Legal fees: can alternative arrangements challenge traditional rates?

According to Perry Yam, partner at Reed Smith and head of private equity for Europe and the Middle East, while a lot of law firms may talk about moving away from hourly billing, in reality this is not reflected in practice. Reed Smith prides itself on its use of alternative fee arrangements (AFA), which, according to Yam: "is a myriad of pricing and payment structures for clients."

It would appear Reed Smith's approach to fees has been well-received. The law firm launched its European and Middle East private equity offering just two years ago and has already picked up a healthy number of private equity clients. Says Yam: "We have built up the private equity practice alongside our leveraged finance capability and fund structuring practice so that we can offer a one-stop shop for GPs and LPs." Yam says the firm has thrived in a very difficult market for private equity, given the declining dealflow. Indeed, the law firm is looking to expand its team as it looks to boost its European footprint.

Yam believes it is the firm's approach to pricing that has driven its recent success. "We're looking at deals and clients not just for today but also for the future, so we need to deliver the right fee on the right deal and are very willing to partner with, and invest in, our clients to develop and maintain a long-term relationship."

McGuireWoods, another law firm with its roots in the US, is looking to boost its AFA offering. "We have been encouraged by clients to do more AFAs as they prefer the predictability they can offer," explains partner Mark Langford. "But you've got to pitch it at the right level." Langford says the firm uses sophisticated modelling based on the experience of its US offices to consider fee arrangements that build the right teams with the appropriate experience levels across fee earners. "We can use lots of different approaches for AFAs but we need to make a call on the probable level of resources it will involve and then decide on whether a cap, discount or other arrangement is appropriate for both the client and for us in the specific case." Langford believes a realistic approach is vital.

While AFAs are clearly more complex than setting hourly rates, they carry huge advantages. The most obvious being a fairer deal for the client – in this instance, the GP. The traditional hourly rate billing system is devised by working out how much revenue the law firm wants to generate that year, then dividing that sum up between the partners and resources. However, the danger with this approach is if a discount is ever offered, it can seem as if the firm is making a loss, whether or not that is the case.

In search of value
As private equity firms look for more innovative ways to reduce the cost of transacting, it is important to note that it is not a cheaper service that is being sought; rather, a more effective and value-driven service. "Clients want to buy certainty with their fees," says Simon Cox, partner at McGuireWoods. 

If certainty is required, then what about buying up hours in advance? Again, this approach has its drawbacks, namely the question of whose time the GP is buying – a senior partner or a trainee?

Cox says blended rates are more frequently requested by clients but, again, this structure can lead to more junior team members working on the deal.

If the real issue behind fee structures is obtaining a better, more cost-efficient service then it is not just the billing arrangement that needs to be reviewed. Instead, it is how the service is carried out and delivered.

McGuireWoods uses a legal processing outsourcing (LPO) service in a bid to offer a more efficient offering. The firm often partners with global LPO Integreon, which, while employing a host of experienced lawyers, is not authorised as a law firm. Integreon senior vice president Mark Ross believes the take-up of his company's services is reflective of the evolutionary change taking place across the legal system: "Change is undeniably underfoot. The traditional default position of the law firm being the single port of call for all legal services on a deal is a position of the past.

"We have reached a point in time when clients are demanding a more effective delivery of legal services. Especially given the globalisation, breadth of tasks involved and complexity of today's deals – it is crucial to disaggregate the various constituent elements of the deal and allocate each to the most appropriate resources given the complexity of each task at hand. Only then can we realise a more cost-effective delivery of services," says Ross.

Contract billers
Integreon's key focus when working on a deal is to review and summarise the target company's key contracts, including those with suppliers, customers, employees and landlords. Says Ross: "While reviewing and summarising these agreements can be done in-house by the law firm, this is an inefficient and overly costly use of resources. In addition, given the global nature of many of these deals, agreements are often in a variety of languages, requiring access to multi-lingual resources."

Integreon can allocate teams of lawyers across the globe to review all of a target's agreements, and then extract and summarise the key information, which is vital to the acquirer in determining if the deal is a sound commercial investment. "We help our clients and their outside counsel by summarising agreements and identifying those clauses within agreements that could potentially be deal-breakers," explains Ross.

The debate over the best billing system is nothing new – far from it, law firms have been discussing new approaches for years. But what is clear is something needs to change to reflect today's market conditions.

AFAs in particular require continuous assessment and rebalancing throughout the deal process. Fortunately these structures will become easier if used more frequently. But, for law firms to entirely change their mindset and their approach to fees requires a huge amount of effort. This is the way law firms have always worked, and if such a change is to occur, it is down to the client – the GPs – to push for a new way of working.

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