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Thursday, May 3, 2012
As Dewey sinks beneath the waves , the eyes ... as to what caused Dewey's downfall , Jerome Kowalski has an interesting piece focusing on what went wrong and whether the declining role of equity partnership might have been an iceberg that helped sink the ship !
As we all daily sit transfixed staring at the horrific train wreck of Dewey & LeBoeuf, a firm with glorious legacies, many have already begun to undertake the post mortem to try to determine what went so horribly wrong as to bring the demise of one of the twenty largest law firms in the nation. The most comprehensive piece that has appeared to date comes from the brilliant and articulate Bruce MacEwen, writing as Adam Smith, Esq., in which Bruce dissects what is now obviousto most informed observers. Some claim that some of the partners were simply too greedy and that the firm’s leadership was too eager to accommodate that greed, providing those partners with guaranteed incomes, regardless of productivity or law firm profitability. The fault, according to some, is base criminality and greed at the hands of the firm’s leadership. Still others point to the firm’s unsustainable leverage: Well over $700,000,000 in bank, institutional, legacy and similar liabilities (not taking into account current liabilities for rent, wages, and vendors), an amount that simply cannot be sustained under any circumstances on the backs of 300 partners, bringing in $900,000,000 in gross revenues. There are those suggesting sexual peccadilloes by the firm’s senior leadership. Still others point to ongoing deception by current firm leadership, which one day encouraged partners to seek alternative employment in rather plain language and the next day, in the tradition of Lewis Carol, said that the epistle didn’t mean what it said. In other instances of unfortunate lack of candor, the firm’s leadership said that help was on its way in the form of a major law firm merger partner which was being discussed with “a number” of firms, only to fail to mention that all of those preliminary inquiries were politely previously declined. Or one day promoting a bankruptcy strategy, while eschewing bankruptcy as an option a day or so later, no matter that the initially promoted bankruptcy strategy had no likelihood of succeeding.
All of the facts will emerge as the long slog of litigation and bankruptcy proceedings take their inevitable course, Presumably, some depositions of key players will be videotaped for the benefit of interested parties, courts and perhaps the movie that (documentary or fictionalized) that seems to be likely.
Instead of dawdling too long over all of the foregoing (too much ink and space on the Internet has already been taken), I turn to the repeated lament of Steve Harper of Northwestern University School of Law, retired Kirkland & Ellis partner, noted author and keen observer of the legal profession. Harper recently returned to a theme he has repeatedly previously eloquently addressed, namely, the devolution of the concept of law firm equity partner, particularly in the face of Dewey & LeBoeuf’s utter deconstruction.
The fact is that in Dewey World, a good number of the firm’s most highly compensated partners were not in fact equity partners, although they proudly bore and boasted of having that moniker.
The hornbook definition of a partnership is two or more people engaged in a business who agree to share the profits and losses of that business. The Dewey highly compensated partners did not share profits. Rather, they were apparently bestowed with contracts which provided them with fixed premium incomes, regardless of their own production or the firm’s profitability. I guess we all now know that this business model doesn’t work. Actually, we learned this lesson in 1987, with the demise ofFinley, Kumble , then the world’s second largest law firm, but as Santayana said, those who have failed to learn the lessons of history are destined to repeat them.
The point is why did all of these very smart, accomplished and talented lawyers take on the visage of “equity partners,” when that was simply not the case? There doesn’t seem to be any rational explanation. These soon to be former highly compensated Dewey equity partners are soon to have some of the torments of Dante’s financial inferno visited upon them, as, among other things, they will be subject to clawbacks, loss of capital, adverse tax consequences and clawforwards.
A noted bankruptcy lawyer, who himself suffered through these torments as his firm went bankrupt thirty years ago said that he would never be a partner in a law firm again. His observation was that partners can do things to you even spouses can’t do, without your express consent: They can make you liable for substantial debt, they can encumber your assets and otherwise wreak very real financial and professional havoc. This lawyer continued to practice for many years quite successfully and with a substantial client following at several very large successful law firms. Yet, he always was simply “of counsel” or “counsel” to the firms. His income never suffered and he says he never missed out on an engagement because he didn’t possess the adornment of partner. Given his success and standing at the bar, he had a voice in all significant law firm decisions. He was never inclined to take less money than he was worth only to have what he described as a meaningless ego gratifying title on his business card.
Surely, ego is likely to prevent accomplished lawyers from taking what is ostensibly a step down, but that bruise to the ego should be assuaged by simple financial and other real world vagaries.
The interesting irony is that some of these highly compensated partners may well take the position in ensuing litigation that in fact they were not partners at all but merely highly compensated salaried employees and should be treated accordingly in the bankruptcy process. I can’t predict how the courts will react, but I would note that for the last thirty years, the lower levels of the law firm partnership have frequently claimed that they, too, were not actually partners; they were nothing more than salaried employees working for wages only. They had no role in management, and at best, were “mushroom partners:” kept in the dark and fed muck. The argument, while repeatedly made, has never gained real favor, except that mushroom partners (a term of art in law firm liquidations) typically wind up writing smaller checks than those at the summit.
Dewey LeBoeuf Near Collapse—Are Other White Shoe Law Firms In Peril?
It would be the biggest law-firm collapse in history, writes Dan Slater. Management experts point to a deadly combination of general economic malaise and the firm's particular mismanagement.
