The How and Why:
AFA use became popular as the result of an important historical market shift. With the Great Market Crisis of 2008, business uncertainty grew high. Businesses had less economic confidence in the prospect of investing in longer-term partnerships. What businesses desired were concrete revenue projections and secure interest alignments in order to weather uncertainty.
This collective sentiment, paired with the rise of Big Data and AI technologies, drove new data-driven cost structures for businesses. AFAs grew popular , as a way for both parties - the firm and the client - to derive value. For clients , Alternative Fee Arrangements offer cost certainty; for firms , Alternative Fee Arrangements offer a way to retain clients and predict revenue. (DL) At first, AFAs offered a way to bill for simple, automated tasks (Bloomberg); but now, they can cover more complex cases. Let’s take a look at their evolution.
AFA Overview:
Alternative Fee Arrangements are pricing structures that do not rely purely on hourly rates and the number of hours billed to determine the overall cost to the client. For example, a common AFA type is a flat fee amount for the entire project that is not subject to change. This set fee amount is often discounted from outside counsel’s normal rates because expectations regarding the scope of work are set from the start.
AFAs thus require in-house lawyers and outside counsel to understand what tasks / activities need to be performed on a given project / matter to negotiate a deal with a fair price, that of which incentivizes the right outcomes for the client.
AFA Types - Quick Overview:
- Flat/Fixed Fees: Arrangement in which the law firm agrees to bill the client a predefined amount regardless of actual hours accrued on the matter.
- Both the law firm and the client share “equal risk;” so it’s best used when each party has a precise estimate of the time and resources required for the given matter. (GLP)
- Historically, this agreement best applied to simple legal tasks that required routine and predictable work (and thus posed low risk / low chance of surprise variations in work volume). But now, given more shared data on case types and outcomes, this agreement can also be applied to more complex matters.
- Fixed + Contingency / Success Based Fees: A type in which there is an agreed-upon fee, plus a certain percentage add-on if the client deems outside counsel’s matter resolution successful.
- Capped Fees: A typical hourly billing rate, but with an established cap set by both parties such that the firm must eat the cost of hours billed beyond the cap
- Hybrid Models: These are used because “not every matter fits neatly into a single type of billing.” (GLP) With this model, you can combine AFA types for the specific needs and matter at hand.
These are just a few. There are subtypes, as well as additional fee models that offer alternatives to the traditional hourly-billing model (e.g., Blended Hourly Rates - which include Volume Discount-based and Matter-based rates); you can read about them here.
Client Advantage:
- AFAs allow corporate legal departments to increase predictability in pricing.
- AFAs offer “substantial savings to the corporation.” (Doe Legal)
- AFAs protect each party from an event (and potential dispute) in which the workload and resulting bills are dramatically different from expectations. (Doe Legal)
- Clients are aware of these benefits: Representatives from Valorem Law and ElevateNext agree that adoption is currently client-driven. (Bloomberg)
Firm Advantage:
- It may seem like Alternative Fee Arrangements only benefit clients, but when “done correctly, these agreements really can represent the best opportunity for both businesses to experience winning with AFAs.” (Doe Legal)
- AFAs imply equal risk for both parties: while AFAs provide clients with cost certainty, AFAs provide firms with predictable revenue.
- More on Risk: A client is assuming risk in that an unexpected reduction in work may leave a client overpaying. That's why it is crucial to negotiate a multi-phased t fee based on the prospective work needed, and agreeing at the outset what a material deviation would look like (i.e. the certain events that would trigger an increase or decrease in price).
- Firms continue to adopt Alternative Fee Arrangements. A 2016 Altman Weil Law Firms in Transition Report showed that 28% of law firms proactively initiated AFAs, while 72% were reactive.
- 84% of the proactive firms reported that AFA projects are “as profitable” or “more profitable” than hourly-billed projects.
Conclusion:
A wild ride, right? So, to recap:
- The economic demand for greater alignment and security paired with technology-driven tools for analyzing patterns of legal spend are fueling AFA adoption.
- AFAs provide an incentive for firms to accomplish work as efficiently as possible, benefitting both the client and the firm. AFAs, when arranged correctly, mitigate unforeseen circumstances and thus unforeseen fees.
- AFAs are being widely and rapidly adopted by industry leaders: Bloomberg Law’s survey data shows a direct relationship between law firm revenue and adoption of AFAs. Half of respondents at $1B+ revenue firms (“with knowledge of billing approaches”) said they’ve adopted alternative billing models.
- AFAs are an all-around beneficial solution to the current economic environment, as well as future circumstances.
Sources:
https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-law-firms-respond-to-demand-for-alt-fee-models; Doe Legal; https://www.globallegalpost.com/blogs/management-speak/the-brave-new-world-of-afas-a-quick-guide-29597536/; https://abovethelaw.com/small-firm-center/2017/12/alternative-fee-arrangements-why-and-when/