In Part 1 of this series we noted the trend in greater demand for legal services walking hand –in-hand with pricing pressures, and came to the unavoidable conclusion that law firms that wish to have a competitive edge and differentiate themselves among their competition will need to be proactive with initiating an alternative fee arrangements (AFAs) strategy. In Part 2, we are going to explore in more depth the types of AFA structures that law firms are using, the practice areas where AFAs are being utilized, and how firms are achieving profitability.
The first question asked by many law firms is “Which practice groups should be considered for AFAs?”
The short answer is that any firm can develop an AFA for any practice group, and, in fact, many law firms have already done so in the simplest form — contingency matters. When you think about it, a firm will take a matter on contingency for a variety of reasons. First, the attorney has the comfort level that they can achieve a positive outcome and yield a positive monetary result for the client. The firm may take a standard 33.3% with the balance of the recovery going to the client. Sounds like a win-win, right?
There are two schools of thoughts to consider here however, legal strategy, which includes managing the case in all respects, but also the financial component. This creates an opportunity for the attorney to review the financial aspects of the case with the firm’s administrator or finance director, which places more focus on case management to ensure the firm (and the lawyer) stays on track with the time/expense so the contingency matter will yield a profit when all is said and done.
There are two schools of thoughts to consider here however, legal strategy, which includes managing the case in all respects, but also the financial component.
The firm’s mantra should be: “The key is to create an arrangement that reflects and supports the long-term, broad scope of the client relationship and provides a chance to grow the client relationship further and into new practice groups.”
Which Practice Group is Best for AFAs?
While any practice group should be considered for an AFA, I would recommend a methodical and practical approach.
- First, identify practice groups where the firm has the most financial intelligence. Attorneys should be working with their administrators and finance directors to ascertain these costs. Specifically drilling down to tasks performed, routine and otherwise, and agreeing on a methodology for determining the cost to complete those tasks at varying levels of the firm (g. partner, associate, paralegal) as well as how to best staff the matter is vital at this stage.
- To maximize the efficiency and cost-effectiveness of the matter, you need to develop methods for producing or managing the work to be performed. This is where I like to think that AFAs are a lot like revenue budgeting, being both a science and an art form. Let the financial intelligence guide you in determining the staffing of the matter to ensure that efficiency and cost-effectiveness is maintained. Keep in mind that your goal is to produce a positive result, while minimizing the cost to produce the work. However, to make an AFA realty work, clients are looking for law firms that are willing to take more risk, thus raising the issues of how to best approach pricing.
In my experience I have seen AFAs developed for corporate/transactional matters, Trust/Wills/Estates Administration, and (may the forces of good forgive me) Litigation! I will be the first to admit that I would cringe when I hear the words litigation and contingency in the same sentence, but AFAs indeed can work with litigation matters if the work is phased properly.
What Do Clients Want to See?
Clients prefer a mix of standard hourly rates and AFAs depending on their varying goals for individual matters, so what is a suitable AFA? In addition to common practices like flat fee or contingency fees, here are some examples that give a flavor of risk-sharing AFAs used in litigation:
- Client retains firm to pursue arbitration against its partner in a $500 million development project. Under the arrangement, client paid 50% of standard rates and firm received a percentage of the value the client received upon liquidation or sale of the venture.
- Client retains firm to pursue litigation against numerous former officers and directors for fraud. Client requested firm pay all expenses including expert costs. In return, firm received full reimbursement of expenses, from “first dollar out” and a percentage of the recoveries from the litigation.
- Client and firm negotiated an agreement, whereby the firm handled a fixed group of defense cases for a 30% reduction in its normal fees in exchange for the right of first refusal for all plaintiff contingent fee cases the client has for a three-year period.
- Several clients asked one firm to “hold back” 20% to 30% of its normal fees in return for payment of the “hold back” and multiples thereof depending on the outcome of the litigation.
These are litigation risk-sharing AFAs that have been utilized by firms with varying levels of success. However before going in any (or all) of these directions, firms need to ask questions about what their client is really looking for, and what the firm is willing to accept regarding the profitability of the work?
A lawyer’s goal is to “play-to-win” for the firm and the client, but unless the AFA makes business sense to undertake, it’s important the firm learns to say “No” to some of these engagements. One of the most significant criteria law firms struggle with is achieving profitability with AFAs. Some firms are generating profits, while other firms continue to lose their shirts by making the same mistakes. The question is are those firms learning from these mistakes?
In Part 3 of this series, we will discuss how many other law firms are using AFAs and achieving profitability. We will review the various profitability metrics to monitor and will wrap up with framing the AFA message for the strategic marketing advantage.