Outsourcing Legal Processes

Legal Process Outsourcing (LPO) firms have evolved and moved up the value chain in the last few years, overcoming initial skepticism around data security and privacy. Most LPO firms successfully addressed privacy concerns by obtaining International Organization for Standardization (ISO) and Information Security Management System certifications. This measure has positively impacted the industry – a trend substantiated with findings from an ORBYS survey in 2011 of in-house counsel heads, which revealed that the majority of respondents used or would consider outsourcing legal processes.

Global spending on LPO continues to increase within the financial services industry as many legal departments have resorted to downsizing and tightening of budgets amid volatile markets and cost pressures. According to a Forrester Research report, the global market for LPO was approximately 250 billion USD in 2012 and is predicted to grow an average of 30 percent for the next three years. The North American market, consisting of U.S. companies and law firms, accounts for more than two-thirds of this market share.

Drivers and Benefits of LPO

Cost savings is the key driver for LPO and one of the most important benefits of outsourcing legal work. Other drivers/benefits for outsourcing legal services are:

Economic Environment: As a result of the global financial catastrophe and ongoing regulatory scrutiny, the financial services industry has witnessed growing numbers of bankruptcy cases, regulatory filings, and other legal proceedings. These events, coupled with severe cost pressures, have fueled demand for legal services and are one of the key drivers for LPO in the industry.

Scalability: LPO is a great tool that has helped law firms and corporate legal departments shift costs from non-value added functions to more strategic objectives. It provides firms with increased capacity without the need for additional headcounts. Thus, firms can do more with fewer resources.

Flexibility: LPO firms can be utilized on a need basis.

Efficiency and Technology: LPO providers are equipped with the latest technologies that can help their clients enhance their operations and business processes. Financial firms in turn can expand their offerings by delivering end-to-end solutions to their clients.

Legal Services Outsourced

Some of the services typically outsourced by financial firms include marketing material review, compliance and transaction support for trading desks, drafting agreements, SEC and other regulatory filings, litigation support, legal research, due diligence, contract review, and M&A.

Reforms in regulations such as Dodd-Frank, GIPS and Basel III have increased compliance and reporting pressures of financial firms, making it challenging for firms to operate independently. Hence, consolidation via mergers and acquisitions is rising especially among small banks, thrifts, and broker-dealers firms, intensifying the demand for legal support and expertise. Many industry players are thus looking for service providers that can offer complete solutions to meet many of their legal and compliance needs.

The LPO model, which uses both legal and non-legal staff, can provide hugely efficient and flexible legal solutions for financial firms by leveraging offshore captives where appropriate and leveraging innovative technologies. Moreover, operating within an environment characterized by cost-pressures and stringent regulations, it makes sense for firms to outsource non-value adding legal work to service providers so that in-house staff can focus on strategic business objectives.

Legal Fees – Hourly or Contingency?

When faced with the decision of contingency versus hourly, generally, you, as the client, want to pay the hourly rate. And, here is why: Suppose you have a regular business tort. You paid someone $2 million for a piece of property in Mexico, and, for whatever reason, it turns out that the title is bad. Now you have discovered you do not own the property. The defendant is a deep pocket defendant; that if you can get a judgment against that party, you will actually get paid the $2 million. If you sit down with your attorney, you both go through the possible costs from beginning to end, and consider the cost of mediation versus litigation and everything in between, you will get an idea of what your overall costs will be. It might turn out to be $250,000 if you pay by the hour. As you sit across the table from your attorney, it feels really good not to have to write a check right then, but fast-forward a year or a year and a half down the road, you have a $2 million judgment, and look at the numbers. If you were working on a standard California contingency rate of 40%, if you win and the defendant pays, you pay your attorney $800,000 (2 million x.40). Thus, for taking the contingency option, you pay a premium of $550,000.

Another thing you should consider, and any good attorney will tell you this up front, is that the cost of the case is not included in the attorney’s fees. If you are working under contingency, the lawyer is going to take his 40% right off the top. Using the example above, after attorney’s fees, you will be left with $1.2 million dollars. Out of the amount left to you, you will still have to pay all of the court reporter fees, mileage fees, court filing fees, jury fees, expert fees, and everything else. After taking all of this into consideration, contingency fees from a business perspective are not an attractive option if you can afford the hourly rate.

You should always take into consideration who the defendant will be. If the defendant is someone that you suspect might not be able to pay, you might consider using a contingency agreement to minimize your business cost while maximizing your potential gain. This shifts the risk from the client to the attorney. If you get the judgment, but you cannot collect, you will have received your attorney’s work for free. If, on the other hand, the defendant does pay, you receive an unanticipated 60% of the money you are owed minus costs. Note that any decent attorney will do the exact same calculation. If it is a judgment-proof defendant, such as Joe on the corner, no levelheaded attorney would be willing to work the case on a full contingency. This leads us, naturally, to our next topic of nontraditional fee structures.

Nontraditional Fee Structures
The idea of the billable hour began in the last century. Everyone hates it: clients, attorneys, associates, bookkeepers, and everyone else. The problem was, until recently, there really wasn’t any better pay-as-you-go system for legal services other than a flat fee. However, because of the recession, people are rethinking the way they pay for legal services, and lawyers are rethinking the way they get paid. Here are a few of the more creative options:

A La Carte Fees
Here, you can pay for your case piece by piece, and pay different amounts for different parts of the case, depending on how time intensive they may be. The client pays the money up front and has the assurance that he or she will not pay more for that particular portion of the case. Many people see the hourly fee structure as equivalent to handing their attorney a blank check, which can be very intimidating for some. A la carte is not hourly; it’s not contingency. It’s a specific rate for specific pieces of work. A la carte is just an extension of a flat fee, and, because the lawyer, the client, the associate, and everyone hates the billable hour, a la carte fees provide a breath of fresh air. Here are some examples of how it could work in a garden-variety noncomplex business tort case:

1. Initial research and drafting of original complaint: $5,000
2. Opposition to demurrer: $2,500
3. Deposition per witness, court reporter cost included, limited to one day each: $5,000
4. Trial, per day: $10,000

Part of the beauty of such an arrangement is that:
a. The client obtains security in his or her cost exposure and, perhaps more important,
b. The client takes an active role in determining how the case will be built, based upon his or her own determination, after considering the lawyer’s advice.

