Editor’s note: This is the second in a weekly series examining how law firms adapted during the last two years and where they are headed as the economy recovers.

Cephalon General Counsel Gerald Pappert doesn’t know what it is like to run a legal department during law firm glory days, but after joining the pharmaceutical company in May 2008, he quickly got to the task of curtailing firms’ old ways.

Pappert’s first order of business was to draft an 18-page document detailing the legal department’s expected billing and case handling practices. It tells firms what is appropriate to be charged to Cephalon and what is not. It demands a budget of the project within a month of the engagement and, Pappert said, quarterly updates on where the budget is.

The names and hourly rates of all attorneys working on a Cephalon matter are also required and there are guidelines for how matters are staffed. When it comes to who from a firm works on his matters, Pappert said it matters to him only that the person of the appropriate experience level handle the appropriate job for that level and that a more expensive sixth-year doesn’t do something a second-year could do.

And, to the opposite of many of his counterparts, Pappert doesn’t mind if a second-year associate works on his case.

“This is where we have to trust the firm,” he said. “We just ask that they staff it appropriately.”

The department’s newly implemented electronic billing system, CounselLink, also helps it catch any deviations on bills from what the guidelines demand. If a new attorney works on the matter who wasn’t initially mentioned, the computer system will catch that and return the bill. The same goes for when Cephalon is charged for something the agreement didn’t envision.

Firms have been amenable to these new changes, including the use of alternative fee arrangements, Pappert said. Some are better at AFAs than others, and those are the firms Cephalon will enter into the arrangements with, always with the caveat that it can be tweaked at the end if one side didn’t make out as well as planned. Pappert said he typically looks for discounted hourly rates and fixed fee arrangements where possible.

“Everybody’s kind of learning together, clients and firms, so the firms are always amenable to discussing it, but there are firms who are better at it than others,” he said.

Several law firms have said their clients just aren’t interested in AFAs, don’t bring up the idea or simply don’t trust that the firm isn’t making out too well on the proposal and just stick with hourly rates.

“The client is the customer. My opinion would be that if the firm wanted to be proactive and smart about it, they would be showing more initiative to come up with and offer clients various alternatives,” Pappert said. “I don’t necessarily think the firms should just wait for the clients to suggest it. Having said that, once the issue arises, I view it as very much a collaborative process.”

Having been a large-firm partner, Pappert said it’s important to him that the firm feels like it, too, is getting something out of an AFA and trusts in Pappert during the process.

Jonathan Peri, the general counsel and sole attorney for Neumann University in Aston, Pa., has seen a willingness from firms to work with his crunched budget and has shifted work to those firms most willing to work with him in that area.

But typically it’s not through an alternative fee deal. Because of the university’s smaller size, he said, he doesn’t think that type of arrangement would be productive.

“My personal view is that the value of work product is going to go down, so I’d rather somebody say to me, ‘We’ll reduce our hourly rate,’ and then I’m more assured that I’m going to get the right work product,” he said, adding that there are counter-arguments to this view.

Susan Hackett, general counsel of the Association of Corporate Counsel, admits there are some problems on the corporate counsel side with implementing AFAs and other goals outlined in the ACC’s Value Challenge initiative. The goal of the initiative is to have firms and clients discuss how to better provide value through the way matters are staffed, managed and priced.

Two things are often happening when it comes to AFA proposals. The first is that the client will assume the deal is too good to be true and go with the billable hour, which Hackett said shows a fundamental lack of trust between in-house and outside counsel.

The second issue is that clients look for firms to come to them with creative ideas and then they will go to their existing firms and let them keep the work if they can match that price. The problem there is that the legacy firms haven’t come up with a way to manage the project at that price and are essentially just offering a discounted rate to get the work, Hackett said. That isn’t sustainable, because eventually the firm will say it can’t sustain those rates anymore or start slipping in bills and saying things have changed, she said.

“It’s a huge problem because they don’t want to leave the firms they know,” Hackett said of clients, adding later, “I tell firms they will be frustrated at times during this process and if you don’t continue to offer it, you might miss out.”

Hackett said she is noticing change. She said she didn’t expect that 75 or 100 percent of matters would be on an alternative fee basis in just a year.

“This has never been about killing the billable hour, it’s about removing it as a default,” she said. “We are seeing people ask, ‘How do you want us to bill this?’ which isn’t a conversation people had more than a year ago.”

Hackett likened the AFA discussion to a high school dance with boys lined on one side of the gym and girls on the other. Neither side wants to come into the middle to start the dance. Most clients are waiting for the firms to raise the AFA issue because the clients don’t have the metrics or knowledge in place to manage it. Frankly, Hackett said, it’s the firms’ business. Clients aren’t interested in driving how firms manage these projects, they just want to feel like, at the end of the matter, they got a fair, valuable price, she said.

“They don’t want to see how the sausage is made,” Hackett said.

For Lorraine Koc, general counsel of Deb Shops, outside firms seem to be highly aware of and sensitive to the cost constraints of their clients. The problem is that while everyone recognizes the prevailing law firm model isn’t sustainable, she said, no new model has emerged to take its place.

“So clearly there is a paradigm shift but the new paradigm isn’t in place yet,” Koc said.

So far there are just interim remedies like reducing hiring and billing and asking under-performing partners to leave the firm. One problem to come of the reduction in attorneys at all levels, but particularly the associates, is a hoarding of work by more senior partners, Koc said. That creates a cost issue for clients who are now paying their higher billable rates.

Ultimately, Koc said, the new model will create a divide between the commodity work that can either be handled in-house or by outsourcing and the specialized work that will go to law firms. But even legal departments are trying to figure out how to bring more of that specialized work in-house or perhaps hire that attorney at a law firm who was fired and can now do the same work for cheaper prices, she said.

Koc called it an unbundling of the law firm economic model.

With more and more work being put into that commodity category, Hackett said firms that offer a “soup to nuts” services menu may be backing away from it. Only the true expertise is where the value is for clients, she said.

“There are some firms that will never have to go forward,” she said. “When you’re Wachtell, you’re Wachtell, but there really aren’t that many Wachtells out there.”

Quality is important, but it’s presumed, she said. Firms have to distinguish themselves and constantly pushing discounted rates just makes them look pretty desperate, she said.

The next installment of The New Firm Order will examine how small to midsized firms have been affected by the recession. •