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INSIGHT: A New Path to Law Firm Profitability—Contingency Fee Litigation

May 3, 2019, 8:00 AM

With ever-increasing pressure on law firms to discount client fee structures, the profitability chasm between practice groups is increasing. For some firms—even those built on the strength of renowned litigation practices and star trial lawyers—profit margins for litigators have eroded.

Litigators now often take a backseat to private equity, regulatory, and bankruptcy practice groups, which typically demand that clients pay full rates and collect nearly 100 percent of their fees.

But litigators have access to a powerful but underutilized tool that is unique to their practice—contingency compensation.

Historically, firms have shied away from contingency fee arrangements, unwilling to bet their own capital on case outcomes. But recent market advancements have left litigators well positioned to leverage innovative value-sharing fee arrangements that can help retain the best clients and build sustainable profitability.

With uncertainty in the markets ahead, law firms need to start thinking about contingency arrangements that can help them manage cases as an investment portfolio and commit to risk-sharing with clients.

A Portfolio Theory of Case Intake

What if law firms approached decisions about case intake and billing the same way savvy individual investors approached their own investment portfolios?

When a firm agrees to represent a client on a particular matter, the firm is making an investment of time and resources on the assumption it will receive a return. Cases billed by the hour are a relatively safe investment—they are a law firm’s equivalent of a double- or triple-A bond. Firms that primarily bill by the hour will certainly receive a fixed return on their investment but will miss the opportunity for big returns.

Unfortunately, there are fewer triple-A bonds out there, as clients push for discounts. Rather than simply discount fees, law firms can diversify their portfolio of cases to include billing models that allow a firm to share in the value created for clients.

Offer Something Better Than a Discount

Client retention is important to every business, but all too often, law firms use discounts as a primary tool to lure new clients or to appease long-time, large-volume clients. But when firms fall into the trap of giving large-volume clients steep discounts, they may wake one day to find they have allocated an enormous portion of resources to reap only relatively modest profits.

When a client demands a discount, innovative lawyers are responding by offering something better. Rather than simply offering the “no win, no pay” traditional contingency fee model, firms are sharing risk in more creative and efficient ways.

Some firms are foregoing hourly billing and charging a variable percentage based on a case’s outcome. Others offer a discounted hourly rate with a success bonus, or an hourly rate up to a certain number of hours with a percentage of the recovery only after the hourly budget has been exceeded. Each solution offers a varying degree of risk for the law firm, and each option allows the firm to collect some portion of a fee based on performance or case outcome.

More recently, clients and law firms have sought litigation funding to pay half of the firms’ hourly fees in exchange for a stake in the case outcome, while the law firms invest for the other half of fees by working on partial contingency.

This new model brings distinct advantages. Clients pay nothing up front but still receive most of the case proceeds. Law firms satisfy clients’ demands while still covering most of their overhead out of the funder’s commitment to finance 50 percent of the firm’s billables. Yet, the firm still retains significant contingent upside should the case succeed.

A diverse portfolio of carefully vetted contingency cases should result in a realization rate that exceeds the 80 to 85 percent rates typical of most litigation practice groups.

Why Isn’t Everyone Doing It?

So why do industry surveys indicate that hourly billing still accounts for more than 94 percent of law firm billings? A number of factors may explain this hesitancy: aversion to change, fear of uncertainty, or just lack of experience identifying the right recovery or success metrics.

Additionally, law firms large and small have special challenges that slow the adoption of contingency cases. On one hand, small firms may lack the capital to take on the optimal amount of contingency work. A lack of adequate capital can force firms to turn away promising cases and hold capital concentrated in too few cases.

Large law firms may be better positioned to take on the optimal number of contingency cases to diversify risk, but they are also likely to attract promising, high-return litigation that tends to be incredibly expensive. Even the largest law firms do not like to have $15 million to $20 million in fees at risk in a single case.

Making a commitment to innovative billing models that rely on a higher risk profile can be unnerving. However, lawyers should look at this practice as they would any investment plan.

No investor should be entirely concentrated in bonds or fixed income products. A mix of contingency cases should be a component of a law firm’s portfolio to boost revenue and improve realization rates. Litigation finance can bridge the gap between fear of uncertainty on the one hand and the desire to reap the significant benefits of successful contingency cases on the other.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Justin Barker is head of Validity Finance’s Chicago office. He was previously a litigation partner at law firm Kirkland & Ellis, where he practiced for 17 years.

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