Time and Money: Discovery Leads to Hourly Billing
George B. Shepard & Morgan Cloud   |   1999 U. Ill. L. Rev.

It is ironic that many clients and lawyers today condemn hourly billing. Starting in the 1950s, both groups demanded a switch from fixed-fee billing to hourly billing. This article explains why these groups made the switch and also suggests why now some are considering a switch back.

Using an economic model they have developed, Professors Cloud and Shepherd show how societal changes, particularly the expansion of pretrial discovery in the 1938 Federal Rules of Civil Procedure, led inevitably to the switch to hourly billing. Cloud and Shepherd's economic model explains two critical factors affecting the type of contract the client and lawyer will choose: moral hazard and cost uncertainty. Moral hazard is the incentive attorneys have to waste time. Cost uncertainty is the risk involved when a lawyer's costs are unpredictable. The model predicts that 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 reduces moral hazard. If instead cost uncertainty increases greatly, as it did after the 1938 changes in the Federal Rules, and lawyers are more risk averse than their clients, then a switch to hourly billing becomes efficient. Hourly billing will reduce cost risk for the attorney, but will increase her moral hazard. However, if cost uncertainty 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 waste from moral hazard. Under these conditions, hourly billing both efficiently shifts new risks away from lawyers and makes legal services cheaper for clients than under fixed fee billing.

History confirms these economic predictions. Before 1938, the standard fee arrangement was a fixed fee. Broadened discovery then increased the uncertainty of litigation costs, especially as states adopted the Federal Rules over the next two decades. Starting in the mid-1950s, as Cloud and Shepherd's model predicts, litigators, spurred by their institutional clients, switched to hourly billing. By the late 1960s, society's greater complexity had increased cost uncertainty for transactional lawyers. As the model predicts, the bar soon also shifted to hourly billing for transactional work. Today, fixed fees can be found mainly in cases involving very risk-averse clients. For example, many personal injury cases continue to be litigated under contingency agreements, a form of fixed fee. This is in part because, as the model shows, these clients have fewer resources and thus cannot bear cost uncertainty as easily as other clients.

Cloud and Shepherd also use their model to explain why firms and clients have now begun experimenting with forms of fixed-fee billing. Cloud and Shepherd suggest that the conditions that once made hourly billing efficient may now have changed. Because of these changes, Cloud and Shepherd predict that economic pressures are building for a return to forms of fixed-fee billing.

* Associate Professor of Law, Emory University; B.A. 1982, Yale University; J.D. 1986, Harvard Law School; and completing Ph.D. in economics, expected 1998, Stanford University.

** Professor of Law, Emory University, B.A. 1969, Grinnell College; M.A. 1972, The University of Iowa; J.D. 1977, Cornell Law School.