A LAWYER’S COSTS: Behind the Legal Fees
Chapter 8: What’s Behind the Legal Fees: A Lawyer’s Costs.
The purpose of this chapter is to give the reader an insight into the financial constraints faced by lawyers. It is also designed to give the reader an appreciation of why legal services are expensive. Moreover, this chapter also creates a foundation for the chapter covering fee agreements.
IMPORTANT COSTS THE LAWYER MUST COVER TO PROVIDE REPRESENTATION TO THE CLIENT:
The costs that lawyers incur can vary significantly depending upon the location in which they work and the type of law that they practice. Costs can also vary depending on the size of the firm. Thus, any discussion of costs based upon hypothetical or supposedly typical figures can be misleading. Nevertheless, an understanding of costs is necessary to understanding a lawyer’s economic incentives. Therefore, to make this concept less abstract and to put matters in perspective, a bold attempt will be made below to come up with a “typical” or average lawyer’s costs.
The Cost of Training and Education.
The vast majority of lawyers have attended three years of law school. The cost of this can vary greatly depending on several factors, namely whether the lawyer attended a public or private law school, whether the school was located in his home state, whether he received any scholarships or grants and various other factors. Tuition alone can cost anywhere from $15,000 to $60,000 or more for three years of law school. Student housing can cost additional thousands. Moreover, many law schools discourage students from having part-time jobs during their first year of law school. This makes it more difficult to offset some of these costs.
If it is assumed that the student can pay for his food, transportation and miscellaneous costs with any part-time income that he earns during law school and that he has completely paid for his undergraduate education, it is not unrealistic to assume that, on average, a lawyer will have $35,000 in student loan debt attributable to his legal education. Naturally, some graduating students may be better and others worse off. (In fact, the author has heard of more recent law students graduating with over $100,000 of student loan debt. Lawyers who have been in practice for a longer period, however, may have no outstanding student loans and their costs should be considered for averaging purposes as well.) It should be noted, however, that the foregoing does not take into account the “opportunity cost” of law school (let alone the opportunity cost of an undergraduate education). Opportunity costs are those costs that reflect the loss of income that a law student would suffer if, instead of going to law school, he was employed in a full time job. In other words, if a law student could have earned $30,000.00 during each of his three years of law school, the real net cost of law school would be $90,000 greater than the figures herein suggested (that is, $125,000). For present purposes, however, and with apologies to all economists, these opportunity costs, which are very significant, will be ignored. (This means, of course, that the costs calculated below will be substantially understated in true economic terms.) From a cashflow perspective, however, it is hoped that the costs calculated in the following sections reflect a fairly normal situation.
Accordingly, if it is assumed that a lawyer has an outstanding student loan in the amount of $35,000 bearing interest at the rate of 8 percent to finance his education and that the lawyer is able to negotiate a repayment term of 10 years, then the average graduating law student will have a monthly payment of $425 to repay this debt.
Some may argue that educational costs are not technically a true “expense” for purposes of determining net profit and that they therefore should be ignored for purposes of calculating any cost of doing business. This is because a line item for the repayment of student loans does not appear as a business expense on the lawyer’s profit and loss statement. The lawyer’s education costs, however, are necessary to the conducting of the lawyer’s business. This is true despite the fact that they were incurred in the past. Perhaps accounting and tax purists would prefer to think of this as a situation where a law firm pays the tuition of one of its employees to go to law school. In this regard, it should be noted that any student loan taken out to fund a law school education is not dischargeable in bankruptcy and that payment of these loans is, from a practical perspective, necessary in order for the lawyer to engage in his business. As such, law school education expenses are a true and necessary cost of providing legal services and should be counted as a part of a lawyer’s cost of doing business.
Rent, Salaries and Overhead.
Firms have a myriad of salaried employees including receptionists, secretaries, bookkeepers, paralegals and associate attorneys. Firms may also employ investigators, computer specialists, human resource personnel and perhaps others. A law firm must pay the salaries, employment tax and the fringe benefit expenses of all of these employees in order to stay in business. As such, each lawyer who is an owner or partner of the firm must pay his pro rata share of these expenses.
