As law firms increasingly bring e-discovery software and services in-house, some grapple with whether and how to bill for those services in a way that is both fair to the client and conducive to the firm's bottom line. At the heart of these questions are ethical considerations about the appropriateness of passing through certain "costs" and "overhead," and, given the ambiguity of those terms and the changing nature of legal technology in general, how certain expenses should be treated.
At a high level, most authorities, including the ABA Model Rules, agree that a law firm can charge a client for all expenses and costs included in the initial fee agreement, provided those fees aren't "unconscionable." But barring that agreement, it is likely only appropriate to recover from the client costs that are incurred directly by the law firm. The purpose of this cost recovery is not for the attorney to profit, but rather to recoup expenses necessarily incurred to represent the client.
In the context of services that aren't in the law firm's bailiwick and that also aren't included in the fee agreement, ABA Formal Opinion 93-379, a definitive analysis on billing norms, states:
In the absence of an agreement to the contrary, it is impermissible for a lawyer to create an additional source of profit for the law firm beyond that which is contained in the provision of professional services themselves. The lawyer's stock in trade is the sale of legal services, not photocopy paper, tuna fish sandwiches, computer time or messenger services.
Or, you could add, data processing and other e-discovery work that may not qualify as "legal services." From a practical standpoint, then, if a law firm seeks to mark up software-generated fees, such as data processing, it must get written permission from the client. Otherwise, it appears that those categories of costs cannot be incurred as a means to generate firm profit -- only passed through.
Here, though, it is important to make the distinction between "services" that are automated by software or hardware, and the additional value-added services the firm can offer clients by leveraging those in-house or cloud-hosted systems. ABA Ethics Opinion 08-451 makes it clear that law firms can absolutely charge for litigation support/e-discovery services, provided they are not unreasonable. A reasonable mark-up fee may even be permitted. So, whereas it may be impermissible to mark up, for instance, processing fees without a written agreement, it is certainly the case that law firms can bill for additional services such as ESI consulting or e-discovery project management that, in the absence of that software, it would otherwise be unable to.
Billing for Overhead
Guidance on overhead is not as clear, as it appears a) that legal and ethics opinions are not in agreement as to whether it can be recovered as a cost and b) whether the expense incurred for the overhead associated with an in-house service can be recovered depends on the type of in-house service. If one were to follow California federal precent (see e.g. American Small Business League v. U.S. Small Bus. Admin. (N.D. Cal. September 12, 2005) 2005 WL 2206486), for instance, it would only be proper to bill back expenses considered to be overhead if such an arrangement was explicitly agreed to in writing. On the other hand, ABA Formal Op. 93-379 states plainly:
"The lawyer may recoup expenses reasonably incurred in connection with the client’s matter for services performed in-house, such as photocopying, long distance telephone calls, computer research, special deliveries, secretarial overtime, and other similar services so long as the charge reasonably reflects the lawyer’s actual cost for the services rendered."
As a rule of thumb, "overhead" can be thought of as the cost of doing business. Often cited examples are fees for legal research, the costs of phone calls and meals and so on. In the context of e-discovery, where the firm has its own internal solutions or is hosting the solution on a cloud-based application, like Logikcull, the overhead expenses may be those incurred to maintain and service the software/hardware or the subscription fee, respectively.
Can these costs be passed through to the client? In short, yes, but billing for so-called "in-house provision services" is a more delicate issue on which Formal Formal Op. 93-379 again offers useful guidance. It states in pertinent part:
"Like professional fees, it seems clear that lawyers may pass on reasonable charges for these [in-house] services. Thus, in the view of the Committee, the lawyer and the client may agree in advance that, for example, photocopying will be charged at $.15 per page, or messenger services will be provided at $5.00 per mile. However, the question arises what may be charged to the client, in the absence of a specific agreement to the contrary, when the client has simply been told that costs for these items will be charged to the client. We conclude that under those circumstances the lawyer is obliged to charge the client no more than the direct cost associated with the service (i.e., the actual cost of making a copy on the photocopy machine) plus a reasonable allocation of overhead expenses directly associated with the provision of the service (e.g., the salary of a photocopy machine operator)."
As with other categories of costs, it is clear that, where the fee is agreed to in advance, these types of in-house services can be passed through at a reasonable fee. And where the cost isn't included in an agreement, only the direct cost and reasonable allocation of overhead can be billed.
The ABA uses the example of photocopying. How would it address in-house e-discovery software? In an initial agreement, the law firm may outline a per-GB processing fee. Analogizing, $.15 per page for photocopying may instead be $50 per GB uploaded and processed. Where the rate isn't agreed to in advance, the firm perhaps might bill the direct cost associated with the service (let's say, the $20 per-GB fee that it is being charged by the cloud provider) and then a reasonable portion of the yearly subscription fee, which, to use the ABA's example, would be the equivalent of a reasonable allocation of the photocopy machine operator's salary.
The Bottom Line
At the end of the day, it's comforting to know that the authors of these opinions aren't sticklers for semantics, nor do they profess to be experts in that which we they do not know. Opinion 93-379 concludes:
"It is not appropriate for the Committee, in addressing ethical standards, to opine on the various accounting issues as to how one calculates direct cost and what may or may not be included in allocated overhead. These are questions which properly should be reserved for our colleagues in the accounting profession."
In other words, act conscionably and fairly. The overriding consideration for how and whether to pass through costs and overhead should be the reasonableness of those fees, and if there's any question about the propriety of passing through the cost, make sure it's outlined in the fee agreement. Comment to ABA Model Rule 1.5 puts a fine point on this, declaring that:
"A lawyer may seek reimbursement for the cost of services performed in-house … either by charging a reasonable amount to which the client has agreed in advance or by charging an amount that reasonably reflects the cost incurred by the lawyer."
Law firms seeking to charge for in-house e-discovery services should pick a basis for those fees -- for example, based on a market formula or flat-fee structure; make sure that this fee structure is reasonable based on the current market; and, lest there be any confusion, clearly communicate fees to the client in writing at the outset of the representation, before those expenses are incurred.
Please note that attorneys and their respective firms are always ultimately responsible for their own interpretation and implementation of legal ethics, and may not simply rely on the advice of others. If you'd like to read about how law firms who don't abide by this guidance get in trouble, download our white papers on sanctions and practice tips here.