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Think You Know AFAs? Think Again: The Seven Biggest Myths of Alternative Fee Arrangements

Nicky Mukerji
Corporate Counsel
January 03, 2011

Alternative Fee Arrangements (AFAs) are among the most widely debated topics in law practice management today.

The widespread acceptability and use of such arrangements arose as cost-conscious clients looked to reduce legal spend, and law firms — already suffering a recessionary decline in profits over the last several years — looked to satisfy the increasing demands of corporate clients.

Law firms' acceptance of AFAs represents a seismic movement in the practice of legal billing. Under AFAs, part of the risk shifts from the client to the law firm, which must utilize new tools to devise and manage a formula that will both appease clients and ensure profitability.

AFAs are a road less traveled for many law firms. And this unfamiliarity has helped fuel serious misconceptions regarding how alternative fee arrangements actually work, and what they're good for. Below, we set out to differentiate fact from fiction among the seven most misunderstood concepts:

Myth:
The basic premise behind alternative fee arrangements is to reduce legal spend.

Fact:
In actuality, the reason should be to improve the client-attorney relationship. From a financial perspective, what AFAs do is bring about some level of cost-certainty, allowing corporate clients to better manage legal budgets. That benefit in some cases is realized even if the cost savings are minimal.

Myth:
Alternative Fee Arrangements will make it so much easier to manage a corporate law department budget.

Fact:
Not completely. Being charged a flat fee for services rendered does effectively reduce the variability associated with the cost of legal representation. However, most agreements have numerous exception clauses — such as what happens if a case goes to trial — which add levels of uncertainty when it comes to budgeting. When negotiating an AFA, it's important to weigh the historical precedent of legal costs against future projections.

Myth:
AFAs always result in a savings for the client.

Fact:
That's often given as a justification for alternative fee arrangements, but it isn't necessarily the case. Law firms that do not fully grasp how to implement alternative billing arrangements may overestimate costs. In addition, if the client and law firm do not share a history of tracking billing matters, the lack of data makes it difficult to frame and monitor a fair alternative fee arrangement. In those cases, AFAs can turn out one-sided for either party if they are not carefully negotiated and managed.

Myth:
Every case can be effectively billed using AFAs.

Fact:
An effective AFA pricing model should be able to predict the total legal fee for a particular matter or group of matters. Even if the client and law firm have historical billing models to project future billing trends, some matters may be too complex to develop accurate projections of future time and billing habits. Alternative fee arrangements are most suitable in repetitive matters such as workers' compensation and other employment-related cases. Simple patent litigation and general liability cases may be appropriate as well.

Myth:
With an AFA in place, there is no need to review time sheets or billing invoices.

Fact:
On the contrary, in order to evaluate the effectiveness of the AFA, corporate law departments should carefully monitor how much time and resources their outside law firms are devoting to a case. The most effective way is through a "shadow-bill" that graphs typical items contained on an invoice, such as details involving the timekeeper, task performed, and number of hours billed. The amount billed to a client under an AFA should be continually reviewed and amended to ensure that it remains beneficial for both the client and the law firm.

Myth:
An alternative fee arrangement transfers risk from the law department to the law firm.

Fact:
Any transfer of risk is limited to the collection of outside counsel fees. Ultimately, in-house counsel will be responsible for managing corporate legal risk as usual. The responsibility of determining, monitoring and evaluating strategy will always remain in-house.

Myth:
Negotiating alternative fee arrangements can lead to fractured relations as corporate law departments and law firms seek diametrically opposed goals.

Fact:
AFAs involve a direct partnership between the client and the law firm. The firm accepts price risk on limited billing matters from their clients in an effort to align their rewards with the success of their clients. This strengthens the relationship between client and law firm.

The use of AFAs will continue to grow as corporate law departments and law firms glean more and more billing data they can use to negotiate deals that are equitable and address the needs of law departments and their outside counsel. By separating fact from fiction, corporate law departments can better understand the benefits of using appropriate fee arrangements instead of experiencing the pitfalls of AFAs when they are employed inappropriately. Nicky Mukerji is the director of business intelligence for Legalbill, a legal information services and consulting company that tracks and analyzes legal spend for corporate legal departments.