Hybrid Attorneys’ Fees for Business Litigation: The Worst of Both Worlds
Alternative fee arrangements are becoming more popular than ever in commercial litigation. Corporate clients, and even small businesses, are increasingly knowledgeable about the costs and risks of litigating business disputes. Consequently, the days of businesses blindly providing a law firm a retainer without negotiating the fee structure and hourly rate are generally a thing of the past.
Clients frequently seek alternative fee arrangements, or AFAs, as a means to limit their exposure and better align the interests of the law firm and client. When it comes to plaintiff’s cases — i.e., lawsuits where a business seeks to recover monetary damages — a common AFA sought by clients is a contingency-fee arrangement. Working under a contingency-fee, the law firm is paid no retainer or hourly fees, but, instead, receives a portion of the recovery from the case.
A contingency fee arrangement aligns the interest of the law firm and client, as both parties’ primary incentive is to achieve the maximum recovery, as quickly as possible. This structure, however, shifts much of the risk of the lawsuit to the law firm, which could wind up spending hundreds of thousands or even millions of dollars in attorney time on a case. The law firm then bears the risk that the recovery is lengthy, insufficient, or non-existent.
The misaligned economic incentives of the hybrid fee structure lead to litigation practices that are not in the clients’ best interests.
Due to the length and expense of complex business cases, few law firms are willing to take these cases on a contingency. Instead, some law firms offer their clients what has become known as a “hybrid” fee arrangement. Under this structure, the law firm agrees to litigate a case for a reduced hourly rate and a percentage of the recovery. For instance, if a business attorney usually charges $500 per hour, she may agree to reduce her rate to $250 per hour, while also receiving 25% of any recovery — which is lower than a customary contingency fee of 35%-45%. The misaligned economic incentives of the hybrid fee structure lead to litigation practices that are not in the clients’ best interests.
At first glance, the client may perceive this hybrid structure to be a better option than a traditional hourly arrangement, as the reduced rate should theoretically result in lower out-of-pocket expenses, and the law firm should theoretically be motivated to maximize the recovery to increase its contingency payout. In practice, however, hybrid fee arrangements often fail to provide these expected benefits.
As likely the largest exclusively contingency-fee business litigation practice in the United States, we review thousands of potential commercial cases each year and select a fraction of those cases to handle. While it would be easy for us to litigate some of the cases that do not meet our contingency-fee criteria on a hybrid arrangement, we do not do so. The reason is simple: the misaligned economic incentives of the hybrid fee structure lead to litigation practices that are not in the clients’ best interests.
This article explains the practical flaws in hybrid fee arrangements and why this structure tends to serve the law firm’s interest more than the client’s.
The Economics of a Hybrid Fee Arrangement
To understand why the hybrid structure generally does not deliver the expected savings and results for clients, it is important to think about the motivations of the law firm. The simple fact for any business is that people are going to do what they are paid to do. For instance, if you want someone to sell as much of a product as possible, you wouldn’t pay them a flat salary for their time, you’d give them a commission for every sale that’s made.
The economics of a law firm are no different. Lawyers that bill by the hour are going to do what they’re paid to do — bill hours. Likewise, lawyers that are paid on a contingency are going to try to achieve a recovery as efficiently as possible, because that’s what they’re paid to do. Even the most well-intentioned lawyers will be, at least subconsciously, driven by these incentives.
Taking this into consideration, there’s one more key fact of law firm economics in play: lawyers inherently will prioritize work that generates short-term, guaranteed revenue over work with long-term, contingent benefits. This is because nearly all lawyers are compensated in some fashion based on the amount of fees they bring in to their firm each year. And lawyers are acutely focused on increasing their fees and, thus, their compensation.
The Inherent Flaws of Hybrid Fee Arrangements
Because of these incentives, lawyers who are handling both AFA and straight hourly cases often focus their energy on the hourly cases at the expense of the AFA cases. That is, if a lawyer is being paid based on the amount of fees brought in the door, and he receives a guaranteed $500 per hour for working on the hourly case, but only $250 per hour for the hybrid case, the lawyer will usually prioritize the hourly case above the hybrid case. Even though it may be rational to work on the hybrid case because of the eventual contingency payout when it resolves, we have found that the hybrid files tend to get less attention because working the hourly file results in immediate and guaranteed remuneration for the attorney. This is a particularly critical problem for business litigation cases, because these matters do not resolve for their maximum value unless the lawyers are engaged and doing everything possible to push the case towards trial.
Hybrid fee clients also lose the benefit of having lawyers with the efficient mindset that is characteristic of a contingency-fee arrangement. One of the most important advantages of a contingency fee structure is that both the client and attorney are motivated to get the maximum value for a case as quickly as possible. This is in stark contrast to hourly arrangements, where lawyers actually make more money the longer it takes to reach a resolution. Because lawyers litigating a case on a hybrid fee do not need to win to get paid, they tend to focus more on billing hours than getting the case resolved. Moreover, when lawyers are working on a reduced hourly rate, concerns regarding efficient billing tend to be less significant. Consequently, attorneys working on a hybrid-fee structure are apt to bill more hours to a file than they would if they were working on a straight hourly arrangement, resulting in little cost savings for the client.
This “you win/I win, you lose/I win” fee structure often leaves clients with a bad taste in their mouth.
Finally, regardless of how much hourly billing a law firm has on a hybrid fee case, when the case eventually does settle, the firm will still expect its contingency fee. Particularly in cases that go on for multiple years, as many business cases do, the contingency fee aspect of a hybrid structure often leaves the client feeling as though the law firm is double-dipping – receiving both significant upfront hourly fees as well as a portion of the recovery. And unlike straight contingency fee arrangements, the law firm did not bear the financial risk of an unsuccessful result, yet it still reaps the rewards of a successful recovery. This “you win/I win, you lose/I win” fee structure often leaves clients with a bad taste in their mouth.
For all of these reasons, we stopped handling cases on hybrid fee structure many years ago. Based on our prior experience and from counseling clients who worked with other firms under a hybrid fee, at the end of a hybrid case, clients tend to regret not litigating on either a traditional hourly or straight contingency arrangement. And although the reason for this dissatisfaction may not be clear to the client at the outset, it is caused by the misaligned incentives described above. Hybrid fee structures are set up to fail – they incentivize inefficient hourly billing, while giving the client the perception they are receiving a discount that ultimately never materializes.
Hybrid Fees Benefit the Law Firm More Than the Client
We generally advise clients to avoid hybrid arrangements in favor of full contingency, hourly, or flat fee arrangements. The benefit of these structures is that the law firm’s motivations are clear to the client, which allows the client to more effectively manage the relationship. The truth, which is often obscured from clients, is that hybrid fees are more about the finances of the law firm than the client. Law firms pitch hybrid fees as a way to reduce clients’ costs, when they are actually a way for a law firm to get the upside benefits of a contingency fee arrangement, without taking on the financial risk.
If a client is offered a hybrid fee arrangement by a law firm, the client should ask the firm whether they will handle the case on full contingency. If a law firm believes in the merits of a client’s case, they should be willing to share the risk with the client. If the law firm does not have the financial resources to take a business case on a contingency, or the facts of the case do not lend themselves to a contingency arrangement, then an hourly or flat fee arrangement is generally the best option.
Clients, however, are not well-served by paying a law-firm to litigate a case hourly without a focus on efficiency, only to then provide a significant portion of the recovery to the law firm. In this hybrid scenario, clients wind up with a fee structure that incorporates the shortcomings of both contingency and hourly arrangements, without the clear benefits of either. In other words, the client gets the worst of both worlds.