Time and money: Discovery leads to hourly billing

It is ironic that many clients and lawyers now condemn hourly billing. Star ting in the 1950s, both groups demanded the switch from fixed-fee billing t o hourly billing. This article explains why. Using a new economic model, Pr ofessors Cloud and Shepherd show that societal changes, particularly the ex pansion of pretrial discovery in the 1938 Federal Rules of Civil Procedure, led inevitably to hourly billing. Hourly billing both efficiently shifted new risks away from lawyers and made legal services cheaper than under fixe d-fee billing. The economic model indicates that clients and lawyers balance two concerns when choosing a type of contract. First, they seek to reduce moral hazard, the incentive for an attorney to devote too much or too little time to a ca se. Second, they attempt to shift the risk of uncertain litigation costs to whomever of the client or lawyer is less risk averse. If litigation costs are relatively certain, then the efficient contract is a fixed-fee contract . Although such a contract imposes a cost risk on attorneys, the contract r educes moral hazard by reducing the lawyer's incentive to overbill. However , if cost uncertainty increases greatly, as it did after the 1938 changes i n the Federal Rules, and lawyers are mom risk averse than their clients, th en it becomes efficient to switch to hourly billing. Although hourly billin g increases moral hazard, it reduces risk for the attorney. If cost uncerta inty is large enough, then the savings from risk reapportionment, which the lawyer and the client can share, will more than offset the cost of the was te from moral hazard. The switch to hourly billing reduces clients' legal f ees. History confirms the model's predictions. Before 1938, the standard fee arr angement was a fixed fee. Broadened discovery then increased the: uncertain ty of litigation costs, especially as states copied the Federal Rules over the next two decades, Starting in the mid-1950s, as the model predicts, lit igators, spurred by their institutional clients, switched to hourly billing . By the late 1960s, society's growing complexity had increased cost uncert ainty for transactional lawyers. Thus, as the model predicts, the bar soon also shifted to hourly billing for transactional work. Many personal injury cases continue to be litigated under contingency agreements, a form of fix ed fee, in part because, as the model shows, clients in these cases are oft en more risk averse than other clients. The model suggests why clients and lawyers have now begun experimenting wit h forms of fixed-fee billing. Cloud and Shepherd suggest that because the c onditions thar once made hourly billing efficient may now have changed, eco nomic pressures are building fur a return to forms of fixed-fee billing.