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Economy Impacts Law Firm Economics — Are There Other Alternatives?

Published by on October 21, 2008

The Washington Post reported yesterday here that law firms are tightening their belts as clients increasingly demand reductions in legal fees.  As the economy shifts, even old line firms with substantial revenues have failed.  But as we have noted elsewhere, an economic downturn is likely to result in an increase in employment litigation.  Given the […]

The Washington Post reported yesterday here that law firms are tightening their belts as clients increasingly demand reductions in legal fees.  As the economy shifts, even old line firms with substantial revenues have failed.  But as we have noted elsewhere, an economic downturn is likely to result in an increase in employment litigation.  Given the conflicting pressures that companies will face, in coming weeks, we plan to comment more on the economics and management of employment litigation.

At a recent presentation by in-house counsel, several attorneys commented on the increasing pressure from their company to reduce legal costs.  The major item that they focused on was reducing the hourly rate for attorneys at the institutional law firms they use.  But as the Washington Post article above notes, large, institutional law firms are businesses too — they are concerned about their profits as well.  

Merely negotiating an hourly rate reduction from an institutional law firm will come at a cost; the question is what that cost will be.  As the article notes, many large firms are hiring contract attorneys to handle matters instead of salaried associates.  This allows the firms to pay the contract attorneys substantially less than a salaried “superstar” associate — who can get close to $200,000 a year right out of law school at top firms — while charging clients a lower hourly rate.  At the same time, the firm maintains its normal profit margin.  So who loses in this transaction?  One suspects that the client is the one who loses out, because they are getting contract attorney work while continuing to think they are getting “name-brand” service.

The other issue with simply negotiating lower hourly rates is that the attorneys in the institutional firm still face the same economic pressures as when their rates were higher.  Their rent has not gone down; nor have their salaries gone down.  If hourly rates are going down, how can they continue to maintain their profit margins?  One way is to increase the number of hours they bill.  But human beings can only handle so many hours — this is a limited way to increase profits and, quite frankly, most institutional firm lawyers were already billing as many hours as they could handle before you negotiated the rate reduction.  It does not take a Ph.D. to see one possible (and unethical) way for attorneys to deal with that pressure — overbill so that you yield the same revenue for a project at the lower rate.  While this is not common, clients should consider if they want to place that kind of pressure on their attorneys for the sake of an hourly rate reduction.

Very few companies get beyond the band-aid approach of negotiating hourly rate reductions to truly consider creative options to reduce legal costs while maintaining a high level of quality in the legal services being delivered.  One general counsel at a recent presentation did speak about his use of smaller, focused firms in specific practice areas that deliver high quality legal services without him having to pay for the bloated overhead of an institutional law firm.  Nevertheless, this kind of creative thinking is the exception and not the rule.  One legal consultant suggests that perhaps there is a scientific/psychological reason why in-house lawyers continue to hire expensive institutional law firms in the face of the many economic reasons why not to.

In coming weeks, we will continue to explore economic issues in employment litigation.  We encourage readers to comment on this topic as well.

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