The End of Billable Hours?

Now that Microsoft has announced that it is driving law firms to perform 90% of its legal work under alternative fee arrangements (AFAs), it seems inevitable that the billable hour model will eventually be replaced. Of course, the death of the billable hour has been predicted for decades, but it remains the dominant method for attorney compensation.

That is poised to change in the next few years.

As the billable hour recedes, firms that are quick to deploy technology and other methods to increase efficiency will have a significant advantage over their competitors. It is also likely that there will be a shift in the type of firm that provides legal services to large, sophisticated clients.

The billable hour is still supported by the senior leadership of law firms in the U.S. Kent Zimmerman of the legal advisory firm, Zeughauser Group, told Bloomberg Law that only 19% of all fees paid to Am Law 200 firms were performed under an AFA. A recent report by the legal consulting firm Altman Weil shows that only 28% of respondents voluntarily offered clients an AFA as opposed to being required to bill under one.

This is simple to understand. Lawyers respect precedent and tradition and mightily resist change. In fact, the Altman Weil report cites resistance to change by firm leadership as the primary reason law firms have not been more adaptive to the new environment. The report further states that 56% of firm leaders said that they had not felt enough economic pain to motivate a significant change. Recent decisions by inside corporate counsel indicate an increasing demand for more efficient methods of billing that give predictability in budgeting the cost of legal services.

Richard Susskind, a professor of law at the University of Oxford and a leading thinker about the changes taking place in the professions, has written prophetically about the shift away from the billable hour. In the recent second edition of his Tomorrow’s Lawyers: An Introduction to Your Future, Susskind has supported a wave of changes and innovations in the legal marketplace. He has decried the billable hour model as “an institutionalized disincentive to efficiency” that “rewards lawyers who take longer to complete tasks than their more organized colleagues” and “penalizes legal advisers who operate swiftly and efficiently.” More ambitiously, Susskind has predicted the end of the large, general services law firm for all but a handful of global firms poised to satisfy the increasingly limited demand for bespoke legal services charged at high hourly rates.

Susskind has envisioned new roles for lawyers in this market environment as well as the liberalization of the profession to permit non-lawyers to take on increasing responsibility in providing legal services. Connected with this trend are such developments as offshore legal process outsourcing, firms that provide an increasingly narrow range of legal services targeted toward client niches, and lower-cost legal services that can be rendered systematically and even automated in high-volume practices.

While AFAs currently dominate the discussion between inside and outside counsel regarding the handling of highly sophisticated transactions and litigation, there are areas of practice that have already undergone a transformation to AFAs: the so-called “commodity” areas. Treating a legal service as a commodity is anathema to a traditional lawyer. But to those clients faced with managing high volumes of litigation, it would be impossible to treat these services in any other way.

Take mortgage foreclosure cases as an example. Prior to the mortgage crisis, a single-family residential mortgage portfolio would typically experience less than a 1% default rate which would produce tens of thousands of cases. Faced with having to prosecute this large number of cases in any efficient manner, clients required counsel to charge a low, fixed fee for each case rather than the billable hour.

Counsel handling these cases, which are referred at higher volumes, quickly learned to manage cases efficiently. But most had been structured for volume at the outset. Instead of a pyramid structure, attorneys are decentralized and control their own case portfolios. The better firms disaggregate cases into component procedures and use sophisticated case management software to determine the work necessary for each stage of the case.

During the crisis, the default rate shot above 5%. This unprecedented and rapid increase strained every aspect of mortgage servicing companies, their counsel, and the courts. The regulatory response to the crisis was swift and comprehensive, adding layers of complexity and variability and producing large volumes of litigation by consumer attorneys. Through all of these changes, the flat rate remained in place, albeit with some upward adjustments to reflect the additional work required.

Some firms did not fare well during this transition. Several failed under the sheer volume of work, while the unsound practices of others were revealed by investigations of state attorneys general. Many of the firms that remain are stronger for the experience, having invested in technology and compliance.

As is the case with other industries being disrupted in the new economy, technology is the key factor in adapting to the changing landscape of the legal profession.

Susskind has unique insight into legal technology. He has correctly predicted that technology will drive down the cost of legal services, but is also instrumental in reducing the need for lawyers generally. He cites the online auction platform EBay as an example. The company estimates that 60 million disputes have been resolved without using an attorney. There have also been significant developments in affected computing and artificial intelligence that are superior to humans in fundamentals of practice such as detecting whether a witness is lying.

By leveraging technology, including artificial intelligence, firms with commodity practice areas have developed legal service delivery models that provide budgeting certainty, compliance, and quality control for default services aimed at mortgage, auto loan, and time-share servicers. These same models could easily be translated into other practice areas such as commercial real estate closings and commercial default services. Regardless of the financial services niche, however, it seems clear that firms that aren’t exploring alternative fee arrangements might struggle in the future. You don’t have to work in the tech sector to know that most of the business world pays attention to Microsoft’s innovations. Where it goes, others follow.

Ted Manley is a co-founder of the law firm Manley Deas Kochalski LLC, a creditors’ rights firm with offices throughout the Midwest and Florida. Ted leads the strategic initiatives of MDK and oversees the firm’s business development and client relations teams.