The structure of law firms, in terms of support staff, varies greatly depending on the type of legal work involved and the volume of business being generated. Some lawyers do not have their own secretary or their own paralegal. Others may share one secretary with two or three other lawyers. Still others may have a secretary, a paralegal and other support staff directly assigned to them. Once again, generalizations are difficult. In an attempt, however, to examine the typical cost of an attorney, it is best to ignore extreme situations as where, for example, a lawyer is practicing by himself with no support staff, and situations where each attorney has two or three members of support staff helping him.
Since it would not be unusual, on average, for an attorney to have the equivalent of one support person helping him, this scenario will be used for purposes of the cost analysis below. Therefore, the cost of that support person must be covered or recouped from the legal fees earned by that attorney in order for him to stay in business and remain profitable. The question then is: What is the cost of that support person?
It would not be unusual for a paralegal to make anywhere from $22,000 to $40,000 per year, depending on the location of the law firm, the size of the law firm and the experience of the paralegal. If it is assumed that a firm pays $33,600 per year in salary, employment taxes and fringe benefits costs for one paralegal, this means that the firm must spend $2,800 per month for that paralegal’s services. Similarly, a secretary will generally cost a firm anywhere from $20,000 to $35,000 per year in salary, taxes and fringe benefits. This means that it is not unrealistic to assume that it costs a law firm $26,400 per year or about $2,200 per month to keep a full-time secretary on staff.
A small firm would probably have one or several persons performing secretarial and paralegal tasks. For present purposes, however, the “average” lawyer is only allocated the costs of one support person. Therefore, the average salary of one half of a paralegal and one half of a secretary would be a fair way to allocate support costs to the attorney. Thus, if that support person is paid at the average of the paralegal and secretary rates, then that lawyer has to pay his support person the equivalent of $2,500 per month (that is, $2,800 plus $2,200 divided by 2) to cover that support person’s salary, taxes and fringe benefits.
Rent, of course, is another expense that a lawyer must cover. The amount of his rental expense depends on the geographical location of the office, the size of the office, the quality of the facility and other factors, including whether cleaning services, utilities and parking are included. However, if it assumed that a lawyer must have sufficient space for himself, one support person and his pro rata share of any storage area, conference room, kitchen, restroom and copier areas, it is not unreasonable to assume that his total rental expense is $800 per month.
Naturally, the lawyer also has other operating expenses such as copier and equipment expenses, telephone bills, the cost of supplies, postage, bar dues, tuition for continuing legal education programs, taxes for business licenses and professional liability insurance premiums.
Below is a breakdown of the monthly costs and expenses of a hypothetical average lawyer who is a partner at a small law firm. The figures take into account the lawyer’s pro rata share of his partnership expenses:
A Lawyer’s Monthly Costs and Expenses.
(figures are approximate and from year 2003)
Rent $ 800
Wages, taxes and benefits of a support person 2,500
Telephone 350
Postage 235
Supplies 100
Equipment Rental 50
Bar Dues and Continuing Legal Education 100
Liability Insurance 100
Gas, Parking, Tolls 200
Advertising/Marketing 200
Miscellaneous 150
Debt on Student Loan 425
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Total Monthly Expenses: $5,210
The Actual Hourly Cost of Doing Business.
If the monthly expense of $5,210 is annualized, the “typical” lawyer will have expenses equaling $62,520 that he must cover each year in order to stay in business. This includes debt service on his student loan. If it is assumed that there are 8 working hours in each business day and that there are 50 working weeks in a year (allowing 2 weeks for vacation), then there are 2000 working hours per year. To put the lawyer’s cost or “breakeven point” on an hourly equivalent basis then $62,520 must be divided by 2000. This means that the lawyer above must make at least $31.26 per hour in order to break even. Consequently, the lawyer in the above scenario will not earn any profit or salary for himself unless he makes at least $31.26 per hour. Thus, if he earns less than $31.26 per hour he will lose money. If he earns more than $31.26 per hour then, and only then, will he have enough money to earn a paycheck for himself. Of course, if he is fortunate enough to make more than $31.26 per hour, then the size of his paycheck will depend on how much larger his hourly billing and collection rate is than $31.26 per hour. Thus, if the lawyer bills and collects $50 from a client for one hour of work, the lawyer can pay himself $18.74.
For ease of reference, the $31.26 hourly breakeven cost will be rounded down to $30 per hour. This $30 per hour figure will hereinafter be referred to as the lawyer’s actual breakeven hourly cost of doing business.
