Articles Posted in Non-Law Firm Costs

An undetermined number of legal departments live rent free. That is, the companies the departments serve do not charge the legal budget with a cost for the offices, hallways, conferences rooms and facilities space the lawyers and staff occupy. If the law department gets off scot free, or if the charge to it is less than market rates, the department’s cost per fully-loaded attorney hour will be artificially low.

What would be a reasonable, imputed-rental charge? According to an article in Directors & Boards, Vol. 33, Fourth Quarter 2008 at 41, in the United states the average lease rate for offices per square foot is $24.50. The data comes from Kalorama Partners harvey@kaloramapartners.com.

Now, what we all are dying to know is how many square feet per lawyer makes up the footprint of a typical law department (See my post of April 23, 2008: square foot costs of filing cabinets; and Nov. 8, 2005: 38-member legal department occupies a space roughly 50 feet by 75 feet [approximately $94,000 a year at $25 a square foot.).

This stunning admission comes from J. Alberto Gonzalez-Pita, general counsel of the Las Vegas Sands Corp. His impression is that many C-Suiters think general counsel “just sit around and write checks all the time – and very expensive checks with very large billing rates to very expensive outside lawyers.” His quote comes from the ACC Docket, Vol. 30, Dec. 2008 at 28.

Shame on you general counsel if your boss and peers do not understand why lawsuits and buying and selling companies costs an arm and a leg. Shame on you if they do not understand the economics and practice model of law firms or the specialized legal issues that come up. Shame on you if executive clients do not understand the number and difficulty of matters your legal team handles and when and why outside firms may be needed.

All general counsel can organize their spend and services information, make it intelligible to non-lawyers and keep educating over time.

Michelle Banks, the general counsel of The Gap Inc. summarized at a recent panel four cost-management steps she has taken lately. I quote from the ACC Docket, Vol. 30, Dec. 2008 at 27.

The Gap is “asking its outside firms to provide staffing plans and budgets and increasingly holding them to it.” To aim at law firm minds and money is powerful if combined with some discipline (See my post of July 17, 2008: core team II with 11 references and citations to 7 earlier;

Aug. 8, 2006: core staff with 6 references; and

JDS Uniphase explains in its Guidelines For Professional Service Providers that Its Legal Department creates an Annual Operating Plan. The plan tracks “well over 200 separate line items and forecasts spending on them each quarter.” That budget is immensely detailed, since two that I have written about had only 40-50 line items (See my post of Sept. 9, 2008: internal budgets with 27 references; and Sept. 12, 2008: internal budgets with 25 references.).

On top of that, the legal department updates its expense forecasts at least three times per quarter, with each forecast covering 12-18 month rolling periods (See my post of Jan. 13, 2008: rolling budgets.). Taken together, these steps indicate a significant commitment to budget detail, analysis and reporting.

Data on payments made for legal resolutions such as damages, settlements, and fines are difficult to obtain (See my post of Dec. 17, 2008: settlements with 26 references cited.). Let’s call them collectively “legal resolution costs.”

What would be useful to know is a typical balance between total legal spending – inside costs and external fees paid – and legal resolution costs. Some data is available. Based on a recent General Counsel Roundtable benchmark study, the ratio is around four to one between total legal spending and legal resolution costs. https://gcr.executiveboard.com/Public/Default.aspx

Let’s translate that benchmark into dollars for the typical distribution in a law department where 60 percent of its total legal spend goes to law firms or vendors and 40 percent to its internal costs. If I have my math right, that means for every $1 million paid in legal resolution costs, the median law department spends about $1.6 million on its own lawyers and staff and $2.4 million on outside counsel. Stated the other way around, for every $1 million spent internally and externally, the law department that conforms to this benchmark ratio spends $250,000 on legal resolution costs.

I could retire if I had a dollar for every time someone mentions “bet-the-company” litigation (See my post of Feb. 28, 2006: bet-the-company litigation, rare but often cited.). So, with some satisfaction, I pored over the chart in the ACC Docket, Vol. 26, Nov. 2008 at 62, which graphs 18 “Primary Causes of 25%+ Stock Drops for 100 of Fortune 1000 Companies.” Way down at the end is “Lawsuits” at zero percent. Zippo.

