If you want to glimpse the future of the law business, consider Microsoft’s announcement this summer that it will start hiring outside legal services almost exclusively under alternative fee arrangements. Citing a desire to get the best value from its law firms, and emphasizing the importance of law firms being “very much our partners on this project,” the tech giant envisions a range of new relationships with outside counsel that flout the hegemony of the traditional billable hour. What this portends for law departments and firms of every size and type is that the familiar rate wrangle—where clients demand reduced hourly rates or a different fee model altogether—is not going away anytime soon. Rather, if the move by Microsoft’s legal department is any kind of harbinger, large swaths of the legal landscape are due to be reshaped.
The business of law has been changing for years—arguably, things have never been the same since the 2008 global economic crisis—but for many in-house counsel, the conversation about how to effectuate the move away from the dominance of the billable hour is just getting rolling. What will new fee arrangements look like for the firms I work with? How can my company innovate to avoid getting left out in the cold?
When I was general counsel of Time Warner, I wrestled frequently with the high cost and uncertainty of litigation, but also the necessity of pursuing claims with strategic or financial value to the business. Often, the challenge was that negotiating incremental discounts on billings simply did not achieve enough savings to make diverting capital to cover the cost of litigation any more attractive to the C-suite.
Out of that persistent challenge came new ideas—ideas that have germinated into a robust set of tools that can relieve the pressures GCs face when working with their law firms to develop alternative approaches, including alternatives to the billable hour. One of these approaches that forward-looking law leaders will be hearing more about is legal finance.
I am not talking about litigation finance 1.0—the kind of litigation finance that applied only to companies that couldn’t afford to pay for needed litigation. Legal finance is a next-generation set of solutions that companies proactively seek out as an efficient and sustainable way to pay for legal services. Lawyers and their clients are beginning to pose the question: I can pay these legal fees upfront, even though success is uncertain and will not materialize for an undifferentiated amount of time, but should I? I may have other uses for my capital, and litigation can weigh down my balance sheets when I fund it in real time.
With legal finance, a third-party firm with specialized knowledge of the relevant practice areas will evaluate commercial litigation and arbitration matters, then supply capital on a nonrecourse basis that is collateralized by those matters. Capital can be used to pay the cost of proceeding or for other business purposes. Pricing is according to risk and other factors such as posture of the case and size of potential award. If matters are successful, the finance firm receives its return from a portion of any award or settlement, but if matters are unsuccessful, it bears the entirety of the downside risk. For corporate legal teams, that means smoothing the ups and downs of litigation spending cycles while moving the costs from their books.
For in-house legal teams, one of the more interesting new forms of legal finance is portfolio financing, where financing is secured across a body of legal matters. An advantage to portfolios is they can combine cases with varying levels of risk and complexity, including offensive claims and defense matters, lending stability to and offloading the cost of the entire portfolio. What’s more, by spreading the risk across the full complexion of its cases and taking the vagaries of litigation off its balance sheet, a business can stabilize its books and tolerate more risk, which may allow a competitive edge in the marketplace.
For law firms, portfolio financing can provide the capacity to offer flexible terms to clients and take on additional risk. For example, a law firm that is most accustomed to working on an hourly basis might craft a portfolio of matters in which it would be able, with financing, to work on a contingent basis for a valued current client or desirable new prospect.
Which leads us back to Microsoft’s announcement heralding the death of the traditional billable hour for any firm that wishes to work with them. Most companies haven’t gone that far. But what lessons can they draw from Microsoft’s move? Here are three:
- Law firms truly need to be partners in the move away from traditional payment structures. If firms are being asked merely for more discounts, the relationship—and work product—will suffer.
- There is no “one size fits all” alternative to traditional payment structures: Microsoft cited fixed fees, fixed fees with upside based on an agreed success metric, and retainer-based agreements, to name just a few.
- Legal finance should and will be a key factor in the transition away from traditional payment structures, as a tool that can create partnership and flexibility for clients and for law firms. Clients can secure financing to shift part or all of their legal cost and risk off their balance sheet, thus diminishing the pressure they are compelled to place on the firms with which they work. Law firms can secure financing to be more flexible to clients’ needs without adding cost and risk to their business.
Microsoft’s nudge to its firm partners ultimately will benefit all GCs, not least by defanging fee negotiations and inspiring partnership with and from firms. And in the coming era when the billable hour simply might not cut it any more, legal finance should prove to play a more central role on this new stage. The industry’s growth attests to this point: from 2013 to 2017 alone, its use quadrupled by U.S. law firms. With that as a basis, legal finance is, arguably, finance for the future of law.
This article by Christopher Bogart was first published by Corporate Counsel.