The ‘unkillable’ billable hour
Though it’s like fighting a zombie, some law firms are trying
In December, the Ontario Court of Appeal issued a ruling that questioned the traditional practice of hourly billing.
“There is something inherently troubling about a billing system that pits a lawyer’s financial interest against that of its client and that has built-in incentives for inefficiency,” wrote Madam Justice Sarah Pepall in a decision that reviewed the size of a legal bill in the receivership of a London, Ont.-area cattle farm. The appellate decision confirmed a lower-court ruling that had cut to $157,500 from $328,000 a bill that law firm Borden Ladner Gervais LLP had sent to Pricewaterhouse-Coopers for work done on a relatively simple matter that took two months to complete.
Justice Pepall is hardly the first person to question the use of the billable hour. Corporate clients want certainty and efficiency. That should spark client demands for flat fees or other pricing alternatives to the conventional system of hourly billing. Yet billable hours are proving to be a tough practice to kill.
A survey of in-house lawyers published in the December 2014 edition of Canadian Lawyer magazine reveals that 47 per cent of Canadian corporations cite billable hours as the primary way they pay their bills to outside law firms. That’s a noticeable drop from the 55 per cent surveyed the year before, but it also means that nearly half of Canadian companies are clinging to billable hours.
“The billable hour is a zombie,” says Peter Carayiannis, president and founder of Conduit Law P.C. in Toronto. “We can’t actually kill it. Every time you kill one, another one comes out.”
Despite the odds, Carayiannis is fighting the unkillable billable hour. Conduit Law works for corporate clients, and the bills Carayiannis sends to clients are based on the firm’s upfront assessment of what the legal service should cost. If Carayiannis underestimates the time and resources necessary for the task, he eats the loss. If he gets it right, he makes a profit. In other words, his firm takes risks just like any other business.
Billable hours are “poison” to the legal business because they’re an incentive for inefficiency, Carayiannis says. It makes more rational economic sense to connect the price of legal services with the value they bring to a client’s business.
“If the dollars-times-hours formula hits the value, it’s really just a monkey throwing a dart against a board. It’s an accidental byproduct. It’s not the lawyer and the client actually trying to assess the value of the retainer,” Carayiannis says. About 90 per cent of his firm’s revenue comes from such “valuebased” billing arrangements. Only 10 per cent comes from traditional hourly billing, and Conduit Law issues such bills only at the express request of the client.
Conduit Law isn’t the only upstart trying to shake up billing practices in the corporate legal market. Cognition LLP has been at it for some time. About 75 per cent of the firm’s clients pay “valuebased” fees, says co-founder Joe Milstone. The remaining 25 per cent ask to be billed by the hour.
Clients generally aren’t fussed about hourly rates if they’re content with the dollar amount at the bottom of the bill, Milstone says. That might look okay on the surface, but it masks a problem. A firm’s hourly rates are typically based on a firm’s need to cover overhead plus the profit expectations of the firm’s partners. Missing from the equation is the value the work is supposed to bring to the client. Milstone says an hourly rate might be a tool that helps begin a discussion on what a legal service should cost, but it shouldn’t be the only thing that goes into the mix.
Milstone says Cognition actually pushes clients to demand alternative fee arrangements. A lot of the work that a corporate law firm does is basically commoditized — that is, high-volume, repeatable work that a well-run firm should be able to deliver on a predictable timeline and budget. “If you’ve done the work as much as you say you have, you should be able to scope out an appropriate project plan,” Milstone says.
For those clients who still cling to hourly rates, Cognition has developed a simple solution: Get rid of the overhead. It’s not hard to do. Bay Street law firms work out of high-rent office space that is decorated with a lot of expensive art. Cognition works out of cheaper surroundings, and strips away enough costs to offer hourly rates for experienced counsel that are about one-third to one-half of the amount charged by big firms in downtown Toronto.
What’s surprising about firms such as Conduit and Cognition is that it sometimes seems like they’re the ones browbeating clients to embrace alternative billing, rather than the other way around. It’s odd, because corporate Canada has tremendous bargaining power.
Amar Sarwal, vice-president and chief legal strategist with the Association of Corporate Counsel, a Washington, D.C.-based group that represents in-house lawyers at corporations around the world, believes Canadian in-house lawyers are in a unique position. With a small number of top-flight Bay Street firms serving Canada’s relatively short list of blue-chip financial institutions and corporations, the country’s in-house lawyers should have the marketing clout to bring rapid change to the legal industry. “Canada has a more concentrated legal market, and because of that, it has an opportunity to change faster than perhaps the U.S. market,” Sarwal believes.
Ian Holloway, dean of the law school at the University of Calgary, says he thinks Canadian general counsel — the job title often given to the top in-house lawyer at a large corporation — aren’t aggressive enough in demanding change. “They could pull the trigger and say that from next year, we’re 90 per cent alternative fee arrangements. And the big firms would all dance to their tune.” So why don’t they? Lawyers are paid to assess risk, and that has the byproduct of making them risk-averse, Holloway suggests. Most senior lawyers grew up with the billable hour, and they’re too comfortable with that system to accept change. In particular, law firms have got used to judging and rewarding performance by a lawyer’s capacity to generate hourly billings. “It’s an easy way to justify why partner X earns so many dollars and partner Y earns another amount,” Holloway says.
Some companies are trying to change the market. Food company George Weston Ltd., which is the 46 per cent owner of Loblaw Cos. Ltd., has a policy that makes it mandatory to discuss alternative fee arrangements for any legal matter worth more than $5,000 in billings. The policy is mentioned in the Canadian Bar Association’s “Futures Initiative” report on ways the Canadian legal profession should adapt to change. Gordon Currie, vice-president and chief legal officer with George Weston, explains in the CBA report that the policy isn’t just about saving money on legal bills. It’s about getting the best value for the fees paid, he said.
Not every in-house lawyer thinks corporate legal departments have been slow to embrace change. “If you look at the corporations that are, like ourselves, large consumers of legal advice and services, I think the rate of change has actually been quite rapid,” says Simon Fish, top in-house lawyer for BMO Financial Group.
“About 50 per cent of the legal fees charged to us today are on a value-based billing basis. However, our long-term goal is to be at or near 100 per cent,” Fish says. “In another three years from now, I suspect we’ll be well on our way to reaching that target.”
The CBA, a voluntary body that represents 37,000 Canadian lawyers, judges and law students, also believes change is inevitable.
“We got into this project because that change is coming, and it’s coming quicker than some people might think,” says Fred Headon, an in-house lawyer with Air Canada, who chaired the CBA’s Futures Initiative. “We need to catch up on fees and other things because we need to be relevant. This is just how the world is moving. The finance department in all these companies is going to be looking at the legal spend, and asking why they can’t get more for less like everyone else in the business.”
Meanwhile, until the rest of the market catches up, a new wave of alternative law firms, such as Conduit and Cognition, is ready to exploit the opportunity that was noted in that recent Ontario Court of Appeal case.
“There is an inherent conflict of interest,” says Carayiannis of Conduit Law. “It pits our clients’ interest in getting a fair value at a fair price for our services directly in conflict with the lawyer’s interest in maximizing his financial gain.”
A billing system that pits a lawyer’s financial interest against that of its client and has built-in incentives for inefficiency.