And heed the plural (“Lawsuits”): all litigation put together does not rock the boat of those large companies (See my post of May 4, 2005: event studies and patent litigation; June 5, 2006: claim that share price is influenced by general counsel’s decisions or appointment; March 10, 2006: lead paint litigation dropped Sherwin Williams’ stock price 30%; July 25, 2005: litigation and share price; Nov. 5, 2006: shareholder derivative suits and share price; and June 14, 2007: firms lose 5% of share price when sued on a patent.).

Do not misunderstand my point. A drop of less than 25 percent can, of course, shake a corporate world. And litigation is costly, strategic, important, and difficult. But compared to business knockouts like “competitive pressure,” “cost overruns,” and “customer demand shortfall,” even major lawsuits don’t cause a ripple on the stock market.

“All too often at many companies, the costs of judgments and settlements are allocated to, and divided between, several corporate departments, therefore diluted effectively enough to relieve everyone of all responsibility or accountability for the total economic impact.” A hard charge laid by Joseph Speelman in the ACC Docket, Vol. 26, Nov. 2008 at 35. Speelman, head of litigation at LyondellBasell, gives no support for his assertion.

I think he errs. My experience has been that companies are acutely aware of settlement amounts. Typically, the business unit that caused the litigation bears the settlement cost. The head of that unit feels the pain acutely on the quarterly results. In fact, some companies “lend” funds to business units so that the units settle when appropriate rather than drag out the litigation and its legal fees and settlement charges to a flusher quarter.

An article in Corp. Counsel, Vol.16, Jan. 2008, at A2, describes a world that should frighten general counsel: aggressive investors capitalizing massive lawsuits as business ventures. For example, the article mentions briefly a public company listed on the UK’s AIM exchange. “Its sole business is funding litigation.”

The article further explains that private financial investors, including hedge funds, who “seek above market returns based on careful assessment of litigation risks and probabilities,” see hefty returns from major lawsuits. They will pony up funds for law firms to pursue big-ticket recoveries (See my post of Sept. 29, 2006: several hedge funds lending to law firms.).

One lawsuit funder is Calunius Capital, which along with The Judge has underwritten a £50 million action against a UK law firm. The lawsuit is being funded through a “groundbreaking financial litigation package combining conditional fee agreements, after-the-event insurance (ATE) and third-party funding.”

A general counsel may countenance offshoring because if promises cost savings. The literature that promotes legal process outsourcing (LPO) speaks of costs being 50 percent or less to provide similar services. That advantage may have been true, and may still hold for some LPO offerings. But according to strategy + bus., Iss. 53, Winter 2008 at 56, in a sophisticated analysis of global R&D, the cut-rate wages are disappearing: “In India, for example, the wage rate for high-end service workers was 53 percent of the equivalent rate for U.S. workers in 2005. In 2008, the percentage had risen to 65 percent, and it is projected to rise to 77 percent in 2012 and 90 percent in 2020.” Slumdog millionaires won’t work for a pittance.

LPO vendors argue that they offer other advantages, such as superior commitment and process improvements (See my post of Nov. 30, 2008: lower costs and improved processes *3.). Cost savings are still to be had, I am sure, but third-world rates may be receding into the past.

Not every law department operates under a single cost center. For example, some law departments have a separate cost center for the Corporate Secretary function or indeed for other functions that report to the general counsel, such as government affairs, EH&S, or compliance (See my post of Sept. 3, 2008: functions overseen by general counsel.). Some law departments have cost centers for reserves and others for litigation. Sometimes, one-off cost centers are set up because otherwise the expenditures would far exceed the anticipated budget of the law department.

Nonetheless, at the highest review levels, somewhere along the line, all cost centers should be rolled up into a single consolidated law department budget. Otherwise, review becomes too cumbersome and senior lawyers who are responsible for the budgets begin to simply go through the motions.