Litigation
MANAGING LITIGATION RISK AND COST by Robert D. Rachlin
Q. Why do companies hire counsel at all?
A. To manage risk.
Q. How is risk managed?
A. By incurring cost proportionate to the risk.
A lawsuit represents risk…risk of financial loss. A company invests resources
to manage that risk. Intelligent risk management can occur only when the
risk is correctly assessed and resources proportionately allocated to manage
that risk.
Risk management is not the same as risk limitation. Companies limit risk ex
ante by purchasing insurance to cover those losses exceeding whatever
retention the company is willing to bear itself. Companies manage risk ex
post by incurring costs to reduce the adverse consequences of an existing
exposure.
The Insurance Company Model
Many defense lawyers lament the stringent fee constraints and controls
imposed by companies, especially insurers. These lawyers fail to appreciate
two fundamental insurance principles:
1. the law of large numbers
2. variation of premium with risk.
Insurers understand that, in an individual case, the result realized by hiring
Lawyer Jones at $130 an hour may be worse than if they had hired Lawyer
Smith at $200 an hour. But the law of large numbers teaches them that,
over the spectrum of hundreds or thousands of cases nationwide, the total
cost expended to manage their overall risks will be less.
Similarly, insurance companies proportionate the premium to the risk
assumed. “Risk” can be simplified as the product of magnitude and
probability. That’s why car owners pay a disproportionately high premium for
low-deductible collision coverage. The magnitude is small, but the probability
is very high.
What is the risk?
To corporate counsel, the risk can be an adverse judgment, a damaging
precedent, an open-Sesame to more lawsuits, or all of the above. The risk
may be insignificant dollars, footnoteable dollars, a critical patent, or a betthe-
company outcome.
To manage cost, we accept cost. Stated another way: we manage the risk of
greater cost by accepting a smaller, proportionate, intelligently deployed set
of costs.
What are the costs?
The most obvious are legal fees and direct out-of-pocket litigation costs, such
as experts, transcripts, and travel. Often greater are the internal costs
incurred by the client
…for personnel deployed to respond to mammoth discovery requests
…for personnel time spent with counsel
…for executive time spent on decisions and guidance
…for in-house legal personnel to monitor or even manage and try the
suit.
Defining the Risk and the “Premium”
Faced with a lawsuit, in-house counsel and outside counsel should share a
common grasp of the risk. Lawyer and client are partners. You, as the client,
are the senior partner. At the outset, you should ensure that your retained
counsel understands your grasp of the risk. Does the case involve more than
this single plaintiff who fell in your parking lot? Does the risk encompass
events beyond the particular lawsuit? Will that risk be enlarged or diminished
by a settlement, rather than a public trial? Or is the case one of minimal
exposure but doubtful liability, i.e., where both the magnitude of the
exposure and the probability of its occurrence are small?
Let’s look a this last example. Retained lawyers are sometimes surprised
that, although their meticulous lawyering and brilliant advocacy have resulted
in a 100% victory in court, you, the client, are less than thrilled. The
problem, of course, is that the lawyer committed you to cost that was
disproportionate to the risk – or more specifically, your grasp of the risk. Is
the lawyer to blame? Not if she failed to understand your grasp of the risk,
because you didn’t clearly convey it at the outset. I’ll qualify that a little: the
lawyer is to blame, to the extent that he failed to recognize the existence of a
cost/risk calculus and failed at the outset affirmatively to solicit your input on
the shape of that curve.
As law students, we all learned a discipline founded on the assumption that
every legal problem warrants unconstrained effort to obtain the desired
result. In law school, the “desired result” is not modified by cost constraints.
No client was paying for the hours we spent in the library researching every
conceivable relevant case. Many – perhaps most – lawyers leave law school
with a mind set that fails to recognize the cost-benefit calculus that you, as
the representative of an enterprise that has a bottom line, must take into
account in your approach to a litigation risk.
The Pareto Curve
The Pareto Principle, named for Italian economist Vilfrido Pareto (1848-1923)
states, in paraphrase, that 20% of the effort produces 80% of the results,
and conversely, the remaining 20% of results commands 80% of the effort.
