The great fixed fee debate - the lawyer's argument

It has been quite a while since I last blogged and even longer since I blogged about a potentially controversial subject so why not kill two birds with one stone.  2013 has been a year of two halves for the legal profession.  The first half of the year firms had it rough and indeed some did not make it through the whole year as a result.  The second half was much more positive overall – deal volumes were up especially in the real estate market in which I largely operate.  Lending has returned partially from banks but also from alternative sources. However regardless of how much improved things are or indeed how much more they might improve there is one thing that is not going to change – the demands for greater price certainty from clients.

First I would like to dispel some myths that many of those not in private practice seem to believe – lawyers do not love hourly rates; most transactional lawyers I know hate the billable hour.  It is seen as a noose around the neck.  We know clients hate it; believing that it encourages us to be inefficient since the more time we spend on something the more we bill.  However, I have never spent more time on a matter than I believed necessary to achieve the result the client required.  Frankly, I rarely have the spare time to time dump.  Even if I did I recognise that there are more valuable things to be doing than being inefficient.

Therefore I welcome the end of the billable hour – it creates a barrier between client and professional; it creates distrust and an assumption that there is padding in any quote given.  But my welcome comes at a price – I am happy to take on more risk in terms of pricing; I am happy to give my clients price certainty.  But I am also a businessman.  I hate to break it to my clients but I am in business to make a profit.  That really should not come as a surprise to many, if any, of my clients since they are all in business for the same reason.  That being said sometimes it feels like clients do not recognise that ultimately law firms exist to make profit.  We do it by providing a service but if the provision of that service is no longer profitable then the ability to provide it disappears.

So what does this all mean in the context of the end of the billable hour and the demands for greater price certainty?  Well here are, what you might call, my wish list of requests to clients when it comes to agreeing price certainty on a deal.

1. Fixed not capped
2. Price the deal
3. Timing is relevant
4. If you want extras pay for them
5. Cash flow quid pro quo

1.  Fixed not capped

When you ask me for certainty don’t ask for a capped fee.  That is akin to having your cake and eating it.  A capped fee seeks to keep the hourly rate open for your benefit but shut for mine.  It is not risk sharing but rather placing all the risk on the law firm for no upside benefit.  At the end of the day agree a price that you are happy with for the transaction.  If your numbers work at that price don’t look to eat away at the potential benefit to me by effectively denying my ability to use efficiencies where I can so that I can try and increase my margin.  It is important to recognise that time specifically spent on a deal may not be reflective of the cost especially where there are efficiencies that I have introduced.  There is an R&D cost to those efficiencies.  If you truly want lawyers to become more efficient and invest in developing processes then the carrot approach will work far better than the stick.

2.  The fee is for that deal

In order to price things we need to know the scope and then once the scope is agreed don’t expect work outside of the scope for free.  Now I admit that law firms can often be their own worst enemies on this front.  There is the tendency to quote on the basis of assumptions or scope that do not really reflect the likely work involved (e.g. when quoting for a property acquisition assuming there will be one turn only of the sale agreement).  We need to be more honest and use our experience to quote properly for the deal; that is a legitimate expectation of our clients.

Further lawyers are always reticent to raise the fact that something is out of scope and the additional charge for doing it.  Part of the reason for this is the response that is often given when this point is raised – the lawyer is made to feel guilty for seeking an additional fee.  But why should they?  If they have scoped the work honestly and legitimately at the outset and something unusual arises resulting in a whole different work stream why should the lawyer not be able to agree a fee for that new work stream?  If I specifically exclude tax from my fixed fee and then the client seeks tax advice because it thinks there might be a VAT angle it is legitimate that as a firm we can agree an additional fee for that advice – it can still be a fixed fee.

Using a non-law example, I ask a stationer to provide me with headed notepaper for which he provides a quote; then I ask him to provide envelopes in addition I would expect him to charge me more.  No one would argue with this because people physically feel the extra envelopes.  The problem is in the legal context clients don’t necessarily see the ‘benefit’ as they picture the legal advice as a single unit.  Fixed price quotes demand the clients change their perceptions as well as the lawyers changing ours.

3.  Timing is relevant

Just because a client is not paying on the basis of hourly rates does not mean that the length of time a deal actually takes is no longer relevant to the quote given.  The longer a deal lasts the more resource it is likely to use up or require to be kept available.  Therefore it is legitimate to quote a price based on the assumption that the deal completes by a given date.  Again the date should be realistic and assume some slippage from the timings given in any agreed heads.  Further the lawyer should seek to agree a fixed fee for each time extension there is not hourly rates for any such extension.  There can be caveats to this such that, for example, a ‘down tools’ period only qualifies for a percentage of the ‘extension fee’.  This needs to form part of the pricing at the outset.

