation portfolio outsourcing companies. On the contrary, these companies’ services can result in some serious cost savings, particularly when it comes to large-scale, long-term litigation, says Brian Lee, managing director at CEB, a member-based advisory company formerly known as Corporate Executive Board.

But Rees Morrison, president of the consulting firm Rees Morrison Associates, cautions inside counsel that they “do need some consulting advice when you do something as unusual as a competitive bid for portfolios of work because it has a lot of consequences.”

The Unocal case presents some valuable lessons about best practices for working with litigation portfolio outsourcing companies, and any legal process outsourcers (LPOs) or outside vendors, for that matter.

First and foremost, in-house counsel must do their due diligence to scrutinize all contracts with service providers.

“The company needs to clearly understand the cost component and the cost structure because what they don’t want is surprises,” says Shahzad Bashir, executive vice president and co-founder of Huron Consulting Group.

Lee agrees. “You need to give a lot of thought as to what success looks like and make sure that that’s written into the contract. How is payment made? What does it look like? How much gets paid upon certain time frames? It’s critical to understand the compensation arrangement.”

Bashir says it’s also important for in-house lawyers to seek out and work with service providers that have a proven track record. “Most LPOs go a long way toward having real, tangible, measurable quality. LPOs have scorecards—and if they don’t, they should have—as to how they measure quality,” he says.

It’s also paramount that companies maintain communication with service providers they’ve hired. “Communication and trust are going to be forefront,” says Lee. “When we look at what companies do that really see a benefit in cost-savings and a quality increase, invariably what we see are long-term relationships or people that communicate very clearly what their need actually is. So whether that is something as simple as doing document review or whether it’s managing aspects of litigation, the common thread is clear communication of responsibilities and understanding what success looks like.”

Spokespersons for DLA Piper, which represented Unocal in its case against eLawForum, had no comment for this story.