Fee Agreements, Litigation Finance, Legal Department Budgets, and Outside Counsel
Successful buyers find sellers who offer products or solutions that directly address their needs or buying criteria. Successful sellers recognize and meet demand by offering products or services that directly address their buyers’ needs or buying criteria. Although these lessons are incredibly basic, there is still a disconnect between buyers and sellers of legal services when applying these concepts.
Corporate counsel is the buyer with needs and buying criteria. The needs of corporate counsel go well beyond a basic need for quality legal services, including needs to manage a legal department budget and for predictability in terms of anticipated spend and results. The sellers are outside counsel who offer legal services for pay, but the reality is that outside counsel does not openly market their ability and desire to help corporate counsel manage its budget or provide predictability. In the current competitive market for legal services, outside law firms are missing the opportunity to position themselves to win more business by failing to market to their prospective buyers. Those firms who will affirmatively and proactively offer ways to help their clients manage budgets and provide predictability in the legal spend will win more business.
The needs of corporate counsel and outside counsel can not only be met, but additional benefits to both sides can be gleaned through the use of non-traditional fee agreements and litigation funding.
Corporate Counsel’s Perspective – The Buyer
Need to Manage Budget
In-house counsel continues to deal with the ever-growing pressures to manage legal department budgets. Legal department budgets are seeing a slight increase, but the demand to contain or reduce expenditures remains strong. These pressures have led to a surge in more legal work being handled by larger internal staffs, increased outsourcing to non-lawyers, a greater reliance on technology, trimming of the number of outside firms engaged, a demand for alternative fee agreements (AFAs) with outside counsel, and a decrease in the pursuit of valuable claims. The need for internal and external efficiency is paramount.
Need for Predictability
In-house counsel wants predictability in legal expenditures as part of the budget management challenge. Corporate counsel needs to allocate limited resources across a multitude of projects, and an unexpected spike in spending for one project could effectively delay or kill another project. Predictability also encompasses outcomes for dispute resolution: realistic settlement, arbitration, or trial numbers, time to resolution, and meeting benchmarks. The need for predictability contributes to the demand for AFAs. For reasons discussed below, outside counsel is grudgingly using AFAs. Corporate counsel can make AFAs attractive to outside counsel by offering incentives for meeting efficiency and outcome benchmarks.
Need to be a Revenue Center?
Other questions should be asked, too: Legal departments are not commonly considered revenue centers, but is that a proper assumption? What if legal departments could be revenue centers? How could revenue derived from the legal department potentially affect its budget allowance? What if the legal spend could be predictable?
Outside Counsel’s Perspective – The Seller
Need to Generate Business and Revenue
Attorneys in outside law firms face internal pressures to generate increased revenues from existing and new clients. The external pressure to be cost effective is driven by a much more competitive marketplace. The typical attempt to be more competitive is to discount hourly billing rates, but are discounts the best way to meet revenue goals or to be truly competitive?
Reliance on Hourly Billing
In the main, outside counsel still rely on the traditional hourly billing model, albeit with discounting to remain price competitive. The hourly billing model provides predictability and comfort, along with avoiding risk associated with contingent or outcome (damages, injunctions) based agreements. The preference for hourly billing has led to outside counsel being primarily reactive in their approach to AFAs, usually offering AFAs only upon corporate counsel’s requests.
Benefits of Marketing to the Needs of the Client
Openly marketing to the needs of the client would attract the interest of prospective clients. Of the thousands of law firm websites, virtually none showcase the firm’s ready willingness or preference to use AFAs. Moving from calling them “alternative” fee agreements, outside firms could refer to them as “appropriate” fee agreements to mirror the sentiments of at least one highly renowned general counsel. Instead of dropping prices, a law firm could proactively offer fee solutions that its competitors aren’t. Emphasis could be placed on how those fee solutions allow clients to effectively manage their legal department budgets. In other words, law firms could market how fee solutions meet the needs and wants of the clients directly.
