In-house counsel are setting more rules governing their relationships with outside counsel.

Over the past nine years, more in-house counsel have required specific terms of retention that dictate what they expect from their outside counsel. This survey collects information on more than 20 specific categories of retention terms, including financial and budget terms, early assessments and periodic status updates, technology expectations, and required pre-approval of changes to legal teams and hourly rates. Across the board, the use of each retention term has generally increased over time. It is likely that this trend will continue, as many in-house counsel state that they are planning to require even more of their firms in the future.

In-house counsel are more carefully monitoring work that is outsourced.

Gone are the days when in-house counsel send out major projects to outside counsel, pay vague bills “for services rendered,” and remain uninvolved while outside counsel do whatever they think is necessary. In-house counsel expect outside counsel to keep them informed on a regular basis, when there are major developments that require decisions, and if there is a change in projected spending or staffing. They are more likely to require that outside counsel provide an early assessment and plan, a budget, reports showing progress against the plan and budget, an analysis of potential exit points in litigation, and a summary of results achieved and lessons learned. In-house counsel generally believe that outside counsel will be more effective and efficient if the client is kept well-informed and is involved in strategic decisions.

In-house counsel are using more sophisticated technology to track the activities of outside counsel, and have plans to do more.

Although many in-house counsel still use home-grown spreadsheets or other internal management software, a growing number are moving toward Internet-based systems that help them collaborate directly with outside counsel. Such systems collect and process not only bills and budgets, but also documents, deadlines, status updates, and other key information (exposure estimates, opposing counsel, settlement amounts, etc.) directly from outside counsel who are working in the same system. Even more in-house counsel say that they plan to use such systems to exchange information on a regular basis with their outside counsel. Because in-house counsel prefer to use such client-centric systems, the use of extranets provided by individual law firms (which require clients to go to multiple law firm sites for information) has significantly declined in recent years.

In-house counsel are becoming bolder each year, requiring more from their outside counsel. This year was a breakout year in which record numbers of in-house counsel took new actions to improve the management of work with outside counsel and to reduce their legal spending.

Roughly one-fourth of in-house counsel are more active in their management of outside counsel than the rest of their peers. Such activities include convergence (reducing the number of firms with which they work on a regular basis), issuing competitive bids for new work, requiring minimum levels of experience of associates working on their projects, getting discounts for early payment of bills, and systematically evaluating the performance of their outside counsel. Although this group has generally been pushing harder each year for change, their progress seemed to be reaching a plateau during the past several years.

This year, however, record numbers of in-house counsel engaged in more activities to get better control over outside legal spending. Examples of unprecedented levels reported in this year’s report are: requiring minimum levels of associate experience, convergence (reducing the number of firms regularly engaged), and receiving discounts for early payment of legal bills. Additional activities, such as requiring outside counsel to provide budgets for each project that they are handling, were significantly higher than last year and near the highest levels of prior years. As the economy recovers, it remains to be seen whether in-house counsel will continue to apply such techniques, which have grown in use during a time when pressure to reduce legal spending is high.

Budgets continue to gain wider acceptance as an effective tool to clarify expectations and monitor performance.

Approximately three-fourths of in-house counsel require at least some budgets, and on average, budgets are now required for about half of the projects that they manage. The use of budgets, which has grown significantly since the survey began, has leveled off in recent years (except for this year when there was a significant increase). Budgets not only clarify spending expectations between the client and outside counsel, but they also give benchmarks against which in-house counsel can see whether projects are progressing as planned. Budgets are also driving in-house counsel to technologies that ease budget administration, including electronic billing systems that automatically compare bills with budgets and flag bills that have exceeded the agreed budget.

After years of being used primarily by larger law departments, convergence is gaining wider acceptance in the in-house legal profession.

Convergence (reducing the number of law firms with which a company works on a regular basis) continues to be a management technique used by a minority of law departments, but this year, the practice hit a record level with one-third of law departments saying that they have engaged in convergence during the past year. These law departments generally hope to achieve greater efficiency, to reduce rates, and to receive better, more consistent results by having a smaller

number of law firms provide most of their legal work. More than two-thirds of the law departments who engage in convergence state that the strategy met their expectations. This practice appears to have been effective in keeping the number of law firms representing specific companies constant or lower over time. In fact, the number of companies who said that they regularly use more than 50 law firms matched last year’s record low.

In-house counsel are terminating relationships with underperforming outside counsel.

