The General Counsel’s Dilemma: In-House Counsel or Outside Counsel [Gaille Energy Blog Issue 84]
- Posted by scottgaille
- On April 21, 2020
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For decades, consultants have sought to systematize the process of allocating work between in-house counsel and outside counsel. The largest companies even have entire “legal services” departments, which provide no “legal services” but are instead responsible for decreasing legal costs across the enterprise. I participated in such endeavors both as a member of a 90-lawyer legal department at Occidental Petroleum Corporation and as the Chief Legal Officer and General Counsel of a NASDAQ-listed oil and gas company. With plummeting oil prices, energy General Counsels are looking for every way possible to cut costs and maximize value.
Calculate the Fully-Loaded Costs of In-House Counsel
The first thing every General Counsel should know is the fully-loaded (approximate) cost of each of their in-house lawyers. The below pie chart shows an example of how I calculated this for a Senior Counsel when I was a GC:
The example totals $397,200 (note that the smallest item amounts are not shown on the pie chart). The next question is: how many hours of billable time is it possible to obtain from an in-house counsel over the course of a year? Legal consultants like to assume 1,800 hours of annual billable time, but in my experience, this number is unrealistic because:
- In-house counsels are required to attend and participate in a wide range of non-billable company meetings, which consume perhaps 20% of their available 1,800 hours.
- In-house counsels are responsible for managing outside counsel matters, and this management function reduces their availability to deliver billable hours.
I preferred to assume about 1,200 hours of matter productivity per in-house counsel. I then divided the fully-loaded cost by 1,200 hours to arrive at the approximate hourly rate that I was paying for in-house counsel. In the example above, it was ~$330.
Ascertain Capacity Utilization Needs Over Time
The reality for most energy companies, however, is that workloads fluctuate over the course of the year, as deals come and go. This leads to periods of inactivity for in-house counsels followed by periods when the in-house counsels’ capacities are exceeded—and the use of outside counsel becomes a necessity. If there is insufficient work to keep an in-house counsel busy on a consistent basis over the course of a year, the hourly cost increases (as the number of 1,200 available hours is eroded by periods of inactivity). For example, if deal flow is low during three months of the year (and there is little work for the in-house counsel), the in-house counsel’s effective hourly rate above increases from $331 to $441.
Another issue for energy companies is that they experience dramatic business cycles. There are years of high activity followed by years of little or no activity. This inevitably leads to:
- Periods in which in-house counsels are hired in a competitive market, with added costs for legal headhunters (often 25% of one year’s salary) and signing bonuses. These costs can further drive up the realized hourly rates when they are amortized across an employment period.
- Periods in which in-house counsels are let go, with added costs of severance payments (which retroactively increase their effective hourly rates).
“This gap of 25 to 35 percent [difference between the fully loaded hourly rate of in-house versus the hourly rate of an outside counsel] leaves out of consideration several other factors. The primary factor is that an inside employee is a fixed cost, whereas outside counsel can be used or not used as circumstances dictate. A 30 percent cost differential for a variable expense may strike many people as a fair trade-off.” The Value and Benefits of In-House Counsel, Association of Corporate Counsel.
Understand the Abilities of Each Lawyer
Whether in-house or outside counsel, each lawyer brings a set of skills, expertise, and experience that is unique. The art of being a good General Counsel is picking the right lawyer for each matter. That may be an in-house counsel or an outside counsel, depending on the bench of experience in-house versus outside. General Counsels learn what value individual lawyers can bring over the course of working with them on matters—or by referrals from others whose opinions are trusted.
Expertise is even more important for energy matters. The value an energy lawyer brings increases with every matter and deal, as the lessons learned compile over the years. Experienced energy lawyers have seen many problems and impasses—as well as their outcomes. This means that they are able to call upon an extensive tool box of contracts, clauses, and negotiation techniques to better and more efficiently solve today’s matters.
While every industry has specialized contracts, the energy industry’s contracting practices are among the most complex for three principal reasons:
- The magnitude of risk to life, property, and the environment is larger (e.g., the Deepwater Horizon accident, pipeline ruptures, and plant accidents).
- The cost of energy projects and facilities is higher (a single well can cost more than $100 million dollars, and pipelines can run into the billions).
- There is a considerable technical overlay that must be integrated into the legal terms and conditions (technical exhibits can add hundreds of pages to an energy contract).
Over decades of dealing with these issues, industry practice has adopted many specialized provisions and types of agreements for managing such industry risks. It takes years for energy lawyers to learn each type of energy contract and the nuances of negotiating them. How much an individual lawyer knows depends on the happenstance of deal exposure. A lawyer who has only represented upstream companies may not be much help to a pipeline company that is building pipelines and compressor stations.
Expertise and experience also translate into cost savings. The same tools that are better at solving problems can decrease the amount of time spent negotiating and quicken the pace of deal-making. Experts spend fewer hours reviewing and drafting contracts. Their minds are habituated to focusing on those clauses that matter the most. People are faster at the work they are familiar with. A General Counsel can actually reduce costs by placing work with appropriately experienced energy lawyers—whether they are in-house or outside counsel.
