This article appeared in the May/June 2004 issue of Leaders’ Edge, published by the Michigan Association of Certified Public Accountants.

Controlling Legal Costs, Daniel Iannotti © 2003

There are lots of things that keep CEOs and CFOs awake at night – falling sales revenue, product quality, motivated employees, and, of course, lawsuits. The mere mention of the possibility of a lawsuit instills fear in most executives. Why? Lawyers are expensive and lawsuits often produce runaway legal fees and involve significant management distraction.

Legal costs are inevitable for any business. But, like any other expense, they can be managed and minimized. This article discusses approaches that leading companies utilize to more effectively acquire legal services, thereby minimizing legal costs and risks.

The following are four examples of effective strategies to control legal expenses – billable hours, preventative law, litigation management, in-source legal services and expense management.

I. Hourly Rates: The starting point is recognizing lawyers bill for their services. By and large, most legal services are purchased on an hourly fee basis. Billable hours are the bedrock of any firm, with legal marketers looking for ways to sell more hours to clients. Virtually all law firms track and analyze daily, monthly and yearly hours billed for each lawyer in the firm. Those lawyers with higher numbers of annual billable hours receive higher compensation (and vice versa).

Clients who acquire services by paying an hourly rate are continuously faced with a dilemma - they understand the need to interact with their lawyers to obtain advice but they’re hesitant to contact them since they’ll pay for the interaction. Most clients fully comprehend that "the meter is always running." This problem is magnified where more than one lawyer in the firm handles a matter. If two lawyers confer with each other on the matter, the company is essentially “double billed” for the interaction. Because such an arrangement is usage based, there’s no limit on how much the legal services will ultimately cost.

In competitive marketplaces, including the marketplace for legal services, the market determines the price for a product or service. In most markets, negotiation over price seldom includes an examination of the hours expended by the seller to produce the product or service. For example, when we purchase a car, we don’t examine how many hours General Motors’ workers have spent in assembling the car. Rather, we look at the value the car in light of competitive alternatives. Why should legal services be any different? The truth is they aren’t.

Law firms that are focused on client satisfaction are increasingly willing to enter into fee arrangements other than based on hourly rates. For example, regularly occurring legal work – such as preventative law work discussed below – lends itself to a flat rate structure. As the general counsel of several public companies, I’ve entered into annual fixed fee flat rate billing arrangements with law firms for regularly recurring types of matters. It didn’t matter to my company or to me whether the law firm spent lots of hours in providing the services. What mattered were the quality of the services and the fixed fee. Knowing what those services were going to cost, I could more accurately budget for total legal costs each month and year (which always made the CFO happy).

There are other types of fee structures other than flat rate billing that help clients manage legal costs, including contingency fee based on a percentage of the damages or settlement amount, volume or exclusivity discounts, blended rates, hourly rates with a total fee cap, hourly rates that decline as hours increase, incentives to resolve the matter expeditiously, etc. Each provides the potential to avoid expensive hourly rate arrangements that may lead to runaway legal costs.

In addition, as with the purchase of any product or service, inducing competition into the process usually results in lower prices. I routinely recommend that companies use a RFP process before engaging a law firm for a significant matter. Websites such as eLawForum facilitate RFPs for the procurement of legal services. Through that process, each law firm invited to bid will clearly understand that price and terms will be a critical component and that it will have to “sharpen its pencil” to win your business. Even if a company chooses to stay with a traditional hourly fee arrangement, the RFP process usually results in a reduced legal costs. I’ve had excellent results with this approach in lowering legal costs and improving the quality of services provided.

II. “Avoidance”: Some companies pursue an “if it’s not broke, don’t fix it” strategy with respect to legal services. That is, they don’t acquire legal services until it’s absolutely necessary. Often, this is a “penny wise, pound foolish” approach that can lead to expensive legal entanglements that may have been prevented by employing even modest legal review at the initial stages of a matter.

With an increasingly complex legal and regulatory business environment, it is not practical for most businesses to avoid incurring legal expenses. At the same time, too much “lawyering” can be expensive and time consuming. The goal should be to find balance between enough and too much legal review, that is, the right mix of “preventative law”. Preventative law, like preventative maintenance of automobiles, should be used to spot potentially serious legal issues that may lead to expensive problems in the future. Every business has areas that lend themselves to preventative law, including employee and employment policies, contracts and significant transactions, advertising and external communications and customer agreements.

Similarly, companies can employ strategies that can prevent disputes ending up in litigation. In its contracts, for example, the company and its contracting partner can utilize a forum provision where there is agreement to have disputes brought before an “alternative dispute” forum (such as the American Arbitration Association or JAMS) rather than by filing suit. By avoiding the expensive litigation court process, companies can reduce legal costs for such disputes - and usually end up with a quicker decision.

III. Litigation Management: We live in a litigious society. A plaintiff seeking to file suit doesn’t have to make a financial investment to bring the suit – he or she need only find a lawyer willing to take the case on a “contingency fee” (a percentage of the amount collected). Lawsuits are a fact of life despite best efforts to avoid them. The proper management of litigation, however, can significantly reduce legal costs.

As discussed above, the first step in managing litigation is to seek to retain a firm on other than an hourly fee basis. With a hourly fee arrangement, the law firm has financial incentives to extend the suit as long as possible. All of the alternatives to hourly fees discussed above can be utilized as part of engaging a firm to handle litigation. For example, a flat rate for each stage of litigation can be employed – pleadings, discovery, pre-trial motions and trial. Or, a firm can be engaged on an hourly basis with caps that limit fees for each stage and/or bonus incentives to resolve the matter quickly (so that substantial hours are not incurred).

In addition, where the company is the defendant, it’s important to keep in mind that 95%+ of all suits are resolved short of trial. Thus, unless the suit is a “bet the company” action, it’s highly likely that it can and will be resolved. Therefore, if one assumes that it will be resolved, it makes sense to explore settlement early in the case so that the defendant doesn’t pay substantial legal fees to prepare the case for trial AND pay the settlement amount. Here's what companies should be trying to avoid:

Consider whether all or a portion of amounts that would otherwise be paid for legal fees can be “diverted” to the proposed settlement amount early in the suit to help reach a mutually agreeable settlement.

Companies who have a regular and ongoing volume of litigation should also explore whether it can obtain more favorable fee arrangements by awarding all of its litigation to a single firm. It’s my experience that law firms look very favorably on “volume discount exclusivity” legal fees. Alternatively, if a company has a sufficient amount of litigation, it may be cost effective to hire an in-house litigator to handle such suits.

IV. In-Source Legal Services: Although “outsourcing” often saves companies money, the opposite is usually true for legal services. The growth in internal corporate legal departments is due to a need to more efficiently manage legal issues and partially offset rising outside legal costs. Companies that have a sufficient amount of recurring legal issues and costs can reduce those costs by employing a general counsel and/or subject matter legal experts (e.g. litigators, employment lawyers, etc.).

V. Expenses: Most fee arrangements for legal fees include a “plus expenses” component. For many law firms, “expenses” are extremely profitable. Many “expenses” billed by law firms are billed at more than the actual cost. Phone and fax charges are typical examples. To avoid these “profit centers”, make sure your engagement agreement spells out what expenses will be billed and how those expenses will be determined.

Summary: Quality legal advice is a necessary component of any business. While legal advice can be very expensive, companies and their general counsel can effectively manage and control legal costs using the strategies discussed above.