Approximately one-half of in-house counsel now state that they have terminated relationships with some of their outside counsel during the prior year. Given this year’s focus on reducing legal spending, the top reason for termination was “fees and costs that are too high,” followed by “lack of responsiveness,” and “poor work product or results.” Other areas of dissatisfaction leading to termination are communication and personality issues, now cited by more than one-third of in-house counsel as a reason for termination.

In response to new questions this year related to the ACC’s Value Challenge, a majority of inhouse counsel state that the value of services provided by at least some of their outside counsel declined during the past year, and more than two-thirds said that they had made specific suggestions to their law firms to increase the value of their services. In what should be a wake-up call to law firms, more than one-third of in-house counsel said that 10% or fewer of their firms implemented their suggestions. In order to avoid losing business in a tight market, law firms should therefore consider redirecting at least part of their marketing efforts to make sure that they are addressing their current clients’ concerns.

A relatively larger percentage of the legal budget is going to law departments and less to outside counsel.

The primary driver of legal costs is outside legal spending, which historically has been roughly double the spending on in-house counsel. However, during the past several years the ratio has shifted in favor of law departments, reflecting the increasing recognition of the value of in-house counsel and the relatively lower cost of legal work that is done in-house. The ratio of spending on outside counsel to spending on company law departments has declined from 2.0 to 1.6 (actually up a bit this year from last year’s record low of 1.29).

Although hourly rates still predominate, more corporate clients than ever are utilizing alternative fees.

Despite a significant amount of negative publicity regarding the perverse incentives associated with billing by the hour, the vast majority of corporate legal work is still done under hourly rates, either standard or discounted. However, many corporate clients appear to be having success in getting discounted hourly rates from their law firms. Although in past years the number of inhouse counsel who use alternatives to hourly-based fees was gradually decreasing, this year the number jumped to a record high, indicating stronger than ever dissatisfaction with purchasing

legal services by the hour. Again, it will be interesting to see if this development continues into a trend in the coming years, particularly if the economy strengthens.

During the past year, in-house counsel have shown unprecedented success in containing increases to hourly rates. They predict that they will have even more success during the coming year.

During the past four years, in-house counsel have reported increasingly higher rates of increase in hourly rates. Furthermore, in-house counsel have projected rates of increase that have always been lower than the actual increases reported the next year.

However, this year for the first time there was a significant break in these trends, with the lowest rate of increase in hourly rates and the lowest projected increase for the coming year. For the first time since this survey began, the reported rate of increase in hourly rates (4.76%) was less than was predicted the prior year (5.02%). This is consistent with a record low increase in spending on outside counsel, which for the first time was unchanged. Also for the first time, the projection for next year is that there will be no increase in hourly rates (the lowest prior prediction was 2.95% in 2004), as well as no change in outside counsel spending for the coming year. In-house counsel apparently believe that the economic conditions and relative shift in bargaining power with their firms will continue at least into the coming year. Increasing competition among law firms has also led to a record number of responses to requests for proposal (RFPs), another factor that may help keep hourly rates flat. In-house counsel are feeling similar pressures on law department spending (which in the past has generally been predicted to increase by approximately 5% annually)—they predict that internal spending also will not increase during the coming year.

Controlling outside counsel spending moved back into the position of being the top concern of in-house counsel for the first time in three years, beating out concerns with legal compliance.

During the first several years of the survey, the top concern cited most frequently by in-house counsel was controlling outside legal expense. During the past three years, it was overtaken by concerns about keeping track of company activities that might have legal implications. The increasing complexity of regulatory requirements driven by Sarbanes-Oxley and related laws, along with high profile trials involving executives and in-house counsel, heightened concerns regarding legal compliance issues. This year, driven by the pressures to reduce legal budgets, concerns with outside counsel spending returned to being the most pressing priority of in-house counsel.

Despite increasing compliance requirements, in-house counsel have generally not put the adequate systems in place to meet their new reporting obligations.

Because of growing concerns over compliance, the survey during the past several years has included specific questions about law department compliance reporting obligations and how they

are being met. It is clear that most law departments must provide periodic reports about legal spending, accruals, liability exposure, legal matter status, and legal results. They also are required to provide immediate updates if there is a material development in any of these areas. However, a primary challenge is that most such information originates from the many law firms that are handling the company’s legal work. Law departments admit that they generally use e-mail, phone, paper correspondence, and other manual methods to collect and report on such information. Many also admit that their methods lack basic safeguards, such as verification of data entered and spreadsheet formulas and maintenance of an audit trail. As a result, law departments are considering new technologies to collect information directly from their outside counsel so that they can comply with these new reporting requirements.