Graeme Johnston / 20 July 2023*
* Updated on 24 July 2023 to deal with paras 1.2, 1.3 and 1.4 in a different way and to split out some content into para 4.2
This article proposes a draft simple, practical, neutral taxonomy for fee structures used in legal work.
- ‘Draft’: it’s work in progress and I’d welcome comments.
- ‘Simple’ and ‘Practical’: I’ve sought to highlight the differences that I believe really matter, economically, with the (many) details and complications being handled at a lower level.
- ‘Neutral’: I’ve aimed to use terminology which is descriptive rather than of a marketing / positioning nature (so, I’ve avoided loaded terms like ‘alternative fee arrangement’ / ‘value-based pricing’)
Here it is. Four top-level types, some with sub-types.
- Time spent
- Open-ended
- Capped
- Volume-adjusted
- Deliverables
- Fixed
- Unit
- Outcomes
- Success
- Abort
- Hybrids
The ordering 1 to 4 does not signify importance: it’s simply a convenient way to grasp the differences.
Let’s go through them one by one.
1. Time spent
1.1 You record the time you’ve spent and charge that at an agreed rate. Simple in principle and highly flexible. Can work well if applied reasonably, though also some risk of bad incentives. Avoids the cost and delay of planning – which can sometimes be a good thing if planning wouldn’t really add value; sometimes a serious trap, if it would.
1.2 In legal work, the most familiar method of charging on the basis of time spent is an hourly rate. Some lawyers still only subdivide the hour into ten units of six minutes each – the system established by Reg Smith a century ago. Others nowadays use billing systems which can bill down to the minute.
- A cap may apply to all the work done on a certain matter or portfolio. Alternatively they may just apply to a subset of work, or to work done in a certain period (or periods e.g. per month).
- The orthodox meaning of a cap is a hard limit on what may be charged.
- Sometimes the term is stretched to include a ‘soft cap’ meaning a volume discount – see below.
- Another stretch that I’ve seen is to cap what will be billed in a particular month but carry it forward to the next.
- Personally, I don’t favour these stretches of terminology but they are examples of how attention needs to be given to the precise language used in an agreement.
1.4 A minimum or floor is also sometimes seen. As with a cap, it may apply to all work done
- This is sometimes called a collar, but that term can be used with different senses so may be best avoided.
1.5 Law firms often agree volume-based variants to their hourly rate for major clients. Some variants of this:
- The most well-known is the volume discount: a % rebate or discount for fees above a certain amount for a given period (e.g. a year) across a given scope of work. For example, an agreement to ‘split the difference’ in fees over £10,000 is a 50% discount on time spent over that level.
- Another possibility, sometimes seen in conjunction with a volume discount, involves an enhanced rate if the total amount is kept below a certain amount. As this requires a certain deliverable or outcome to be useful, I’ve addressed it below in the hybrid category.
- The aim of both these approaches is to promote efficiency and a quick resolution, but effectiveness varies with context, parties and detailed terms. Careful thought should therefore be given as to how things may play out.
1.7 Some possibilities which I haven’t sought to taxonomise separately as I see them more as implementation details rather than major concepts.
- Blended rates: rather than having higher rates for more experienced people, a single relatively low rate is agreed for everyone working on the matter, perhaps with exceptions. The idea is to incentivise the firm to get the work done at an appropriately low level. This may or may not work out well for the client depending on the circumstances.
- A non-volume based % discount ‘from our standard rates’: this is something that some companies insist on, but law firms price it in by increasing their rates.
2. Deliverables
2.1 Sometimes deliverable-based and outcome-based pricing are described collectively as value-based, but I think it’s helpful to separate the two out as the risk profile for the law firm / service provider and client / customer are significantly different.
2.2 Deliverables are fundamentally within the provider’s control, assuming basic cooperation from the client and perhaps third parties (e.g. registries) who can be expected to co-operate.
2.3 Examples include – A letter of advice. A will. A contract template and playbook. A pack of documents to help to get your start-up company started. The completion of a certain phase of a more complex matter.
2.4 Pricing by deliverables is often a fixed sum. It’s normal to agree the fixed sum in advance. Determining how to do so is an art – there is lots of discussion about how to decouple value from time spent. There’s a whole industry of advice and consultancy about this, easily found by googling.
2.5 But value can be hard to determine by reference to deliverables alone. In practice, despite lots of talk about decoupling time from value, my impression is that many lawyers still assess the appropriate fixed sum figure with an eye to time spent.
