April 01, 2015

The Wisdom of "Baking in" Legal Fees

Faegre Baker Daniels partner Mark Voigtmann authored the following article for the Control System Integrators Association in April 2015.

I am sure we can all agree, as a general proposition, that lawyers are too expensive. We might even agree that lawyers with particularized expertise (such as those familiar with the business of CSIs) can be pricier than attorneys who consider themselves generalists. Where we might disagree, however, is when the point comes where those fees are so high that they should be avoided.

I suspect that most CSIs who have been in business for any length of time would say something like this: “We compare the legal expense to the amount of money at stake.”   

But what exactly are we talking about when we say the “amount of money at stake”? That phrase means different things to different companies. In our role as attorneys for many CSIA members, we have seen three distinct approaches (each with its own advantages and disadvantages):   

  • Project specific. One common method is to take a look at the contract amount (or sometimes the amount of the upside) for a particular project in question. For instance, if the project is small to medium-sized — perhaps $50,000 — some would say that the legal “overhead” must be limited to some percentage of that — say 2 percent or $1,000; otherwise the project may no longer be profitable. The advantage of course is cost. The disadvantage is that legal risk is not a creature that feels constrained to the limits of project value. And when the uninsured meltdown occurs (as, dare I say, it does all too often), take a look at your company valuation. That amount, not the dollar signs on your contract, will be a much more accurate measure of the “amount at stake.”    
  • Erecting fences. A rival theory of legal spending can be, for lack of a better label, described as “erecting fences.” Here one does not simply hope that the horses will not get out of the barn (this is the optimism of the project-specific approach), but to assume that they will — and to erect fences that will contain them. The fences are a combination of effective insurance (such as the program tailored to technology companies that is available through Paul Barnard) and frequent use of attorneys, with the attorneys specifically assigned to be on the lookout for the places where the horses typically get out. Those places would be one-sided contract clauses (e.g., indemnity, warranties and scope definitions) and missing contract provisions (e.g., limitation of liability, intellectual property protections), among others. The “savings” comes from focusing the attorneys only on the big stuff. This is pretty smart — and some clients of ours have even created a “protocol” for reviewing contracts. But even here there is a disadvantage. Sometimes legal risk arrives from stuff that is not on the protocol.      
  • Baked-in fees. The third way is what I would describe as the “baked in” approach. Here the CSI views legal fees as a sort of overhead that is part of the cost of doing business. The disadvantage of this approach is, as you might suspect, the higher cost — because lawyers are consulted regularly on risks of all sorts. The advantage, of course, is that the CSI is building up a culture of risk avoidance — and, as strange as it may seem, building up a tolerance of the cost of such avoidance (the legal bill arrives more or less monthly and is paid along with salaries). 

As you might suspect — and while it is utterly self-serving for us to say so — we think the “baked in” approach is the sign of a mature business. Having said that, the owners of CSIs unquestionably are entrepreneurs who did not get to where they are without taking calculated chances. So we do not cry foul when any one of the three approaches is followed. We only cry foul when CSIs do not choose a strategy consciously.    

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