Why Alternative Fee Arrangements Work

So, you are at a networking event and you meet an attorney.  What is one of the first questions you ask him or her?  “What is your hourly rate?”

It seems that the law firms have conditioned consumers to the use of the hourly rate, or the billable hour, as it’s called in the legal services industry.  The billable hour dates back to the founding fathers and, aside from continuously going up, has changed very little since then as the predominant methodology for pricing legal costs.

That is, until recently.  There has been a lot of press in the last year or so about alternative fee arrangements but what are they?  Alternative fee arrangements, or AFAs, are the alternative to the billable hour and typically involve legal costing in methods that include some variation of fixed costs or variable costs not based on the hour as the unit measure.  So, let’s look at an illustrative example.

Say you just received a strategic marketing agreement to sign from a potential business partner.  You would like an attorney to review the contract to make sure you don’t inadvertently sign away your company (yes, it’s possible to give away equity in a strategic marketing deal but I will save that discussion for another post).  You send the agreement to your attorney to take a look and to let you know if it’s okay to sign.  Under the billable hour paradigm, the attorney would review the agreement with the clock running during this time.  The amount of time it takes to review the document times the attorney’s hourly rate will equal your bill. Easy enough, right?

Now, let’s take a look at how this transaction might work under an AFA.  Using an AFA could mean that you will be billed by the page, or by the type of agreement.  So, if the cost for legal review charged by your attorney is $25 per page and the agreement is 15 pages, you know (in advance) that your legal cost for review is $25 times 15 pages, or $375.

Working with law firms that regularly use AFAs can result in a lot of saved money and time.  How? First, the law firms that use AFAs deeply understand the legal risks and benefits of those types of tasks that they bill for using an AFA.  In our example above, the law firm charging $25 per page for strategic marketing agreements arguably knows these types of deals inside and out and can therefore quantify the cost to perform such a review with relative certainty. Second, you know what a particular task is going to cost in advance and you can therefore plan your cost accruals for your company accordingly.  Accountants appreciate this and it can result in better financial budgeting and planning for your business since you can factor this legal cost in as part of a net present value (NPV) analysis for the overarching project.  Last, since you know what a particular project will cost in advance and you can make a decision based on cost-benefit analysis, you can make a rational decision whether to pursue a project at this time.  If it costs more than you can afford, you can delay it to a later point in time when you can better plan for and justify the cost.

If subject matter depth and expertise, cost containment and cost predictability are important to you for your projects, it’s a good decision to have your legal work performed via an AFA, or to at least consider discussing it with your attorney. Using law firms that regularly offer AFAs is an even better decision.