The alternative fee arrangement is underused in the legal industry, despite regular predictions that its usage will increase. This is especially true during times of economic strife when corporations are most cost-sensitive. Will the current downturn flip the script on this, resulting in AFAs being the norm? As the legal industry increasingly turns to business practices, the answer may finally be yes.
According to Bloomberg Law’s 2020 Legal Operations Survey, AFAs are more commonly used by larger law firms (those with more than 100 practicing attorneys) than smaller ones. But even larger firms tend not to rely on AFAs for the majority of their work. As the chart below shows, more than three out of 10 larger firms use AFAs for 10% or less of their work.
When larger law firms do use AFAs, client demand is the primary driver of that usage. While other drivers are relevant, client demand dwarfs all others, with nearly all larger-firm respondents selecting it from a range of options.
Corporations, on the other hand, are driven to use AFAs primarily for cost reasons. Cost savings and cost certainty were selected from a range of options by at least seven out of ten in-house respondents from corporations that utilize AFAs.
With cost factors being the primary drivers of AFA usage from the perspective of corporations, it is likely that pressure on firms to reduce their bills will increase, and this pressure could result in more AFAs. However, a significant increase in AFA use was similarly predicted during prior downturns but never materialized, so why might it occur here?
Why This Downturn Could Be Unique for AFAs
Corporations are especially cost-sensitive these days, taking numerous actions to preserve their financial security, including furloughs and lay-offs. Corporate legal departments will likely find themselves cutting costs due to reduced operating budgets. There are many options available to corporate counsel seeking to trim outside counsel expenses, including: eliminating projects, handling more projects internally, relying more heavily on legal technologies and alternative legal service providers [ALSPs], transitioning to firms with lower rates, and aggressively negotiating rates with firms on an hourly-rate basis or through demands for more AFAs. All of these options will likely be exercised as corporations adjust to their current financial realities.
While AFAs failed to make significant inroads in prior economic downturns, the legal industry has changed. More ALSPs and legal technologies are available to help reduce workloads. This means that firms have more outside (non-firm) competition. In addition, due to the wider impact of this downturn, a significant number of industries are in financial distress. As a result, a majority of a firm’s clients may be exerting pressure on it to cut costs or lose them as clients, thereby increasing competition among firms in acquiring and retaining business. Furthermore, organizations are increasingly integrating business tools—including the use of metrics allowing for data-driven decision-making—into their legal practices. This change is corresponding with the increasing use of multidisciplinary teams and greater demand for legal operations professionals and practice managers. The importance of business tools and personnel in legal organizations should not be overlooked; it could be crucial in moving the market towards AFA models, leading to improved data collection and evaluation tools and skills required for thoughtful decisions based on measurable data.
Metrics Could Be the Key
To effectively evaluate AFAs, organizations need to collect and analyze project data. One way to determine the value of an AFA is by comparing costs of projects pursued under an AFA with their costs under traditional billing models with the help of shadow bills.
Once an organization has enough experience utilizing AFAs, shadow bills may be unnecessary. Even so, it may make sense to consistently collect high-level data from a firm, such as the percentage of time devoted to a project by different team members, so the corporation can evaluate factors including commitment to diversity and attention paid by partners and senior attorneys. However, larger law firms report that they do not always create shadow bills. In fact, shadow bills are seen by some corporate counsel as reinforcing the billable hour as the industry norm, instead of as a tool for gathering data as an organization acquires institutional knowledge.
Qualitative data is also important in evaluating the success of a project. Qualitative evaluations completed by all corporate legal team members can help determine how successful a project was. Such data would help address concerns by corporate counsel that the incentive for firms is to push workload down to the least-cost resource to preserve profit margins, thereby reducing the quality of the final outcome. Combining qualitative data with cost figures and other quantitative data collected in the course of a project would offer a more comprehensive understanding of the value of AFAs.
Now may be the time for AFAs to come to the fore. Firms willing to meaningfully invest in clients through AFAs, and offering high-quality work in support of those projects, may find themselves in the enviable position of being preferred outside counsel—a status that may mean the difference between survival and dissolution during the dark downturn days.
Access analyses from our Bloomberg Law 2021 series here, including pieces covering trends in Litigation, Transactions & Markets, the Future of the Legal Industry, and ESG.
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