Inefficiencies Create Higher Hourly Costs.
Unfortunately, matters are much more complicated than even these useful breakeven numbers reveal. This is because lawyers perform many tasks during any business day that are not directly billable or attributable to any particular case or client. Such tasks include handling basic business matters such as marketing, billing, bookkeeping, collection of past due fees, banking, attending required continuing legal education seminars, law firm meetings and general public relations. These non-billable tasks can consume a significant amount of the lawyer’s time. This is significant because during the time that the lawyer is performing these tasks he is not generating any income to offset his hourly costs.
War Story: John, a lawyer, received a call from a prospective divorce client. He spent twenty minutes on the telephone with the prospective client discussing property settlement, alimony, child support and a myriad of other issues. After listening to the client, John concluded that the prospective client had a “contested” divorce case.
As a result, John told the client that he would require a deposit of $1,500 to take the case. The prospective client then set up an office appointment for 11 a.m. the following Thursday. John, however, really didn’t want to schedule an appointment at that time because John had one court appearance scheduled at 10:00 a.m. and another at 1:00 p.m. Moreover, both appearances were scheduled to be at the same courthouse fifteen miles from John’s office. The appointment and the forty minute round trip necessary to attend it would prevent John from conducting some legal research that he wanted to do at the courthouse library during the period between hearings. Eleven was the only time, however, that the client could get off work, so John agreed to meet him at that time.
On Thursday, John finished his first hearing at 10:45. He then rushed back to the office for his appointment. Unfortunately, the client failed to appear for his appointment. John then called the client, who apologized but informed John that he had found a cheaper lawyer.
In the war story above, John not only lost the twenty minutes he spent consulting with the prospective client but he also lost the travel time between the court and his office. This equaled approximately one hour of potential billable time that, of course, was lost. Moreover, he had accrued costs of $30 for the hour that he wasted.
In this regard, it is important to note that the less support staff that an attorney has the more time he must spend on the administrative, general business and clerical matters for which he cannot bill clients. Thus, for example, sole practitioners who have no support staff would have a lot more non-billable time that is inefficient than a lawyer who has one, two or even three support people working for him. Thus, while a lawyer working without a staff would have less salaried overhead, he also cannot usually bill as much time as a lawyer who has more support staff.
Time Not Billed on an Hourly Basis.
There are other examples of inefficiencies in a lawyer’s day. In this regard, and as will be seen in the chapter dealing with fee agreements, a lawyer cannot bill or collect legal fees on contingent fee cases that he has lost. An example of this would be a plaintiff’s personal injury case in which the jury returns a verdict for the defendant. All of the time spent by the lawyer working on such a case is, in essence, wasted. Moreover, a lawyer will not receive hour for hour compensation on any case on which he is working for a set or specified flat fee. This can cause a lawyer to lose money to the extent that he spends more time on a flat fee case than he anticipated. Again, the reason for this will be discussed in more detail in the flat fee section of the chapter dealing with fee agreements.
In any event, the lawyer must still pay his rent, his secretary and his other overhead costs, even if he isn’t billing. In this regard, if the hypothetical average lawyer above had spent an entire day on matters such as a contingent fee case that he ultimately loses, he would have lost 8 times $31.26 or about $250.00 for that day. By the same token, if he had charged someone a set or flat fee of $200 to handle a minor traffic offense but unexpectedly spent all day in court, the lawyer would lose $50 for that day.
In the chapter on fee agreements, the issue of “implied limits” on hourly fees is discussed. The war story of Jane, the newly minted lawyer, in that chapter is relevant to the concerns addressed above. Suffice it to say that many lawyers feel that, on average, and given the inefficiencies discussed above, they are fortunate to “bill” five hours for each eight-hour day. In any event, this is one reason why most lawyers work more than forty-hour weeks.
The Effective Hourly Billable Cost.
The importance of all of the foregoing is that, assuming that five hours per day is actually billed, and, if it is further assumed that $250.00 in breakeven costs must be covered each day, then the hypothetical attorney discussed above has an “effective” breakeven cost per hour equaling $250 divided by 5 or $50.00 per billable hour. Thus, for each hour that the lawyer actually bills, he must collect at least $50 per hour, otherwise, not only will he not make money, but he will also lose money.
