I want this post to be an introduction to how modern corporate
legal departments work and how that might affect you as a lawyer or as an innovator.
Ben Heineman Jr. wrote a ~400 page book about what he’s
calling the Inside Counsel Revolution. For our purposes as law students and legal innovators, it is the best entry point for learning about the business of law.
As the "revolution" in the title suggests, Heineman tells the story of an industry in flux, that for quite some time has been driven by changes on the client side and in the broader economy. Because corporate legal departments are probably the largest discrete segment of legal spend (estimated at over $100B), "the revolution" will continue to be relevant to us:
- If you plan to practice at a law firm after graduation, knowledge about business of law and some understanding of how corporate legal departments work should help you win clients and keep them happy
- Obviously, if you want to work in-house, learning about how legal departments work is a no-brainer, and law schools don't usually cover it
- Even though we won't talk at length about what Heineman calls "Alternative Providers" (i.e. legal tech startups and service providers) in this post, what you learn here might set you on the path to being a great employee or founder of one
What this post will cover
A few of the highlights:
- What's driving change at corporate departments
- How in-house professionals decide where to send legal work
- An introduction to legal operations, aka your point of contact in the legal department
- An actual framework to help you understand what legal technology can and can't do
- Which law firms are least vulnerable to pricing pressure
- A few ideas for how to help in-house folks justify legal expenditure
Why listen to Heineman?
As retired General Counsel (“GC”) of General Electric, he was the top
lawyer in a company that employed ~1200 lawyers. Before that he was Supreme Court litigator
(you can listen to one of his oral Arguments to The Court here), he clerked for Justice Potter Stewart on the Supreme Court, and also was the Editor
in Chief of the Yale Law Journal.
How corporate governance affects the corporate legal services market
Because “The Revolution” Heineman describes is driven by many economic, legal, and technological threads, there are any number of ways to introduce it. I think we’d best start our discussion with corporate governance because this offers a glimpse of the big picture
The upstream fiduciary duties of the Board of Directors and
the GC, who are tasked with protecting the corporation, manifest themselves downstream as more a more
accountable and therefore sophisticated and performance-driven law department
than what was common in eras past.
Because the GC’s job is to protect the corporation, the GC can’t be effective unless they’re included by
other members of the management team in important discussions. And in those meetings, the GC’s must command
respect. To earn the sort of clout that
GC’s need to be effective in the C-suite, they need to demonstrate performance.
Heineman here: “[The GC’s] credibility
in the company often depends on cost control.” Also Heineman: “The General
Counsel must pay intense, personal attention to questions of cost and
productivity as the foundation in a relationship of trust with the CEO, the
board, and other senior executives.”
The point is, “upsteam” corporate governance and fiduciary
duty ends up affecting the rest of us
“downstream” because lawyers at corporations are no longer at liberty to
just send work to their friends at law firms and get the bill paid with no
questions asked. As we’ll see, in some
cases corporate legal is asking for, and getting, more for less from their
service providers.
So if your business model happens to be compatible with
offering more for less, it seems like a great time to work with corporate clients.
Structure of a corporate legal department
I haven’t yet had the pleasure of selling legal services to
a corporation, but I imagine knowledge of centralization and decentralized
would be fairly helpful in navigating a deal.
Selling to corporate is one set of relationships, selling to the
business unit is another.
Centralized vs.
Decentralized
·
Who are inside lawyers accountable to?
·
Who pays them?
·
Who pays the service providers they hire?
·
Who pays their department’s settlements, fines,
and penalties?
·
Who can hire or fire them?
If the answer is “Corporate HQ” then the department is
centralized. If the answer is “the
business unit,” then the department is decentralized. Heineman recommends a hybrid model, which is
applicable to all the above as you might expect. Three clarifications are in order:
1)
the business units pay the lawyers and their
service provider’s costs, the for settlements, fines, and penalties, except
when Corporate is concerned that the business units are “being short sighted
and disapproving the costs needed for adequate legal responses to serious
problems.”
2)
In a large company, Corporate should pay and
house “lawyer’s lawyer” specialists, i.e. tax, anti-trust, etc
3)
the GC can stop a firing that was prompted by a
lawyer (rightly) standing up to their boss on an important issue, but in the
case of hiring, the GC can only go to far as setting a slate of candidates from
which the business leader will select.
Legal Ops and Managing Cost
One developing area that few have mastered but now everyone
seems to be interested in is legal operations.
The tagline we’ve come up with for
CLOC’s student section to
describe what it is, in a nutshell, is “Law + Strategy + Technology + Leadership.”
