Legal Fees: Missing the Point

02/02/2009 09:30 am ET | Updated May 25, 2011

Last Friday's (January 30) New York Times front page included an article about legal fees: "Billable Hours Giving Ground at Law Firms." This article raised the question whether clients were being treated fairly when the measure of a legal fee is the attorney's time expended. An obvious concern is whether an attorney compensated solely on the basis of time expended has any incentive to work efficiently or, to resolve a matter when doing so cuts off revenue.

The Times reporter analyzed the plusses and minuses of the billable hour process. However, he totally missed one of the primary reasons law firms cling to the billable hour system - the leverage between the $/hour they pay an associate (anyone who does not have an ownership interest in the firm) and the $/hour the client is billed for the associate's time.

When clients are billed by the hour, it is fairly easy for a big law firm to lever off an associate's time. Let's assume an associate is paid $150,000/year which with benefits say is $200,000/year. Let's assume that associate is expected to bill 2,500 hours at $300/hour ($750,000 in revenue). The math is pretty clear: pay associate $80/hour and bill associate time at $300/hour. While the law firm has overhead expenses (figure 50% of revenue), the law firm makes (in our example) about $70 per hour on billable associate time.

This model clearly works best when clients are billed by the hour. If a client is quoted a flat fee or a success fee, then the law firm is taking the risk as to how efficient and effective the associate will be. When the system is pure billable hours, there is no risk to the law firm. Every hour the associate spends is profitable to the law firm (assuming the time is billable) when the associate's time is billed by the hour.

There are arguments for and against the billable hour system. It seems to me that the choice should be the client's. Every client retaining an attorney should have a clear discussion with him or her as to billing procedures. The client should ask for an estimate of time needed to conclude a matter, whether the attorney will cap his fee at $X, what other expenses will be billed, and whether the attorney would consider tying his fee to a specific result instead of just hours.

Everyone is watching their money today. Attorneys who claim that they only work on an hourly basis may, in fact, find themselves just not working much.

Jim Randel is the author of the stick people books (tm) series and is about to release his latest book, The Skinny on Credit Cards: How to Win the Credit Card Game. Clover Leaf, 2009).