Wednesday, July 6, 2011

Law Firm Billing Practices - Why is My Bill So High?

Note:  This is a posting from my related Patent Blog.   While the information is directed toward Patent Practices, it is also applicable to a lot of general practice firms as well.

Law Firm Billing Practices - Why is My Bill So High?

During this downturn in the economy, I'm pretty busy.  As a low-cost provider of quality services, I find that many companies are seeking me out as they try to reduce costs and overhead to remain competitive. My friends at larger firms report that many are laying off Attorneys - and that some clients, to cut costs, are not even paying issue fees!  Meanwhile, my solo practitioner friends all seem to be doing a banging business.  Perhaps most companies are realizing that large firms and large bills do not necessarily make for the best Patents.

My fees are fairly reasonable, I think.  But I don't work for free. Filing and prosecuting any Patent Application can cost thousands, if not tens of thousands of dollars. Yet on occasion, I hear horror stories from some clients about firms that charge upwards of $30,000 or $40,000 to file even a mediocre Patent Application - and that does not include prosecution fees.

How can fees be so high? And how do they calculate these fees?  The following is a brief analysis of law firm billing practices, which illustrates how legal fees can balloon out of control, and also suggest some steps you can take to keep costs in line.

Legal Bills - the Most Uncollectable Debt

To begin with, there is a dichotomy in some firms between "billable" hours and "billed" hours.  And of course, there is always the "paid" hours to consider. Legal bills, like medical bills or consultant's bills are some of the most uncollectable debt there is.  In bankruptcy, a lawyer's bills go to the end of the line - behind the tradesmen and suppliers, who may have real costs to recover.  A Lawyer has only his time, and it is viewed as something he can afford to write off.

Once a bill is issued, if the client refuses to pay it, it is considered legally risky and unseemly to sue the client for the unpaid debt.  A simple complaint to the State Bar by the Client can result in legal expenses for the firm that far exceed the amount billed.  As I noted earlier, legal fees are some of the most uncollectable debt there is.

Thus, when approaching a legal bill, the first thing to consider is the possibility of negotiating it down. Of course, it would be better to have the bill negotiated in writing first, as I do in my practice, but few lawyers seem willing to take this approach, even though the costs of preparing and filing a Patent Application fall within pretty standard price guidelines.

Now granted, Lawyers do have fixed expenses - they have to rent office space, pay Associates, Paralegals, and Secretaries, and also pay the light bill, filing fees, and malpractice insurance.  However, there is a lot of headroom in many legal bills.

The Billable Hour Gag

Most firms operate under the "billable hour" theory of billing.  Each Partner, Associate, Law Clerk, and even Paralegal is assigned a billable hour rate, which may range from as little as a $100 a hour for a Paralegal to over $800 an hour for some Partners.

By doing some quick math with these numbers, you quickly realize that the annual cost for such work (based on a 50-week year and 40-hour workweek) would be staggering.  A simple Paralegal would cost $200,000 per year, while a Partner would fetch a cool 1.6 million.  Many in-house counsel, after doing this math, tend to think that hiring people "inside" might be a cheaper and better option - and in some cases it is.

In most firms I worked for, an Associate's salary was determined by the "law of thirds": 1/3 of an Associates annual billings should cover his salary, 1/3 of his annual billing should cover firm overhead, and 1/3 of his annual billings should go to partnership profit.  Some firms have taken this a step further by going to quarters - with two quarters (one-half!) going to partnership profit.

Any company that has a 33% profit margin is doing pretty well.  In fact, for most businesses, that would be considered a staggering profit margin.  And again, this is the profit margin, not merely the markup, reduced by overhead (that is covered by the other 33%).  So there is a lot of wiggle room in bills to cut back on.

Earlier, I alluded to the terms "billable hour", "billed hour" and "paid hour".   In many firms, these terms have different meanings, but they generally fall along the same lines. A "billable hour" is an hour of Attorney time which can legally be billed for some legal service.  Thus, if you are analyzing a legal matter, researching it, or drafting a response, this is all "billable" time.