Heineman: “[Senior Counsel-Legal Ops/COO] will work with the
legal leaders to drive innovation ideas across the legal organization, whether
they are reducing cost, increasing productivity, implementing uniform
standards, being on the forefront of technology, or increasing the
effectiveness of the legal intranet. Alternatively, she will lead innovative
initiatives herself, especially ones that mirror broader corporate efforts like
productivity or quality.
The fundamental
mission of improving legal operations through innovation is now a critical job
in law departments, not only because of inevitable cost pressures, but because
the pace of technological change is so rapid.”
Areas for continuous improvement:
·
Information
·
IP
·
Litigation
·
Contracts
·
Transactions
Tools:
·
Virtual deal rooms
·
Digitized environmental compliance
·
Practice group document troves
·
Early case assessments
Heineman on how legal ops interacts with technology: “[T]here
is little doubt that the legal organization’s head of operations must have
changing technology—and its numerous applications—as a primary focus . . . increasingly,
technology touches, and can improve, almost every aspect of law department
operations. It is, of course, based increasingly on the capacity to digitize
core functions and to utilize computerized databases. It increasingly uses
third-party vendors, not law firms (a broad trend often called ‘Legal Process
Outsourcing’).”
Competencies of a legal ops head:
·
Organizational needs assessment and strategy
·
Best practices sharing w/in the organization;
global integration
·
Use of big data for important decisions, i.e.
fixed fees
·
Moving work from firms to more economical
vendors
·
Budget, project, document, and case management
·
With finance, creating metrics for measuring
costs, effectiveness, and efficiency
Heineman again on the challenges of pushing for productivity
in a mature industry: “[The legal ops head] will then work with the whole
organization to embed those metrics in legal operations in quest of the
business holy grail: true productivity improvements. This will usually mean a
central role in patrolling the contested frontier over economics between law
departments, law firms, and third-party vendors . . . ”
How legal departments decide who gets what legal work (segmentation)
One of the deceptively simple but highly impactful decisions
that departments make is segmenting work.
“Low to High” are the poles, and the spectrum is risk and complexity. Departments should first segment their matters
by risk and complexity, then if necessary segment the tasks within those
matters.
Matters:
LOW to HIGH risk and complexity:
·
One-off project, expertise required, but limited
complexity and risk.
·
Routine work with moderate complexity and risk
(patent filings, trademark filings, arbitration)
·
Repeating and complex, higher expertise
required, higher risk (securities annual filing, products liability lines,
multiparty contracts for high ticket price capital expenditure)
·
One-off with high risk and complexity
(class-action, patent infringement against a major comp)
·
“Bet the
company” (Deepwater horizon spill, Megamerger on the level of
Comcast<>Time Warner).
Tasks (using litigation as an example):
·
Production
·
Discovery
·
Analysis
·
Authentication
·
Doc Management
·
Doc Organization
Deciding who does the work
Heineman estimates that business spending on law firms was
about $118 billion in 2014, with GC’s at the top 200 companies in the USA
controlling 50-80% of it. Much ink has
been spilled on topics like
“falling law firm realization rates” and “flat
demand for BigLaw.” It’s also worth repeating Heineman’s observation here that
“the legal marketplace is in a period of transformation with long-term secular
trends in transparency, competition, globalization, and technology (especially
digitized information technology).” My
personal hunch is that the corporate legal market is probably about the same
size or slightly smaller, but law firms’ share of the pie is shrinking because
of technology and alternate providers, to name two.
At any rate, the relevant question seems to be, who should oversee
the work and who should do the work?
Heineman doesn’t lay out the universe of options there, but
there are five buckets as I see it:
·
high cost lawyer
·
low cost lawyer
·
high cost non-lawyer
·
low cost non-lawyer
·
machine
One example: I might assign a Lawyer to oversee production and discovery, but I
might delegate a substantial part of the work to
Technology Assisted Review (a machine). Authentication, Doc Management and Doc
Organization might be managed by a high cost non-lawyer, and performed by a
combination of low cost non-lawyers and machines. We’ll discuss this a bit more below in the
“technology” section.
Whether the lawyers, non-lawyers, machines, etc are
within
the department or
outside is another decision point. You might tactfully remind decision-makers at departments
that while the idea of bringing resources in-house is often seductive because
it seems to offer a way to paying markup on expertise, hiring professionals
only works if it’s truly economical and culturally sound over a long enough
time period.
One more thing—even if someone outside the department is overseeing
the work, the department is going to try to have the bill sent directly from
the provider to them to prevent markups.
So to recap –
1)
Who will manage the work?
2)
Who will perform it?
3)
Is that person (or machine) inside or outside of
the legal department?
Alternative Providers (non-law firm)
Heineman writes about alternate providers at length and
surely I’ll do a post focusing solely on them sometime soon. To tide you over until then there’s a book
co-authored by Mary Lacity that does a deep treatment of Legal Process
Outsourcing – you should pick it up on Amazon.
