Law Firms Take Aim at Outside Counsel Guidelines, Irking Clients

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By Samson Habte

The members of large U.S. law firms who gathered at an annual ABA ethics conference in St. Louis this month were presented with a proposal that will antagonize their most valuable corporate clients.

The proposal, floated at the 43rd ABA National Conference on Professional Responsibility, was for an ethics rule change that would make it easier for law firms to resist “outside counsel guidelines” (OCGs) that corporations and other large organizational clients increasingly seek to foist upon the firms they hire.

The regulatory proposal was unveiled during a June 2 panel on outside counsel guidelines, which corporations have increasingly used to exert control over various aspects of their relationships with law firms they retain.

Many commentators have said that the ubiquity of OGCs is a byproduct of a recent shift in bargaining power between corporations and the law firms they turn to for legal advice.

“Many of these outside counsel guidelines micromanage in incredible detail what the law firm may or may not do [and] how it is to manage matters on almost a minute-to-minute basis,” said Anthony E. Davis, a partner in the New York office of Hinshaw & Culbertson LLP who advises law firms on ethics and risk management issues.

The OCGs that have raised the most hackles are clauses that redefine the term “conflict of interest” so broadly as to prevent a law firm from ever representing a client’s competitors, and provisions that require firms to indemnify clients against any losses incurred in connection with an engagement—whether or not those losses were attributable to the firm’s negligence.

Collective Action Difficulty

Davis implored conference attendees to “collectively push back” against those types of agreements by asking bar regulators to adopt a rule change—an amendment to ABA Model Rule of Professional Conduct 5.6(b)—that could give law firms more leverage in negotiations with clients who demand that OCGs be included in their retention agreements with law firms.

Davis, who moderated the panel discussion, first suggested the proposed rule change in a 2016 article that he coauthored with Noah Fiedler, another Hinshaw partner.

In an interview with Bloomberg BNA, Davis reiterated his assertion that the proliferation of OCGs poses a threat to the long-term economic viability of law firms. He also expounded on why he believes the profession must mount a collective response—one that involves bar regulators—to this phenomenon.

“While law firms may be constrained by the antitrust laws from taking collective positions, the professional regulators, who are usually state actors, are in a better position to establish standards,” Davis said.

Davis was speaking to an audience that could conceivably transform his reform proposal into actual policy. The annual ABA National Conference on Professional Responsibility is attended not only by law firm general counsel and insurance underwriters, but also by bar regulators—individuals with the power to push their supreme courts to enact the rule changes that Davis proposed.

But some critics and neutral observers said the antitrust problems may prove to be more acute than Davis has suggested.

And Amar Sarwal, vice president and chief legal strategist for the Association of Corporate Counsel, said businesses would not be pleased to see the law firms they hire pursue a regulatory initiative that would impede the use of OCGs.

Sarwal said the in-house lawyers he represents, and the businesses those lawyers work for, would resist Davis’s proposal if it ever did advance beyond the discussion phase.

“I think it’s very important that they think about the client first before going forward with something like this,” said Sarwal, who is ACC’s vice president and chief legal strategist.

This proposal would “definitely strain [the] relationships” between corporate clients and “the law firms that push it,” Sarwal added. “They would say that these law firms are not on our side.”

Restraint on Trade?

Davis’s proposed rule change would alter the black letter of ABA Model Rule 5.6(b), which prohibits lawyers from from “offering or making” agreements that restrict "[a] lawyer’s right to practice.”

As currently written, that provision is limited to settlement agreements that restrict a lawyer’s right to practice; it has been invoked to attack the ethical propriety of “non-disparagement” clauses in settlement agreements that require a settling plaintiff’s counsel to agree not to represent future clients in claims against the settling defendant.

Under Davis’s proposal, the scope of the rule would expand beyond the settlement context—and be transformed into a regulatory measure that could give law firms a stronger hand in their retention negotiations with corporate clients.

Rather than merely prohibiting agreements “in which a restriction on the lawyer’s right to practice is part of [a] settlement,” the Rule 5.6(b) Davis envisions would forbid lawyers—including corporate in-house counsel— from “offering or making … an agreement in which a restriction on the lawyer’s right to practice is part of the terms of engagement of a lawyer by a client.”

How We Got Here

Davis’s panel included two attorneys who have acquired expertise on OCGs because they serve as the general counsel of large U.S. firms—roles that put them on the front lines of retention negotiations with corporate clients.

Panelist Stuart Pattison, an insurance executive who underwrites professional liability policies for Endurance International Grp., spent most of his time on the dais telling cautionary tales about how law firms can lose insurance coverage if they acquiesce to some of the more onerous OCGs he has seen in the marketplace.

“Law firms will be incurring increased liability by signing these agreements,” Pattison said.

The panelists seemed to agree that OCGs are a byproduct of a recent shift in the bargaining power of law firms and the corporations that hire them.

“Up until 2008, it was very clear ... that the sale of legal services from law firms to clients, however large, was a seller’s market,” Davis said. “But at the beginning of the recession, clients woke up to the fact that suddenly it was a buyer’s market. And the fact that we’re never going back is very clear from everything we read every day in the legal press.”

Paper Pushback

The loss of bargaining power that law firms have suffered—and the increased pressure to acquiesce to outside counsel guidelines—has also been partly attributable to changes in the personnel responsible for managing corporate legal budgets.

