Is this the death of hourly rates at law firms?

Kathy Kirmayer calls it the “bad first date” phenomenon.

Many law firms and in-house lawyers shy away from using flat fees for litigation because they once had a bad experience with it, she said.

“Because it’s a new frontier, there are law firms that don’t know what they’re doing and are going with crazy low pricing hoping they can get a new client that way,” said Kirmayer, a partner at District-based law firm Crowell & Moring. “And once they get a client to hire them, they try to figure out how to deliver for what they quoted ... and the client is surprised by the level of service.”

Kirmayer is part of a small but growing contingent of lawyers who are urging law firms and corporate counsel to experiment with alternative fee arrangements for litigation. Alternative fees include anything that is not hourly billing — the way law firms have historically charged corporate clients. Alternative arrangements can include flat fees, success fees and contingency fees. They are typically less expensive than hourly fees.

Law firms have been using more alternative fees in the past several years, largely to meet the demands of their chief clients, in-house lawyers who are scaling back on outside legal spending. In 2009, 28 percent of law firm leaders believed that non-hourly billing would be a permanent change in the legal industry, according to legal consulting firm Altman Weil. By 2013, the figure had jumped to 80 percent. Since 2012, a handful of major firms, including Holland & Knight and McDermott Will & Emery, have even ditched the billable hour model altogether for entire teams of people.

But the move away from hourly rates for litigation specifically is newer and perhaps even more significant because trial work has always been viewed as the last vestige of the hourly billing model. This is because litigation tends to be more unpredictable than other types of legal work, so law firms have long argued that it is harder to charge a flat rate for it.

“It’s easy for people to understand a fixed fee for a real estate transaction,” said Steven Greenspan, head of litigation at the 330-attorney legal department of United Technologies, the Hartford, Conn.-based technology and aerospace giant. “You want to buy a building, you know how much it’s going to cost to bring that closing. Litigation has always had a lot of uncertainty. It was easy to accept the mystery of, ‘We don’t know what the future will bring.’”

That perception is changing.

“Now it’s significant that in-house legal departments realize litigation isn’t all that mysterious,” Greenspan said. “There are rules and processes. You should be able to price a case in most circumstances and negotiate for carve-outs with outside counsel in the event that something unexpected happens.”

Change in philosophy

In 2007, United Technologies’ general counsel created a program to discourage its hundreds of outside law firms from using hourly rates, and over the past five years the company has significantly increased its use of non-hourly fees, Greenspan said. Today, more than 70 percent of the company’s legal fees are on a non-hourly rate. Roughly the same percentage is true for the company’s litigation fees. Instead, United Technologies and its outside law firms break down each litigation matter into phases, and the company pays a flat fee per phase: investigation, followed by discovery, trial preparation and trial, and an appeal, if it reaches that point.

“We believe the hourly rate is dead, and we shouldn’t engage outside counsel on an hourly rate basis,” Greenspan said. “I almost never get pushback [from law firms] today. Two or three years ago, I got pushback all the time.”

The change in pricing philosophy did not come easily.

At first, “law firms were fearful,” Greenspan said. “It was easiest to price a legal engagement by just recording your hours and cha-ching cha-ching, you come up with a number. It took firms a long time to figure out how to price their services that would protect a reasonable [profit] margin.”

Some law firms are now creating programs to figure out how to charge non-hourly fees for litigation. For the past 18 months, McKenna Long & Aldridge has been developing an internal software program called MLA Value Track that will predict how much a litigation matter will cost based on how much similar litigation has cost in the past. The program is currently being beta-tested by the firm’s litigation department, which is using it to track about 30 percent of the firm’s litigation matters. The program breaks litigation down into phases in order to price each stage, like how much it costs to file a complaint, how much it costs to file an answer to a complaint and how much each deposition is expected to cost. Tami Azorsky, head of McKenna Long’s litigation department, said she hopes the software will be out of the beta stage and finalized by the end of June.

“I think the move toward actually doing [non-hourly billing for litigation] is not as far along as people may think,” Azorsky said. “It’s definitely a topic of conversation, but there are still many [clients] out there that feel comfortable with the concept of an hourly arrangement.”

Close to tipping point

Kirmayer thinks the shift is inevitable, and could alter the business model that has allowed law firms to flourish for decades. Most law firms pay their lawyers using a formula that relies heavily on the number of hours they bill. If the billable hour fades away, law firms will have to rethink that model.

“Law firms have been extraordinarily profitable over the last 50 years based on a model that has them charging by the hour, so clients are rewarding effort, not results,” said Kirmayer, who regularly speaks at in-house counsel conferences about how to structure alternative fees. “But now with changes in the economy, clients realized they couldn’t continue spending on legal services the way they had been. They shrank the market, so law firms had to shake up the way they did business and figure out how to deliver the same quality of legal services at a more realistic price point. That’s like changing an entire culture.”

Kirmayer is an anomaly. She is a litigator at a big law firm who does not charge hourly for most of her work, which is nearly unheard of among litigators in Big Law. Instead of charging hundreds of dollars an hour, Kirmayer and her clients agree on a set rate at the beginning of a case — often a flat fee with a success fee that will reward her if, for example, she gets a case dismissed in the early stages of a lawsuit — based on estimates on how much the case will likely cost. A couple years ago, Kirmayer started using this type of fee for almost all of her work.

“What I’m looking to do is provide the lowest cost to the client as possible — asking how few people can do this task?” she said. “How quickly can we get this task done? What’s the lowest cost to the law firm, and what’s a reasonable return on that investment? It’s cost-up pricing rather than basing off an hourly rate.”

About 37 percent of chief legal officers expect the use of alternative fees to increase, according to a recent survey of 1,200 general counsel by the Association of Corporate Counsel, the Washington-based trade group that represents in-house lawyers. Only four percent said it would decrease.

“We are extremely close to the tipping point in the legal services market on this issue,” said Amar Sarwal, the association’s vice president and chief legal strategist. “The billable hour’s day has passed. It’ll still be a part of the market but it won’t be a leading part of it.”

80%

The percentage of law firm leaders, in 2013, that believed non-hourly billing would be a permanent change in the legal industry. That is up from 28 percent who believed in 2009.

37%

The percentage of chief legal officers who expect the use of alternative fees to increase, according to a recent survey of 1,200 general counsel by the Association of Corporate Counsel. Only 4 percent said it would decrease.

Catherine Ho covers law and lobbying for the Capital Business section of The Washington Post. She previously worked at the LA Daily Journal, the Los Angeles Times, the Detroit Free Press, the Wichita Eagle and the San Mateo County Times.
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