Many applications of this rule have been observed, for example:
80% OF A MANAGER'S INTERRUPTIONS COME FROM THE SAME 20% OF THE PEOPLE
80% OF OUR PERSONAL TELEPHONE CALLS ARE TO 20% OF THE PEOPLE IN OUR ADDRESS BOOK
80% OF THE DECISIONS MADE IN MEETINGS COME FROM 20% OF THE MEETING TIME
80% OF THE TRAFFIC IN TOWN TRAVELS OVER 20% OF THE ROADS.
Does the Pareto Principle apply to litigation? I contend that it does – that
80% of the benefit to the client comes from 20% of the lawyer’s time and
effort…and, therefore, from 20% of the possible cost.
In one important respect, however, the rule is misleading. The relationship
between that first 20% of cost and first 80% of result is roughly linear: i.e,
for each increment of cost there is a roughly-uniform, but much larger,
increment of result. But when you pass the 80-20 point, the relationship is
no longer linear. Each cost increment beyond the first 20% yields a results
increment that is less than the increment that preceded it. Very quickly, the
cost increment exceeds the results increment – the opposite of what occurred
at an earlier stage. So you’re paying more and more for less and less.
If you were to plot this on a graph with the x-axis representing results and
the y-axis representing costs, you’d find that the value of xy increases in
more or less a straight line for 80% of the length of the x-axis; then it begins
to increase more and more steeply until it turns into what the
mathematicians call an asymptotic curve. The 100% point on the x-axis is
never reached.
How does this apply to lawyering? I can illustrate it with a story from the
early days of my practice. A real estate appraiser asked me to draft an
agreement he could sign with clients. I told him that for 20% of the possible
cost, I could draft a “Dear Ed” letter that would address 80% of his possible
problems. For 100% of the possible cost, I could cover most of the remaining
problems. (I say “most” because – you remember – the 100% point on the xaxis
is never reached.) He opted for the 20/80 solution. As far as I know he
had no problems thereafter with the unaddressed 20%.
Is this choice always the right one? Of course not. Depending on the
magnitude and probability of the risk, it may be desirable to travel much
farther along the x-axis, and accept the disproportionately-increasing cost.
Why? Because the risk warrants it. Bill Gates would not have been content
with a Pareto approach to the Government’s antitrust litigation.
What retained counsel often fails to understand (because you, the client,
have failed to convey it) is that in many, even most, routine cases, you don’t
expect, and don’t even want, anything approaching 100% on the x-axis. In
fact, you may be quite content with as little as 40 or 50% on the x-axis, or
even less – depending on the your grasp of the risk. To the lawyer
unaccustomed to entrepreneurial thinking, anything less than 100% may
seem unprofessional. This misconception arises from the lawyer’s inadequate
understanding of the client’s overall strategy of risk management and the
lawyer’s failure to appreciate that he or she is a component of the client’s
overall goal: maximize income, minimze expense. The lawyer may still be
thinking like a law student: Pareto doesn’t get you A’s. To such a lawyer,
the very idea of doing less than 100% on every case smacks of
unprofessionalism. Indeed, some lawyers, aware of client cost constraints,
will “sneak in” extra work at no charge to the client, simply because she just
can’t bear doing less – even without pay. (I will add: May such as these be
blessed.)
Controlling the Costs of Outside Counsel
I omit the obvious stuff: avoiding double-teaming, limiting travel, assigning
work to lower-rate personnel where practical. We’re all familiar with these.
Let’s look instead at some factors that may not be so obvious.
Some companies rely on rigid policies and canned forms to create the
impression that costs are being controlled and the risk managed. It’s an
illusion. Cost-control begins with communication of your assessment of the
risk, your goals in the litigation, and a realistic budget that will take you as
far along the x-axis as you, the client, want the lawyer to go. The canned
approach has the further drawback that risk assessment and management
tend to be petrified at an early stage. In fact, risk assessment and
management are ongoing processes. As case development progresses, the
lawyer and client share insights, information, and opinions on a continuing
basis – revising goals and budgets as necessary. This is an inescapable, and
fortunate, consequence of modern discovery practice. The farther along we
get, the more we know; the more we know, the better able we are to
evaluate the risks and prescribe the costs needed to manage them.
Effective cost control must include a recognition of your outside lawyer’s own
costs. You can help her minimize her costs, and pass some of that saving on
to you, by adopting principles that promote efficiency and discourage
needless “process” and paper-pushing. Here are some specifics:
1. Insist that your outside counsel practice with the rhythm of the
Internet. There still seem to be lawyers who take pride in being computerilliterate.
