Everyone who works in the pharmaceutical area has heard of the patent cliff for blockbuster pharmaceuticals. The patent cliff has caused generic pharmaceutical companies to re-think how they approach litigation. With potential profits being less, generic pharmaceutical companies are looking for ways to save costs. One key cost of a generic drug entry is the cost associated with the Paragraph IV litigation. Consequently, generic pharmaceutical companies are looking for possible ways to restructure their legal costs.
Although alternative fee arrangements are a relatively new concept in the Paragraph IV area, they are quite common in other areas of the law. To understand the various alternative fee arrangements, it is easiest to consider that each alternative fee arrangement shifts, to one degree or another, the financial risk of the litigation from the litigant (in this case the generic pharmaceutical company) to the law firm. As more financial risk is borne by the law firm, the cost to the litigant becomes less and the cost to the law firm becomes greater. With such increased risk borne by the law firm, however, there is an expectation on the part of the law firm of greater reward should the litigation ultimately be successful. Thus, alternative fee arrangements can almost always be viewed in terms of the risk/reward equation with respect to the client and the lawyer.
Let’s look at some alternative fee arrangements and explore the strengths and weaknesses of each. For purposes of this discussion, we will review some, but not all, alternative fee arrangements along a continuum from a straight hourly fee billing arrangement to a pure contingent fee arrangement.
Hourly Fee Arrangement
In an hourly fee arrangement, the law firm bills the client for each hour of time (or fraction thereof) spent working on the matter. In such an arrangement, the law firm bears no financial risk in the litigation. The entire risk of the litigation is borne by the client; if a client is successful, the client will reap the entire benefit of its investment in legal fees. The disadvantage of this billing arrangement from the client’s perspective is that it is often difficult to control costs. As a result, several modifications of the hourly fee arrangement have arisen in an attempt to minimize the financial risk for the client.
Blended Rate Fee Arrangement
In a blended rate fee arrangement, the law firm agrees to bill every attorney at the same rate, called a blended rate. This rate will be somewhere between the highest billing rate and the lowest billing rate that the law firm offers. This can be an attractive arrangement for the client if the client is able to have high billing rate attorneys do the majority of the work on the file. In that case, the client receives a discount off the higher billing rate attorneys’ normal hourly rate. In practice, however, a blended rate allows the law firm to shift most of the work to attorneys with a billing rate under the blended rate and to receive a financial bonus for doing so. Because it is the law firm who ultimately determines who will do what work on a matter, it is more likely that the law firm will reap the benefits of this fee arrangement than will the client. As such, it is not a particularly well-used or popular billing arrangement.
One way to temper the cost of an hourly fee arrangement and to try to control excessive costs, is to build in a volume discount. Under this arrangement, straight hourly fees apply up to a certain level. Beyond that level, discounts apply. Although this does not totally take away the problem of a client being unable to control the amount of billing done on a given matter, it may limit the number of hours that attorneys work on a given matter because their effective billing rate will be lower after a certain point. In practice, the volume discount also benefits the lawyers because the discount only applies after a certain minimum volume of work has been reached. Usually, these agreements are structured such that that volume of work is quite high. In that case, the law firm is quite happy to provide a discount because the volume of work from the client is substantial.
A retainer agreement is more a method of controlling cash flow than it is a method of constraining legal fees. In a retainer agreement, the client agrees to pay a set amount of money to the law firm each month regardless of how much work is done on the file. This tends to smooth out a client’s cash flow so that it is not faced with months of high billing or unanticipated billing. The disadvantage to a client, however, is that in those months where legal activity is low, the client is still paying the same amount of money and the effective hourly rate of the work being performed increases. For the law firm, the downside occurs when there are months in which the amount of work exceeds the retainer amount. Then the attorneys are essentially working for free. A well-balanced retainer agreement attempts to even out the risks for both the client and the law firm so that neither side is disadvantaged, on balance, over the life of a particular matter.
In a success fee arrangement, the attorneys bill only a fraction of their hourly fees, foregoing their full hourly fee. If the litigation is successful, the law firm recovers not only its deferred fees, but a multiplier of those deferred fees. In essence, the law firm risks a percentage of its actual fees and the reward is a multiplier of those deferred fees at the end of the litigation. The advantage to a client is that its actual legal bills are less than they would be under an hourly fee arrangement. The arrangement also provides an incentive for the law firm to be successful, but it comes at a cost. That cost is a monetary reward to the law firm at the end of the litigation, if they are successful. The end result, if the law firm is successful, is that the law firm will make more money than it would have under an hourly fee arrangement. This is because it took more financial risk in the litigation.
Partial Contingency Arrangement
A partial contingent fee arrangement is similar to a success fee arrangement except that instead of the reward for the law firm being a multiplier of deferred fees, the reward is some percentage of the recovery in the litigation. Although contingent fee arrangements are more common when a law firm represents plaintiffs, they can be applied to defendants, such as generic pharmaceutical companies. In the case of a generic pharmaceutical company, the contingent fee is usually a percentage of revenue derived from the successful introduction of the generic product into the market. As in the success fee arrangement, the law firm bears some of the risk of losing and, therefore, if the law firm is successful, it shares in the profits of that success. The advantage to the client is that the out-of-pocket costs of the litigation are less than they would be under an hourly fee arrangement, but the downside for the client is that if the law firm is successful, the client will pay more in compensation to the law firm than they would have under an hourly fee arrangement.
Straight Contingency Fee
In a straight contingency fee arrangement, the law firm essentially works for free and takes a percentage of the recovery if they are successful. A contingent fee arrangement has the advantage of costing the client very little money but the disadvantage is that a large portion of the recovery goes to the law firm. In such arrangements, the law firm bears almost the entire financial risk of the litigation and that does not come without a cost. Law firms typically expect to be compensated well for taking the entire risk of a litigation and, therefore, a client can expect to pay much more in legal fees through a contingent fee arrangement if the lawyers are successful.
The patent cliff has caused generic pharmaceutical companies to examine the same alternative fee arrangements that have been used in the legal industry for many years. Ultimately, the fee arrangement that works best for any given matter or client is one which takes into account the absolute cost of the litigation, the cash flow considerations of the client, and how much risk the client is willing to take versus the risk that might be borne by the law firm. Law firms are used to dealing with alternative fee arrangements in other areas, so if one of these fee arrangements (or any other) looks attractive, do not hesitate to discuss it with your outside legal counsel.