Often time extensions may be associated with or run in parallel with changes in scope.  No one is suggesting you can charge twice for the same thing but the pricing needs to reflect both the resource required and the length of time for which it is required. 

4.  If you want extras pay for them

Clients want pricing certainty and, more often than not, they want the cheapest quote.  To achieve this I need to be able to work in the most efficient manner possible.  Therefore, nothing destroys the pricing relationship more than when a client demands a cheap quote and then insists on the matter being ‘partner-led’.  Partners are more expensive because of seniority.  If you want a ‘partner-led’ transaction you have to be prepared to pay for it.  Again not on an hourly rate basis but rather on a higher fixed price basis.  Clients are entitled to expect their work to be done properly by those qualified to do the job; senior input may be necessary but how much may be a matter of choice rather than need.  If you want the cheapest price this has to come at a cost – you will get less experienced people doing the work.

If you book and pay for a Superior Room at The Dorchester you don’t turn up and demand the Presidential Suite.

5.  Paying the bills

My final point is probably the most important but also likely to be the most controversial.  If clients agree a fixed fee then they should be prepared to pay that fee on, say, a monthly basis during the transaction not merely at completion.  There can still be balloon payments at milestones or at the end of the transaction to avoid a perception of a lack of impetus to get the deal done.  Fundamentally a law firm’s biggest risk is its ability to manage its cash flow (in recent history this has been the biggest cause of law firm failures).  In a transactional department the time taken from matter inception to completion to billing and then payment can be significant.  Law firms need to be able to reduce this time period. 

Even on a transaction that takes two months from inception to completion (about the average expected for a real estate acquisition) then assuming another month for payment of the bill a firm is looking at a minimum of three months before earning a penny for its work carried out three month’s previously; bearing in mind much of the work is front loaded that is a long wait.  In that time it has had to pay all of its overheads.  In the days of hourly billing this was largely accepted as part of the quid pro quo for charging per hour. No pain no gain.  But if law firms are, rightly, to move to fixed fees it is legitimate for them to expect to be able to smooth out the cash flows.  Whilst law firms can be expected to take on the pricing risk they should not also be required effectively to finance their clients’ transactions by being unable to expect payment of anything until completion.  That’s a double-whammy.


So hopefully you have made it through my thoughts on the brave new world lawyers and clients are now entering in the billing arena.  I welcome the need for greater certainty on fees.  I believe it is in both clients’ and lawyers’ best interests.  But if clients truly want to see the end of hourly rates and lawyers to embrace the idea of pricing certainty they need to come to terms with what lawyers need in return.  I do not think that I am asking too much.  I am just a businessman seeking to have an honest and open discussion in the hope that together we can build a new future in the provision of legal services.  As such I would welcome and actively encourage others to express their views.  I openly admit my bias on this subject but do not feel I have been dishonest in my approach; if you disagree then please let me know and why.

BPF's "Taking the Profit" - extracting maximum value

The British Property Federation (BPF) is an organisation which represents Landlords.  Therefore it is an organisation which is important to me because it is important to my clients.  It recently launched its "Taking the Profit" campaign.  The target of that campaign is the use of administration particularly in the retail sector as a route to turning a distressed business into a more profitable one with the result that landlords either face shop closures or reduced rental income.  I made one prediction in my blog on New Year's Day and this fight was it.  Thank you to the BPF.
As frequent readers of my blog will know, I have much to say on the insolvency regimes and have blogged many times on the issues facing landlords arising out of administrations and other insolvency regimes as well as the impact of recent case law.  It is good to see the BPF seeking to tackle the issues head on and I cannot argue with the first points the BPF makes that the government has failed to act on tightening up pre-packs and making it easier to complain against Insolvency Practitioners.
However, whilst the BPF is to be praised for raising potential abuse of the insolvency regimes for the benefit of shareholders at the cost of creditors (and particularly landlord creditors) I think that in highlighting certain areas which are, perhaps, most headline grabbing some important areas for review have not received similar attention.  Some of the publicity around this campaign suggests that landlords are the unwitting, weak and undefended party in a war which is being waged against them by a united force of IPs and private investors.  Quite simply, in my experience, this is not the case.  Now it may be that my experience (which I admit is largely at the 'better' end of the retail property market (by better I mean primary and secondary) and involves dealing with the likes of KPMG, PWC, E&Y, BDO, Grant Thornton and others) largely misses out the activities at the tertiary end of the market and perhaps practices at that end are a little more shady.  However, my suspicion is that some landlord practices at that end of the market are not quite 'code compliant'.  Further by failing to identify the real reasons why the current regime unfairly prejudices landlords over and above other creditors risks losing the war.
The bad arguments
1.  It is largely pre-pack administrations where landlords are leant on to agree concessions
This is not the case. A pre-pack is when a deal is agreed and documented (but not signed) before the appointment of administrators.  Some of the administrations where landlords have been pressured to give rent concessions have been pre-packs.  However, most high profile administrations have not been pre-packs yet rent concessions have been sought by the new buyer.  Therefore, the BPF is, in fact and rightly, targeting administrations and not just pre-packs with this campaign.
2.  Administrations are effectively being used to transfer funds from pensioners who have invested in property funds and property companies to private investors buying businesses from administrators and then seeking rent concessions or threatening to close down
Using pensioners in any argument seems to be 'de rigueur' at present.  I think care needs to be exercised in utilising this argument.  Apart from anything else when it comes to unprofitable sites there are arguments that the landlord community carries some of the blame:

• in good times landlords happily agree high rents fully in the knowledge that if trading conditions deteriorate that rent may break the business
• the UK leasing model with relatively long lease lengths, upwards only reviews and full repairing and insuring provisions, whilst providing secure income in the sense of no costs, means that rising service charges add to the burden on tenants increasing the risk of insolvency
• the use of quarterly rents creates cash flow issues for tenants and also creates greater risk for landlords in the light of recent case law
• whilst some landlords have been sympathetic to struggling tenants many others have taken an aggressive route refusing to consider any concessions accusing the tenants of trying to make them pay for a bad business

3.  Landlords are being forced to agree rent reductions
No one is being forced to do anything.  Landlords may not like the threatening manner in which some agents and/or buyers act; saying that unless the rent is reduced a unit will be closed down.  But, at the end of the day, the landlord can call their bluff and refuse to agree the concession.  Landlords are not above being threatening either.  I had one case where a landlord (not institutional) unlawfully re-entered a property through the use of, what can only be described as, thugs because he did not like the possibility of a CVA.  That is far more serious than aggressive posturing in a negotiation.
Landlords are big boys and just as able to use an aggressive negotiating stance.  As advised in a recent blog landlords have quite a good negotiating position albeit limited by the commercial realities affecting each individual property.  In reality landlords are often paying for the fact that they own a property which is not in a prime location and which can no longer command rents at the level originally agreed.  If they could get a better rent then they should refuse the rent concession and get possession.  That is called risk and, without wishing to teach grandmothers how to suck eggs, that risk should have been reflected in the yield when the property was acquired.

The other side of the coin

The BPF is absolutely right to put the issue of administrations on the public agenda.  I think it is important to recognise that there are issues with the system which impact (possibly unfairly) on landlords which should be at the forefront of the campaign:

• the current legal position on payment of rents (especially in the light of the decision in the recent case of the Leisure (Norwich) II Ltd & Others -v- Luminar Lava Ignite Ltd (in administration) & others [2012] EWHC 951 (Ch) gives freedom to tenants not to pay rent and for administrators to trade rent free until the next quarter day.  The Game administration is the biggest example of this.  This flies in the face of the "pay for what you use" approach to insolvency situations and is unique to leases due to a clash between real estate law and insolvency law.
• the moratorium preventing forfeiture without consent - with all other contracts the provider can effectively terminate the contract on insolvency and there is nothing to stop them from doing it.  However termination of the lease can only occur by use of forfeiture which is a form of proceedings.  Due to the moratorium such action requires court approval (or administrator consent).  This exposes the landlord to greater potential future loss than other creditors who, whilst they might lose out on arrears, are not exposed to further losses unless they choose to contract with the administrators or the new business

In my view these are the mischiefs which the BPF should be seeking to undo.  Whilst anti-private equity and pro-pensioner arguments attract good press the reality is that they do not properly encapsulate the issues with a system which, whilst not completely broken, is not working in perfect harmony either.

Insolvent Companies' Directors and TUPE - a small loophole with a big cost.

Here is a bizarre scenario for you. A company exists and it is run, as all companies are, by directors. They are the mind and decision makers of the business with ultimate responsibility for the success or failure of that business.

The business fails and falls into an insolvency process. On a sale of that business the directors will automatically transfer over to the owners of the new business with the same terms and conditions unless the new owner can agree a compromise with the directors.

This is all thanks to a wonderful piece of European legislation lovingly referred to as TUPE. This legislation has a very honourable purpose - it ensures that employees of a business are protected against losing their jobs or having their terms of employment unfavourably altered just because a business changes ownership. It is widely drafted to prevent clever lawyers finding loopholes for their clients and, rightly, applies even to the sale of parts of an insolvent business to a new owner.

