When capped fees may not make sense

Capped fee engagements may be tempting, but on closer examination are a blunt instrument with often counter-intuitive consequences. Alternative fee arrangements are increasing in popularity, and this is because – on instinct – they represent something that is surely incontrovertibly good: a hard ceiling on costs. But we feel they can represent a false economy.

Experienced in-house practitioners will be familiar with one common scenario. As one GC told us recently: “It’s very obvious when the other side you’re working with is on a capped fee transaction, because the intensity and the volume of work disappears overnight when they hit the cap.” Suddenly, one side is putting up lower grades of lawyer, or devolving to different, perhaps even offshore, offices. Quite obviously, the desire and motivation to serve, question, challenge and investigate is gone when a cap is reached. At the very least, it’s an encouragement for a firm to deprioritise the matter. If that is noticeable to the opposing party in what is likely a fractious negotiation, it’s unlikely to be serving the client well.

Worse of course, the work still needs to be done. Generally, that ends up with the other side picking up the slack - and spending more, because they must bridge the gap in tasks that aren’t being done properly.

But what’s the problem, you might ask? So long as you are the party doing the capping, aren’t you just offsetting costs to the other side? Possibly. But in dispute, this is a highly unwise strategy. By letting the other party take up the effort, you are inviting them to set the terms. Any old-school Partner will tell you that this is going to be a costly mistake if it allows the other side to structure evidence and arguments to their own advantage. You are more likely not only to lose the case but end up paying the other side’s costs, inflated by your own parsimony.

Flat cap v. Top Hat

Perhaps the problem here is not the cap, per se, but the level at which it is set? Perhaps the trap is to have set the cap according to the estimate, rather than for, say, the 5% chance of litigation rolling into dramatic uncertainty. Let’s look at some possible scenarios.

• Low cap and you lose. As we have seen, you will end up footing the bill anyway, an unnecessarily large bill for costs which you have effectively pushed onto the other party.

• Low cap and you win. A best case, perhaps, as the other side picks up your fees as well as their own costs. But in this scenario, the cap was immaterial - except for the extra risk it created to your position and the inevitability that someone, somewhere, feels hard done by.

• High cap. A high cap is almost justifiable. Instead of trying to lock down a legal firm’s rates, you are instead perhaps buying a little security for a GC and their CFO to reduce risk and offer some forward visibility across the 12 and 24 month business cycles. But you still have no fundamental idea whether the cap will be hit, or whether you are getting value for money from your spend: it’s merely an artificial marker.
   

To make this more obvious, let’s take capping to its logical conclusion: both parties are on a capped deal. Quite clearly, the advantage lies with whichever party survives the longest without reaching their limit, because they will be entitled to the greater diligence. If advantage lies with the softest cap, why have one at all? 

Billing isn’t the problem. It’s visibility.

Let’s be clear - there is a place for alternative fee arrangements, including caps and fixed fees, in certain cases. The classic example is a real estate lease. More and more conveyancing pieces of work are being conducted on a fixed fee basis because it is a sufficiently commoditised activity and attracts enough throughput that sometimes both sides will win, sometimes both will lose, and the risk is worth the effort because it is outweighed by the increased business. The cap is effectively a marketing tool, not an instrument of financial management.

But there can be little doubt that capped fees are spreading too far. As we have seen, the apparent predictability they create is an illusion. In more complex work where the scope is likely to change – precisely the complex work where expense is less predictable and a cap more attractive - the challenge is not the actual cost, it’s visibility of work (and the associated cost).

Knowing from the start what the service will cost is a poor but increasingly common substitute for knowing exactly what you are getting. No one likes to emerge from a transaction with the feeling they have been taken advantage of. Yet in a capped situation, either lawyer or client is practically bound to feel aggrieved.

When the focus is exclusively on price, whatever happens, one side will feel cheated. Whatever the number is, no matter how justified or unjustified, either the client will ultimately think “I am no longer receiving value”, or the law firm will feel “We’re throwing in effort for nothing”. All because of an arbitrary number based on initial perception rather than the reality of a matter and the course it has taken.

For the vast majority of work, the key to cost control is visibility. Transparency of the sort offered by Apperio, is invaluable in any matter, opening up in-house or even out-of-house comparisons whereby businesses can compare similar legal issues and the resources and effort required to resolve them. It allows clients to understand their spend, to appreciate the value they have received and to satisfy the CFO’s need for forward planning.

Not only are capped fees an obstruction to the best work; they are therefore an encouragement to opacity and a distortion of market value – making useful comparisons of work harder, not easier. A cap should be there at best for when things go wrong. No one is saying that cost control should not be a priority – but real control comes from visibility, not an arbitrary cap.