With the spiralling cost of outside counsel showing no sign of abating, bringing lawyers in-house could be economical for your business and result in a higher standard of work, says Michael Ross

Little needs to be said about the continuously increasing cost of retaining outside counsel and there is little hope that the economic downturn will do anything more than temporarily slow the increases. Moreover, the slow economy will step up the pressure on companies to reduce their legal costs.

Alternate billing arrangements have become more common but still account for only a small percentage of outside counsel billings, and those arrangements do not guarantee lower long-term costs. Moving work to smaller firms or firms in geographic locations with lower rates can help, but only so much. There are transition costs and risks, and only some sorts of matters may be movable.

It is, therefore, no surprise that many companies are considering moving more legal work in-house. Here is a brief summary of some of the considerations and issues.

Outside billings

The process must start with a careful and thorough analysis of outside billings. Billings of five years or more should be used to identify steady volumes of work and to avoid statistical anomalies. Decisions should not rely only upon averages, which can be misleading, but should also take into account the distribution of costs over the years reviewed. Consideration of the matters behind the numbers is important when it comes to determining if costs were affected by non-recurring factors. Targeted work may well not be the work that is billed at the highest rates but, more likely, the work that comprises high volume in outside legal billings. On the other hand, 'commodity' work (performed outside at highly-competitive low rates and costs) will be difficult to do in-house at lower costs.

The selection of practice areas that may be moved in-house is critical. The results will vary by industry and geographic location. Generally, the prime candidates include: regulatory; employment; employee benefits; intellectual property; commercial; environmental; and tax. Some corporate and securities work may also be manageable for in-house counsel. In many situations, some continuing consultation with outside counsel will be necessary.

Consideration must also be given to the capacity of in-house lawyers to manage matters effectively and efficiently. Often this means that in-house counsel will handle routine, recurring and relatively low-risk matters, but this need not be so.

Qualified in-house counsel can deliver results at levels comparable to or better than outside counsel if they have the resources to stay up to date and react quickly to changing circumstances and laws. There should be a sufficient number of in-house lawyers to ensure coverage for expected and unexpected absences. They should have adequate paralegal and other administrative support. In-house counsel will also need to keep abreast of what similarly situated companies are doing; something that outside lawyers can do because they and their colleagues are working for many clients.

Inside costs

The next step is to calculate the expected cost of adding in-house counsel. This begins with deciding on suitable salary and benefit packages (which, according to recent surveys, account for approximately 80% of total in-house cost) in order to attract high-quality lawyers from law firms and other legal departments. Total compensation at many law firms and legal departments has been rising in recent years, so hiring away lawyers can be expensive. But there may be opportunities to hire fee earners from firms and departments where compensation is lagging. The initial cost will depend on the targeted practice areas and geographic location of the lawyers and the hiring company. Cost estimates should include dedicated support staff and other applicable general and administrative costs.

In-house departments should not need to compete pound-for-pound with the lawyer's current employer. Ancillary benefits may be very attractive and offset compensation shortfalls. In-house legal work generally allows for a more accommodating lifestyle than what is available at many law firms. In-house lawyers become part of a team and can develop closer ties to their clients. In-house counsel are not responsible for producing business and often there are opportunities for in-house advisers to move into business careers within the company.

Just as outside counsel costs are expected to increase, so are in-house costs, driven primarily by lawyer compensation and benefits. Lawyers will expect and receive salary increases and, in many public companies, stock options may appreciate in value and result in additional expense when the options are exercised.

In some practice areas, special attention to accounting and tax treatment of outside counsel costs is important. In some matters, including real estate projects, outside counsel costs may be capitalised while employee costs are treated as ordinary expenses.

Managing expectations

Some businesses use a rule of thumb, based upon experience in other areas, that the cost of doing something inside the company should be approximately one-third of the cost of obtaining the services outside the company. It will, therefore, be important for general counsel to manage expectations about the possible savings from bringing additional work inside the company.

One of the biggest risks in moving work is that doing so will adversely affect results. Obviously, the savings from bringing work in-house may be more than offset by the cost of lower-quality legal work, from regulatory compliance to dispute management. It is critical, therefore, that the company hires qualified, highly-competent lawyers for the targeted work, that they are fully supported and that they never sacrifice results for reduced costs.

The analysis of the advantages and disadvantages of bringing legal work in-house is complex. Costs and benefits will vary by industry, practice area, the geographic location of the company and its culture. Although much of the focus will be on future outside costs to be replaced and future in-house costs to be incurred, additional in-house counsel may create benefits that are difficult to quantify. Although they may be working for numerous people, they will be serving one client and may be better motivated than outside counsel to achieve the highest-quality results at the lowest possible cost. They will not have the inherent conflict of interest created by the billable hour. In-house lawyers should gain a better understanding of their company's business than outside counsel, whose attentions are often split among numerous clients.

As a result, in-house counsel may be more effective and efficient than outside counsel in managing many matters. When their workload permits, in-house counsel may be more available and effective than outside counsel for prophylactic advice and training. Look for more companies to be adding lawyers to their legal departments in the future.

Michael Ross is a former general counsel of Safeway and a consultant at Altman Weil.

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