Many beyond the stage of computer-illiteracy have not made the
modest effort needed to learn how to navigate the Web and use search
engines effectively. Lawyers who are individually adept with wordprocessing
and with the Internet produce output with reduced support staff involvement
and without the corresponding delay. Their operating costs are lower, and
their bills should reflect that. Before hiring counsel, find out in advance
whether they’re practicing with the right rhythm.
2. Reduce paper; use e-mail. Yes, we lament the slow demise of the
epistolary art. But routine communications are best accomplished by e-mail.
E-mail provides a simple vehicle for keeping you informed of case progress.
Ask your retained counsel to copy you with documents electronically. If the
document was generated by your counsel, it can be sent as an attachment.
It if was generated outside your counsel’s office, your counsel can scan the
document and e-mail it as an attachment. This allows you to minimize
storage costs, file documents electronically, and retrieve them swiftly for
viewing on your screen or printing. Lawyers who prefer not to use scanners
can accomplish the same thing with eFax®, which allows you to fax a
document to a dedicated telephone number and receive the document by email
in eFax® format. It can then be forwarded to anyone in that format, or
saved first in a more commonly available format such as Adobe .pdf. See
WWW.EFAX.COM for details.
3. Use electronic reporting forms. If you want your retained counsel to
send you reports in a prescribed format, e-mail him a template in electronic
form. The lawyer can load the template on his wordprocessor and prepare a
legible document, with space expanded as necessary to fill in complete
information, instead of trying to squeeze words into a pre-designed paper
form.
4. Don’t invite fudging by unrealistic billing policies. No lawyer should
ever fudge a bill – for any reason – ever. Yet outside counsel promote such
practices by imposing constraints that don’t correspond to the way good
lawyers practice. Example? Some clients refuse to pay for office
conferences. Is this realistic? Why do lawyers practice in firms? One
reason: to enjoy the benefit…passed on to the client…of bouncing ideas and
issues off of colleagues. Another example? Some clients refuse to pay for
electronic research. If that same lawyer were to go to the library and spend
– and bill for – quadruple the time pawing manually through books, the client
would presumably have no objection. Westlaw®, Lexis®, and similar online
charges are trivial, when compared to the lawyer’s hourly charges saved by
exploring the law electronically rather than manually. I’m not talking about
unnecessary research. Bills should be carefully monitored for redundancy.
But don’t throw out the baby with the bath.
5. Insist on monthly billing. Monthly billing keeps you abreast of what’s
happening. Quarterly billing invites unpleasant surprises. There’s a corollary.
Lawyer’s should be allowed to bill monthly. Some clients insist on quarterly
billing. There may be good administrative reasons for reducing the time
spent internally processing bills. No criticism on that count. But don’t use
your outside counsel as a component of company cash management. There’s
a time value to money. Your lawyers have to pay their own bills monthly.
When a client insists that bills be rendered quarterly, then takes ninety+ days
to pay them, the lawyer has extended the client a significant interest-free
loan. Such long deferral of payment increases the lawyer’s costs, and those
costs inevitably get passed on to the client.
6. Don’t increase your lawyer’s overhead by demanding custom billing.
Efficient law firms have automated their billing. The output should be
sufficiently detailed to satisfy any reasonable client. If the details are there,
don’t ask the lawyer to custom-design bills for you. That adds materially to
the lawyer’s costs, and those costs must be passed on to clients. Some
companies are moving to the ABA’s UNIFORM TASK-BASED MANAGEMENT STANDARD
format for billing. See WWW.ABANET.ORG/LITIGATION/LITNEWS/PRACTICE/UTBMS.PDF for
details. DRM is adapting its automated billing to accommodate the UTBSMS
codes for those clients requiring them. If you’re moving in that direction,
make sure that your retained counsel is prepared to comply with it on an
automated basis.
Summary
Outside counsel are part of a company’s total risk management program.
Risk is managed by accepting costs proportionate to the risk. Company and
retained counsel must share a common grasp of the risk – as well as desired
outcome – for the in house-outside counsel relationship to work costefficiently.
Early and ongoing communication about the nature of the risk,
the desired outcome, and the magnitude of appropriate costs is essential.
Companies can help reduce the cost of litigation by adopting policies toward
retained counsel that encourage efficiency without sacrificing the realities of
effective law practice.
Copyright © 2002 DOWNS RACHLIN MARTIN PLLC
