A recent Law 360 article by Lourdes Fuentes, “Twitter Legal Fees Suit Offers Crash Course in Billing Ethics”, reports on ethical lessons from the recent Twitter fee dispute litigation case.  This article was posted with permission.  The article reads:

Corp.'s case against law firm Wachtell Lipton Rosen & Katz, filed over Twitter's legal bill in connection with Elon Musk's $44 billion acquisition of the company, highlights the importance of following proper billing practices, which are governed not only by contract law but also by the higher standards imposed on lawyers by the rules of professional conduct.  The claims in X Corp. v. Wachtell Lipton Rosen & Katz, filed in early July in California's San Francisco County Superior Court, include restitution (unjust enrichment), breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and violation of California Business and Professions Code, Section 17200.

The pleading contains a litany of facts but recounts a concise timeline. From when Wachtell was retained on June 21, 2022, to the Oct. 13 party held to celebrate the month-end closing of the deal at the original $44 billion price, only 114 days had elapsed.  In that time, Twitter received two invoices.  These invoices were included as exhibits to the complaint.  A review of the invoices reveals blank time entries, vague descriptions, irrelevant references and block billing, among other issues.  The invoices amount to close to $18 million.

To compound these perceived improprieties, the final fee statement then added an extra $72 million dollars to that tab.  This was a "success fee" that was referenced in the closing day letter agreement drafted by Wachtell and signed by Twitter's then-chief legal officer, Vijaya Gadde, allegedly hours before the closing sale of Twitter on Oct. 27.  Significantly, the success fee had not been outlined in the engagement letter.

While the validity of the claims will be decided in court, the suit spotlights vital legal billing practices and ethical considerations for attorneys and clients alike.  Even if Wachtell defeats X, the suit has put the reputation of the firm's billing practices at risk.  Moreover, the suit has put the reputation and ethics of individual attorneys at risk by disclosing the invoices at issue, tying timekeeper names to time entries.

Further, the answer to whether the $90 million is fair pay or windfall may not be based on the amount itself, but on whether the parties followed the rules of professional conduct governing attorney-client relationships.  By reexamining billing approaches in light of the Twitter fees case, law firms and clients can take away important lessons on proper billing practices.

The Relevant Rules

Client and lawyer can maintain a positive partnership that is founded on transparency and trust by following an ethical road map.

The claims in the complaint provide us with a good starting point.  They are based on common law tort, contract law and the American Bar Association's Model Rules of Professional Conduct, which have been similarly adopted to varying degrees in other states' jurisdictions.  These are:

    Section 6147 of the California Business and Professions Code, which addresses contingency fees;

    Rule 1.5 of both the California and New York Rules of Professional Conduct, which prohibit unreasonable or unconscionable fees;[6] and

    Rule 1.8 of both the California and New York Rules of Professional Conduct, which prohibit soliciting gifts from clients.

By keeping these rules — or their equivalent from your jurisdiction — top of mind, practitioners can avoid the appearance of impropriety. Though not mentioned in the complaint, I would also add ABA Rule 1.4, which deals with attorney-client communications, to this list.

8 Crucial Steps for Success Fees

Fees based on the outcome of a case, like the success fee in the Twitter case, are permissible, but they still need to be reasonable.  While the ABA rules do not specifically mention success fees, they state that a fee may be contingent on the outcome of the matter for which the service is rendered.  The rules do, however, state that:

A contingent fee agreement shall be in a writing signed by the client and shall state the method by which the fee is to be determined.  Success fees are common in transactional matters, but these are typically negotiated as part of an engagement letter.  They are structured to incentivize the law firm to achieve the best possible outcome for the client.  However, the exact nature and amount of these fees can vary and are a subject of negotiation between the parties.  As a result, it is crucial for both parties to follow these steps.

Transparency and Disclosure

All terms related to the success fee should be clearly stated in the engagement letter or contract.  This includes how the fee is calculated, when it is to be paid, and under what conditions it may be modified or waived.

Reasonableness of the Fee

All fees must be reasonable.  Look for guidance in ABA Rule 1.5 for factors that can be considered to determine reasonableness of a success fee. These can include:

    The novelty and difficulty of the case;

    The skill required to properly provide legal services;

    Comparable rates in your area for like services;

    The amount at issue and the results obtained;

    Time limitations imposed by the client or by the circumstances;

    The reputation, experience and ability of the lawyers performing the services; and

    Whether the fee is fixed or contingent.

Proportionality

The success fee should be proportional to the value provided by the law firm.  This could be in relation to the deal size, the complexity of the transaction or the level of risk involved.

