Why AFAs?
The data speaks for itself: firms that embrace Alternative Fee Arrangements (AFAs) are outperforming everyone else in the market, while delivering better value for their clients.
Proactive firms that initiate AFA agreements with their clients are often more profitable because they have already determined what their profit margin is, and use data to determine an optimal staffing model and cost to serve a particular matter type. Meanwhile, reactive firms that only commit to AFAs when compelled by their clients experience less profitability.
AFAs have the potential to deliver higher value to law firms AND clients. CEO of Buying Legal Council Silvia Hodges-Silverstein highlights how external counsel frequently demand heavy (15-20%) volume discounts instead of pursuing AFA agreements with firms. But volume discounts lack the incentive to maximize efficiency and only deliver value to external counsel if firms bill beyond a high number of hours. Alternatively, AFAs encourage firms to leverage tasks by assigning more junior attorneys to matters and to embrace more sophisticated technology.
AFA Types (It’s About to Get Technical!):
Activity-Collared AFA
These AFAs delineate a flat fee per client matter, with activity level pricing for major cost drivers. Typically if there’s a 30% deviation in the quantity of the assumed major cost drivers, the firm can adjust the total up or down based on the agreed upon price-per-activity. Therefore, there is a collar around the quantity of activities performed. These AFAs help external counsel accurately predict their legal spend and they encourage law firms to innovate and optimize efficiency.
Pros:
- Spend predictability ( moderate to high )
- Formulaic method for adjusting fee amount when material deviations occur
- Non-reliant on billable hour
- Focuses on outcomes and deliverables rather than effort
Cons:
- Could be more complex to define price in the case of major cost-driving activities
Blended Hourly Rates
In an AFA with blended hourly rates, the firm establishes blended rates for specific titles or one rate for every attorney who works on the matter. These typically are irrespective of seniority/position at the firm. However, blended hourly rates do not provide cost predictability, which is a fundamental goal of a true AFA.
Pros:
- Simplicity
- If negotiated right, these can result in lower hourly rates for attorneys with high billing rates.
Cons:
- Not a true AFA: no spend predictability
- Relies on billable hour
- Client loses the advantage of staffing leverage to drive down costs - one may pay more for more junior resources
Capped Fee
In a capped fee agreement, the firm bills the client hourly up until a cap. If the firm exceeds the cap, then the firm ceases to bill for the hours worked beyond this point. A capped fee shifts the risk entirely to external counsel. For this reason, firms may pad their capped fee amount to protect themselves. Some clients have begun to cap each phase on the matter such that there is greater cost certainty in earlier case phases.
Pros:
- Spend predictability ( mild )
- Discourages firm overbilling
- Fits firms’ hourly billing culture
Cons:
- If the Cap is set too high, firms will not be incentivized to be efficient
- Still relies on effort as the barometer for value (which is tied to the billable hour)
Collared Fees with Risk Sharing
Here the firm and client agree to a set amount for a matter (e.g. $100,000), and to a collar on this amount (e.g. 10%). The firm bills hourly and there usually is a penalty for billing beyond the high end of the collar ($110K) and there is a bonus for efficiency and savings below the low end of the collar ($90K).
For example, if a firm finished at $60,000 , the firm would be paid $75,000 (50% of the $30K savings under the collar). But if the firm finished at $140,000 then the client would only pay $125,000 (50% of the $30K overage). This type of agreement seeks to incentivize efficiency.
Pros:
- Incentivizes efficiency
- Fits firms’ hourly billing culture
Cons:
- If the collar is set too high, firms can easily get a premium without being more efficient
- Still relies on effort as the barometer for value (which is tied to the billable hour)
Contingency
Contingency fees can generally be divided into two groups: ‘pure’ and ‘reverse.’ In a pure contingency fee agreement, the firm receives a specified percentage of the damages recovered in their representation. Meanwhile, in a reverse contingency relationship, the firm receives an agreed-upon percentage of money that was saved for the client in the representation. Contingency fees create a strong incentive for the firm to achieve wins for the client and advocate vigorously on their behalf.
Pros:
- Firm does better when client does better
- Works well when client is plaintiff
- Focuses on outcomes rather than effort (which diverges from billable hour)
Cons:
- Tough to align on approach if client is a defendant
- No spend predictability
Flat-fee per Matter
With this type of flat fee, pricing structure is not broken out by phases. Rather, the firm and client agree to a total fee amount that does not change. The idea is that the firm and client share the risk that more or less work may be required. This encourages the firm to attain a speedy resolution and/or to be more efficient and leveraged as it can improve its profit margin by doing so.
Pros:
- Simplicity
- Spend predictability ( strong at matter level)
- Focuses on outcomes rather than effort (which diverges from billable hour)
Cons:
- Potential for too much shared risk
- No lever for changing the fee agreement when scope deviates materially
On-site Legal Expertise (Secondment)
Here external counsel and law firms strike an agreement to have a member of the firm’s legal team stationed at the company for a particular period of time. This allows the law firm’s attorney to provide dedicated support to the external counsel and build a strong relationship in the meantime.
Pros:
- Low cost resource can save the client money
Cons:
- Client has to manage the resource which could be more costly and deliverables could be delayed
- Firms can be reluctant to provide secondees
Phase-Level Fixed Fees
In contrast to a flat-fee per matter AFA, phase-level fixed fees have a set fee for each phase of the client matter. It’s easier for the client to adjust the total price of the matter with a phase-level fixed fee rather than a flat fee, because if a case settles, the client only pays for the phases that have occurred.
Pros:
- Spend Predictability ( moderate )
- Flexibility in method for adjusting fee amount
- Doesn’t rely on billable hour
Cons:
- Slippery slope: if “phase” gets cut in half, how do you adjust?
- Complexity in frequency of adjustments
Portfolio Fixed Fee
An agreement in which the firm and client agree to a fixed fee for all the matters in a portfolio of work. This arrangement grants predictability for the fiscal year across a wide swath of matters, which helps external counsel achieve predictability goals more quickly. However, portfolio fixed fees can be tough to negotiate and challenging to evaluate.
Pros:
- Spend predictability ( high across greater volume of spend)
- Less frequent negotiations - annual approach minimizes transactional / administrative burden
Cons:
- Difficult to estimate an appropriate fee amount because the likelihood of material deviation is high
- Could lead to contentious true-up negotiations if one side is “winning” the deal in a significant way
- High amount of shared risk
Success Fees/Bonus
Success fees are fees paid to the law firm if the law firm achieves a favorable result for the client. These fees are used to reward the firm for extraordinary service/success and incentivizes strong advocacy from the firm.
These agreements are often coupled with phase-level fixed fees, where the firm would propose a fixed fee for the case “work-up”; for example, along with a success bonus that would be paid if the case is dismissed during pleadings. A separate fixed fee and success bonus could apply if the case proceeds to trial and a successful verdict is reached.
Pros:
- Firms will bet on themselves and lower the fixed fee in return for the possible bonus
- Focuses on outcomes rather than effort (which diverges from billable hour)
- Aligns incentives with quality of work
Cons:
- Clients may have difficulty defining success in certain instances