Utah Bar Journal

Most firms do some work, such as uncontested divorces or foreclosures, for flat fees, but lingering in the back of every law firm manager’s mind is the nagging possibility that what started out as a routine matter will suddenly become contested. When that happens and the fee arrangement is for a flat fee, there is usually only one of two unhappy outcomes. Either the law firm absorbs the loss in the interest of keeping the client, or the firm must go to the client and ask to change the fee agreement, usually with the result that the client, while it may acquiesce, feels gouged. To avoid this, many firms avoid the flat fee altogether, preferring to bill on an hourly basis.

However, from the client’s perspective, the billable hour is the work of the devil. No matter how detailed a billing statement may be (or perhaps precisely because a billing statement is detailed) the client always wonders if it is getting its money’s worth. And with good reason. The billable hour equates the value of something with the cost to produce it. While it is necessary for a law firm to cover its overhead and that overhead is a component of the billable hour, one cannot equate the value of legal services with the cost of those services in the same way one can equate the value of a house with the cost of materials and labor to build it. Yet law firms continue to price their services as if this were true.

If you doubt that flat fees are gaining popularity outside of simple matters such as real estate foreclosures, consider this: Cisco Systems now farms out about 75 percent of its annual legal budget, estimated at $125 million, under fixed-fee arrangements, including most of its litigation. A small boutique firm in Chicago won a bid for all of Houston-based FMC Technologies’ mass tort work based on a fixed-fee proposal. Now is a good time to begin implementing flat fee arrangements in your legal practice.

The problem with the flat fee is, and always will be, the uncertainty inherent in the legal profession. With few exceptions, the practice of law involves two or more parties, often with adverse, or potentially adverse, interests. While the majority of a certain type of legal matter may be uncontested and routine, any single case has the potential to become contested. A flat fee based on the time it takes to handle an uncontested divorce, for example, is certainly unfair to the lawyer in the case of a contested matter. Likewise, no client is willing to pay a flat fee based on a contested divorce if the matter is uncontested. So how can you arrive at a flat fee that is fair under all circumstances?

The answer lies in your time management records and a statistical process known as simulation. With the advent of time management software and sophisticated mathematical programs such as Excel, any law firm can simulate as many scenarios and outcomes of a matter as it wants, and from those replications arrive at a fee that, over time, will yield a desired outcome regardless of whether the matter is contested or not. Simulation has been used by airlines to design call centers; by banks to determine when to add another teller or open another branch; and by supermarkets to determine how many checkers to schedule. Now you can use it to set a flat fee in your practice. Here’s how it works.

Assume you do a lot of work for an auto finance company whose customers file bankruptcy. As a result, you frequently file motions for relief from the automatic stay. The majority of these motions are resolved through stipulations, but a small number require hearings. Through your time management records, you determine that the average uncontested motion is resolved with 2.5 hours of paralegal time in negotiating and drafting a stipulation, and 1 hour of attorney’s time to review the documents and stipulation. The attorney’s time is billed at $225 per hour and the paralegal’s time is billed at $85 per hour, for an average fee of $437.50. On the other hand, an average contested motion requires 7.5 hours of attorney’s time and 10 hours of paralegal time, resulting in an average fee of $2,537.50. Looking back at the last year’s worth of matters, you find you filed 25 motions for relief, 23 were resolved by stipulation, while two required hearings. From this data, you can arrive at a flat fee that will compensate you for the contested as well as uncontested matters.

To do this, you need to create a simulation based on your experience and run that simulation many times to determine your average fee regardless of the type of case, contested or uncontested. This can be accomplished easily with Excel or any other spreadsheet software. Figure 1 shows a simulation spreadsheet.

In cells C3 and C4, enter the attorney’s and paralegal’s respective hourly rates. In the box entitled Uncontested Motion Cost Data, cells B7 and B8, enter the average time expended by the attorney and paralegal for uncontested motions. In cells C7 and C8, enter the formula to calculate the total attorney’s fee and paralegal’s fee: = B7*C3 for the attorney’s fee and = B8*C4 for the paralegal’s fee. Finally, in cell C9, enter the sum of C7 and C8, that is, = C7+C8, to arrive at your average fee. In the box entitled Contested Motion Cost Data, enter the same information for contested motions, that is, C12 = C3*B12; Cell C13 = C4*B13; and C14 = C12+C13. If you enter the formula as shown instead of the number itself, all you need to do is change cells C3 and C4 to see how varying your hourly rates will affect your outcome.

The next step is to create a demand distribution based on what your records show as to how many motions are contested and how many are uncontested. In cell G9, enter .92, representing the percentage of uncontested motions (23 of 25). In cell G10, enter .08, representing the percentage of contested motions (2 of 25). Cells I9 and I10 equal cells C9 and C14, respectively, representing the average fee for each type of motion, uncontested or contested. The column entitled “Cumulative Probability” is the total of the different outcomes’ individual probabilities. It must always total 1 to ensure that you have accounted for all possible outcomes. In this case, there are only two outcomes. A motion is either contested or uncontested. However, there could easily be three or more outcomes, for example, if you handle insurance claims and some matters were resolved by stipulation, some went to arbitration and still others went to trial. In those cases, your demand distribution would have three probabilities, based on the three possible outcomes and your records of how many cases ended up being resolved by which method. Likewise, you would have three average fees corresponding to the three types of outcomes.