Incentive Alignment

Make sure that the fee structure selected aligns the firm's incentives with the client's goals.  Otherwise, it could be considered a conflict of interest, among other ethical pitfalls.

Regulatory Compliance

Understand your state-specific rules or regulations that might apply.  For example, California's Section 6147 speaks to contingency fee agreements.  Research your jurisdiction's rules and regulations.  Remember, as well, that some jurisdictions may cap or ban certain types of fees.

Dispute Resolution

Include a clause specifying how any disputes over the success fee will be resolved, whether through arbitration, mediation or court proceedings.

Periodic Review

It may be prudent to include provisions for reviewing the success fee arrangement at various stages of the transaction.

Client Consent

Explicit, informed consent from the client is crucial, especially if the success fee arrangement is unconventional or complex.  It is important to note that all fees must not only be reasonable but also adequately explained to clients.  Circumventing clear documentation enables end-runs around billing safeguards in violation of ABA Rule 1.5 and violates Rule 1.4.

While a lawyer and client may renegotiate a fee agreement during an ongoing relationship, the lawyer typically carries the burden of establishing fairness of the new arrangement if it is ever challenged.  Fee agreements entered during the attorney-client relationship will get heightened scrutiny to avoid the appearance of undue influence or impropriety.

In the case of Twitter, the success fee was agreed upon allegedly hours before the closing of the deal.  Although Twitter's old board agreed to the fees, the circumstances in which this transpired could be perceived as unethical and improper because of the lateness of the agreement made by the parties to include a success fee.  Hence, in addition to challenging the fee as unreasonable, the lawsuit claims that, based on the facts leading to the closing day letter agreement, the success fee should be considered a gift, and hence a violation of ABA Rule 1.8.

10 Proper Billing Practices

The controversy highlighted in the Twitter fee case provides a valuable reminder of the heightened scrutiny in attorney-client relationships due to its fiduciary nature and the rules of professional conduct.  In addition to the steps specific to success fees outlined above, it is important to keep these broader billing best practices in mind.

Engagement

Always formalize the fee arrangement in a written agreement.  This holds true whether you are dealing with an hourly rate, a contingency fee or some other type of fee structure.  Any modifications to the engagement terms or fee structure should also be put in writing.

Transparency

Clearly outline how legal fees will be calculated, any percentages that may accrue in the case of a contingency fee and any other expenses that will be deducted from the recovery.

Client Communication

Keep the client informed about any developments.

Alternative Fee Arrangements

There is nothing wrong with exploring creative billing options that can benefit both parties, but ensure they are in line with ethical guidelines and are clearly outlined in the agreement.

Data-Driven Metrics

Consider using data-driven methods to establish fees, especially for alternative fee arrangements.  This adds an element of fairness and can help align incentives between client and lawyer.  Notably, today we have the benefit of using artificial intelligence to come up with creative data-based alternative fee arrangements.

Review and Oversight

Periodically review the billing practices to ensure compliance with your client guidelines.  Train your timekeepers in proper billing practices and client-specific billing guidelines.  This training should be done annually and while onboarding new personnel.

Regulations

Understand the rules governing fees and conflicts of interest.  Train your lawyers in the rules of professional conduct.  This training should be done annually and while onboarding new personnel.

Fiduciary Duty

Always act in the best interest of the client, keeping in mind the fiduciary nature of the attorney-client relationship.

Avoid Surprises

Be proactive to avoid sticker shock.  Discuss potential scenarios and outcomes openly with the client, so they know what to expect in terms of fees.

For example, one fact alleged in the complaint is that:

[I]n the middle of the board's final October 27 meeting, former Twitter general counsel Sean Edgett sent the chart of fees that the Twitter board was meeting to approve.  Upon seeing the magnitude of the fees being presented for the board's approval, one former Twitter director immediately exclaimed in an email reply to Edgett: "O My Freaking God."

Regular Invoicing

Provide detailed invoices that outline the work done, the time spent and the costs incurred.  This not only aids transparency but will also help in resolving any disputes that may arise.  Also remember, your time entries should be treated with as much care as any work product; they should be clear, concise, descriptive and grammatically correct.

By following this ethical road map, the parties will reduce the likelihood of disputes and misunderstandings and, also, maintain a good working relationship.

Conclusion

Whether you are the client or the lawyer, beware falling asleep at the wheel when it comes to new engagements, modifications to billing and billing practices generally.  To do so may risk legal action and your reputation.