Other Costs
There are also significant hidden costs that substantially affect the $30 and $50 per hour hourly cost rates noted above for the average lawyer. These hidden costs, which may increase these rates (depending on whether they are included in the “miscellaneous” costs category of the typical lawyer set forth above), are discussed below.
Financing Costs
Like most businesses, lawyers have financing costs. These are costs that are related to situations where the accrual of attorney’s fees and cash revenues do not match cash expenses. For example, most lawyers handling personal injury cases on a contingent fee basis get paid only if they win, and then, only after the case goes to trial or is settled, which could take months or years. In the meantime, lawyers must pay, in cash, their overhead and their other operating expenses. Borrowing money to pay these expenses while the case is pending causes the lawyer to incur an interest expense (or, if the lawyer has retained earnings sufficient to cover these expenses, at least an expense in the sense that there is a delayed enjoyment in the use of the funds). For most businesses this would appear on the income statement as an interest expense for business loans for working capital that have been made to the company. Indeed, many law firms have a line item for interest expense on their income statements.
Losses on Costs Advanced.
In many states, a lawyer is not permitted to pay a client’s litigation costs unless the lawyer maintains the right to seek reimbursement for those costs from the client after the case is over. In other words, in these states, clients must remain ultimately responsible for paying these costs. Litigation costs include filing fees, court reporter fees, fees for expert witnesses and investigators and a myriad of other “out-of-pocket” costs that lawyers incur in the course of representing their clients. Many states have ethical regulations regarding the right of the lawyer to “advance” these costs. Many firms do, however, advance costs, particularly in personal injury cases. Even if the lawyer advances these costs, however, the lawyer must, in many states, seek reimbursement from the client for these advanced costs at the end of the case. Nevertheless, and ethical principals notwithstanding, many lawyers do not seek reimbursement of these costs from the client if the case is unsuccessful. There are public relations and marketing reasons for this. Also, many, if not most, contingent fee clients simply cannot afford to repay these costs.
For example, in a typical personal injury case, the person injured (that is, the plaintiff) and the lawyer usually enter into a contingent fee agreement whereby the lawyer will be paid a legal fee only if he is successful in obtaining a judgment or a cash settlement on the client’s behalf. In such a case, the lawyer’s fee is based upon the amount of the recovery. If the lawyer and client lose the case, however, the attorney earns no fee. Unfortunately, the client may still be responsible for reimbursing the attorney for costs advanced. Costs advanced, in turn, can reach hundreds, if not thousands, of dollars, depending on the case. In this regard, costs can be particularly high in cases where there are several expert witnesses. In products liability and medical malpractice cases, for example, litigation costs can reach $10,000, $20,000 and beyond. If a law firm advances funds in order to pay these costs out of its own pocket it is obviously a significant drain on the firm’s cashflow. This can be particularly expensive in cases where costs are high and the case takes a long time to resolve. This, in turn, can significantly add to the firm’s interest or financing expense during the year because the firm, in the meantime, must pay for its other overhead expenses. Moreover, this is true even if the firm is ultimately successful and wins the case. The situation is much worse, of course, if the firm loses the case and the client does not reimburse the law firm for the advanced costs. Thus, for example, a law firm could lose a lot of money if a client does not reimburse a law firm for $20,000 in costs advanced in an unsuccessful product’s liability case. In short, losses incurred for unreimbursed costs must be paid out of the lawyer’s own pocket and represent a cost that must be recovered in other cases. In this sense, they can significantly add to the lawyer’s cost of doing business.
The Lawyer’s Compensation; One Perspective.
Assume that the hypothetical average lawyer above has a billable rate of $150 per hour and that he, in fact, is billing his clients for five hours of his time each day. (Remember, under the previous discussion, it was assumed that a lawyer can only effectively bill five hours per eight hour day due to the inefficiencies previously discussed.) This means that for each five-hour day in which his effective costs are $50 per hour, his “profit” is $100 per hour. If there are 50 weeks in the year and 25 billable hours each week this means that his “profit” would be $125,000. On the other hand, if the lawyer’s billable rate is $100 per hour then his “profit” would only be $62,500. Out of both of these profit figures, however, the lawyer would have to fund any retirement plan that he has and pay his employment taxes and the premiums on his health insurance. Thus, the amount of money that the lawyer has to “take home” is even less than what might be assumed under either of these scenarios.
