January 25, 2023

 Erica White

Consulting best practices AFAs alternative fee arrangements law department law firm

Alternative fee arrangements (AFAs) are nothing new, yet my colleagues and I frequently hear from law departments struggling to design AFAs and implement them with their outside counsel. Often, their efforts to establish AFAs create tension with outside counsel and leave the impression that a law department wants AFAs solely to save a buck.

It doesn’t have to be this way. Having guided many law departments in obtaining AFAs, I know first-hand that it can be a collaborative, less painful process for all involved.

The first step is to stop thinking about AFAs as strictly about reducing legal spend. Unfortunately, most articles and information about AFAs emphasise how AFAs can help law departments cut costs and create more predictability in their budgets. They can, but only if you succeed in implementing them – and that means persuading outside counsel to go along. If your sole objective is for your law department to save money, that will make AFAs a tough sell to a law firm.

Operationalising a better approach to AFAs begins before you propose them to outside counsel. It is crucial to identify what you seek to achieve from AFAs beyond cost savings. Most likely, your fundamental goal is increasing efficiency and effectiveness – making sure the right work is getting done by the right people in the right manner at the right cost at the right time.

Laying the Groundwork for AFAs. Consider a product liability litigation matter and some potential AFA scenarios, starting with billing data revealing high partner billing by one firm during the written discovery phase. The seemingly obvious solution is to use a different (i.e., less expensive) firm going forward. But we all know it’s not that simple, nor should it be. Outside counsel relationships have value, in the form of (for example) institutional knowledge, a well-established working relationship with a firm and its lawyers, or a firm’s strong record of achieving favourable results for you. AFA structures should take these sorts of considerations into account. Yes, you must address budgetary restrictions, but AFA structures should operate to prioritise both effectiveness and efficiency for all involved.

Continuing my hypothetical, once you understand why you want to discuss AFAs with this particular firm, start thinking about how an AFA structure could encourage the firm to shift written discovery work to associates or paralegals. Several AFA structures fit the bill (no pun intended!), some applicable to portions of the matter and others suitable for the entire matter. While not an exhaustive set of examples, consider these options:

Risk Collar. A risk collar incorporates the hourly billing model but with a bonus to the firm for completing the work under budget and a discount for the client on all fees billed over the estimated budget. Risk collars incentivise firms to find ways to come in under budget and avoid going over it. In our scenario, the firm might shift written discovery work from partners to associates or paralegals (or both) with lower rates than those of partners.

However, a risk collar involves uncertainty, especially compared to a fixed or flat fee. Nothing guarantees the firm won’t exceed the budget. Moreover, a risk collar could lead less scrupulous firms to inflate the initial budget estimate to try to ensure that they come in under budget. You can reduce or remove this risk with an RFP process and other techniques.

Graduated Fee Caps. A fee cap is still hourly billing, but with billing rates for each timekeeper category (i.e., partners, associates, and paralegals) capped at a certain figure. A graduated fee cap builds on this. It might preserve paralegals’ billing rates, only slightly reduce associates’ billing rates, and impose a larger reduction in the partner billing rate. This incentivises firms to shift work to timekeepers (i.e., associates and paralegals) with the smallest discounts.

Fixed-Fee Arrangements (by Phase or by Matter). Fixed fees provide the most predictability about costs and, for law firms, the most predictability concerning revenues. You can establish a fixed fee for an entire matter or specific phases. In our example involving written discovery, a fixed fee might encompass the entire matter or only the discovery phase. Both approaches are likely to encourage a firm to trim the total amount billed by shifting written discovery work from partners to associates and paralegals.

Fixed fees are not suitable for every type of matter. Litigation can be tricky, with the scope of work changing quickly due to a particular development (e.g., a ruling on a motion expanding or shrinking the scope of the litigation, a verdict prompting an appeal, etc.), the volume of discovery materials received, the number of depositions needed, and more. Understandably, some law firms feel fixed fees boil down to a law department simply wanting to pay less. This can damage the client-firm relationship in ways that ultimately negatively impact legal spend. If you nonetheless believe a fixed fee is the best option, you will likely find that outside counsel is more amendable to this approach if you discuss with them the reasons that prompt you to propose a fixed-fee approach or if you present several AFA structures for consideration.

Thinking Things Through Thoroughly. Designing, selecting, and implementing an AFA is a process. It requires data analysis, trial and error, and thoughtful collaboration. Industry knowledge, historical data, and modeling can help law departments analyse the bottom-line impacts of the various AFA structures. But rather than impose an approach, it is best to have data-driven, collaborative discussions with outside counsel.

In my next post, I will share additional insights on AFA – other approaches, how to model various AFA structures, and best practices for productive collaboration with outside counsel to develop and use AFAs. Stay tuned!