2.6 Implementation details:
- Some clients insist on ‘shadow billing’ – an indication of what hours at certain rates would have been spent had there not been a fixed fee. That’s not ideal in my view, as the ‘observer effect’ can lead time to be recorded liberally on such matters, reassuring the client of the ‘good deal’ they received while enabling associates to contribute to their billable hours targets.
- A few law firms have sufficient market power to adopt a practice of agreeing the fixed sum after the event.
- If the scope of the fixed price is defined too tightly, with time-based pricing applying for out-of-scope work, ‘bait and switch’ problems can arise. The English solicitors’ regulator, the SRA, notes this problem in its transparency requirements.
2.7 Where there are lots of small, fairly predictable deliverables (e.g. small cases or contracts in a portfolio, documents to be reviewed for basic relevance) then a unit price may be agreed, assuming that the provider is sufficiently comfortable about being able to make a reasonable margin by reference to the cost of paying people to do the work. This can have some risks – for example, the occasional matter in a portfolio which inevitably blows up into something more serious. The challenge is to provide for that sort of situation appropriately while not undermining the substance of the unit pricing — not letting the exception distort the rule.
3. Outcomes
3.1 A more adventurous, risk-sharing approach is the outcome-based fee. The lawyer is paid if the case is won or the transaction completed, even though this outcome is not entirely within their control. Caveats (such as some limitations on scope of work, team size and period) are sometimes seen where the effort required risks getting out of control.
3.2 The sum paid may be fixed or a % of the transaction value or of the sum recovered (or, much less often, a % of the sum resisted).
3.3 A definition of ‘success’ is important here, especially in disputes. Also bear in mind that there are regulatory restrictions on this kind of fee in litigation, though the details vary from place to place.
3.4 Outcomes other than success may also carry fees – the classic example is an ‘abort fee’ payable when a financing or other transaction cannot complete for market or other commercial reasons. The law firm receives some compensation for the work they’ve done, but less than the time-based or success-based fee they would have made had it gone ahead.
4. Hybrid
4.1 Fixed fees without significant caveats are fairly straightforward for a legal services provider to manage if the deliverables are well understood and there’s no major uncertainty. On more complex matters with unpredictable elements, hybrid fees are common once you move as soon as you move away from open-ended time-based charging.
4.2 Here is an example combining possible volume discounts and enhanced rates for time spent in certain scenarios;
- I will refer to this as ‘range-based’ pricing – the term ‘collar’ is also sometimes used in this context to signify the target range of costs.
- This may operate, and be expressed, in different ways. For example:
- The target is agreed to be £100,000 with an agreed ‘collar’ of 10% either side, i.e. an upper end of £110,000 and a lower end of £90,000.
- One possible agreement is that, if the time spent at the agreed rates falls into this range, the actual amount will be billed. Another possible agreement is that exactly £100,000 will be billed in that scenario.
- For fees above the upper end of £110,000, some % discount will apply. This could be the same discount irrespective of the amount or it could increase in bands.
- If time spent in total achieves the agreed deliverable or outcome while staying below the lower end of £90,000, some % bonus may apply. Alternatively, a minimum may apply. An example of an arrangement which achieves both purposes is an agreement to split the difference between the time spent and the lower end of the range. This would in effect be an agreement for a minimum fee of £45,000, assuming that the agreed deliverables or outcomes are achieved.
4.3 Some more examples:
- It is common to have a cap or a fixed fee for a certain scope of work and period, but with time-based charges applying outside that.
- In the event of a successful outcome, the law firm may receive an uplift to hourly rates and perhaps a bonus, while still receiving lower hourly rates in the event of a loss.
- Another possibility is that a client may holdback a small % of fees based on general satisfaction criteria – responsiveness, quality and so forth. This tends to be a fairly minor variation on time-based charging.
- Some lawyers will agree ‘retainers’ in the sense of a fixed payment for a certain period (e.g. monthly) which rolls on until terminated, sometimes with only limited commitments (e.g. a monthly report and a promise ‘availability’). Depending on the exact structure, this can operate as a sort of minimum fee designed to ‘compensate’ the lawyer for agreeing not to act for other parties on the relevant matter.
4.4 The variations are legion. If you google guides to ‘alternative fee arrangements’ and ‘value-based pricing’ in legal services you will find lots of examples from organisations large and small, together with discussion of all sorts of nuances, additional terminology and tactics for how to achieve a better price. But as my aim in this article is merely taxonomical, I will stop here. I hope it’s been useful.
What do you think? What would you change? It’s still only a draft so please let me know.
Photo of dominoes by Mick Haupt on Unsplash
