Controlling legal spend has never been more critical than it is now. Around the world and across industries, legal departments are seeing law firm rates increase even while having to work within lower budgets. Strong competing forces like these mean that legal teams must use every tool they have available to curtail rising costs. Alternative fee arrangements (AFAs) are an excellent way to address this challenge and help keep outside counsel firms aligned with your goals.
AFAs, pricing structures in which you pay a fee for legal services based on something other than a traditional hourly rate, are usually more popular in financially challenging times. Wolters Kluwer ELM Solutions analysts found that over 20% of rate increases in 2023 were in the double digits. This is precisely the type of pressure that tends to make AFAs more popular with legal teams.
Why AFAs?
ELM Solutions recently hosted a focus group on AFAs, which included some polling of attendees. During that session, poll results showed that all participants use AFAs at least sometimes, with 28% indicating they are used often by their legal departments. When asked where the impetus to use AFAs came from, 33% said that the legal ops team suggested it. In a few cases, in-house attorneys, or even a law firm, instigated their use.
Wherever the initial prompt comes from, there are several common goals that lead companies to the use of AFAs. These include:
Cost certainty for clients. One of the main benefits of AFAs is that they provide clients with cost certainty. Some enable you to know exactly how much you will be charged for a matter, simplifying the budgeting process. By contrast, the billable hour model can lead to unpleasant surprises as costs rise over the life of a matter.
Improved efficiency for law firms. Another commonly cited reason for AFAs is to encourage firms to be more efficient. Since many AFAs are versions of a fixed price, the law firm has an incentive to be more efficient and maximize profitability.
Better alignment of interests. AFAs can also create a better alignment of interests between law firms and their clients because both parties typically work towards the same goal, such as completing a project within an agreed-upon budget. Using the billable hour model can create tension over how much time is spent on a matter.
Understanding the AFA options
When you begin to consider whether AFAs might be worthwhile for your legal department, you need to understand the various types to know what your options are. Here are brief descriptions of some common arrangements:
- Blended rate: The law firm charges a single, unified hourly rate for all timekeepers working on a particular matter, regardless of their experience level or role. This encourages the use of the most appropriate level of staff for each task to control costs.
- Capped fee: You agree with the firm on a maximum amount to be paid on a matter. Even if the work performed exceeds this amount, you do not pay the overage.
- Collared fee: Both parties agree to a specific fee in advance, along with a defined percentage that the firm would have to go over or under in order to change the amount due.
- Contingency fee: You pay only if the legal matter has a successful outcome, with the firm assuming all of the risk.
- Daily fee: The firm is paid not for hours worked but for each day, normally of a trial.
- Fixed fee: You agree on a set price for a matter (also known as a flat fee) regardless of how much work is performed.
- Fixed phase or task fee: This works like a fixed fee, but you agree to a price for each phase, instead of a matter as a whole.
- Success or performance incentives: You agree to a bonus to be paid if the law firm is successful.
- Hybrid fixed + other fee arrangement: You combine a fixed fee with another AFA, such as a success incentive.
Getting started
When you are ready to begin the process of implementing AFAs for your legal department, you should start with your data. This will give you the baseline knowledge of how much you have paid in the past so that you can better control spend going forward. Choose typical matters that you understand well and that are unlikely to yield surprises or uncertainty. Work with a law firm with whom you have a good relationship and that has experience with AFAs.
It’s best to start with a relatively simple AFA, such as a capped fee or a fixed fee. As a pilot, apply these AFAs to just one or two matters while you move through the learning curve. This should be an iterative process where you make any needed adjustments and then move on to additional matters and/or types of AFAs. Throughout the process, communicate regularly with firms to make sure the arrangements continue to work for you both.
As you make progress on and complete matters with AFAs, compare your spend on them to similar matters where AFAs were not used. Be sure to compare apples to apples. If you do see savings, you’ll want to be sure that they are the result of greater efficiency, not other factors.
AFAs are not the solution to every legal spend problem you might have, but when the circumstances are right, they can be a powerful tool for managing legal costs. For more on effectively managing your legal spend, visit our website.