However, what does not appear to have been considered is that this legislation results in every employee passing across. Directors are employees (often the highest paid ones). Where a sale is one sought out by the company and it is agree that the directors will leave this is not an issue (although it does potentially create a conflict of interest for the directors concerned).

But where a company is insolvent the directors are ultimately responsible for that failure. By TUPE applying to directors even in such circumstances it has inadvertently placed directors at the front of the queue to extract payouts from any potential suitor where the money involved could have been invested in the new business providing a better chance for the future success of the phoenix entity.

So, as with the bankers and their bonuses, those with most of the responsibility for the failure of a business are given the opportunity to be compensated for their failings whilst the less responsible employee faces an uncertain financial future. An easy loophole to close if someone would just pull the right strings.

Is the FRI lease manifestly unfair?

I sat in a very interesting meeting the other day which was a general discussion on various points in negotiating an agreement for lease and lease when acting for landlords and tenants. Much of the discussion focused on the inter-relationship between warranties, repairing obligations and service charges and then moved on to insurance and uninsured risks. However, what was most interesting was that the discussion touched on a more general issue about the English institutional fully repairing and insuring (FRI) lease - is the whole proposition of an FRI lease not manifestly unfair and unbalanced.

For the uninitiated, in England and Wales the starting point with a lease which will be acceptable to institutional investors is one in which the investor receives all the rent and the tenant is financially liable for every cost associated with the property (apart from "income" tax on the rent). This works by imposing full repairing obligations on the tenant, requiring the tenant to fully re-imburse the landlord for the cost of insuring the building and requiring the tenant to pay, through the service charge, for the cost of repairing parts of the building outside the tenant's demise.

Now let us examine the relative positions and aims of the parties.

The landlord owns the property for the purposes of investment. It receives income in the form of rent and the potential for capital increases resulting from rent increases and/or yield compression. It is very much interested in the long term existence of the property.

The tenant is renting the property as a place from which to conduct its business. It does not care about the building per se. Its income is generated out of the property but not from the property and it does not, in general terms, specifically have to be located within a specific property. It does not benefit from changes in yields and only sufferes from rent increases.

Now let us consider where the risk in relation to the property should lie. The tenant requires occupation to run his business but has no interest in the long term existence of the property and sees no benefit from any increase in value. The Landlord benefits not only from the existence of the property but also from the continuing ability of the property to meet the tenant's needs. As the tenant's business flourishes so does the value of the property as it is likely to be let to a tenant with greater covenant strength. Therefore you would expect that the landlord would bear the risk of need to repair the property or it being destroyed; he is the owner afterall.

However, the FRI lease is such that the only risk the landlord is taking is that the tenant goes bust. All other risks are placed firmly at the tenant's door. Repairs within the demise the tenant will be required to carry out itself. Repairs outside the demise the landlord will carry out but recover the cost from the tenant. If the building is destroyed by an insured risk there is likely to be a rent cesser but this will only be for the period for which the loss of rent insurance is available and after that the rent restarts even if the building is still unbuilt. Uninsured risks, all things being equal, can fall completely on the tenant with the landlord being able to recover the cost of rebuilding through the service charge. So a tenant who decided against being an owner/occupier could actually find itself in a worse position as a result with higher annual costs and the potential for huge liability when something goes wrong.

Of course, the above is a worst case scenario but it is one which is likely to represent the legal position on a significant number of leases in the market today. The UK is unusual in its total lack of legislation in seeking to prevent landlords from placing the full burden and risk on the tenant. In Germany, for example, it is against the law for landlords to seek to recover the cost of structural repairs through the service charge; this is a risk the landlord took when he bought/developed the building.

Matters have in the last 20 years moved somewhat from the position highlighted above. Tenants have seen much success in toning down liability for things such as uninsured risks and liability to repair latent defects but the the risk is still most firmly with the tenant. So all you tenants out there, a little less criticism of the tenant lawyer who seeks to negotiate a lease and is reprimanded by his client for delaying the deal; the detail could very well matter.

Is this fair? As always it depends on who you ask. In reality it is market forces and perhaps as a result of the current downturn tenants and their lawyers will use the opportunity to further push the pendulum back towards the landlord in terms of carrying the risk. However, I doubt very much that it will swing too far. The fact is that tenants don't appear to care that much - maybe that is because occupiers are businesses who are used to taking larger risks than the institutional property owner funds who tend to be risk averse. Fair it might not be but so what.