Articles Posted in Non-Law Firm Costs

To charge back or not to charge back time, that is a question for inside lawyers. Those law department managers who advocate a time chargeback system do so in part because it makes clear that legal services are not a free good. A chargeback encourages clients to use lawyers when they are most valuable. If you bill for your time, your company benefits because clients take more care of your singular resource: time.

A thoughtful article, even though five years old, disagrees. “[E]xperience seems to hold that companies that adopt this approach end up devoting enormous amounts of time, energy, and resources to the billing process, often to the point of having business units hire their own lawyers to manage and negotiate bills,” ACCA Docket, Vol. 18, May 2000 at 4 (Stephen J. Friedman and C. Evan Stewart). I have never heard of that latter wasteful step of in-house lawyers hired to war over charge-backs! The authors also believe that “such internal billing procedures may well inhibit corporate clients seeking important legal advice in a timely fashion.” That worry has more bite, as units that struggle to make their numbers may be tempted to shave legal costs.

Friedman and Stewart recommend that the general counsel negotiate with the chief executive a workable aggregate budget paid from general revenues. Only in exceptional situations, such as a major acquisition or lawsuit, should a business unit incur the legal costs.

On one side of the aisle sit those who believe that general counsel should be responsible for only two components of corporate legal costs: the overhead costs of inside attorneys and outside counsel fees. On the other side sit those who would add to responsibility for the total amount of settlements and money damage awards. A thoughtful article by two former general counsel, Stephen J. Friedman from E.F. Hutton and Equitable. and C. Evan Stewart from Nikko Securities, sides with the latter: “a general counsel should be judged by the ability to manage the overall cost of all three components,” ACCA Docket, Vol. 18, May 2000 at 2.

Responsibility for total legal costs fits with Friedman’s and Stewart’s view that to the corporation all legal costs from whatever pocket are fungible (a dollar spent is a dollar spent), and that “a company should be indifferent to which component of legal costs an expenditure represents, as long as the overall cost of a project is as low as is practical.”

The prickle is that business unit heads are held accountable for their budgets, so that if settlements and awards come from their purse, they do not want to cede complete authority to the lawyers to decide the timing and amount.

While law firms drink by far the largest draught of law department spending, many other vendors draw from the same well (See my post of April 18, 2005 on the cottage industry and April 2, 2005 on unbundling.). What is the legal ecosystem’s revenue?

If US law departments pay vendors on the order of $100 billion a year, approximately 10 percent of that covers law firm disbursements and the costs of non-law firm vendors. Very loosely, that amounts to $10 billion a year. Most of that expense, we all recognize, is travel and lodging. Perhaps 10 percent would be other vendors who provide products and services to law firms.

Another tier consists of vendors who sell not through law firms but directly to law departments. Examples include stationers, CLE providers, expert witnesses, software companies, publishers, consultants, and many others who operate symbiotically with law departments.

“The concept of defense alliance fund is that groups of companies in complementary businesses pool their resources to buy a portfolio of patents. They can then either borrow patents from this pool needed to counter assertions made against them, or target the pool to create revenue that can then be used to offset royalties paid to the patent powerhouses.” Admittedly cryptic as quoted, this arrangement is described by Ron Epstein, CEO of IPotential, in a March 11, 2004 Web conference organized by Foley & Lardner.

From what I can glean, this appears to be a management initiative that makes more productive use of the company’s patents as well as related patents, and helps control patent defense costs (See my post of Oct. 14, 2005 on collective activities by law departments.).

The 2006 InsideCounsel/DataCert Annual Report of Corporate Law Departments features responses from about 180 law departments. When those departments identified which of eight cost-control steps they had taken, the dominant method was to bring more work in-house.

Here are the rankings from InsideCounsel, May 2006 at 70 and the percentage of respondents who chose it:

1. Brought more work in-house (72.8%)

A table in the 2005 California Bureau of State Audits’ review of LA’s Office of the City Attorney estimates the distribution of services provided by outside counsel to three entities (Dept. of Water and Power, LA Airports, and LA Harbor). Of the approximately $16.1 million they spent on outside counsel in the latest fiscal year, litigation comprised three-quarters (id at 6).

It was the basically even split between spending on plaintiff and defendant litigation that got me thinking. Law department metrics do not often separate the litigation spend, yet I can imagine that a law department will spend more as a plaintiff, if only because it has recommended bringing the lawsuit, because it has a chance to recover funds, and because its outside firm might be working on a contingent fee basis.

One cost for law departments embroiled in litigation are fees of expert witnesses. “The expert-services industry was estimated by one insider to be reaping $6 billion to $8 billion a year,” according to the Star-Telegram.com, May 14, 2006 (Barry Schlacter). A litigation manager can locate an expert through various directories, referral services, and internet sites I have served as an expert witness.in two cases (both on law department billing arrangements and fees), and found the responsibility challenging and stressful.

At least four companies that provide expert witness have gone public: LECG, Huron Group, Navigant and FTI Consulting (See my post of April 19, 2005 on patent expert witnesses, and its reference to Exponent.).

A partner at UK-based Simmons & Simmons, Jonathan Kelly, compiled an enlightening list of differences on the litigation front between the United States and the UK (England and Wales). He notes particularly these six, Corp. Counsel, Vol. 13, April 2006 at A6:

1. No class actions (See my posts of Oct. 29, 2005 and Feb. 28, 2006 with some data on the prevalence of US class actions.)

2. No contingency fees as a share of damages recovered (See my post of April 27, 2006 about the vast sums re-allocated in the US by this system.)

Experts who not only provide a valued service but also tell the customer what service is needed control both ends of what economists call a “credence good,” according to the Economist, April 15, 2006 at 78, because customers – think of a law department that retains a partner who is an expert in some arcane field – take it on faith that the partner has given them the legal services they need, and no more.

As derived from the article, to reduce the risk of being sold too much legal work (over-lawyered), an in-house lawyer can cope two ways. If that purchaser of legal services understands the incentives the partner faces and acts on that knowledge, some of the incentives for expert dishonesty shrink. If hours billed is the partner’s driver, fly-speck bills or insist on fixed fees. The other way to cope is to consume services when the margins for all services are the same. Huge lawsuits have higher margins for firms than do slip and fall cases. This tactic works, however, only if the partners and associates are fully booked. “In quiet periods, however, the opportunity cost of ‘overtreating’ clueless [in-house lawyers] falls, and the rewards rise.” The counter-intuitive second tactic, if you are worried about being over-charged or over-worked, is to pick the busiest capable partner you can find.

Sometimes, when a law department recommends that a lawsuit be settled, the client from whose purse the funds must come may balk (See my post of Nov. 25, 2005 about whether law departments should manage settlement funds and recovered amounts.). To hit their numbers during the quarter, top executives may defer funding the settlement until the next quarter. Meanwhile, legal fees continue to bleed, which worsens the numbers of the law department.

If there are internal barriers to settlement that result only from business unit performance goals, and not from the wisdom of the settlement itself, law departments need to rush the barricades. At one company I worked with, headquarters would lend operating units funds so that units could settle litigation at the soonest appropriate time and yet not take drastic hits all in one quarter to their bottom lines. That’s a sensible workaround.