In A Financial Model for Law Firms to Embrace Alternative Fees & LPO we explored how, by structuring LPO vendor services into fixed-priced, litigation offerings, law firms could offer lower prices while potentially maintaining margins in return for managing LPO vendors and retaining the liability for them. This second in the series of two posts explores the ethical and professional responsibility challenges associated with such an arrangement.
The fundamental challenge for law firms bundling LPO vendors’ services in combination with alternative fees is that the rules for legal ethics and professional responsibility have not contemplated these arrangements, and, as a result, it is not clear how the rules should apply. There are multiple rules implicated by outsourcing, but the authorities that have addressed them have not done so in the context of outsourcing services being bundled with law firm services, and the combined services being provided in return for a fixed fee.
The major ethical concerns for law firms offering such an arrangement (there are many others) are requirements that they (i) disclose the fact of LPO vendor retention, (ii) disclose the cost of LPO vendor retention, (iii) not mark-up LPO vendor charges without the express consent of the clients, and (iv) retain responsibility for the combined work product. While both the fact of disclosure and the assumption of liability may be economically viable and commercially reasonable, the requirements to disclose costs and consent to markup are not.
The requirement to disclose the fact of LPO vendor retention is clear and unambiguous. The Supreme Court of Ohio Opinion 2009-06 provides an overview of Bar Association opinions from North Carolina, Los Angeles County, San Diego County, the Florida Bar Ethics Committee and an ethics committee of the Association of the Bar of the City of New York, all requiring a minimum of informed consent to outsource. Also see ABA Comm. on Ethics and Professional Responsibility, Formal Opinion 08-451 (2008) (“where the relationship between the firm and the individuals performing the services is attenuated, as in a typical outsourcing relationship, no information protected by Rule 1.6 may be revealed without the client’s informed consent.”)
The requirements to (a) disclose the cost of LPO vendor retention and (b) not mark-up the charges are more challenging. Various opinions make clear that legal or support services that are charged to the client as an expense (i.e. disbursement) cannot be marked-up without client consent. ABA Comm. on Ethics and Professional Responsibility, Formal Opinion 08-451 (2008)(citing ABA Comm. on Ethics and Professional Responsibility, Formal Op. 93-379 (1993)(if the firm decides to pass those costs through to the client as a disbursement, however, no markup is permitted.)); ABA Comm. on Ethics and Professional Responsibility, Formal Op. 00-420 (2000). These are not implicated by the combined offerings described here because a law firm offering LPO vendor services as part of a fixed fee would not be charging for them as a disbursement. However, the authorities providing guidance about billing for outsourcing as a component of legal services provide some contadictions. Formal Opinion 08-451 states,
“ the lawyer is not obligated to inform the client how much the firm is paying a contract lawyer; the restraint is the overarching requirement that the fee charged for the services not be unreasonable. If the firm decides to pass those costs through to the client as a disbursement, however, no markup is permitted. In the absence of an agreement with the client authorizing a greater charge, the lawyer may bill the client only its actual cost plus a reasonable allocation of associated overhead, such as the amount the lawyer spent on any office space, support staff, equipment, and supplies for the individuals under contract. The analysis is no different for other outsourced legal services, except that the overhead costs associated with the provision of such services may be minimal or nonexistent if and to the extent that the outsourced work is performed off-site without the need for infrastructural support. If that is true, the outsourced services should be billed at cost, plus a reasonable allocation of the cost of supervising those services if not otherwise covered by the fees being charged for legal services.”
It seems that Formal Opinion 08-451 did not follow the logic of Formal Opinion 00-420, which states,
“Recent ethics opinions in Virginia, Colorado, and the District of Columbia have approved the right of a retaining lawyer to charge the client more for the services of a contract lawyer than is paid to the contract lawyer when those costs are billed to the client as legal services, subject only to the obligation of Rule 1.5(a) to charge a reasonable fee. There is no duty to disclose the surcharge when the work of the contract lawyer is supervised or, absent supervision, when the work of the contract lawyer is adopted as the work of the retaining lawyer.” (Emphasis added.)
While the ABA provides useful guidance, many prominent firms are at least partially bound by the Association of the Bar of the City of New York Committee on Professional and Judicial Ethics which has stated,
“[b]y definition, the non-lawyer performing legal support services overseas is not performing legal services. It is thus inappropriate for the New York lawyer to include the cost of outsourcing in his or her legal fees.  Absent a specific agreement with the client to the contrary, the lawyer should charge the client no more than the direct cost associated with outsourcing, plus a reasonable allocation of overhead expenses directly associated with providing that service.” Assn. Bar of City of New York 2006-3 (2006).
The New York City Bar opinion, which is determinative for many firms, precludes firms from offering LPO services as part of fixed fee arrangements without informing clients of the cost of LPO vendor services (essentially its “raw materials”). It may be economically viable for firms to disclose and clients to accept a markup for LPO services in return for the law firm managing the LPO vendor and assuming liability for its work. However, the commercial reasonableness of such arrangements will be difficult to maintain over time because law firms will be subject to significant pressure to reduce the mark-up of LPO vendor fees, which will reduce both law firm profits and their ability to invest in and manage processes and systems that will reduce that liability. One potential solution is for law firms to create subsidiary (i.e. “Captive”) LPO units, which may not be “outsourcing” within the definition of the existing opinions, but captives have their own set of problems. (See a discussion of captives at: BT Transitioning Legal Services Captive to UnitedLex). There are numerous other significant management and professional ethics issues to consider, and many of them are outlined in “Navigating Professional Ethics Issues in the Changing Legal Service Paradigm,” forthcoming from Susan Hackett at the Association for Corporate Counsel (available to Legal OnRamp Members here.)
Particularly where the parties are large and sophisticated economic actors (i.e. client corporations, law firms and LPO vendors), ethics authorities should find ways to allow parties to contract for services without the need to disclose their cost structures. As the New York rule currently exists, even in situations where the firm does agree to disclose its cost structure, the disclosed mark-up could vary dramatically from month to month if the standard fee (i.e. monthly portion of a fixed annual fee) is divided by varying amounts charged by the LPO vendor in a given month. Clearly, this is not what Ethics and Professional Responsibility Committees intended.
I am very interested in other’s views of these topics. Please comment on this post below!