Fixed-Fee Deals: 3 Traps For The Unwary
Fixed-fee deals can be great -- but watch out for these possible pitfalls, identified by in-house columnist Mark Herrmann.
Fixed-fee deals; everyone’s doing ’em!
The law firm agrees to handle all matters of a specified type for a specified period of time — perhaps all individual employment discrimination or wrongful termination cases filed against the company between January 1, 2015, and December 31, 2017.
In return, the corporate client agrees to pay the firm a fixed fee — perhaps $360,000 in the first year, payable in monthly installments of $30,000 each, with annual increases of four percent per year in each of the next two years.
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The law firm receives a guaranteed stream of revenue and a set of repetitive matters that, with a little thought, can probably be handled cost-effectively. In return, the corporate client receives predictability: It can now budget its defense costs in these cases, confident of precisely how much it will spend every month for the next three years. Everyone wins!
Clients are itching to do these deals nowadays, not just to buy predictability, but also because many law firms are anxious for the work and thus willing to offer reasonable fees. Conversely, law firms are itching to do these deals because of the guaranteed work flow and the right to brag that the firm is a leader in entering creative alternative fee arrangements with its clients.
So do it!
But, as you enter this type of arrangement, consider three issues that you might easily overlook.
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First, remember that no cases will be subject to this agreement at the instant that it starts. That is: On January 1, 2015, the law firm will not be defending any employment cases. If no cases are filed in January 2015, then the law firm will have collected $30,000 for having done no work in January. If one case arrives in February, the firm will have collected $60,000 in return for having done essentially nothing — for having done some preliminary work on a single case.
The deal may well make sense by July — when a boatload of cases will have entered the system, and the arrangement will be running at full steam — but the deal may not work for the first few months.
Consider addressing this truth in the fee agreement itself, perhaps by having the amount paid to the firm ramp up over time, as the number of cases subject to the agreement is anticipated to increase gradually.
Second, think about your insurance deductibles.
Suppose your company has insurance coverage for employment cases, subject to a deductible. When you’re being billed hourly, it’s easy to tell when the deductible has been exhausted: If you have a $100,000 deductible, the threshold has been crossed when you’ve incurred $100,000 in defense costs in the case.
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But it’s harder to tell when the deductible has been satisfied if you’re not paying defenses costs on an hourly rate. You’ll have to work out an arrangement to satisfy your carrier that defense costs are being allocated appropriately across cases and that gives you and the carrier an easy way to tell when the deductible has been met for any specific case (and how defense costs will be allocated across cases after the deductible is satisfied).
Third, remember that many cases will be pending and subject to your flat-fee deal on the day that it ends.
Come December 31, 2017, you may have 30 pending cases being defended under your flat-fee arrangement. This can make it hard to run an RFP process to pick a firm to defend these cases for you in 2018 and beyond. The incumbent firm — already defending the pending cases, and anxious to renew the fixed-fee deal for the next three years — can easily say that it will charge you $400,000 per year in 2018 and beyond to (1) continue defending the pending cases and (2) assume the defense of any new ones.
That’s fine for the incumbent firm.
But firms trying to compete for the 2018 business are at a disadvantage: It would be inefficient to change firms for the defense of the already-pending cases. And, if you don’t change firms, then you’d presumably be double-paying for the defense of your employment cases for a while: You’d be paying the incumbent on an hourly rate to conclude the defense of the pending cases. And you’d simultaneously be paying the new firm a fixed monthly fee to defend all of the new cases that arrive. This creates a strong incentive to renew the deal with the incumbent firm, even if a competing firm offers a more attractive proposal at what would otherwise be a competitive price.
That’s not an insurmountable hurdle. You can address it in the 2015-17 contract by including terms for winding down the defense of cases pending on December 31, 2017, if the incumbent firm does not continue as counsel in 2018. Or you can include terms in the 2018 contract that account for this issue.
The key is just to think about it, so you don’t accidentally put your client in a bind.
Have at it!
Fixed-fee deals are the new, new thing. So enter ’em left and right, but make sure you think about the how they’ll work in practice.
Mark Herrmann is the Chief Counsel – Litigation and Global Chief Compliance Officer at Aon, the world’s leading provider of risk management services, insurance and reinsurance brokerage, and human capital and management consulting. He is the author of The Curmudgeon’s Guide to Practicing Law and Inside Straight: Advice About Lawyering, In-House And Out, That Only The Internet Could Provide (affiliate links). You can reach him by email at [email protected].