Lourdes Fuentes is a seasoned litigator, Founder & Chair of Karta Legal LLC, law firm partner and CEO.  She has a law degree from the University of Pennsylvania and is also a certified Legal Project Manager and Lean Six Sigma Black Belt.  With decades in the field, her expertise lies in optimizing legal operations and promoting ethical billing.  Lourdes founded Karta Legal to tackle these specific challenges, offering tailored solutions that include innovative technology adoption and process improvement.  Her firm caters to a diverse range of clients—from Fortune 100 companies to specialized boutique law firms—ensuring they adhere to transparent and ethical billing practices.

A recent Law.com story by Dan Roe, “Twitter Fee Lawsuit Brings Wachtell’s Billing Practices to Light”, reports that, in addition to charging hourly fees on par with top Wall Street law firms, Wachtell, Lipton, Rosen & Katz routinely charges success fees that rival the fees of investment banks in merger and acquisition transactions, according to an email Wachtell partner William Savitt sent to Twitter’s in-house counsel on the eve of Elon Musk’s takeover of the company.

The firm also adds success fees between two and two-and-a-half times the firm’s hourly fees in “premium billing matters that involve substantial litigation,” according to the email.  Wachtell’s billing structure diverges from Big Law’s traditional hourly structure by billing clients in the manner of investment banks, negotiating success fees by a percentage of deal value or bankers’ fees.

Last week, Musk sued Wachtell in California Superior Court on counts of unjust enrichment and breach of fiduciary duty, alleging Wachtell took advantage of Twitter’s “lame duck” in-house counsel ahead of the company’s sale to Musk and pushed through a success fee that represented the bulk of Wachtell’s $90 million fee for four months of work.

The lawsuit, filed by Reid Collins & Tsai, referenced Twitter’s master retention agreement, signed by Savitt, which made no mention of a contingent or success fee. (The document also states the retention agreement supplements any fee arrangement entered into between Twitter and outside counsel.  No such documents appeared in the complaint.)

In an emailed statement, Wachtell said the firm was “extremely proud” of its work representing Twitter, which “generated billions of dollars in shareholder value by compelling Elon Musk to abide by his contractual obligation to buy Twitter for $54.20 per share,” the firm said.  “The fee for our work was entirely appropriate and expressly approved by Twitter’s board of directors, which was independently advised.  The suit against us is meritless, and we will respond to it in due course.”  Simpson Thacher & Bartlett advised Twitter’s board in the deal.

Last October, when Twitter’s in-house counsel asked Savitt to justify the $90 million fee—which included $26 million in work billed hourly—by outlining comparable arrangements, such that Twitter’s board could approve the fee before the sale, Savitt outlined two methods.

In the first, “Engagement fees as a percentage of banker fees,” Wachtell stated it was frequently paid 60% to 80% of the fees paid to investment advisers.  In seven examples, the firm described instances of being paid between 67% and “over 100%” of the fees charged by investment banks.

The second billing method referenced litigation-intensive engagements, citing examples of the firm charging up to three times its “run-rate” (its hourly rate plus costs and other disbursements) and stating it frequently invoices two to two and a half times its hourly rate.

Wachtell has guarded its billing arrangements and declined to comment for previous American Lawyer articles discussing them.  Yet, in 2015, The American Lawyer obtained a standard fee arrangement Wachtell sent to client CVR Energy in January 2012.  In it, Wachtell stated its “extraordinary expertise and sophistication” didn’t lend itself to hourly fees, with the firm preferring to “base our fees not on time but on the intensity of the firm’s efforts, the responsibility assumed, the complexity of the matter and the result achieved.”

In the CVR Energy engagement letter, the firm said it typically charged 1% or more of the total value of M&A and takeover deals worth less than $250 million and charged 0.1% of matters worth more than $25 billion.  Compared with billing based on total deal value, Wachtell’s apparent preference toward billing a portion of banker fees in deals or multiplying hourly fees in litigation-heavy matters appears more lucrative.

Had Wachtell billed 0.1% of the $44 billion Twitter sale, it would have made $44 million.  Instead, the firm offered Twitter the opportunity to base its fees on those charged by the investment banks on the deal.  Three weeks before partner Benjamin Roth pitched Wachtell’s services to Twitter’s in-house counsel, news outlets reported Goldman Sachs and JPMorgan Chase & Co. were poised to earn a combined $133 million in fees if the deal went through.