“General counsel traditionally managed outside counsel relationships,” Davis said. But in recent years there has been more of “a tug-of-war between general counsel and chief financial officers about who controls the spend,” he said. “And to at least some degree corporations have wrested control over the spend—or partially wrested control over the spend—away from general counsel, in order to better manage how much money goes out the door.”

“And the new players are the procurement officers, in the purchasing department,” Davis said.

Those individuals have played an outsize role in the rise of OCGs, Davis said.

“Typically, corporations have one department that buys goods and services for the company that controls all procurement decisions, from professional services to paper clips,” Davis noted.

And these procurement professionals, who had long demanded that all of their company’s other vendors acquiesce to indemnity provisions and other guidelines, made a push for standardization that led to law firms being treated like other vendors.

“They want standardized agreements, and the procurement officers, along with their superiors the CFOs, often say ‘why should law firms be any different?’”

The audience Davis spoke to did not include some key stakeholders in the debate over whether and how to regulate the use of outside counsel guidelines: the corporations who use those contractual tools to control their legal spending, and the in-house lawyers, financial officials and procurement professionals who are responsible for overseeing corporate legal budgets.

And the ACC’s Sarwal, whose organization speaks for some of those stakeholders, did take issue with some of Davis’s narrative regarding how, when, and why law firms lost bargaining power vis-a-vis corporate clients.

Sarwal said the shift in bargaining power began approximately 10 to 15 years before the economic crisis of 2007–08. That shift, he added, was attributable in part to changes in the composition of corporate legal departments—and, more specifically, to an increase in the number of attorneys who left large law firms to work as in-house lawyers for large and medium-sized businesses.

“A lot of sophisticated lawyers went in-house, and they knew where the bodies are buried—they understood how law firms work,” Sarwal said. “They looked at [legal] bills and started realizing that these law firms were not delivering the value [companies] expected.”

Thomas D. Morgan, a George Washington University law professor emeritus who taught both antitrust law and legal ethics, echoed that observation. In an interview with Bloomberg BNA, he said the attorneys who have made the exodus from law firms to corporate legal departments have the knowledge and incentives to be tough negotiators when dealing with outside counsel on behalf of their companies.

“The people in corporate counsel offices are some of the shrewdest and sharpest in the profession, because they have a sense of their clients’ industry [and] needs—and they can get promoted in the company by showing how tough they can be in dealing with lawyers, instead of being the person who just facilitated business as usual between law firms and companies,” Morgan said.

As bar rolls grew and economic growth stagnated, those corporate counsel realized the leverage they had to “play law firms off against each other” on a number of fronts. “And one of the areas in which you can see that taking place—but only one—is in these types of [OCG] clauses,” he said.

Morgan said corporations took advantage of the shift in bargaining power to demand concessions on fees. “There are a lot of firms nowadays—very good, mid-sized firms—that will do the work for two-thirds of the price of the big firms, and they’re getting hired on the price basis,” Morgan said.

Corporations also began handling more legal work in-house, Morgan noted, which also affected the bargaining power of the firms that used to get the work that companies were now handling internally.

"[T]he outside lawyers became people who had to come hat in hand to explain what they could contribute that the corporation couldn’t buy inside,” Morgan said. “And that’s where the change—from a seller’s market to a buyer’s market—really started taking place.”

Morgan also noted that the antitrust concerns about any regulations limiting OCGs may be heightened because the guidelines that firms find so objectionable affect fees as well as other issues like conflicts and indemnification—and could thus be viewed as a concerted attempt to deter price competition.

"[Y]ou can’t assume that antitrust plaintiffs will not see interference with that negotiation as part of an anticompetitive process,” Morgan said.

Arm’s-Length Transactions?

Sarwal, the vice president of ACC, was skeptical that the opposition to OGCs is truly driven by concerns that those agreements restrain lawyers’ right to practice.

“When they talk about the effect on [lawyers’] freedom of movement, I really have to roll my eyes,” Sarwal said. There is a “dramatic need” to expand the availability of legal services for the middle class, he noted, and law firms have ignored that market to service large businesses and pursue their “ever-dwindling” corporate coffers.

“They feel like they don’t have market power because they are living on a model that is dying,” Sarwal said. “They have tremendous freedom of movement,” he added “They just choose not to act on it.”

Sarwal also turned around the arguments made in favor of the Rule 5.6(b) amendment. The rule Davis has proposed “would be a restraint on trade itself,” Sarwal said, one that infringes on corporations’ freedom of contract.

Sarwal also said that bar authorities shouldn’t be wasting their resources on measures that would regulate lawyers’ relationships with “more sophisticated consumers.”

“It makes no sense,” Sarwal said. “You should target your regulatory dollars and resources towards those who most need the protection.”

Outside counsel guidelines are the result of arms-length transactions between sophisticated parties, Sarwal said, and proposals to limit them through ethics rule smack of rent-seeking.

“Are they?” Davis replied, when asked to respond to the assertion that OCGs are the result of arm’s-length transactions.

“How is it an arm’s length transaction if in an RFP for legal services, the last box says you agree to [all of our] terms and conditions—especially if the terms and conditions are not attached?” Davis asked. “And even if the terms are attached, they usually explicitly preclude the law firm from proposing any changes if they wish the response to be considered.”

To contact the reporter on this story: Samson Habte in Washington at shabte@bna.com

To contact the editor responsible for this story: S. Ethan Bowers at sbowers@bna.com

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