Posted by: Ian Group, July 22, 2019

AFAs Are Here to Stay

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AFAs Are Here to Stay

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When you underwrite a loan, the calculation always boils down to risk. It is no surprise then that lenders are becoming wiser to a growing trend in the industry used to thwart the risk of unpredictable closing costs: alternative fee arrangements (“AFAs”).

An alternative fee arrangement is a departure from the traditional billable hour structure by which clients are able to close with more predictable and controlled fees. By requesting non-billable hour fee arrangements, lenders are removing the risk of any unforeseen costs at closing, ensuring greater predictability for their borrowers and their bottom line.

If you haven’t considered AFAs for your business, now is the time to get on the bandwagon. Legal consulting firm Altman Weil reported back in a 2016 study that 88% of law firms are “initiating conversations with clients about pricing and budgets.” Ninety-seven percent of those firms maintain alternative fee arrangements with their clients. Nema Daghbandan, a partner at Geraci who manages the Real Estate Finance Group, says that his firm relies heavily on AFAs: “Parties to a transaction are looking for certainty in timing and transaction costs. When a fee is agreed upon at the outset of the transaction, both sides can have peace of mind about the value of the services being delivered.”

As a lender looking to take advantage of AFAs, the data shows that you need to be proactive. Of the law firms that offer alternative fee arrangements, the Altman Weil report said that 72% of those firms were doing so in reaction to client requests. Contrast this with the fact that only 28% of those law firms were responsible for initiating such arrangements. A recent Bloomberg survey also supports this assertion: only 22% of respondents from national law firms (i.e. firms with revenue under $10 million) said their firms have adopted alternative billing models. Approximately 50% of firms with revenue in excess of $1 billion have adopted these structures.

While client demand is driving this trend, there is another oncoming headwind in the works: technology. In 2018, an Originate article by Robert Greenberg titled “The Future of Lending is Through Automation and AI” reported that online mortgage lenders have seen annual growth rates at 30%, with the ability to process applications 20% faster than traditional counterparts.

As lenders use workflow automation, transaction management platforms and machine learning to close and underwrite their deals, lawyers are not yet responding to the tools making things faster. Per a 2019 Bloomberg Analysis titled “Law Firms Respond to Demand for Alt. Fee Models,” Legal Analyst Meg McEvoy reports that only 25% of law firms had implemented any changes to their billing model as their use of legal technology increased. This won’t always be the case, however. As clients and firms both make use of newer technology (all of those tools are available for lawyers as well!), firms can continue to bill at their rates and still maintain higher levels of profitability . . . they just need AFAs.

So what are the most popular AFAs that you can discuss with your counsel today? Here are four general types:

  1. Fixed Fee. A fixed fee is an all-in price for a specific matter. This arrangement is ideal for high volume lenders. This type of AFA works best within a long-term relationship between firm and client where the firm is familiar with the client’s business and workflow.
  2. Periodic Flat Fees. Building on the flat fee model above, clients and firms can also structure a predetermined flat fee billing over a period of time, such as a month or year. Periodic flat fees might also incorporate volume discounts based on the amount of work anticipated during a specific time period.
  3. Fixed Fees with Collar. This arrangement is based on hourly rate billing but contains a range above and below a budgeted amount called a collar. If the legal fees are below the collar, the client pays the difference; if the fees are above the collar, the client gets a discount. You might see this type of arrangement between a client and recently-hired counsel.
  4. Broken deal discounts. Not all deals close so having an arrangement with your lawyers regarding broken deal fees will give you greater predictability.

With a growing percentage of the market already offering AFAs, your service providers have, at the very least, started to consider these billing models, and so should you. The above examples do not represent the entire world of AFAs. In fact, firms have entire departments built to structure AFAs. And remember: the current data shows AFAs are overwhelmingly client-driven. While your firm may have thought about AFAs, it is in your interest to do your research and figure out what you want.

So how do you get in on the AFA action? For your existing service providers: ask. If you are looking for new lawyers, make AFAs part of your search’s success criteria. Firms today know AFAs are necessary to be competitive. “As a law firm, [Geraci] often times earns less using an AFA than [they] would have using a traditional hourly billing model as the transaction is more complex than originally anticipated or understood, but [Geraci] believes that AFAs are here to stay and are generally a great way to practice,” says Daghbandan.

For the lenders out there that are unable to convince their counsel to provide an AFA, take action by using cost-cutting technology. Leverage those platforms and tools that focus specifically on scalability. This will not only streamline your business but also require your service providers adapt to your workflow.

This shift is inevitable because cost control comes down to an improved user experience. Just as borrowers are gravitating to platforms with quicker approvals and faster closings, lenders are looking for the same thing. Whether it’s through AFAs or adopting technology, we are in the midst of a significant change in the way in which we all control risk. Now that you’re wiser to these trends, how will you leverage the data?

Originally published in the July 2019 issue of Originate Report, which can be read by clicking here.

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