Value Based Dealmaking
Both corporate counsel and outside counsel need to communicate early in the process. In addition to describing the substantive aspects of the project, corporate counsel needs to lay out all additional concerns, including the need to manage the overall legal budget and the need for predictability. Other needs, such as timeline and outcome expectations should be openly communicated to outside counsel. Outside counsel needs to communicate acceptable incentives for working efficiently, meeting benchmarks, and attaining desired outcomes. Using this information, outside counsel should work consultatively with corporate counsel to structure the terms of the fee agreement(s).
Litigation Funding as Part of the Process and Solution
In conjunction with the use of AFAs, litigation funding can be used to benefit both the corporate client and the law firm. Non-recourse funding for affirmative and defensive litigation can be obtained by a corporate client against the expected proceeds from a single case or multiple claims. (Non-recourse means that nothing is to be repaid unless and until an actual recovery is realized). In addition to covering litigation costs (fees and costs), this money can also be used for operational costs across the company. The result can be that a portion or all of the legal department’s budget is financed through litigation funding. By monetizing its affirmative claims (especially those it would not have pursued but for litigation funding), a legal department essentially becomes a revenue center. Moreover, the advance does not go negatively against the legal department budget financials as a loan, and any payments will come due only after money is recovered.
Law firms can obtain non-recourse funding against its expected contingent fees that include contingent fees for affirmative litigation and fees earned from outcome/damages agreements in defensive litigation. The funding advance can be used to cover litigation expenses and operational expenses for the firm.
A litigation funder, or better yet a good funding consultant, can help the process in several ways. First, this party can act as a mediator or facilitator in the discussion and negotiations between in-house counsel and the outside firm(s) to help identify and communicate the true needs and establish buying criteria. Second, this party can offer creative ways to structure fee agreements that address the needs of the parties. Third, this party can provide the financial resources necessary to de-risk loss and provide incentives for outcomes that align with the interests of both corporate counsel and the outside firm.
The company has an inventory of 50 smaller, meritorious breach of contract claims. Although each claim by itself does not warrant the expenditure of limited legal department funds, the aggregate value of these claims is $30M. The company also has a large breach of contract claim with a value of $200M. The company has an expansive IP portfolio and is engaged in both seeking to enforce its IP rights valued at $25M and defending against questionable claims of infringement valued at $20M.
Additionally, the company is being sued for $10M in a very weak wrongful termination and defamation lawsuit brought by a disgruntled former employee. Although the case is weak, the company wants the matter resolved as quickly as possible, but without having to pay a substantial settlement to deter similar claims in the future.
Hourly Fees Scenario
In these circumstances, the outside law firm has the ability and desire to represent the company in each of these matters. Under the traditional hourly billing model, the outside firm’s fees for these matters are estimated to be:
1. Smaller breach of contract claims $4.5M
2. Large breach of contract claim $12M
3. IP disputes $15M ($8M for affirmative claims, $7M for defense)
4. Wrongful termination $.75M
In an effort to be competitive, the firm is willing to discount its hourly rates.