Alternatively, a litigation multiplier of 2.5 would place Wachtell’s success fee near $90 million if the addition of the firm’s October hourly fees, which weren’t discussed in the lawsuit, brought the total hourly bill to $36 million.  Twitter also waived its standard 15% discount for outside counsel, according to the complaint. Additionally, Musk took issue with several Wachtell partners leaving time entry descriptions blank.  Wachtell’s highest-billing partners, according to billing records surfaced in the complaint, include Savitt at $1,850 an hour and Leo Strine, of counsel and the former chief justice of the Delaware Supreme Court, at $2,000.

Strine was central to Roth’s email pitch to Twitter Chief Legal Officer Vijaya Gadde, general counsel Sean Edgett and Chief Financial Officer Ned Segal in early June 2022.  “I’ve been following with interest the news about your pending transaction with Elon Musk,” Roth wrote, saying later in the same email, “Leo Strine is now with our firm and sits about 25 feet down the hall from me.”

Roth also emphasized litigation co-chair Savitt’s experience litigating in Delaware and Savitt’s representation of Roth and the firm in a malpractice lawsuit filed by Carl Icahn over the CVR deal.  In 2013, Icahn sued Wachtell for not disclosing to CVR executives that the company’s investment banks would earn more money if the company accepted an existing bid (rather than the banks being incentivized to drive bids up).  The lawsuit also said Wachtell broke from its own engagement letter and billed based on the success fees of the banks instead of using total deal value, with CVR’s counsel stating, “Wachtell is perversely incentivized to negotiate engagement letters that benefit the investment bankers, not the client.”

A recent Law 360 story by Sue Reisinger, “GC Cheat Sheet: The Hottest Corporate News of the Week,” reports that, as several law firms have significantly increased their rates over the past year amid a slowing economy, the relative silence from corporate clients has been deafening.  Law 360 columnist Aebra Coe writes that based on her experience covering the legal industry during the fallout of the last economic downturn, the level of "meh" reactions around the increases is a major shift from the volume of outcry we heard from in-house legal during the 2010s.

So fast-forward to today.  Released at the end of May, the LexisNexis CounselLink 2023 trends report found that timekeeper rates grew on average 4.5% in 2022, the highest level the enterprise legal management platform had recorded since it first produced the report in 2013.  According to CounselLink, average partner billing rates at law firms with 750 or more lawyers increased from $656 in 2015 to $895 at the end of 2021, an increase of 36%.

And yet, Coe doesn't think we've seen the same revolutionary spirit in-house that we saw a decade ago.  Some structural changes are at play, including reducing the number of outside counsel used by legal departments, adopting alternative fee arrangements, using legal technology, outsourcing some lower-level tasks to alternative service providers, taking some work in-house, and making use of data to ensure outside counsel are performing to a high standard and providing value for the money.

A recent Law.com by Maria Dinzeo, “Law Firm Partner Hourly Rates Rose Last Year at Biggest Clip in at Least a Decade,” reports that hourly rates for law firm partners jumped 4.5% in 2022, driven in part by law firms’ fears of profitability losses from inflation and a drop in M&A activity, according to a report from LexisNexis CounselLink.  The report, based on $52 billion in legal spending across 420,000 timekeepers and 1.4 million legal matters, says that annual percentage increase was the largest since CounselLink put out its first report in 2013.

The largest portion of corporate spending went to partners at the 50 largest firms, those with 750 lawyers or more, where the average partner billed at a 46% higher rate than the next tier of firms with 501-750 lawyers.  The 50 largest law firms also saw their market share swell to 47.3%, particularly in regulatory and compliance, mergers and acquisitions and financial matters, where the 50 largest firms consumed 55% of legal billing in 2022.

“There’s all this increased regulatory pressure going on out there.  And who do you want to handle this stuff?  You’re gonna go to the firms that you think had the most insight into this and that’s going to be the big firms,” said report author Kris Satkunas, director of strategic consulting for CounselLink.  She also recently took a preliminary peak at this year’s numbers, and partner rates are on track to rise 5.4%, an even bigger increase than the 2022 record.  Those rates rose 3.4% in 2021 and 3.5% in 2020.

“It’s a very big leap compared to where we have been running for the last 10 years.  But that number will change.  Will it go up or down?  I don’t know,” she said.  “But that’s where things stand today through the first four months of the year.”  Satkunas noted that 25% of partners had increases of over 10% last year.  She said some legal departments also reported seeing double-digit rate increases.  The hikes could be attributed to firms beginning to feel the effects of inflation and less demand for certain types of work.  “I think there’s some fear about being able to hit profitability,” she said.

