Alternative fee arrangements are growing in popularity and getting more sophisticated but they still face institutional obstacles to their wider adoption. One key reason: matching the fee to the work is hard to do. That leads many legal departments to stick to what they’re familiar with – the billable hour. 

“There are a lot of clients that ask for an alternative fee proposal, but ultimately accept the hourly,” Alan Guy, managing director for underwriting and value optimization at Kobre & Kim, told Legal Dive.

About a third of the work that law firms do for in-house teams is paid using some kind of alternative fee arrangement, according to data from the Association of Corporate Counsel and Major, Lindsey & Africa.

That’s up from about 29% last year. The biggest growth has been in the use of retainers, which jumped about 21% during the past year. The use of blended hourly rates also increased. 

But until both sides get more comfortable with the arrangements and spend the resources to structure them in a way that makes sense for both sides, how much more their use will grow is unclear, specialists say. 

Cost predictability

In-house legal departments that pursue alternative fees often see them as a way to bring costs down or get more predictability into their legal spending, typically their biggest budget burden. Over the past few years, more corporations have started requiring law firms to offer alternative fees or they’re providing incentives for them to do so, said Guy. 

But that doesn’t mean that they’ll necessarily end up using alternative fees.

A major reason that occurs is that law departments are often afraid of getting the short end of the stick. Corporate counsel are sometimes dissuaded from accepting alternative fee arrangements over the fear that if costs exceed expectations, it will reflect poorly on their judgment. “They sort of revert back to what they’re familiar with,” Guy said. 

If work performed at an hourly rate costs more than expected, that’s more easily attributed to the firm, and not the law department, he said. 

Some areas of law seem better designed for alternative fees than others. It’s relatively easy, for example, to adopt outcome-based fees in fields with a large volume of matters, like insurance or employment law, since the high number of cases is effective at distributing the risk.

Process efficiency

But for lower volume areas, putting resources into more efficient methods of undertaking legal work can be a better way of reducing costs than negotiating alternative fees, said Peter Eilhauer, managing director at Epiq.

Opinion in the field agrees. In a survey of more than 80 law department professionals conducted by the Blickstein Group, a corporate law consultancy, a majority said that work done with good legal process management, whether technology-based or otherwise, is more cost effective than work done under an alternative fee arrangement.

“Legal tech can be the efficiency tool that allows you to reduce the costs” even more than an alternative fee would, said Brad Blickstein, founder and principal of the Blickstein Group and co-head of the NewLaw Practice Group at Baretz+Brunelle.

Increased use of competitive bidding, alternative legal service providers or other tools can also bring down costs as much as alternative fees can. Supporting this argument is the fact that companies are increasing their use of alternative legal service providers and are expected to continue to do so.

Proper structuring

But alternative fees can still be used to increase efficiency or lower costs. As alternative fee arrangements increase in volume, they are also getting more sophisticated, with law departments making increasing use of legal operations professionals, and firms taking on more legal project pricing experts. These experts then take charge of the negotiations over alternative fee structures.

“What's increasingly happening is that those discussions are happening directly between the pricing professionals, as opposed to between the general counsel and the partner,” Guy said. 

These individuals possess skills that enable them to create fee structures that are more sophisticated and more finely tailored to the specific matters at hand than the structures devised by lawyers negotiating with lawyers.

This can lead to fee structures that include multiple outcome-based metrics, continuous improvement programs and any number of options more sophisticated than the simplest type of alternative fee, a flat rate.

This trend still has enormous room for growth. In another survey by the Blickstein Group, nearly nine-tenths of law firms said that most of their clients don’t know how to structure or evaluate alternative fee arrangements.

Especially with such a knowledge gap among law departments, companies that acquire this expertise “are in a much better position to have smart conversations with their lawyers and get to deal structures that work really well,” for both the company and the firm, Guy said.

Using finer-grained metrics to negotiate optimal alternative fee structures is conducive to “driving a deeper substantive relationship with the law firm,” where the firm is incentivized to work more intentionally to support the business goals of the company, said Lucy Bassli, founder and principal of InnoLaw Group.

Work scope

This type of close attention to fee structures can solve a problem that has plagued some alternative fees in recent years: inefficiency. If a certain alternative fee structure means that a company is paying a firm to do work that could be performed by an alternative legal service provider at a much lower rate, that fee is unlikely to be efficient.

“You need to understand at the specific task level what work is being done so you can determine what work should be included in your alternative fee,” Eilhauer said.

Some companies that had moved towards greater use of alternative fees have returned to hourly structures after failing to do the necessary work to construct efficient fees, he added.

Despite the increasing sophistication and prevalence of alternative fee arrangements, the billable hour still dominates, representing over three-quarters of total billing according to a report released by Thomson Reuters earlier this year.

One reason for this is simple inertia. It can take significant effort to devise an alternative fee structure, especially for complicated matters, and law departments may not feel that it's worth their time to do so.

Firms also may decline to offer alternative fees, especially if they don’t feel that the size of the company’s spending is big enough to justify the extra work necessary to devise one. Larger companies, or companies that have their entire legal spending with one firm, are more likely to be able to negotiate alternative fees, Blickstein said.

Ultimately, the move to alternative fees relies on “mutual trust,” said Steven Shanker, founder of the Shanker Law Firm, which offers alternative fees to all of its clients, and has used alternative fees for years with some of them. This trust entails firms believing that fee structures will allow them to receive reasonable compensation for their work, and corporations having confidence that without time-based compensation, firms will still put in the work necessary to achieve successful results.

If this is achieved, “you take out the billable hours that most people hate,” Shanker said. “You can get proactive counseling rather than having a relationship you treat solely as a business.”