Technology
When people think about legal
technology, they often think “robot lawyers.” Or
maybe they’re not quite sure what they’re thinking about, but are nevertheless convinced that, sometime soon, their job will be redundant.
Anyway, in my observation what’s actually being adopted
right now are things like eBilling, which enables analysis of a law firm bill
(before it goes out to check for compliance with guidelines, upon receipt by
client to check for the same, both sides with their own motives).
I’ll just note here a few common technology implementations
from Heineman:
·
Organizing documents
·
Searching law firm bills
·
Tracking actuals v. budgets (i.e. see what you
actually get charged)
·
Doing legal research & drafting documents
·
Embedding regulations into systems &
machines
·
(I might add blockchain technology for certain
aspects of transactional work, and hope to write more about this)
Because there is a perception vs. reality gap, I think it’s
important for us to at least try to fully get our arms around what “legal
technology” is. My best advice is to
familiarize yourself with this nice taxonomy of legal tech from Roland Vogl, a
professor at Stanford Law School.
It includes
3 categories (Information Retrieval, Infrastructure, and Computational).
In the same vein,
SLS’s techindex contains 9 species (i.e. Legal
Research, E-Discovery, Analytics, Document Automation).
Law firms: Biglaw
vs. ‘String[s] of Pearls’
Let’s start at first principles. If a law department is sophisticated enough
to segment its matters and tasks, why would they want to engage a mega-firm for
“one stop shopping?”
Heineman is not a fan of large global law firms. Heineman reckons it’s better to “use an elite
firm that has informal associations with elite firms in other nations and a
track record of working together on the type of matter at issue. That informal
‘string of pearls’ may provide better service than the supposedly integrated,
too often mediocre, mega-firm.” I love the
string of pearls metaphor, and of course it’s above my pay grade to comment on
whether or not mega-firms are mediocre.
Alternative Fees
Many have observed that the hourly billing system makes it
hard to align departments’ and firms’ incentives. Departments don’t like hourly billing because
it does little to reward efficiency, and lawyers often dislike it because
filling out time sheets is no fun.
I frequently hear about alternative fee arrangements
(sometimes called “fixed fees”) these days.
The basics are that for relatively predictable engagements
where there’s a course of dealing between the department and the firm, the
parties can agree on a rate which is not based on hourly rates, which leaves
enough of a profit for the firm, and is paid in a way that eases the cashflow
problems many firms must deal with.
What happens if the matter comes in below the cost? The law firm still gets paid the fixed fee,
so that matter was more profitable to them.
What about cost overruns? The
firm has to absorb the cost. (There are
also “collar” agreements where within a band, i.e. 20% above cost, 20% below
cost, the parties split the burden or profit, but only within the collar. So starting at 21% under budget, it’s pure
profit for a firm)
Heineman’s insights on AFA’s: “Historical data can provide
the starting point for negotiating the fixed fee, especially for books of
recurring business/cases. Both firms and corporations have detailed information
on the past costs of a variety of matters, especially if task-based billing
codes have been used in good faith over a number of years. This is an instance
where new technology can really be important. Big data and data-mining
techniques can determine reasonable ranges of cost for the different types of
matters. While this may be a good way to start, a history of the costs of
matters may be an imperfect guide because it is the sum of hourly rates plus
out-of-pocket costs and may reflect precisely the type of inefficiency and
overbilling that the fixed fee seeks to eliminate. Developing big data screens
to deal with this issue is vital.”
Heineman on pitfalls to watch out for: “The good news about fixed fees is that they
may drive firms to leaner, more productive staffing. The bad news is that, even
though they need to produce a good result, firms may cut resources too far and
impair quality in order to get a bonus for coming in under the fixed fee. Or,
despite the sales pitch up front, the key partner may spend less time on the
matter than promised (or warranted). That is why inside counsel must either
consistently—or on a sampling basis—review the quality of the ‘tasks’ that
comprise the ‘type’ of work. So, too, if the corporation is on the hook for
absorbing part of an overrun, it will want to track costs the firm is actually
incurring. This may result in review of ‘shadow hours billed’ or other law firm
‘cost’ categories—if not on a monthly basis, then perhaps on a quarterly or
half-year basis. Technology and project management in both corporations and law
firms can make this tracking more transparent, effective, and, perhaps, timely.
Technology also may have an important role in helping inside counsel manage the
matter when multiple outside parties may have tasks to perform.”
But in some ways, nothing really has changed in law land
While it’s true there’s a lot of useful innovation in law
land, it still is the case that truly
elite law firms have almost nothing to fear and will probably change little. It’s unclear that they really need to. But. If
you have to ask whether you’re elite, you already know the answer.
