Articles Posted in Non-Law Firm Costs

Assailed by law suits, American International Group announced in May 2005 that it would pay the legal bills of its independent directors. According to unnamed securities lawyers, “AIG’s decision to pay its directors’ legal expenses is standard practice.

In a separate post today, I discussed the complexities of board retaining independent counsel. This is a variation on the same theme. I take the position that total legal spending should encompass all payments made to outside vendors whose services are closely related to legal issues. If that is the rule, declines in share price would not count, even if the declines were directly attributable to litigation risks. (See the post today about Merck and its Vioxx-related loss of market capitalization.)

Merck, battered by its withdrawal last September of Vioxx, faces possibly tens of thousands of lawsuits. According to the New York Times (July 23, 2005 at C6) “analysts say the current [Merck share] price factors in $10 billion to $18 billion in costs related to Vioxx.” By way of comparison, the pharmaceutical Wyeth, maker of the diet aid fen-phen, took charges against earnings – I think that does not mean Wyeth paid out, but reserved against – of more than $20 billion.

Some titanic companies smash into adverse legal icebergs, and the costs of representation, settlement and damages can sink them, as was true with more than 70 companies that used asbestos. Share value immediately reflects the disclosure of major legal liabilities.

If total legal spending of law departments included such catastrophic costs as drops in market capitalization, metrics on total legal spending would skew upwards. (See my posts on May 4, 2005 regarding event studies and patent litigation, May 30, 2005 on including settlements and judgments in total legal spending, and on July 20 regarding internal litigation costs.)

Several insurance companies offer policies for companies against legal costs and damages that can arise from IP litigation. One broker is Miller Insurance Services Ltd. in London [info@miller-insurance.com]; another is 2XFR, a service of TPSearchEngine. [www.2XFR.com] The policies cover defensive and offensive litigation.
I have not encountered a company, let alone a law department, that draws on such insurance. Would the cost of such a policy be borne by the law department? What other kinds of insurance exist for litigation?

Like the Holy Roman Empire was neither holy, Roman, nor an Empire, “Total Legal Spending” as used in benchmark surveys is neither comprehensive, nor within the sole purview of the law department, nor cash out the door. [For example, see my post on May 30, 2005 about missing data on judgments; my post of May 4, 2005 about TLS declining with company size.]

For nearly all law departments, some amount of spending on outside counsel or for fines, judgments or settlements end up in other budgets. Tax, to cite one obvious payor of such legal costs, joins risk management, and collections as TLS evadors. Then there are special reserve accounts or capital transactions. Another source of leakage are business units overseas who hire and pay lawyers out of their own budgets. Sometimes the marketing department or R&D picks up the tab for IP services. All in all, TLS is not all in all.

The latest Corporate Legal Times survey of law department – law firm sentiment tucks in a curious statement. The article states (at 38): “If a client is under financial pressure and a lawsuit appears unfounded,” law firms may offer alternatives to hourly billing. Well, except for a litigation being “unfounded” I accept that possibility.

“Or, the author continues, “suppliers and business partners will be asked to contribute to the legal cost, since they stand to benefit as well.” Does this mean there are instances where a manufacturer, having a tough quarter, extracts contributions from its suppliers and joint venturers when the manufacturer sues a buyer for breach of contract? When has any company had another company – not an insurance carrier – carry some of the cost spears into battle? Litigation isn’t “coalition forces” in Iraq. But, perhaps I have missed an innovative way to reduce outside counsel spending – pass the buck to your buyers or sellers. After all, if you go out of business, they lose too.

Consistently, benchmark surveys tell us that law departments spend 40 cents of every dollar on their inside costs and the other 60 cents on outside counsel. Year after year, this median ratio holds true. Why?

If you knew nothing about law departments, wouldn’t you assume that the inside lawyers would do most of the work, and only turn occasionally to outside counsel? Wouldn’t you marvel that these expensive, talented groups have to buy still more expertise and manpower from even more expensive external counsel? Other staff groups don’t spend more outside than inside. Litigation accounts for a chunk of the explanation, as it swallows half of the outside fees. Even so, it troubles me in a way that I can’t pinpoint why law departments do less than they buy!

It is difficult to obtain metrics about the costs of litigation [but see my posts of March 29, May 1 and 4, 2005 on patent litigation costs.] Thus, when the Sullivan Group’s Autumn 2002 report shared some data on D&O suits (from a 2001 Tillinghast Towers Perrin study), I grabbed it.

The average cost of defending a D&O claim – back in 2000 – was $540,000. The average payment was $5,650,000. Thus, the ratio of defense costs to settlement or judgment costs was one dollar for every ten.

Legalaffairs, in its May/June 2005 issue at pgs 10-12, discusses sending legal work to Indian firms. Here is the eye-popping metric: “The market for outsourced legal work is expected to reach $163 billion by next year, and India is positioned to seize the largest share.” [See my posts of Feb. 20, 2005 and of May 20, 2005, the latter attacking a figure one-hundredth as large.] Before such a figure sinks to urban legend, we really need to know how it was calculated.

Editor Daniel Brook’s piece cites three companies, Intellevate and Lexadigm and Imaging & Abstract International. It otherwise adds little to the hubbub about Indian outsourcing.

An article in The Metropolitan Corporate Counsel (June 2005, pg. 48) presented a teaser of data on the costs of compliance with Sarbanes-Oxley Section 404. Jeffrey Steinberg, an Ernst & Young partner who was interviewed for the article, explained that E&Y’s most recent study “indicated that fifty percent of the incremental cost of Section 404 are internal costs of the organization; twenty-five percent are extra costs from the audit firm; the other twenty-five percent are external costs…” Thus, inside counsel show up in the first category and outside counsel in the third category – but the study apparently dug no deeper.

In-house counsel, to be sure, spend time on Section 404 reviews. Steinberg said “[w]e have worked with corporate counsel in every one of my Section 404 experiences.” [See my posts of May 30, 2005 regarding Adecco’s costs and May 10, 2005 regarding SOX and IP audits.]

I thought that the British system of requiring the losing litigant to pay the winner’s costs had the advantage of lowing overall legal costs. Everyone would eschew frivolous litigation out of justified fear of bearing the other side’s legal fees. For that reason alone, total legal fees as a percentage of turnover should be lower for UK companies than for their US counterparts.

But an article in the Economist (May 28, 2005 at pgs. 57-58) undercut my supposition, at least as to fees. First, since losing brings dire consequences, litigants spend more to avoid that fate. Second, plaintiffs’ lawyers since the late 1990s have been allowed to accept clients on a conditional (contingent) basis. If they win, they can claim a success fee from the losing side, amounting to a surcharge of up to 100% of their costs, which encourages them to rack up still higher charges. Finally, many victims of injury buy insurance that protects them against paying fees should they lose. Thus, they do not heed spiraling attorney’s fees.

Aside from the point that a loser-pays system favors deep-pocket litigants, it is a policy that has boomeranged in unexpected ways.