How to examine legal bills.
Increasingly, cost-conscious chief executive officers are calling for greater oversight and control of spiraling legal costs. Gone are the days when, as one CEO lamented, "Legal is our only department with an unlimited budget, and it already has exceeded that."
Such examinations are becoming more common as legal bills mount. Consider this: In the last few years federal agencies have ordered the examination of millions of dollars of legal bills submitted to them by outside law firms.
Here are some of the things a management accountant should know to examine a legal bill effectively.
ASSESSING THE ENGAGEMENT
The first step is to determine the relationship between the company and the law firm. The management accountant should read the engagement (or retention) letter (or agreement) between the law firm and the company. Typically the agreement is very perfunctory and general; sometimes there is none. And while its terms are legally binding, it nevertheless may raise issues that the CPA may need to address. For example, if the document provides that the company pay the law firm $.25 per page for photocopies, the CPA's examination may question the reasonableness of that charge.
When appropriate, the examination should recommend the future use of comprehensive engagement letters, detailing the terms and conditions of the engagement--including the services that are expected to be performed, the basis for charging for those services, the attorneys to be assigned, billing rates and the nature of the working relationship between attorney and company.
The examination also should recommend the future use of planning and budgeting documents for major, discrete legal projects. Such documents describe strategy, implementation issues and cost-control measures for the project. They should be performance-oriented, describing what is to be done, when, by whom and at what cost. Departures from estimated costs should require prior agreement.
Legal bills are divided into two parts: professional services and other charges.
There is no standard billing model for legal services. Among the billing alternatives are flat fees, fee caps, value pricing and incentive arrangements. However, the most common method is billing by the hour. For the fee to be reasonable, both the hourly rate and the time expended must be reasonable.
Hourly rates should be consonant with the professional experience of the lawyer or paralegal and within the range for a comparable skill level within the geographical area where the legal services are performed. To find out the legal background of a lawyer, check the Martindale-Hubbell Law Directory. If more detailed biographical information is needed, check directly with the law firm. Legal trade papers and bar associations sometimes publish fee rate information.
Also, rates should not be increased during an engagement without the client's agreement or, at the very least, advance notice.
The size of a legal bill generally is much more a function of the hours that are expended than the hourly rate charged. To support their legal bills, law firms typically provide details, including the date of the activity, the name of the professional involved, hours worked and a description of the tasks. In a major legal matter these details can be voluminous and may require specialized analysis.
Descriptions should be sufficiently specific to support the charge. For example, "legal research" should identify the subject matter in sufficient detail to assess its necessity and relevance to the project. Sometimes the descriptions aggregate several tasks performed in a stated period without indicating time spent on each. For example, a senior partner might report performing legal research and several other tasks during five hours billed without saying how many of the five hours were devoted to the research. In such cases the law firm should be required to produce disaggregated data or some explanation. If it doesn't, the CPA should question the entire five-hour entry.
RED FLAGS IN BILLING
The principal disadvantage of hourly billing is that it rewards inefficiency. Following are some billing practices that should be examined:
* Time spent to develop an understanding of basic issues should not be charged to any particular client. The hourly billing rates imply a certain level of professional knowledge by the professionals designated to perform the assigned tasks. The cost of increasing their qualification level should be borne by the law firm.
* Tasks should be performed by professionals at the appropriate skill level. If underqualified personnel are assigned a task, it probably will take them too long and cost too much. More commonly, overqualified professionals perform tasks at their normal billing rates. As one judge said: "Michelangelo should not be paid Sistine Chapel rates for painting the farmer's barn."
* Most law firms bill in 6-minute increments. A few bill in 15-minute increments. Time generally is rounded up to the next increment. On the reasonable assumption that the average amount of time actually expended in a 15-minute increment is 7.5 minutes, all the time entries on average would result in a 7.5-minute overcharge. Such increments could add up to a substantial sum.
A law firm is responsible for effective case management. When tasks are assigned to numerous professionals on a part-time basis, the following inefficiencies arise:
* Each professional must invest time to get up to speed on the project. The more professionals involved, the more learning time is billed.
* With many professionals on the case, more time is put into incidental instruction, direction, coordination and consultation.
* A related issue is intraoffice conferencing, in which professionals communicate on matters sufficiently important that they record the event on their time sheets. Such conferences can be very expensive for the client because several professionals are billing at the same time.
Only the necessary number of professionals should bill for attendance at a hearing, conference or meeting.
Tasks performed should be necessary and relevant to the project. For example, legal work in anticipation of every eventuality, no matter how obscure or remote, is unjustified.
Duplicate efforts within a law firm or among law firms working cooperatively should not be billed.
Some attorneys bill for time spent traveling even though no productive work is done. The rationale is that (1) they are losing time that otherwise might be billable and (2) they can't work on client matters because they never know who is looking over their shoulders. The CPA should respond that not all client work is secret or confidential. Moreover, attorneys always have material they must read to stay abreast of legal developments; they can do that work while traveling. While it's best to disallow such charges, some large clients permit their outside law firms to bill at half their hourly billing rates for nonproductive travel time.
Long work days also require special scrutiny. When a bill shows 10-plus-hour days with some frequency (except during a trial), it is reasonable to ask whether the lawyer was merely logging hours.