After a funding consultant is engaged, corporate counsel and the attorneys and from the law firm with their business development team meet to discuss the underlying issues. As part of the negotiations, the funding consultant suggests the use of several AFA models that employ discounts and caps on the fees from hourly rates:
1. All breach of contract claims - hourly rates reduced 50% and capped at 50%, plus 15% contingency fee
2. IP disputes (affirmative claims) - hourly rates reduced 50% and capped at 50%, plus 15% contingency fee
3. IP disputes (defensive) - hourly rated reduced 30% and capped at 70%, plus graduated bonuses based upon outcomes/damages paid (up to 130% of estimated fees for $0 damages)
4. Wrongful termination - hourly rates reduced 30% and capped at 70%, plus flat bonus of $75,000 for settlement/dismissal in 6 months or sooner, and graduated bonuses based upon outcome/damages paid (up to 130% of estimated fees for $0 damages)
Under these terms, the potential fees could be:
1. Smaller breach of contract claims $2.25M hourly fees, $4.5M contingent fees
2. Large breach of contract claim $6M hourly fees, $30M contingent fees
3. IP disputes – affirmative claims $5M hourly fees, $3.75M contingent fees
4. IP disputes – defense $4.9M hourly fees, $4.2M graduated bonuses for $0 outcomes
5. Wrongful termination defense $.525M hourly fees, $.1M early resolution bonus, $.225M bonus for $0 outcome
Maximum total potential fees:
1. Hourly Fees $18.9M
2. Contingent Fees $38.25M
3. Outcome Based Fees $4.525M
Minimum total potential fees:
1. Hourly Fees $18.9M
2. Contingent Fees $0
3. Outcome Based Fees $0
Maximum total potential net recoveries $216.75M (after fees)
Now consider the impact of funding for both the company and the law firm:
The value of the affirmative claims for the company is $255M. A reasonable funding amount for these claims would be $25M. The total hourly fees for both affirmative and defensive matters is $18.9M, so the net remaining would be $6.1M. This net remainder of $6.1M could be used for virtually any business reason, such as marketing, product development, or even the funding of a portion of the legal department’s budget. Furthermore, litigation funding avoids the need to allocate money ($23.25M) from the budget for litigation. Any contingent fees would be paid from realized recoveries with no negative effect on the legal department’s financials.
Corporate counsel is able to retain high-quality representation from outside counsel, effectively manage the legal department’s budget, and has predictability of fees.
Corporate counsel has transformed the legal department into a revenue center where legal claims are made into assets and are monetized through a litigation funding advance and recoveries through pursuit of the claims themselves. On the low end, the legal department’s monetization of the company’s claims yields $25M in a non-recourse advance. On the high end, the legal department could be recovering a net of over $200M through litigation, made possible in part by litigation funding.
The law firm has an anticipated amount of $38.25M in contingent fees and $4.525M in outcome based fees for a total of $42.775M. A funding advance of $4M to the law firm is reasonable. The $4M advance can be used for the operations of the law firm. From the perspective of risk avoidance/sharing, this $4M could be considered “insurance” against the possible loss of $4.525M in outcome based fees.
Assume the law firm was willing to discount its original hourly billing estimate of $23.25M by 5% to $22.09M to be competitive. Using the proposed AFAs and litigation funding, the law firm would, at a minimum, have $22.9M from discounted fees and its funding advance. Clearly, the use of AFAs and funding delivers more money to the law firm than the traditional billing model. Now imagine if the law firm was willing to offer an even steeper discount and had no contingent or outcome based fees – how much money would have been left on the table?
The greatest effect can be seen with regard to revenue. With the hourly billing model, the law firm stood to earn $23.25M at the very most. This amount would have likely been discounted to “win” the business. Instead, AFAs and litigation funding could net the firm $61.675M on the high end and $22.9M on the low end as described above. Even if the contingent and outcome based fees were “only” $20M instead of about $42M, the firm would still earn $38.9M (nearly double the original revenue estimate).
In sum, the law firm secures the legal work with the company for these litigation matters, minimizes or eliminates the potential risk of loss while substantially increasing potential revenue, and still generates a significant portion of its fees from billable hours.
The scenario paints a picture in which corporate counsel, outside counsel, and the funder are able to create a situation that addresses the respective needs of everyone involved as well as actually placing them in better financial positions than could be achieved through the traditional hourly billing model. Because the litigation funding is non-recourse, the risk of loss is mitigated or wholly eliminated as repayment of the advances would come only from the recoveries (for the company) or contingent/outcome based fees (for the law firm).
Other considerations include the financial reporting and tax benefits that advances may offer over loans, and the infusion of additional capital for business expansion.