Fee and Hourly Lids
Here, the attorney and client throw the discovery phase out of the cost calculation, and then everyone agrees that the client will not spend more than X and the attorney will not work more than Y on a particular phase of a case. Again, this is reassuring for the client because he or she knows the costs right up front. It is reassuring for the attorney because he knows he will not be held captive on an infinite project for an a la carte/flat fee amount. The added benefit of this is that if, in fact, the work takes less time than expected, the client receives the added benefit of a potential cost reduction on the work, which is not possible with an a la carte pay structure.

Blended Agreements
Another option that I see more and more frequently is the blended agreement. Personally, these are my favorite as they allow the attorney to put skin in the game, partner with the client, receive a bump in pay if successful, and provide the client with a lower up-front cost structure. Imagine a spectrum where point A is an hourly agreement at whatever hourly rate you agree upon and point B is 100% a contingency amount with whatever rate you agree to with your attorney. Then you take the ball and slide it somewhere in between points A and B. For example, let’s say the normal billing rate is $400 per hour, and the normal contingency rate is 40%; sometimes we can meet in the middle where you agree to pay only $200 per hour, and I will take only 20% if we succeed. You and your attorney can agree to slide the ball anywhere on the spectrum that works for you. This structure is frequently dependent on the strength of the case and whether the defendant can pay when the case is won.

Traditional Nontraditional Fees
Attorneys don’t always have to be paid in currency. I come from a long line of attorneys, and I am used to the Thanksgiving table stories of the criminal defense lawyers being paid with a nickel plated.45, samurai swords, or an old Mercedes. Paying for a business litigation case with nickel plated.45s would necessitate a huge amount of firepower and would probably get both you and your attorney an interview with the ATF. However, the basic creative concept can be applied in the business realm.

If you are a business, attorneys are one of the few exemptions to the rule that you cannot pay in company stock for services. The specific rules regarding this practice will vary from state to state. This is not an uncommon arrangement if a business plans on working with an attorney during a long period of time. For example, the attorney might help with a lot of different things, such as contracts or day-to-day incidents or paperwork, not just litigation.

Many clients choose to do this not because they cannot afford the hourly rate, but because they want their lawyer to have skin in the game, which is the business. The attorney gets a percentage of the business, and the client receives a reduced hourly rate. But a word of caution: There are all sorts of ethical issues to be aware of, and any attorney worth his or her salt will let you know that up front. In this instance, for the purpose of a contract, your attorney is not your attorney, but a businessman, and you must recognize that difference.

Captive Insurance Companies Need Independent Directors

Owners of captive insurance companies, as they continue to grow in asset value, need to look at expanding their Board of Directors to include the experienced Independent Director, regardless of domicile. The longer the captive insurance company remains in business, the greater the chance the captive will get into serious issues that will require a good deal of insurance industry expertise.

As an insurance practitioner for 40 years, let’s go over some of the issues that will come up for the “mature” captive taken from actual experiences.

Reinsurance Recoveries

The initial feasibility study contemplated only one reinsurer and now, due to market conditions, the captive insurance company finds itself with five reinsurers, with different limits of excess of loss protections. One of the reinsurers does not want to pay the excess claim and the captive has to select a reinsurance litigation law firm. This is not exactly within the job description of an insurance risk manager. Where does the captive’s risk manager turn for good advice? Does the captive litigate or arbitrate? What is the arbitration process all about, and can captives secure reinsurance recoveries through the arbitration process? Most captive owners have had no experience with this type of event. Failure to collect the reinsurance recovery may result in an insolvent captive insurance company.

Renegotiate the Fronting Fee

How many renewals have you gone through without getting the “front” insurance company to reduce its fronting fee? Who is responsible to devote the financial resources and time to explore new options for a “front” insurance company? Many captive owners never shop their fronting fee on the simple basis that they have no resources available to meet with potentially new “fronts”. It will be necessary for the “fronts” to solicit the captives, as they do at all the captive insurance company conferences held both domestically and offshore, especially in a soft underwriting cycle.

Captive owners need to understand the components of a “fronting fee,” and more importantly, what parts of the “fronting” fee are negotiable. The “front” company has all the components qualified from state premium taxes to residual market fees, to insurance company overhead.

Restructuring the Reinsurance Program

It is the responsibility of the captive owner to continuously monitor the reinsurance program and search for economic options. The pricing of reinsurance is not controlled by any regulatory body and therefore it is market driven. Many captive owners have never been exposed to the reinsurance negotiating process, nor are they in a position to benchmark reinsurance prices. Risk managers have very little national contact, other than their local chapter meetings. The cost of reinsurance is a big factor as respects the profitability of a captive, and must be negotiated by experienced executives. Independent Directors can help with that process.

Independent Directors

In contrast to the captive insurance company, the publicly held insurance company has used Independent Directors, mostly from the accounting and legal professions. Private equity firms that invest in insurers are looking for Board Directors to represent their interests, especially where they have a significant stock position.

Conclusion

More captive insurance companies are going to reach out to Independent Directors, with parental consent.