The Dirty Little Secret of Law Firm Billing

The Wall Street Journal's front-page headline on billing rates in February tells only part of the story. “Legal Fees Cross New Mark: $1,500 an Hour,” the Feb. 9 article announced (see http://on.wsj.com/1Q5z6y9, subscription req'd.), before listing partner hourly rates at several big firms: $925 to $1,475 at Proskauer Rose; $895 to $1,450 at Ropes & Gray; $875 to $1,445 at Kirkland & Ellis; and so on and so on and so on.

That's great if you can get it, but most firms can't. The 2016 Report on the State of the Legal Market (http://tmsnrt.rs/1PSeStN) from Georgetown University Law Center and Thomson Reuters Peer Monitor tells a second part of the story: Realization and collection rates have plummeted.

How much a firm bills doesn't matter; what it actually brings in the door does. In 2005, collections totaled 93% of standard rates, the report found. By the end of 2015, the realization rate was down to 83%.

The Music Stopped, Almost

Annual standard hourly rate increases have blunted the profit impact of declining collections. Except in bankruptcy courts, that is. Here's the third element of the story and the profession's dirty little secret: One of the most lucrative Big Law practice areas has no client accountability for its fees. Even worse, the process facilitates pricing behavior spills over into other practice areas.

Take the recent Wall Street Journal article. Where did the reporters get the detailed hourly rates for the firms they identified? A note at the bottom of the chart reveals the answer: “Source: Bankruptcy court filings.” If managing partners exchanged their firms' hourly rates privately, it would raise serious antitrust issues. But in bankruptcy, publicly filed fee petitions do all of that work for them.

It gets worse. In bankruptcy, no one forces attorneys into the discounting that produces the current 83% overall average collections rate. Traditional mechanisms of accountability are ineffective. Unlike a solvent corporate client, a company in trouble has little leverage in dealing with its outside counsel. Until it emerges from a Chapter 11 reorganization, the days of minimizing legal expenses to maximize shareholder value are suspended. If the company winds up in Chapter 7 liquidation, those days are gone forever.

At the same, time, the lawyers handling the bankruptcy have little risk. They get paid ahead of everyone else. Lawyers for creditor committees are a theoretical check only. They too get paid first, and debtor's counsel in one bankruptcy may be creditors' attorney in another and the liquidating trustee's lawyer in yet another. In none of those capacities is there any incentive to rock the long-term, “paid-in-full hourly rate” boat.

More Theoretical Accountability

The U.S. Trustee Program receives all attorneys fee petitions before courts approve them. The trustee can object, but its offices don't have sufficient resources to analyze detailed line item time and expense entries on the thousands of pages that firms submit. The trustee issued new guidelines that became effective for cases filed after Nov. 1, 2013. See http://1.usa.gov/20QbHpD. Perhaps they will make a difference. But in the end, they are still guidelines, and the final decision on attorneys fees resides with the bankruptcy judge.

As hourly rates have increased to the $1,500 level that the Journal highlights, courts have given their rubber stamps of approval to the trend. Rather than challenge the high rates that all firms charge, bankruptcy judges determine merely that they are “reasonable and customary” because, after all, comparable firms are charging them for comparable work. The circularity is as obvious as the resulting payday for the lawyers. Someday, media attention and popular outrage may force meaningful change that has yet to occur.

Worse Than It Seems

Considering the 83% collection rate in the context of the nearly 100% rate for bankruptcy lawyers yields an insight relevant to the fourth and final part of the larger big law firm story: The current 83% collection rate is deceptively high. If a firm's average is 83% and its bankruptcy lawyers collect close to 100%, then firms with large bankruptcy practices have non-bankruptcy clients pushing some practice areas into deep concessions off standard rates.

Combining this with two conclusions from the Georgetown/Thomson Reuters Peer Monitor report produces ominous implications for such firms: 1) “Demand for law firm services ' was essentially flat in 2015″; and 2) bankruptcy experienced the largest negative growth rate in demand by practice area.

Unless the country heads into a recession that few economists expect, the continuing reduction in bankruptcies will drive overall average collections dramatically lower. That's bad news for big law firms with significant bankruptcy practices.

Back in 2011, an icon of the bankruptcy bar, the late Harvey Miller of Weil, Gotshal and Manges, defended his firm's approach to legal fees: “The underlying principle is, if you can get it, get it.” See “Hourly Rates: Please Don't Read,” http://bit.ly/1UhZtGm.

Miller isn't around anymore, but his unfortunate credo for a noble profession survives ' for now.

Steven J. Harper is an adjunct professor at Northwestern University and author of The Lawyer Bubble: A Profession in Crisis (Basic Books, http://amzn.to/1Oq37qx). He blogs about the legal profession at (http://thelawyerbubble.com), and a version of this article was first published on that website.