Heineman: “Finally, despite all the changes in the past 25
years, there is little question, in my view, that on any matter of signal
complexity and consequence—the ones high up on the segmentation ladder and on
which the GC will be judged—it is still the ‘lawyer not the firm.’ The ‘free
agency’ of talented lawyers and the churn as firms poach each other’s top
partners—with corporations following the lawyer—demonstrates the continuing
power of the ‘lawyers not law firms’ rubric. Top inside lawyers must spend time
identifying the neurosurgeons—and having a relationship with them—as an
important insurance policy for the deeply important ‘predictable surprises’
that will invariably occur and will require the absolute best talent.”
He mentions that certain bankruptcy lawyers in 2008 were in
extremely high demand and were able to just send their clients a substantial
“for services rendered” bill. And that
lawyer’s fee was probably well worth it.
Metrics corporations use to measure legal spend
Generally, corporations will measure legal’s performance using
one of more of the following metrics. I’ve
quoted Heineman’s thoughts on each point at length because there wouldn’t be
much ROI on condensing them here:
1) Total spend (not
ideal!): “A key historic metric for legal organizations is total annual
legal spend: the cost of inside lawyers plus the amount spent on outside law
firms and other vendors serving the Legal function (but excluding the costs of
verdicts or settlements). A crude measure of legal organization efficiency is
total legal spend as a percentage of total corporate revenues compared to peer
companies. On this metric during my tenure, GE was at the bottom of the second
lowest quartile of large companies (defined at the time as having more than $5
billion in revenue) as surveyed by third-party accountants or consultants. But
there were all sorts of problems with this number.”
2) Department’s percentage
of total legal spend (higher is better?): “Another common number is
inside legal spend as a percentage of total legal spend: 40 percent, 50
percent, 60 percent? An increase in inside legal spend can mean lower total
legal spend if highly talented and productive lawyers are working closely with
business leaders and doing the corporation’s legal work rather than using their
contact lists to call law firms.”
3) “Reality based”
(Heineman’s pref): “In the new, more sophisticated world of
law department management and finance, determining appropriate cost would
ideally be “reality based,” turning on the opportunities and risks associated
with different corporate activities. The cost analysis should involve
developing and implementing not just metrics for the legal organization as a
whole, but, importantly, for specific legal areas—Tax, Trade, Antirust,
M&A, etc.—as applied to specific businesses within the corporation and to
different geographies. Where can there be fewer resources? Where should there
be more? What is the mix between inside/outside legal and non-lawyer resources?
. . . There are now legions of consultants and experts willing to assist legal
departments with these fine-grained, context-specific issues.”
Best practices for GC's and the legal department to justify expenditure
There are a few species of justifications corporate legal
departments can make to justify proposed legal expenditure. (You’ll want to be familiar with these so you
can help your internal champion make them.)
Five approaches:
·
Increased productivity/net reduced direct cost
·
Net added direct financial value
·
Intangible future value
·
Nonfinancial and Financial Costs Avoided
·
Identifying catastrophic risks
Heineman says sometimes numerical logic is most persuasive,
but sometimes ‘another approach’ will work better. There’s a fair bit of tactical coverage on how
to wage ‘the budget wars’ that you can read when you pick up the book.
How to fill law schools' education gap for vital in-house skills?
The casebook method that all American law schools use
has served us for over 100 years. Close reading and basic legal analysis are important
skills. But more’s required to be an
in-house contributor. “General Counsels
have a wide range of options to fill in this knowledge gap for those lawyers
who have not already had experience with business matters (or a joint JD-MBA).
My effort was called the Advanced Business Course for Lawyers. It was given each
year to about 25 high potential lawyers who attended a week-long course at GE’s
business school where they were taught by experts in corporate finance,
including visiting professors from business schools. But this initiative didn’t
reach enough people, and I should have realized this mistake earlier than I
did.
I should have created an online
course that could have covered some of the basics and been available to
everyone. GE had the resources to create its own online education, but
today there are many opportunities outside the corporation, including mini-MBA
courses for inside lawyers offered by the Association of Corporate Counsel”
Wrapping up
The Inside
Counsel Revolution is a must read for law students. Even if you’re going to end up at a firm,
being aware of the "long term secular trends" that Heineman mentions like
transparency, globalization, and technology will help you decide how to productively allocate your time as a student.
Given the choice, should you read one more footnote, or learn about emerging
technologies and new processes that could benefit your future clients?
You’ll need to decide what’s right for you.
But it does seem that we live in an
exceptional time, one where the gameboard is changing, few want to acknowledge
it, and even fewer have the courage to do anything to capitalize.