However, whether this time gets billed is another matter.  In many instances, an Attorney may put more time into a matter than can be billed to a client.  For transactional work, the client may say, for example, that an Amendment should not exceed $2500 unless there are extraordinary circumstances. If the Attorney has $3500 in "billable" time on his time sheet, some of that will have to be written off to put the bill in conformance with client expectations.

As we shall see, cuts to billing can also be done for other, more nefarious purposes, to reduce the Associate's billings and thus justify a lower raise, while at the same time increasing Partnership billing by "padding" on time.

Some firms rate Associates based on "billable" time, but most prefer to use "billed" time as a benchmark. The "billed" time is the actual amount of Attorney hours billed to the client. This is a much more effective benchmark in evaluating an Associate, as it rewards efficiency. However in a mixed-practice firm, some specialists, such as Patent Attorneys, can suffer under this standard, as their billed hours may be far lower than other Attorneys, such as litigators.

The Paid hours are, of course, the real issue.  As noted previously, in many types of legal work, the bill sent to the client and the actual amount paid are often two different things. If an Attorney is hired to handle a piece of litigation, and loses badly, he might have to "eat" a lot of his time, if he intends to keep that client for future work.  For litigators, the initial bill is a merely a shot across the bow - with the expectation that most clients will call and negotiate the actual amount to be paid.

Partnership Profit

The billable hourly rate tells only part of the story. Some Partners make even more than what their hourly rate would suggest.  Most Attorneys make far less, of course.  Partnership pay is determined by the overall profitability of the Partnership, in addition to a percentage of billable hours.  And individual Partners are often paid based on the profitability of their own client matters.  Some Partners, if they have a lot of cases and a lot of Associates working for them, can literally rake in millions of dollars a year. However, such Partners are few and far between.

And unfortunately, most folks think we all make that much money. And unfortunately, many young people get into the law business thinking they are going to make that much money.  And unfortunately, it just ain't true for the bulk of Attorneys - even Partners - out there.

Opaque Billing Practices

In many firms, the accounting systems are anything but transparent or easy to use.  Often this is by design. An Associate cannot easily determine how much they are billing or how much of their billing is actually sent to the client and paid.  At the end of the year, an Associate may feel they have done well and made a lot of money for the firm.  But mysteriously, the firm's accounting software shows otherwise - that they are lucky to even be employed.  Smart Associates keep track of their billing using their own accounting software, to determine where they actually stand.  However, a lot of games played by Partners can result in an Associates time mysteriously disappearing.

Accounting systems in many law firms are antiquated or ill-suited to their practice. In many firms, accounting is centralized.  Each Attorney enters his "time" on a time-tracking computer, which in turn generates bills automatically from the Attorney entries.  Often this results in a printout of pages and pages of time entries making little or no sense, with a huge number at the end. The client has no idea what has been charged for what service, and moreover, since bills are sent monthly, it is not clear how much each transaction (e.g., Patent) is costing.

For some types of practices, such as litigation, such billing systems may make sense, as every hour of every Attorney and Paralegal needs to be tracked and billed (whether this is paid is another mater).  But for Patent Prosecution work, such systems make little sense, unless the intent is to obfuscate the total bill and make it difficult for the client to track costs.

Many Patent Prosecution firms practice "event billing", so that each event in the prosecution is billed separately - filing, amendments, appeal, issue costs, etc. - rather than sending a fragmentary monthly bill for every matter for that client.  Event billing makes keeping track of legal expenses easier, as the in-house counsel can look at an individual invoice (often sent contemporaneously with the matter) and make a fair appraisal of how much work was involved and the corresponding costs.

Many organizations, such as AIPLA publish an annual salary survey which also sets forth average pricing among Attorneys for various services. While the AIPLA survey is somewhat biased to the high side (Attorneys self-reporting, tend us use inflated numbers) it at least provides a means to compare an individual bill against some standard.