M&A activity also declined in 2022 after hitting an all-time high in 2020, experts say, when high demand for M&A work, with accompanying litigation, tax, real estate and intellectual property issues, gave firms more work than they could handle.  “M&A was the gift that kept on giving in 2020 and 2021,” said law firm consultant Kent Zimmermann of the Zeughauser Group.  “The massive demand for talent led to a big rate increase and that caused some firms to pull away a lot relative to their peers on profitability and talent advantage.”  Even though M&A work has slowed, Zimmermann said firms are still vying to attract the “best” lawyers as a path toward profitability.

“Even though demand is soft, that rate lever is still important,” he said.  “If there is any recession, it’s looking like it’s going to be short and shallow, so law firms are thinking.  We need to plan two to four years ahead.  We can’t under-do it on the rate increases.  It’s a big driver of our ability to enhance profitability and compete and attract the best lawyers.”

Some firms raised rates twice over the span of 12 months to keep up.  “The internal messaging was we need to pay to be competitive in the market for associates and their pay is going up,” Zimmermann said.  “You need the best and brightest associates and this is what it takes.”

If law firms have only two levers to profitability- raising rates or drumming up more work— raising rates is the easier of the two, Satkunas said.  “Typically, they are more comfortable raising rates.  It’s actually easier to raise rates and go find new customers or find new new work,” she said.  Though alternative-fee arrangements have grown more popular in recent years, this year’s report notes that their adoption remains largely unchanged, and represented 6.3% of total legal billings in 2022, according to the CounselLink report.

“At the end of the day, I believe that most corporate counsel are just more comfortable negotiating an hourly rate discount than being creative.  It’s easier to negotiate a rate than it is to have to think about, what’s the value of this matter, what am I willing to pay for the outcome I want?” Satkunas said.  “I’m disappointed and I really would love to see a real meaningful uptick in the use of AFA’s but it just hasn’t happened.”

A recent Law 360 by Aaron West, “ABA Stresses Client Protections in New Prepaid Fees Guidance,” reports that a committee of the American Bar Association issued new guidance on the ethical obligations surrounding retainers and prepaid attorney fees, offering guardrails to protect clients from paying non-refundable fees for unearned legal work.  The opinion from the Standing Committee on Ethics and Professional Responsibility spells out how lawyers should handle advance non-contingent fees paid by clients for single-issue matters like divorce, defense of criminal charges and certain civil litigation, among others.

"[ABA Rule 1.15] requires that fees paid in advance must be held in a trust account until the services for which the fees will be paid are actually rendered, thereby allocating various risks to lawyer and client," the opinion says, referring to the flat fee rule at issue in the guidance.

According to the ABA's Formal Opinion 505, the problem it seeks to clarify stems from flat fees being classified as retainers, which are often nonrefundable. Attorneys shouldn't consider retainers as a "payment for the performance of services, but rather is compensation for the lawyer's promise of availability," according to the opinion.

"Given the rarity and unusual nature of a general retainer, and the fact that very few clients would actually need or benefit from one, the nature of the fee and lawyer's obligations and client's benefits under such an agreement must be explained clearly and in detail," the opinion states.  When it comes to handling upfront fees, the committee suggested that attorneys use "plain language."

"Instead of 'retainer' say 'advance' and explain that it is a 'deposit for fees,'" the opinion says.  "Explain that the sum deposited will be applied to the balance owed for work on the matter, and how and when this will happen."  The committee also stressed that "an advance fee paid by a client to a lawyer for legal services to be provided in the future cannot be non-refundable."

"Any unearned portion must be returned to the client," the opinion says. "Labeling a fee paid in advance for work to be done in the future as 'earned upon receipt' or 'nonrefundable' does not make it so."  The ethics committee periodically issues opinions to guide lawyers, courts and the public in interpreting and applying ABA model ethics rules to specific issues of legal practice, client-lawyer relationships and judicial behavior.

Although the ABA Model Rules provide guidance that U.S. legal jurisdictions can adopt, many states have their own rules that aren't necessarily in line with the ABA model.  In the case of ABA Rule 1.15, multiple jurisdictions have rules on the books that don't align with the new guidelines.

For instance, California and Oregon have their own model rules that clarify and outline how flat fees paid in advance of legal services should be deposited or labeled.  The ABA in its opinion acknowledges the jurisdictional discrepancy but also says that the approach "departs from the safekeeping policy of the Model Rules" and "creates unnecessary risks for the client."  While it's important to safeguard client payments from being considered non-refundable when an attorney hasn't yet earned them, too broad of an approach also risks preventing states from creating their own legal regulatory rules.

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