Why legal costs build up: and how to address this

Practical Law UK Articles 7-506-9910 (Approx. 4 pages)

Why legal costs build up: and how to address this

by Andrew Dunkley, Herbert Smith LLP

Why do costs increase?

Two key drivers of cost increases in construction projects are change and acceleration. Change is where the original scope is amended during the project. Acceleration is where elements of the project are required to be delivered faster than originally planned.

Change. A common occurrence in the construction industry is when contractors and employers do not fully consider possible project requirements at the tender stage and are later caught out when changes are needed that cause costs to rise. In particular, employers are sometimes vulnerable to "mission creep". Both lawyers and clients will be familiar with the scope of cases and transactions growing and shifting as they progress. Examples of factors that lead to change include:

Poor initial scoping. This can involve a failure at the start of the matter to recognise what will, or might be, involved.
Technical developments in a case or transaction that require specialist or expert input. These can sometimes be very hard to predict in advance.
Commercial developments that alter the rationale behind a matter.
Client requests for ad hoc advice that go beyond the initial scope.

As in construction projects, change in a legal matter increases costs. A proportion of time already spent on the matter may be wasted. The original timetable may be compromised, leading to the need for acceleration (see below). Simplest of all, the change might just mean that more work is required.

Acceleration. Acceleration in construction projects can be very expensive, as it often requires extra resources which may not be deployed efficiently. Acceleration can be instigated by either party to a construction contract. For example, an employer may accelerate a project for commercial reasons, while a contractor might end up having to accelerate the second half of a project because it has delivered the early stages inefficiently. Acceleration can also happen in legal matters for unexpected reasons including the following:

Commercial developments that force deadlines to be moved forward.
Late provision of instructions or documents, reducing the time available for lawyers to complete their part of the transaction.
Elements of the matter overrunning, resulting in less time to complete later stages.
Lawyers offering to meet a deadline earlier than is actually required for the matter. This can be a sign of over-resourcing, not efficiency.
Change requiring extra work, which also compresses the timeline.

Acceleration has a particular impact where the lawyer is charging by the hour. The most common consequence of this type of acceleration is a team of tired lawyers working late at night. Unsurprisingly, working when tired radically reduces productivity and so dramatically increases costs.

Possible solutions

How can lawyers and clients better manage change and acceleration? Construction contracts generally contain extensive provisions for managing and allocating any additional costs, rather than just being "cost reimbursable" contracts (see box "Cost reimbursable contracts"). Usually, but not always, costs are borne by the party who instigates the change or acceleration.

The obvious solution would be for the engagement letter expressly to provide for these issues. Possibilities include alternative fee structures, e-billing, more detailed project scoping, provision for regular cost estimation and updates, "call off" provisions (where project elements are separately scoped and instructed under an umbrella engagement letter) and provisions requiring notification of any change or acceleration.

However, construction contracts already use these mechanisms and cost overruns still occur. Ultimately, the solution lies not just in the engagement letter, but in how the parties use it to manage the legal project.

Active cost management

The construction projects that best control costs are those where the employer and the contractor acknowledge that some change and/or acceleration is almost inevitable, and agree that these should be actively managed when they occur.

For cost control in the legal industry to improve, both lawyers and clients will also need to manage matters so that change and acceleration are recognised and planned for. Parties should take time to consider whether a change or acceleration is necessary, and whether it will actually add value and increase the chances of the case or transaction succeeding. The change or acceleration can then be tracked and managed.

This will involve open conversations between lawyer and client from the outset, which, in turn, will require a high degree of mutual trust. Both parties should fully understand the scope and timetable for the matter, and realise when either may be exceeded. This understanding needs to permeate the entire team, down to the last trainee and client team member. Scope and time management cannot just be the remit of partners and senior in-house counsel.

A case in point

A good illustration of how active cost management can work is where a client asks ad hoc questions that are relevant to the matter but were not in the original scope. Lawyers and clients have probably experienced the following scenario:

The client asks for advice that is commercially relevant to a transaction but was not covered in the original cost estimate. The lawyer is happy to assist and records the time to the main matter file.
The matter is billed a month later but comes in above the cost estimate, partly because of the ad hoc work. By then, the lawyer and client may not realise or remember that the ad hoc advice was outside the original scope.

This causes problems on both sides. Before issuing the bill, the lawyer is likely to write off a percentage of time and work that was legitimately undertaken. The client may then argue for a further reduction on the basis that the matter went over its estimate. The client feels that his lawyer is trying to overcharge, and the lawyer suspects that his client is trying to avoid paying for work he instructed. In other words, everyone loses.

In the same situation, what if the lawyer politely explains that the work is out of scope when it comes in? At this point, the lawyer and client have several options:

They can agree that the ad hoc work does not add enough value to the project and the request can be dropped.
They can decide that it would generate value and go ahead. Systems may be in place, or can be set up, to manage and account for out-of-scope work.
The lawyer can offer to do the work at a discount. This reaches the same costs position as the scenario above, but via a much more constructive process. The client understands that he is getting a benefit. Although the lawyer loses some profit, he gains trust.

A win-win situation

The result of this second approach is that the parties retain cost control. Even if costs do go up because of change or acceleration, that increase happens in a managed way. Equally importantly, change and acceleration will only occur if they add real value to the client's project. Both parties will be aware of this when the matter is billed, which means that the client can have confidence that he is not being stung by his lawyer, and vice versa. This benefits the ongoing partnership. In other words, everyone wins.

Making this cultural shift towards addressing the causes of cost increases calls for a change in perspective on how legal projects are run, but the result will be a much more positive approach to cost management.

Andrew Dunkley is an associate at Herbert Smith LLP.

Cost reimbursable contracts

A cost reimbursable construction contract is one where the employer pays the contractor for the time and materials actually used on the project. This is essentially the same as a lawyer billing his client by the hour and charging for disbursements.

Cost reimbursable contracts are very rare in the construction industry, precisely because they have no mechanism to control cost escalation. Instead, structures including fixed prices and "target cost" mechanisms are much more common.

Why legal costs build up: and how to address this | Practical Law