Learning from law firm failures

Yesterday VQ attended a lecture with Harvard Law School Professor David B. Wilkins arranged by the Research Panel for the Globalization of Law on the topic “When Things Fall Apart: Learning from Law Firm Failures”. In the lecture, Professor Wilkins, drew on lessons learned from the 2012 collapse of the US law firm Dewey & LeBoeuf and other recent law firm failures to discuss the future of the global market for corporate legal services.

The question is if the legal market is in a paradigm shift – are things falling apart for BigLaw to paraphrase the title on Chinua Achebe’s book – but as Professor Wilkins said in his opening remark, you can’t really know when you are in the middle of the changes, it can only be determined to have been paradigmatic change in hindsight. But we are seeing a lot of large scale changes, such as increasingly sophisticated clients, new competitors and a huge pressure on the traditional law firm business model. We are clearly in the age of ‘more for less’ as predicted by Professor Richard Susskind. Client demands are forcing efficient unbundling and repackaging of legal services and a move towards “value” billing. Former drivers of law firm revenue growth like rate increases and leverage is becoming less important. Employing and training associates to ensure succession is becoming harder as clients no longer are willing to pay for the work of a first year associate. And even though the world is becoming more global and complex, with more complicated legal issues to handle, increasing the clients need for help more than ever, there is a new challenge to meet the clients’ needs in a way they understand and feel is worth paying for. There is a reduced need for bespoke legal services as most clients are “sometimes willing to pay for a Savile Row suit, but in most cases off-the-rack is sufficient enough”.

A good way to respond to the current changes is to draw lessons from others’ failures, to avoid making the same mistakes and find better ways to adapt to the new marketplace. Professor Wilkins therefore presented case studies on two recent law firm collapses – Howrey and Dewey & Le Boeuf – analyzing the mistakes that led to their downfall.

In 2008 Howrey was thriving and had increased its revenue with 30% despite the recession. They were also early adapters of alternative fee arrangements, especially contingent fees. But then, in 2009 revenues fell by USD 100 million. The decreased partner profits made partners leave the firm. To stem the tide, the firm started to lay off associates, which led to massive negative publicity, and only drew more partners and associates into leaving the firm, not wanting to risk being the last one left. In 2011 Howrey was forced to declare itself bankrupt.

The two leading law firms Dewey Ballantine and LeBoeuf, Lamb, Greene & MacRae merged into Dewey & Le Boeuf in 2007. Then, the merged firm directly started acquiring “star” lawyers by offering guaranteed revenues, creating a large difference between revenues for existing partners and the laterals. In 2008 revenues dropped by USD 200 million. To cover the guarantees, the firm took a USD 125 million bond. In October 2011, the guarantee set up was disclosed, making all other partners demand guarantees as well. In 2012 more than 200 partners left the firm and the bankruptcy was a fact.

The largest mistake Howrey did was to bet on increased litigation when times are hard. Previously litigation matters have increased in times of recession, but this time clients were more knowledgeable about litigation costs, more proactive and willing to find settlement solutions in line with business objectives. Litigation therefore didn’t take up but actually decreased in the same way as the general legal market.

Dewey & LeBoeuf’s largest problem was the lack of a common culture and loyalty strong enough to survive in hard times, combined with the harsh demands from the bank, with covenants on number of partners, revenues etc., threatening to withdraw the loan.

The capital issue is a general problem for law firms. The only capital a law firm has is partner contribution or bank loans. This adds to the structural problem and the loose ties, the lack of glue. If other capital were invested in law firms, like private equity investments, a stronger structure and more solid corporate ground could be created. The new entrants on the legal market all have huge investments backing their business, making them able to compete on other conditions.

Both Howrey and Dewey & LeBoeuf also had leadership issues. They both had strong leaders, recognized for their innovation and visionary leadership. The problem was, the managing partners didn’t listen to others, didn’t acknowledge the warning signs, and made ill-considered decisions. A common problem for law firms is the lack of a lateral market for law firm managing partners, which creates a culture where you’re not allowed to fail and where the managing partners stay on too long, with succession problems as a result.

Another common theme for both Howrey and Dewey & LeBoeuf was the rapid growth by mergers and acquisitions and large lateral hirings, which led to internal problems. Compared to other business, post-merger integration is very challenging in law firms, since the assets are the people and it’s not as easy to achieve scale economy. The people also carry a firm identity that is not so easy to give up. In other businesses you can buy out trouble-making minority shareholders, but in a law firm you often end up with the resisting partners creating an inefficient two-stage process with dual leadership.

Professor Wilkins also presented study results on 22 mergers conducted in AmLAw 200 law firms during 1999-2009, showing that mergers have no effect on profit per partner results, but it did create an increased presence and more publicity. The size of the merged firm was larger, but not much larger than the size the separate firms presumable would have had. An interesting fact was also the loss of qualified lawyers. In the merged firm, a higher quantity of top lawyers and lawyers from the acquiring firm left than lawyers from the acquired, less prestigious firm. It was also clear that women left to a higher extent, undermining the gender diversity. Lessons learned from these mergers is the importance of post-merger integration and the time aspect. Even the successful mergers could have been judged a failure five years out. The hardest part is the social and cultural issues, not the economic, to create a common culture and loyalty – the glue.

A recent New York Times article, “A Lawyer and Partner, and Also Bankrupt”, put the consequences of the law firm collapses into a more personal perspective, telling the sad story of former Dewey & LeBoeuf partner Mr Owens, who recently filed for personal bankruptcy. Mr Owen’s faith is linked to the increasing trend of salary partners. According to Thomas S. Clay, law firm management consultant at Altman Weil, the number of nonequity partners has swelled because “firms have been reluctant to confront the reality that in many cases they’re not economically viable and that successful service partners are probably going to need to work more hours than rainmakers, not fewer, to justify their mid-to-high-six-figures salaries.”

In light of the lessons learned, the future of the global market was then discussed. An interesting trend is the new multidisciplinary professional services firms – accounting firms and the like moving into global true partnerships offering the whole spectra of services to their clients – creating a new, tough competition for law firms. A responsive trend is the mergers and acquisitions and/or rapid growth of law firms, to meet this new competition and general market pressure by creating large global firms. There are many examples of this, but a recent interesting one to follow is the King & Wood Mallesons and SJ Berwin merger, creating a network with more than 2,700 lawyers in 30 locations. Another interesting, and somewhat contradictory, trend, is the increased importance of locality. Local knowledge is more important in law than in other markets, which is the reason that we do not see the same kind of consolidation as on the accounting market. Even though you need a global presence, law firms need high quality local lawyers, with one foot in the law firm global culture and one foot in the local culture. General counsels are also generally nervous about using global firms. Unless they are forced by global policies, they prefer using local stand alone high quality firms over global ones, which creates a unique market position for local stand alone firms unseen on the accounting market.

But, as concluded by Professor Wilkins, no matter which way you choose – growth, merger or focus on high quality local presence: “In the end law firms must learn how to deliver value for all their constituents to survive, external and internal, owners and employees.”