The Two-Way Links Between Discovery Behavior and Billing Practices

George B. Shepherd
Emory University School of Law

Discovery Transforms Legal Practice and Increases Cost Uncertainty.
1. 1938 discovery rules transform legal practice.
  1. Shift from trials to pretrial practice. "Trial lawyers" become "litigators" because main effort is now pretrial practice, not trials.
2. Discovery is used for two purposes:
  1. Obtaining information from adversary.
  2. Gaining tactical advantage by imposing discovery costs on adversary.
3. Discovery increases average cost of litigating a case.
  1. Discovery causes litigation costs to increase.
  2. Discovery causes fewer cases to settle.
4. Discovery increases cost uncertainty.
  1. After broad discovery was introduced, a lawyer was much less certain about the time and expense that a case would require to litigate. Although discovery caused litigation costs to increase greatly in some cases, it caused little increase in others.
  2. A major reason for the unpredictability of a litigant's discovery costs was that the costs depended not only on the litigant's own discovery behavior, but also on the adversary's conduct; the litigant would need to devote time and expense to respond to each of the adversary's discovery requests. Adversary's discovery behavior was discretionary and unpredictable.
5. Discovery limited access to legal services.
  1. By increasing the cost of litigating a case and increasing cost uncertainty, discovery made litigation too expensive for many potential litigants.
One Influence on Discovery Behavior is the Attorney's Fee Agreement.
1. Various categories of fee agreements:
  1. Fixed-fee agreement. Client pays lawyer a fixed retainer per year or month, or a fixed amount for completing a certain task, such as litigating a case or drafting a contract. Commonly used until the mid-1960s.
  2. Contingency agreement. Client pays attorney a fixed fraction of any recovery.
  3. Hourly fee. Client pays attorney an amount per hour that the attorney devotes to the matter. Common only after mid-1960s.
2. Fee agreement can create wasteful, inefficient discovery behavior by attorney.
  1. Principal-agent conflicts and moral hazard: Fee agreement can create conflicts between the interest of the attorney and her client.
3. Lawyer's incentive under fixed-fee contract: do too little work.
  1. Because the client pays the lawyer no additional amount for the lawyer's additional work, every minute of extra time that the lawyer devotes to the matter reduces the lawyer's income. By spending additional time on this client's matter, the lawyer sacrifices income that she could have earned by instead devoting the time to other matters. Lawyer has incentive to shirk.
  2. The lawyer's incentive under a fixed-fee contract to reduce costs could extend to reducing costs below the level that is optimal for the client. The fixed-fee contract pays the lawyer the same fee regardless of the lawyer's level of work. The lawyer has an incentive to devote too little work to the matter because, although the lawyer bears the costs, the client, not the lawyer, reaps the benefits. Suppose that the lawyer is considering drafting a motion that the lawyer estimates would benefit the client $1,000. Drafting the motion would require two hours of the lawyer's time, for which the lawyer could earn $400 from other clients. Although the motion's benefits to the client exceed its costs by $600, the lawyer may have an incentive to shirk his duty to the client and not draft the motion. The lawyer will pay the motion's $400 cost, but he would receive none of the $1,000 benefits. Lawyer has incentive to shirk.
4. Lawyer's incentive under contingency agreement: do too little work.
  1. As under other fixed-fee agreements, the lawyer under a contingency agreement has an incentive to do too little work because the lawyer does not receive the full benefit of the additional work that he does for the client. If a lawyer under a one-third contingency agreement does two hours of work that increases the plaintiff's recovery $1,000, the lawyer receives only $333. The lawyer has an incentive not to devote the two hours to the case if, as I assumed before, the lawyer could earn a larger $400 for the two hours on another case.
5. Lawyer's incentive under hourly agreement: do too much work.
  1. The hourly contract creates a strong incentive for the lawyer to conduct unnecessary work. In an hourly contract, the lawyer receives no fixed fee. Instead, the fee that the lawyer receives for each hour of work not only reimburses the lawyer for the cost of her time, but also provides the lawyer with an additional amount of profit. Moral hazard exists because the lawyer profits from each additional hour that the lawyer devotes to the client's matter, regardless of whether the additional hour benefits the client. The more billable hours, the more profit that the lawyer receives.
6. Not all lawyers will succumb to the moral hazard.
  1. Several forces may constrain an attorney's willingness to be disloyal to his client by shirking under a fixed-fee contract or by padding his hours under an hourly contract.
    1. Many lawyers are simply unwilling to be disloyal to their clients. Ignoring selfish incentives, many attorneys comply both with their ethical responsibility to act in their clients' best interests and with their own personal commitment to honest excellence.
    2. Some attorneys may fear that their clients will fire an attorney who performs too little work or who bills excessive hours. Because lawyers are often what economists call "repeat players," a lawyer might choose not to exploit the client in a given case. The lawyer would hope that his frugal performance in this case would induce the client to hire the lawyer again for the next case. The constraint may be weak. An attorney can often convince an inquiring client that the attorney's chosen level of effort is appropriate, even if the level is inappropriate. Just as a patient must rely on her doctor's judgment in deciding her treatment, a client often must rely on her attorney's judgment in evaluating the attorney's activities.
    3. Although clients at a law firm might pay the firm on an hourly basis, many associates at law firms receive fixed salaries that do not vary with their firms' profits. An associate on a fixed salary sometimes may have little incentive to do excess work. However, a countervailing pressure to pad hours will exist for the many associates who receive bonuses or promotions to partnership based in part on the number of hours that they bill.
Discovery and the Optimal Fee Agreement: A Model of Choice of Contract Type.
1. Choice between fixed-fee/contingency fee arrangement and hourly contract depends on three factors:
  1. degree of uncertainty in amount of cost in time and resources that will be necessary for the lawyer to complete the legal task;
  2. relative fear of risk of client and attorney.
  3. degree of moral hazard created by two types of contract.
2. Fixed fee/contingency contract is optimal if:
  1. degree of cost uncertainty is small; and
  2. moral hazard is more of a worry under an hourly contract than under a fixed-fee/contingency arrangement.
    