Keep Your Lawyers Busy
The longer a lawyer has to complete a task, the more time will be spent on it. Lawyers are inherently contemplative, and given enough time, they will think of angles and nuances—and rabbit holes to launch themselves down. Sometimes these add value, but more often than not, the 80% solution was sufficient for the client’s needs. At the same time, a General Counsel should not “jam” lawyers, either. Great legal work does require deliberation and careful drafting. If lawyers are overworked, both quality and productivity declines. It’s all about finding the sweet spot where lawyers are under time pressure, but not so much that quality and productivity per hour suffer. This is where value is maximized.
General Counsels accomplish this by:
- Slightly understaffing their in-house counsel so that everyone is kept busy;
- Restricting the number of lawyers at a given firm who can work on an individual matter;
- Limiting the number of outside counsel who are used (by monopolizing the time of a few partners at a handful of law firms, efficiency can be improved);
- Asking about how many hours their law firm associates are working over the course of a year for all clients (too many billable hours = declining productivity and loss of associate value); and
- Assigning discrete tasks with deadlines (deadlines improve efficiency) while avoiding open-ended matters without clear deliverables/deadlines.
Understand the Cost of Using Top Outside Counsel
Law firm hourly rates have increased in recent years, which is likely driven by increased specialization. The average partner rates at large law firms are reported as ~$1,000 per hour, with top partners’ rates approaching $2,000 per hour (Holding: $1,745-an-hour lawyers due for disruption, Reuters, May 25, 2018). Associate rates are not far behind. I have been teaching the Energy Law Seminar at The University of Chicago Law School for several years now, and I routinely speak with my former students—who mostly work as energy associates at the largest law firms in Houston, Dallas, Chicago, and New York. They are reporting hourly rates in the $400s, $500s, and $600s. Assuming in-house legal departments can recruit comparable expertise, General Counsels do have an opportunity for cost savings by shifting some work from large firms to in-house counsel.
Consider the Boutique Law Firm Alternative
It’s precisely the billable rate gap between fully-loaded in-house counsel and the largest law firms that led me to start GAILLE PLLC five years ago. Energy transactions boutiques such as GAILLE PLLC seek to provide clients with a choice between in-house options and big law firm rates. Our business plan is to create a law firm with the same quality of energy lawyers as big law firms—but at lower rates. We’ve accomplished this by keeping our overhead low and recruiting associates who were more concerned about quality of life than the highest salaries.
The advantages of transactional boutiques include:
- Leaner office overhead = lower rates
- Associates are not overworked = more productivity and higher quality per hour billed
- More efficient staffing = fewer hours billed
- Fewer clients = faster turn-around times
Boutique law firms can serve as an efficient capacity manager for legal departments. When the in-house expertise is fully allocated, boutiques can handle the overflow work and fill the gaps more cheaply than it would cost to hire another in-house lawyer—and at considerable savings compared to the large law firms.
Consider Alternative Billing Structures
While most of this post focuses on hourly billing rates, clients also are considering alternative billing practices, including:
- Flat fees. I have had generally positive experiences with flat fees for well-defined scopes of work. Flat fees work best for clients who must lock-in a legal budget at the start of a matter—and have difficulty increasing it later. A flat fee for a legal engagement is like a lump sum construction contract. The law firm includes some contingency in the flat fee to account for risks, such as negotiations taking longer than expected. If the risks fail to materialize, the law firm should do somewhat better than it would have on an hourly basis; if the risks do materialize, then the client is protected from blowing past its budget. Clients also may like lump sums because they incentivize the law firm to move as quickly as possible (with faster closings to transactions having additional commercial benefits other than lower legal costs).
- Transactional Contingency Fees. Transactional contingency fees tie some or all of the firm’s legal fees to the successful closing of a deal. These are most attractive to smaller energy companies, which may struggle to pay legal fees when a deal fails to close. For example, a law firm may receive a multiple of its hourly fees if the deal closes and be paid nothing if it fails to close.
- Minimum Work Commitments. Clients can promise 60-, 90-, or 120-day minimum work commitments in exchange for lower rates on the committed hours.
All of the above demonstrates why efforts to systematize selection of in-house and outside counsels have struggled. Systems are likely to miss certain opportunities and may actually increase costs. For example, how does a system determine the quality trade-offs between two lawyers? The sacrifice of quality can quickly prove penny wise and pound foolish.
“Only the most foolish, shortsighted outside counsel would compromise the quality of representation, client service, or outcome for financial gain.” Garry L. Sasso, The Corporate Legal Department of Today and Tomorrow (Feb. 2019).
Enterprise losses from one weak energy contract—e.g., from poor negotiation or selection of inappropriate contractual terms—can quickly run into the tens of millions of dollars. As such, we should expect that General Counsels will continue to carefully analyze their selection of in-house and outside counsel for energy matters.
About the Gaille Energy Blog. The Gaille Energy Blog (view counter = 130,117) discusses issues in the field of energy law, with periodic posts at www.gaillelaw.com. Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development), and the co-author of Strange Tales of World Travel.
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