Two important qualifiers must be recognized in undertaking any assessment of the reasonableness of professional fees.
1. The standard is reasonableness, not perfection. With 20/20 hindsight, it is easy to identify departures from some theoretical ideal of how a project should have been managed. Efforts that appeared reasonable at the time may turn out to have been unnecessary. A professional with precisely the right experience level cannot always be expected to be available to perform a necessary task. Charges are unreasonable only when departures from the norm are persistent, pervasive or substantial.
2. Technical legal expertise is needed in some areas. For example, expertise usually is required to assess whether the tasks performed were necessary and relevant and whether the time expended was commensurate with a task's complexity and significance. On the other hand, legal expertise usually is not required to question nonproductive travel time.
THE DISBURSEMENTS ISSUE
In recent years, as clients have resisted fee increases, law firms have turned to disbursement charges to increase profits. Such charges constitute at least 10% of a typical legal bill and frequently as much as 30% or more, especially when extensive out-of-town travel is involved.
The CPA should understand that only a fraction of what law firms describe as disbursements or out-of-pocket expenses represents money paid to independent third parties. Most are charges for a law firm's own in-house clerical services. Sometimes law firms impose surcharges on actual disbursements to create profit centers and shift their overhead costs to clients. Many such charges are unwarranted or excessive.
Last December the American Bar Association's standing committee on ethics and professional responsibility circulated its first opinion on this issue. While Formal Opinion 932D379 is not binding on lawyers, it provides guidance on the subject of disbursements. It says that "in the absence of an agreement to the contrary, it is impermissible for a lawyer to create an additional source of profit for the law firm beyond that which is contained in the provision of professional services themselves. The lawyer's stock in trade is the sale of legal services, not photocopy paper, tuna fish sandwiches, computer time or messenger services."
Here are some costs (in boldface type) that require particular attention:
* Photocopying charges have become a major item on legal bills. Some law firms charge $.20 to $.25 per page. In a major legal case such copying can add up to tens of thousands of dollars. The CPA can determine whether commercially available photocopying (including pick-up and delivery) is available for much less. Law firms are not in the business of photocopying for profit. If their costs exceed market prices, the work should be sent out. The small number of truly sensitive documents can be reproduced in-house or security arrangements can be made with outside copying companies.
* Facsimile charges are not objectionable so long as they do not exceed outside market prices. A few law firms even charge for incoming faxes. Such charges are unjustified.
* Secretarial overtime and temporary staffing (and related meals and local transportation) sometimes are charged to clients. Such charges are unjustified overhead-shifting except in client-specific emergencies. For the same reasons meal and local transportation expenses related to overtime or temporary staff should not be charged to the client.
* Word processing is a secretarial service that should not be charged for.
* Online database legal research is on the increase. Some law firms bill the line charges to clients, but the propriety of such charges is debatable. While the cost clearly is out-of-pocket and directly attributable to particular clients, it simply is today's technological equivalent of the law library, and the cost should be borne by the law firm as general overhead. Because on-line costs can add up quickly, some clients establish at the outset of the legal relationship either that they will not pay any of the law firm's on-line research costs or that advance authorization is required.
* Travel and related lodging and meals are large items on many legal bills. Reimbursement of such expenses at reasonable levels is justified. The CPA should, at least on a sample basis, trace such charges back to source documents to ensure the airfares were no higher than business or coach rates and lodging and meals were moderate.
Some law firms may have rebate arrangements with travel agencies. Since the actual cost to the law firm may be less than the invoice amounts, the CPA should check that all such benefits have been passed to the client.
* Surcharges to certain disbursements are added by some law firms. For example, law firms may add a 10% to 75% surcharge on phone charges. Such surcharges are invisible, so they rarely are questioned. The CPA should ask the law firm about its practice on this issue.
In addition, charges for opening new files and for items described as "computer charges," "automation charges," "salary recovery" or charges "for technology services rendered" are unwarranted attempts to shift ordinary overhead to clients.
In view of the above practices, an examination of claimed reimbursable costs should include a written request to the law firm to (1) identify all claimed reimbursable costs not paid directly to independent third parties, (2) the reason why such charges should be reimbursed at all (rather than absorbed as ordinary business overhead) and (3) the justification for the amount of each charge.
With this information the CPA will be able to begin to assess the validity of the claimed reimbursable costs, and it's likely that savings will be found.
* MANAGEMENT ACCOUNTANTS should take the opportunity to examine the bills submitted by their outside law firms.
* TO BE SURE HOURLY charges are fair and accurate, the CPA should require the law firm to support its legal bills with details on the date of each activity, the name of the professional involved, hours expended and a description of the tasks.
* ONLY THE TIME actually worked on a task should be billed. This issue most often arises in connection with travel time or long work days.
* TIME SPENT SHOULD be commensurate with the complexity and significance of the the task.
* DUPLICATION OF EFFORT in a law firm or among law firms working cooperatively should not be billed.
BENNETT FEIGENBAUM, LLB, is president of Legal Management & Audit Group, a Florham Park, New Jersey, company that advises businesses and government agencies on controlling legal expenses. A former corporate vice-president and assistant general counsel, he is a member of the American Bar Association and is admitted to practice in the District of Columbia, New Jersey, New York and Washington State.
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|Publication:||Journal of Accountancy|
|Date:||May 1, 1994|
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