Now that you have your cost and average fee data, and your demand distribution, you are ready to simulate as many motions for relief as you want. You do this by generating a series of random numbers in cells C17 through C116 (not all 100 rows are visible in Figure 1). You do this by entering the formula =RAND() in cell C17 and copying that formula through cell C116. This tells Excel to generate 100 random numbers, one in each cell. Each of those random numbers represents one motion for relief. In column D you will have Excel calculate the fee for each of those motions based on your data, which shows that 92% (23 of 25) of the motions are uncontested and 8% (2 of 25) are contested. This is accomplished by an “IF-THEN” command in cells D17 through D116. In cell D17, enter the formula =IF(C17<=$G$9,$I$9,$I$10). This tells Excel to look at cell C17 and compare it to cell G9. If the random number in C17 is less than or equal to .92 (G9), Excel is to enter the uncontested average fee, $437.50 (I9). If the random number in C17 is greater than .92, Excel is to enter the contested average fee, $2,537.50 (I10). Copy this formula in cells D18 through D116. If you try to duplicate this spreadsheet, you will not get the same values in cells C17 through C116 and D17 through D116 because the random numbers generated by Excel will not be the same. In fact, your random numbers will change every time you hit F9, because that command tells Excel to generate a new random number wherever the formula =RAND() appears. However, that does not change the validity of the results.

You have now simulated 100 motions for relief based on your historical cost data, the equivalent of four years’ worth of work. In cell G13, calculate your average fee by entering =AVERAGE(D17:D116). That is your average fee for 100 motions for relief, assuming 92% are uncontested and 8% are contested, and based on your hourly rates and time records.
If you hit F9 repeatedly, you will see that the average fee varies within a low to high range. Where within that range do you set your fee? You can get some help with this by calculating a 95% confidence interval. This is a range within which 95% of your fees will fall. There will always be outliers, but by calculating a confidence interval, you can be assured that 95% of the time your fee, on an hourly basis, would fall within that range.

To calculate a confidence interval it is necessary to have both the average and the standard deviation of your sample. In cell G14, enter the standard deviation of your 100 replications, by using the formula =STDEV(D17:D116). In cells G17 and G18, you will calculate the lower and upper limits of a 95% confidence interval using the formula =G13-NORMSINV(0.975)*G14/10 for G17, and =G13+NORMSINV(0.975)*G14/10 for G18. This is a fairly sophisticated statistical calculation that takes a normal, bell-shaped curve and cuts off the lower and upper 2.5%, leaving 95% of the population enclosed by the curve. What this means to you is that 95% of your matters will generate a fee between those upper and lower limits. NOTE: The formula above requires that you divide by the square root of the number in your sample. In this case, we ran 100 simulations. The square root of 100 is 10, so the formula has 10 in the denominator. If you only run 60 simulations, for example, you must divide by the square root of 60 to calculate the confidence interval.

Based on this particular simulation, 95% of your cases will generate a fee between $508.12 and $744.88. If you were to set a flat fee somewhere in this range, you can be assured that the fee is fair in terms of yielding compensation based on the average time and billing rate of your firm for this matter. Exactly where in that range you set the fee is up to you and may depend on a number of factors wholly unrelated to your desired hourly rate, the number of hours required to perform the work or the cost of your paralegal. You may set it low if you are trying to win a new client. You may set it higher if the client only has a few matters to send to you. You might couple a lower flat fee with a bonus for quick resolution or other performance-based incentive.

A couple of caveats apply. First, the rule “garbage in, garbage out” holds true. If your time management records are inadequate to reflect the true time spent on a matter, or if your hourly rates are not properly set to your firm’s needs, or if any of the parameters are faulty, the result of the simulation will be meaningless. Second, you should always maintain time records and review your flat fees at least annually. If any of the parameters change, such as a higher percentage of matters becoming contested, re-run the simulation and perhaps adjust your fees accordingly.

This method works for any type of case so long as you have a “sufficiently large” sample. By sufficiently large, statisticians generally mean something in excess of 25. If you do a relatively large number of one type of matter, you have probably noticed that they all follow a similar pattern in terms of what has to be done, whether it is a criminal case, a personal injury defense, a divorce, or a securities filing. The key is having done enough that you have adequate records on which to base the simulation.

The flat fee can be an excellent selling point to a client. Many clients hesitate to send work because they are afraid the cost of resolution will outweigh the benefit to them if legal fees escalate in a contested matter. By quoting a flat fee, you are assuming that risk. However, by going through the above exercise, you have all but eliminated that risk to your firm over time. When the inevitable contested matter arises, you can still sleep well at night knowing that all those other uncontested matters are money in the bank against which you can draw and never be overdrawn.