Cutting Time and Bill Padding

One common game played by Partners is to cut an Associate's bill for a piece of work and add corresponding "supervisory" time of their own to the bill.  By cutting the Associate's bill, they reduce his billings, and thus can use this as justification to deny raises and promotions to the Associate.  By adding their own time to the bill, they get a larger share of the overall profits, as the Partner generally gets two-thirds of his own billing, as opposed to one-third of his Associates'.

In one celebrated incident, a Partner at a Patent firm foolishly sent out a memo to all the Associates, instructing them to add an hour of his time to every client matter for "supervision" - "Regardless", he said in the memo, "whether I actually reviewed the file or not."  One disgruntled Associate sent a copy of this memo to the State Bar and all heck broke loose. Yes, Virginia, that is bill padding.

The Associates were angry over that memo because in order to add one hour ($300) of his billing time to the matter, they would have to cut their own time by a proportionate amount (e.g., two hours), to keep the bill in line with client expectations.  So not only was the Partner screwing them out of their time and money, he was making the play blatant and apparent to them - and asking them to commit the fraud in the process.

The Law Firm - a Pyramid Scheme

To some extent, the law firm is like a Pyramid scheme.  At the top of the pyramid, the founding or senior Partners rake in the most amount of money, based on the work of the underlying ranks of Senior, Mid-level, and Junior Associates.  Each rank of Associates is promised that, if they work long hours and bill a lot, they will one day make it to the top of this pyramid.  However, unless the pyramid can grow exponentially, there is little room at the top, other than for a determined Lawyer who is willing to claw his way there - at the expense of others.

Like an MLM marketing scheme, most firms quickly reach a critical size, where the billing gets too high (due to the size of the top-heavy Partnership) that the firm breaks - like an iceberg calving, into smaller units.  One unit retains the firm name (or most of it) and soldiers on as the "original" firm.  While other spin-offs start anew, or merge with other firms.  It is a continual process and anyone foolish enough to believe that a 100-year-old law firm has some sort of "continuity" probably also believes that genealogy determines their personality traits.

The Rainmaker - Does He Really Make It Rain?

You may have heard of the term "Rainmaker" when used in connection with law firms. Generally, this term is used in a laudatory manner to suggest a Partner who is responsible for securing work for the firm. In many instances, such a Partner may get "origination credit" - a percentage of the billing - for every piece of work done for that client subsequently. Often, these origination credits amount to a substantial sum of money for basically doing little or no work.

Sometimes, a "Rainmaker" actually has some sort of hold on the work, but usually this hold is based on a personal connection. The rainmaking Partner was college chums with the in-house counsel, for example, or perhaps they were Fraternity Brothers. In some cases, these links are based on more unsavory criteria - including kickbacks and favors. While a rainmaking Partner can threaten to leave a firm and "take the work with him" in nearly half of all cases, this never works. And if the "link" (friend on the inside) is broken, then the rainmaker's ties are severed completely.

Recently, it was brought to my attention that the term "Rainmaker" has a negative connotation in some instances. Traditionally, "Rainmakers" where shysters and hucksters who went from town to town in rural drought areas, promising to make it rain, if paid a substantial fee. If the townspeople paid, and it rained, the "Rainmaker" would take the credit and keep his money. If it didn't rain, well, he'd leave town quickly. The joke is, the "Rainmaker" is essentially taking credit for something he had no control over to begin with.  And in this regard, the term seems apt for many firms.

Origination Fees - Getting Paid for Not Working

Fighting over origination fees is a major struggle in many firms. If a client approaches a firm without having a specific Partner in mind, a bloody struggle will ensue as the Partners, like small children, cry "I saw him first!" and lay claim to the mantle of "Originating Attorney."

For the young Associate who tries to bring in work, such efforts can be heartbreaking.  Associates, oddly enough, are not encouraged to bring in clients.  They are hired to perform the actual work for the clients that the Partners claim "origination" credits for.  An Associate who brings in his own clients is of no use to the firm, and he will likely demand Partnership or leave as a result.

