A recent Law 360 article by J.B. Heaton, “2 Overlooked Advantages of Hourly Fees,” reports on hourly billing advantages.  This article was posted with permission.  The article reads:

I was happy to see that my former colleagues at Bartlit Beck LLP prevailed at arbitration on a large fee dispute with a contingency client.  However, it appears that the dispute remains active, and that the firm is now forced to seek confirmation of the award (Bartlit Beck LLP v. Okada, in the U.S. District Court for the Northern District of Illinois) before beginning what may be a long fight to enforce it against a Japanese billionaire.

Bartlit Beck was a forerunner in the effort to move clients away from hourly fees toward alternative fees.  While most of the firm’s work while I was there (1999-2017) was on a flat monthly fee with bonuses, some work was on a contingency of the type now at issue in the arbitration recently reported.  Those flat monthly fees and bonuses were also a source of tension with clients who sometimes felt (wrongly, in my view) they were not getting good value for their money.  The firm hurt its relationship with Microsoft Corp. when it insisted on the payment of a relatively small promised bonus.  And the firm has been in a similar arbitration before like the one now at issue, where a client, EchoStar Corp., unsatisfied with its payment obligation to the firm found itself in arbitration.

While alternative fees continue to get attention in the legal press, there is no question that such fees remain overshadowed by the hourly fee.  Fee disputes like the one Bartlit Beck finds itself in again may tell us something about the reasons for the continued vitality of the hourly fee, especially among clients who have the wherewithal to pay.  It is no coincidence that most of the very large fee disputes we read about involve alternative fees.  What we don’t read about, but what is well-known to plaintiff-side lawyers such as I used to be, is the additional problem that large contingency fees can cause in generating suspicion of the lawyer recommending that the client take a large, pretrial settlement offer.

Fee arrangements for litigation require picking between two bad choices.  Hourly fees come with the incentive problem that lawyers make more money with every hour for which the client is willing to pay.  Since clients are usually not in the best position to determine the efficiency of undertaking a particular task (that is, it’s impact on the expected value of the litigation), the possibility exists that lawyers will respond to their incentives to undertake tasks that are not worth doing.

Flat fees address this problem by removing the incentive to work on inefficient tasks, but flat fees bring their own serious problem: They create an incentive to underwork the case, again taking advantage of the client’s poor positioning to see that a worthwhile project was left undone.  This allows the flat-fee lawyer to either use those hours on another flat-fee or hourly case or use the time in leisure, not working at all.  Contingency fees create an even more powerful incentive to end a case on terms that generate a large return for the lawyer on few hours worked.

The possibility of high-stakes fee disputes may be a relatively unexplored reason why alternative fees have not caught on among well-funded clients in high-stakes cases.  Clients may say — on the front end — that they want to pay for performance, but it can be hard sometimes to judge the importance of the lawyers’ actions in resolving high-stakes business disputes.

Where a dispute is resolved for reasons unrelated to the work of the lawyers, it is difficult for a client to pay a walloping fee that was, perhaps, based on the assumption that the resolution would have depended more on the lawyers’ work.  In the place where huge contingency fees reign supreme — class action litigation — the court has the power to set the fee, and virtually never ignores the hours worked in doing so.

Even where the lawyers have generated huge value by identifying a novel legal theory and bringing a defendant to the table for serious settlement talks, even the most sophisticated of clients can and do question the incentives of the lawyers advising them.

In some cases, a defendant can be brought to the table with a very large settlement offer based on the legal risk it faces in a relatively untested area of law.  The client, however, may question the lawyer’s advice to take the settlement where the lawyer stands to make millions of dollars on only a few hundred hours' work.  This suspicion, in turn, may lead the client to reject the settlement, only to find out later that the lawyer was right, the theory was too risky to have a large enough possibility of prevailing, and the huge settlement was the best that could have been obtained.

Discussions of hourly versus alternative fees will no doubt continue in 2020.  The market has spoken rather clearly, however.  The legal market seems to prefer hourly fees, especially in high-stakes cases for clients that can pay the fees as they go.  The bad incentives are controlled by long-term relationships with lawyers and firms, and by more and more sophisticated review of bills and descriptions.  Especially for high-stakes cases, the cost of not doing a valuable task is higher than the cost of doing some additional tasks that may be inefficient or unnecessary.  There are exceptions, of course, but they remain the outliers.

Here, I suggest that hourly fees have two advantages not yet adequately focused on: minimizing large-scale fee disputes, and maintaining the perceived integrity of the lawyers’ advice.

J.B. Heaton is President of J.B. Heaton PC in Chicago.