In addition to the foregoing, it should be remembered that there is a limited amount of time in the year. Thus, unless a lawyer actually bills more than 5 hours per day and actually gets paid for it, the profit figures in the previous paragraph represent the maximum that the typical lawyer above can expect to receive during the year. This assumes that all of his clients actually pay their legal bills and/or that the lawyer receives no windfall profits on a contingent fee or a flat fee case.
Taking this discussion even further, if it is assumed that the lawyer is responsible and has paid all of his costs and expenses for the year, any unpaid legal bills represent a direct reduction in the lawyer’s expected net profit. For example, if the lawyer above had paid his secretary’s salary, his rent and his overhead and other expenses then any uncollected legal fees represent a dollar for dollar deduction from his expected profit. Thus if clients, A, B and C owe the attorney $2,000, $5,000 and $8,000 respectively and if they do not pay, then the attorney (assuming he is billing at $100 per hour) will net only $47,500 in profit for that year. All of this, of course, is before taxes, health insurance and other benefits. Under such circumstances, the attorney above, would be highly upset at A, B and C, particularly if, for his own personal financial reasons, he needed an income of more than $47,500 in order to pay his home mortgage and his other personal expenses.
What Are the Consequences for Clients?
When dealing with lawyers and determining the probable cost of the legal services you should ask yourself the following questions. (The hours in parentheses denote the typical minimum amount of legal time that would be required in the simplest cases. Your case, of course, could require more time.)
- How much time will the lawyer spend during the initial consultation and information gathering stage of your case? ( 1 hour minimum, although some firms provide this service free of charge.)
- How many telephone calls, letters, e-mails and faxes are likely to be exchanged by the lawyer with you, the opposing party’s lawyer, witnesses, expert witnesses and other parties to the transaction? (1 hour minimum.)
- How much time will the lawyer spend on any legal research? (Maybe none in simple cases, but research could require a significant amount of time in contested cases.)
- Will there be any “discovery” in the case? How many witnesses are likely to be deposed? How long with that take? (The answer may be none if the case is tried in a Lower Court. See the discussion in the chapter dealing with civil procedure for a further a discussion on this issue. In civil cases tried in a Court of Record, however, a large amount of attorney time may be required.)
- How many agreements and pleadings will have to be reviewed, drafted or prepared? (1 hour at minimum will usually be required. Obviously, however, this figure can vary significantly. In this regard, it should be remembered that even the simple act of settling a case normally requires the drafting of a settlement agreement and the entry of a court order.)
- How many court appearances will be required and how long will they take? (This often depends on whether the case will be held in a Court of Record, whether any discovery will be necessary in a case and whether any pretrial motions will be necessary. Even in simple cases in the Lower Courts where only one court appearance is necessary travel time and congested court dockets can cause a court appearance to be time consuming.) (1 hour minimum.)
- As will be seen in the next chapter an additional important question is whether expert witnesses will have to be hired.
Significantly, if the hours noted above are added and then multiplied by the lawyer’s effective hourly cost, this means that the average lawyer has costs of at least $200 when he handles a simple case. (This is computed by taking the 4 minimum hours noted above and multiplying that figure by the $50 per hour effective breakeven cost discussed in previous sections.) Moreover, in the event that the lawyer only needs to earn $62,500 in a given year, this means that he will bill his clients at a rate of $100 per hour. Consequently, his legal fee is likely to be more than $400 for a simple case. In this regard, it is likely to be more than $400 because most lawyers want to make as much money as they can. Moreover, even if they aren’t greedy, they will often bill a client more than $100 per hour if for no other reason than they must offset losses that they’ve incurred from nonpaying clients. This, in turn, implies that if the hypothetical average lawyer charges the client less than $400, he is not likely to spend much time on the client’s case. This, of course, will affect the client’s perception of how much the lawyer cares about his case.
In any event, by asking yourself these types of questions, you may be better able to estimate the amount of money that you are likely to be charged for legal services in any given case. You should then consider whether you have budgeted for such an expense when figuring your personal finances.
The final point to be made is that the figures above assume the simplest case requiring the least amount of legal effort. Many, if not most, legal cases require more than the minimum effort. This, in turn, raises questions as to the ability of certain persons, especially those of lower or moderate incomes, to afford legal services, especially in situations involving complex factual or legal issues where their lawyers’ time involvement is likely to rise significantly.
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