In one unsavory instance I recall, a Senior Associate brought a fairly good-sized client to his firm, after one of his college buddies was made in-house counsel at the company.  The Associate thought that the Partnership would be happy that he brought in this work.  He was shocked when the Partners told him that Associates were not entitled to "origination credit" for bringing in a new client, and that a Partner would be assigned to him to "mentor him in client development" - with that Partner taking the origination credit and the lion's share of the billing profits for that client.

The Partner in question justified his actions on the grounds that this "mentoring" would take time away from his clients and he was justified to the extreme compensation.  The Associate?  He ended up getting what he would get for any other work - maybe 1/3 of his "billing" minus, of course, any "cut time" the Partner justified for "supervisory work".  Not surprisingly, that Associate left, and in his instance, the client went with him.

The example illustrates the amount of outright greed that goes on in many firms - and the shortsightedness of many firms.  In many of these firms, where the money becomes more important that the practice of law, the client "churn" rate is astounding.  The "Rainmakers" are needed to constantly bring in new work, as the old clients are continually going out the door - disgusted by staggering and incomprehensible legal bills as well as the antics of the Partnership.

Reporting Fees -Pure Gravy

In addition to origination fees, the 1/3 profits, and "supervisory" billing, a Partner can extract additional fees from a client that are pure profit.  In the Patent business, a large amount of papers are generated by the Patent Office.  Most of these are routine matters that are reported to the client with a simple, generic cover letter automatically generated by a Secretary (some docketing systems literally generates these automatically).  Many if not most firms charge a small fee for "reporting" matters, which can be on the order of a hundred to a few hundred dollars.

These reporting fees are pure profit for the partner, as they are automatically generated every time the Patent Office generates a piece of paper, regardless of whether a response is required. And since the labor involved is largely performed by a Secretary (oftentimes even signing the letter) there is no actual work involved for the Partner.  For a client with 20-40 pending Patent Applications, these reporting fees alone can generate a revenue stream that would equate to a handsome salary for many Attorneys.

How Can You Reduce Your Company's Legal Expenses?

Reducing legal expenses is not all that difficult. To begin with, investigate whether your in-house counsel and the outside firm have any pre-existing relationship (old school chum, fellow Mason, or whatever).  If this is the case, then perhaps you are paying too much as the outside counsel was selected on non-performance based criteria.  It might not be a bad idea to see whether your in-house counsel has a new Jaguar, or other indications he is living far beyond his means.

Second, insist on transactional billing, not monthly statements that go on for pages.  If you cannot make sense of a legal bill, there is no reason you should pay it.  With each transaction billing, you should make sure that it is approved by the person in-house who worked on that transaction - making them clearly understand they are responsible for the accuracy of the billing.

Some firms will claim that they cannot bill any other way than to send you a 500-page printout of their firm's time-tracking software.   Some even have the Chutzpah to suggest that if you want transactional bills, fine, they will do so - but charge you an hour of Attorney time to prepare them.  Those are firms that you should consider walking away from, either because they are horribly inefficient or are horribly crooked, or both.

Third, ask whether you are being billed for reporting of matters, routine docketing, and the like. Oftentimes these trivial bills are pure gravy for the law firm and in no way reflect any actual work done.

Fourth, carefully examine the structure and nature of the firm you are using.  My general rule is to never hire a law firm larger than your own organization.  If you are a 100-person company, your are just another small-client to a 500 Attorney multi-State firm.  If the bulk of your work is being handled by one or two Associates, but a lead Partner is tacking on hours or taking huge origination fees, then perhaps it is time to find a smaller firm, where the person handling your matters is also the one getting credit for them.

Fifth, consider using competing firms, if your company has enough business to justify it.  Many of my larger clients use two, three, four or more Patent Attorneys.  This strategy allows you to compare quality and price in real-time, and assign work based on competence in a specific area. In addition, it allows you to drop a particular Attorney or firm without a lot of drama - revoking Power of Attorney for your entire docket, and transferring files, etc.

