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Alternative fee arrangements (AFAs) are often studied, often debated and only sometimes tried. But with clients becoming more sophisticated in their choice of outside counsel and use of fee arrangements, you need to be prepared to answer this question: “Can we use an alternative fee arrangement rather than hourly billing in the matter your firm wants to handle for us?”
In my business development and coaching work with lawyers around the country, I often role-play as a client and ask that very question. More often than not, I get a response along the lines of “My firm is definitely open to discussing it” or “We have utilized those structures with clients before.” Not exactly a direct answer to my question. In our follow-up discussions, I usually find out that the indirect response is a result of the attorney being unprepared for the question and not having any meaningful idea how it would actually work.
Research has shown that clients are increasingly demanding that their outside lawyers look at alternatives to straight hourly billing as a way of translating the value of legal services—as the client sees the value, not as the outside lawyer sees it. Clients believe AFAs are about billing a fee that is appropriately based on what value the client receives.
Your firm’s clients perceive value in different ways: Did your legal work help them avoid a problem? Did it help win a case? Did it provide unique insight and expertise into a new way of structuring a transaction? If it did one or more of those things, then the legal fee is not an expense in the client’s mind. It is an investment.
When asked about your firm’s use of AFAs, the key is to focus on the message you want to deliver to the client about the value of the AFA to the client, not the AFA method itself.
An example: When I worked in house at a bank, most of our loans were in the middle market and corporate lending areas to large companies. The bank had its lawyers, and the borrower had its team of lawyers negotiating the terms of the loan such as interest rate structure, security, warranties and representations, etc. It was generally agreed that the law firm would bill the negotiation of the term sheet on an hourly basis. But after the term sheet was drafted and approved, the bank’s lawyers would be tasked with drafting the dozens of documents necessary to close the loan, with their bill being paid out of closing (POC) by the borrower. This is where a problem often occurred.
At loan closing, it was common for the borrower to complain about the amount of the lender’s legal fees that it was being asked to pay. If the bank agreed to a reduction, its profit margin was reduced; if the bank’s counsel agreed to a reduction in its fee, the same result. If the borrower refused to close, everyone lost. More often than not, the bank’s in-house counsel was called to mediate among the parties, usually resulting in all parties leaving the loan closing dissatisfied with the process.
The solution to this continuing problem was an agreement, up front, to develop a fixed-fee arrangement for preparing the necessary closing documents after the term sheet was negotiated. Both lender’s and borrower’s counsel participated in the fixed-fee arrangement, resulting in no surprises at closing. The borrower was being charged an appropriate fee based on what value was received. The closing fee became an investment, just like the business loan.
Having AFAs in your firm’s arsenal of business development plans is essential in today’s legal marketplace. Being able to show to your clients and your firm’s management that utilization of AFAs can work, and that they can be profitable to the firm and a relationship-building tool with your clients, requires thinking through matters ahead of time as well as project management skills (such as the banking example mentioned above).
Ultimately, you must be prepared to directly and specifically answer the question: “Can we use an alternative fee arrangement in the matter your law firm wants to handle for us?”