When Aaron Sorkin conjured Sam Seaborn, the fictional White House staffer inThe West Wing, he wanted to invest the character, played by Rob Lowe, with a distinguished pedigree. So Seaborn graduated magna cum laude from Princeton, edited the law review at Duke, and cut his teeth at a famous law firm, Dewey Ballantine.
In the late 1990s when The West Wing was conceived, it was an obvious choice: Dewey, a powerhouse in corporate law since the presidency of Teddy Roosevelt, had 500 lawyers in offices around the world. It was spoken of in the same breath as other old-line New York firms, many of them recognizable to the general public, such as Cravath Swaine & Moore, Sullivan & Cromwell, and Debevoise & Plimpton.
A few years later, Hollywood came calling. Dewey's opulent offices in midtown Manhattan were used to shoot scenes for the George Clooney legal thrillerMichael Clayton. In 2007, Dewey's dominance was only expected to grow when it pulled off the largest law-firm merger in history, joining ranks with LeBoeuf, Lamb, Greene & MacRae, creating a 1,300-lawyer firm with annual revenues of about $1 billion.
But it could all be over soon, as the news came in over the past week that the firm, now known as Dewey LeBoeuf, is flirting with ignominious collapse. Dewey’s demise has many wondering what's next for the embattled law-firm industry, and whether other “white shoe” giants, previously thought to be immune from recessionary strain, could also fall.
"We've seen some prominent firms fail in recent years," says Peter Zeughauser, an adviser to law firms. He cites Coudert Brothers, Heller Ehrman, Howrey, and Thelen. "But Dewey has an incredible legacy. In many ways, this is a first – at least for this era." Zeughauser, a former general counsel, says a failure by Dewey would be the largest law-firm collapse in history.
What brought Dewey down, law-firm management experts say, was a deadly combination of general economic malaise and the firm's particular mismanagement. The problems began when the 2007 merger with LeBoeuf went from being a great idea to a horrible one: practically overnight, the ensuing financial crisis flattened demand for legal services. In 2010, the firm's chairman, optimistic about a recovery, began recruiting scores of rainmakers from other firms – so-called lateral partners – by promising huge pay packages that Dewey could not afford.
People walk past headquarters of law firm Dewey & LeBoeuf in New York City on May 1, 2012. , Lee Celano, Reuters / Landov
Not surprisingly, Dewey's partnership was divided over the wisdom of these hires.
"Normally, when new star talent is recruited, everyone in the partnership bears equal risk," explained Zeughauser. "But what happened at Dewey is that partners at the higher end of the pay-scale demanded guarantees on their money. That transferred all the risk to the people at the lower end of the pay scale, creating huge pay disparities."
Dewey was not alone among firms of its ilk in going after star hires. American Lawyer magazine, the law-firm industry's leading trade publication, reported that 2011 "was the year that partners jumped back into the lateral market with full force." Dewey, having hired 33 new partners in the 12 months ending September 30, 2011, ranked ninth, among top-gaining firms, in lateral-partner hires. American Lawyer cautioned, however, that 2011’s "uptick in lateral churn does not mean the boom years are back ... In many cases, it's cherry picking, as firms try to counter a stagnant economy by poaching top performers from rivals." The hiring binge, American Lawyer wrote, “was driven by desperation, not a thriving economy.”
"The only thing holding many large firms together now is money. No shared history. No shared values. Money by itself is weak glue."
In October of 2011, Dewey announced it had compensation commitments it could not meet. Slashed pay led to lawyer defections. Since January, at least 85 of Dewey's 300 partners have left. Last week, the Manhattan district attorney launched a criminal investigation into alleged wrongdoing by Dewey's former chairman, Steven Davis, in his management of the firm. On Friday, Dewey told its incoming class of summer associates, scheduled to begin in a matter of weeks, making more than $3,000 per week, that the summer program was cancelled. On Monday, Dewey advised its partners to begin looking for work elsewhere.
"If the economy had clipped along, like in 2006 and 2007, Dewey management might have looked wise," said William Henderson, a law professor at Indiana University who studies the business of law firms. "But with the downturn, the pay guarantees essentially sheltered some new hires at the expense of the rest of the rank and file partnership."
Historically, in order to afford those $3,000-per-week salaries for first-year attorneys with no experience, and to keep rainmaking partners happy, law firms have been, like some of the Wall Street institutions they service, heavily leveraged entities. The difference is that, in law, the leverage is not financial but human. Banks gamble on investments, while law firms gamble on people. In a sense, it’s all the same: if business is good, leverage pays off.
It's best, Henderson says, for a firm to grow organically, nurturing its own talent rather than paying high prices for rainmakers who might not make it rain. But under pressure, many firms are giving up on organic growth and turning to a lateral-hire strategy in the downturn. "Lateral partners seem like the cure," Henderson says. "As a result, the only thing holding many large firms together now is money. No shared history. No shared values. Money by itself is weak glue."
Some brand-name firms, like Latham & Watkins, have done well with lateral hires by vetting them carefully and being cautious with pay guarantees, says Zeughauser, the law-firm adviser. "But it's always risky. Law firms are just fragile. In a consolidating industry, even the strongest of them won't be around forever. Dewey proves that."
The legal press has compared Dewey's situation to the 1987 collapse of Finley Kumble. It was that year ironically, that American Lawyer published the first edition of its now heralded law-firm rankings, the Am Law 100, and ranked Finley Kumble #2. By year's end, the firm folded, in part because of rich guarantees to star laterals.
Twenty-five years later, 11 of those original AmLaw 100 firms are now extinct.
Jerome Kowalski
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