With regard to this last point, it is often very tempting for in-house counsel to drop a firm and pick a new one. Such an action, however, is fraught with peril on many levels. To begin with, others in the Corporation may view your actions as an attempt to steer work to your old school chum (with the implication of kick-backs) and thus could arouse suspicion on your actions, when in fact you may be trying to correct that very situation, with regard to previous counsel.

Second, the previous law firm will stick a wrench into everything, sending you a "From Hell's Heart, I Stab at Thee!" final bill, along with cartons and cartons of Patent files, in no particular order and no notice of what is due and at what time.  As a result, you will be immediately swamped with work, and may miss filing deadlines, amendment deadlines, and maintenance fee deadlines. To say the least, it is a good idea to line up your ducks before taking such action.

Taking Work In-House - Is It Feasible?

Many in-house Attorneys contemplate taking the work in-house to reduce expenses. Is this a good idea? The answer is not simple.

To begin with, some in-house counsel want to take work in-house to boost their own profile. If you have six or seven Patent Attorneys working under you, then you certainly deserve to be paid more than they are.  So empire-building is sometimes the name of the game, even if it is on a subconscious level.

Because of this, many corporations may resist you taking work in-house. Stock prices will go up if the number of employees goes down, so keeping "head count" low is often the name of the game.  This means that an in-house Counsel will have a tough time selling increased head count to the CEO, even if it means overall cost savings.

And the cost savings can be illusory, unless you run a tight ship.  Prosecution Attorneys are attracted to in-house work because they perceive it to be less taxing, with no billable hour pressures.  However, if you do not ride herd on your in-house Patent Attorneys, they may end up doing little or no work, or not enough work to justify their overhead cost.

And if the volume of work changes, then you either have to hire outside counsel anyway (to handle overloads) or lay off in-house staff (when there is not enough work to do).  So you have to have a consistent and solid caseload before hiring in-house staff.

This is not to say it can't be done, only that there are pitfalls.  Some large firms have in-house staffs that are very efficiently run.  But it takes effort and talent to make sure the in-house staff is doing as good a job at a lower cost than outside counsel.  There may not be some billable hour quota, but there has to be a quote nevertheless.  And it should be a quota set at a rate that shows substantial savings, taking into account not only in-house salaries, but overhead and expenses as well.

One approach I have seen is to take the docketing and control of cases in-house.  By hiring a paralegal and purchasing a Patent docketing system, you can control all the cases for your company.  Chances are, you probably will end up having an in-house docketing system anyway, so this makes a lot of sense. Rather than pay outside Attorneys for docketing cases and paying garbage fees for reporting letters, you can hire a fairly inexpensive paralegal to handle this work in-house.  There is risk involved, of course. You have to ride herd on your cases and if you let one go abandoned, well, there is no outside lawyer to put the blame on.

But such a scenario allows you to control the case flow better.  If an outside Attorney is charging too much or doing slipshod work, you can cleanly terminate the relationship without having to even re-docket the cases. In addition you can spread the work over a larger number of firms, or even individual practitioners with little or no extra expense.

IBM used this formula for many years. As the largest Patent filer for many, many years, they had to control costs accordingly. Many former IBM Engineers found second careers as outside counsel or Patent Agents, drafting Patent Applications on a contract basis for the in-house legal department. Using this scheme, they obtained high quality work at a fraction of the big-firm cost, and didn't have to worry about Partnership antics.

Starting with docketing in-house can also be a good way to transition into a full-blown in-house practice. You'll have to have an in-house docketing system and paralegal if you intend to do prosecution in-house, so it might as well be the place to start. If it works out, then hiring in-house attorneys might be the next step.

However, expect that many of the hotshot Attorneys will want to work for law firms instead - chasing that almighty buck. If you hire some in-house staff, you can expect that after a few years, they may leave for the increased job prospects and perceived "better life" in the big firm. Unfortunately, you may end up as a mere training ground for young Attorneys, if you are not careful.