    These are the conditions that existed before discovery increased cost uncertainty: absent discovery, costs were relatively predictable. Thus, clients and lawyers generally used fixed-fee contracts.
3. Fixed fee/contingency contract also optimal if:
  1. moral hazard is more of a worry under an hourly contract than under a fixed fee/contingency arrangement; and
  2. provider of legal services is less risk averse than the client.
    
    These are the conditions that often exist for representation of individual personal injury victims; unlike corporate clients, an individual client is often more risk averse than her lawyer. Thus, lawyers and personal-injury clients usually choose contingency agreements.
4. Hourly contract is optimal if:
  1. degree of cost uncertainty is large;
  2. provider of legal services is more risk-averse than the client.
    
    These are the conditions that prevailed after pretrial discovery became commonly used in both federal courts and state courts: Discovery increased cost uncertainty, and law firms were much smaller than today and so more risk-averse, especially relative to their large corporate clients. Thus, in the mid-1960s, lawyers and clients generally switch to using hourly contracts.
    However, these conditions may no longer exist in many situations. Because many law firms have recently grown much larger, they may no longer be more risk-averse than their corporate clients. The model thus helps to explain why some law firms and clients are once again experimenting with fixed-fee billing.
References.
1. George B. Shepherd and Morgan Cloud, "Time and Money: Discovery Leads to Hourly Billing, 1999 University of Illinois Law Review 91-180. Using economic analysis, the paper analyzes the relationship between discovery behavior and fee arrangements, addressing the following:
1. The incentives created by various fee arrangements.
2. The paper creates an economic model to show how the introduction of broad pretrial discovery led inevitably to hourly billing.
3. The paper reaches various of the other conclusions that I discuss above.
1. "An Empirical Study of the Economics of Pretrial Discovery," 19 International Review of Law and Economics pp. 245-263 (June 1999). Using a survey data set, the paper empirically examines litigants' discovery behavior. Among the findings are:
1. Fee arrangements influence lawyers' discovery behavior.
2. Litigants often use discovery strategically, without regard to any need for information.
3. Plaintiffs and defendants use discovery differently. Plaintiffs usually base their discovery amounts on the case's fundamentals. In contrast, defendants base their discovery not on fundamentals, but by copying the plaintiff's amount.
4. Defendants and plaintiffs respond differently to apparently-excessive discovery from the adversary. Defendants respond tit-for-tat with more discovery. Plaintiffs conduct less discovery.