Law Firm Turnarounds

Law firm failures are not that uncommon as indicated by this list of Am Law 200 law firms that failed during the past two decades:

• Altheimer & Gray;
• Arter & Hadden;
• Bogle & Gates;
• Brobeck Phleger & Harrison;
• Coudert Brothers;
• Heller Ehrman;
• Howrey LLP;
• Jenkens & Gilchrist;
• McKee Nelson;
• Morgan & Finnegan;
• Pennie & Edmonds;
• Shea & Gould;
• Thacher Proffitt & Wood;
• Thelen Reid & Priest;
• Wolf, Block, Schorr and Solis-Cohen.

Can a firm be saved when it is facing multiple critical threats to its existence? The answer is yes ' if the firm acts quickly and decisively.

The primary steps in an effective rescue plan are:

• Stop the bleeding;
• Restore trust in leadership;
• Retain key partners;
• Shrink to a profitable core operating size;
• Restructure operations and renegotiate commitments.

Stop the Bleeding

The underlying cause of the fiscal crisis must be addressed directly. Cash flow and liquidity are the primary concerns for the law firm to continue operations and survive. Usually a financially distressed firm will begin this process on its own, but it often balks at taking all of the steps that are required. A third-party adviser can provide needed objectivity, facilitate the process and “take the heat” for what can be very painful and difficult decisions.

In Altman Weil's crisis management work, we help firm leaders prioritize which payments must be made to continue operations, and which non-critical obligations can be deferred. Every law firm CFO is capable of making those distinctions without any difficulty. The challenge is implementing this process and dealing with the public relations issues for those payees who have been relegated to the “non-critical” list. Oftentimes these issues affect long-time vendor relationships and friendships that may include vendors who are also clients and those who have personal relationships with one or more partners.

Restore Trust in Leadership

We have found that all too frequently the firm's leadership has understated the extent and magnitude of the fiscal crisis, and has projected optimistic results that did not materialize. Rather than “confront the brutal facts,” they have not fully understood the magnitude of the issues the firm is facing, misinterpreted the financial data and/or have attempted to boost morale by portraying a rosier picture of future operating results wherever possible.

For example, as partners leave for greener pastures elsewhere the lawyer head count decreases so that even if revenues decline, the “revenue per lawyer” statistic might increase due to the lag time in collecting receivables and the lower head count. Clearly, the decline in revenues is not good and portraying it as if it were because “revenues per lawyer” increased would be misleading.

Once leadership loses the confidence of the firm's lawyers there is no choice but to change the leadership team. There is no time for the existing team to regain the trust of the lawyers. This is another area where the need for swift, decisive action may be best served by an independent expert who can guide the partners to consensus on new leadership at a time of high tension and crisis.

Frequently, the most qualified and respected individual is unwilling to make the sacrifices required to accept a “battlefield promotion.” Other viable candidates must be identified and consensus built around their elevation. In addition to assuming substantial potential risk as a leader of a law firm that might implode, the partner's clients and law practice will certainly suffer from less attention as the partner focuses on the firm's survival. Here is a telling paradox: Those very clients are the lifeline for the partner if the firm does not make it, as the market seeks lawyers who have sizable, profitable, portable and strategically important clients.

A willingness to make large personal sacrifices and dedication to the law firm are essential qualities of aspiring leaders. Some call this statesmanship or stewardship. Whatever one wants to call it, finding a leader who will place the firm's interests and preservation above all else is an absolute requirement for a successful turnaround. Once the selection process is complete, an announcement should be made that includes the new leadership's honest assessment of the situation and an outline of the process going forward. Clear and forthright communications from this point forward are paramount.

Retain Key Partners

The importance of listening to the concerns of partners and eliciting their input cannot be over-emphasized. The partners have to believe their concerns are being heard, considered in a thoughtful and careful manner, and that appropriate action will be taken.

Partners with vitally important clients, and their associated revenue, have the most options in terms of moving to another firm. In order for the law firm to have any chance for success, those partners and their clients must be retained. The firm's leaders must maintain an open, candid and constructive channel of communication. These partners want actions that will help them demonstrate to their clients that the firm can survive and their legal needs will be properly serviced. The firm must demonstrate a deep and thorough understanding of the situation and a pragmatic, decisive approach to recovery.

Fair and competitive compensation is not the most important short-term consideration. However, a realistic path to this end is absolutely necessary. Competitors move swiftly with lucrative pay offers and promises of resources to partners in troubled firms. An extensive lawyer recruiting industry assists these efforts. A troubled law firm's leaders must spend their “trust capital” quickly to hold those partners until cash flow recovers. Then they can replenish that capital by delivering results.

Shrink to a Profitable Core Operating Size

Difficult decisions often have to be made to save the troubled law firm. The first step is to identify a core set of clients, practices, offices and lead partners that will form the surviving law firm. This is the inner ring. Surrounding this group are the essential lawyers, paralegals and other timekeepers that service this business. This is the second ring. Finally the appropriate administrative support group and infrastructure is wrapped around creating the third ring. All else is redundant. Usually this will result in a smaller law firm.

Unfortunately, the execution of this outcome is far more complicated than the more straightforward number crunching. Some personnel may be marginally profitable ' that is they cover direct costs and contribute something to indirect costs that cannot be relieved in the short term (such as long-term leases). And here exists another paradox where locked-in costs stymie efforts to achieve a reduced core size. Yet another challenge may come from clients who may require a portfolio of services from their law firm. Some of those services may not be core, but are essential to retain important clients. Often those services are less profitable and will require some creative re-engineering to improve.

The business of law is currently dominated by people and compensation expenses. Restructuring will affect the lives and livelihoods of many individuals. It is one thing to release an individual in a market where realistic alternate job prospects exist. This past economy was and in many ways continues to be an enormous challenge in this respect. We have counseled many leadership teams on these issues as they struggled with business and moral implications of their decisions. The right course varies by firm and the immediate circumstances of their situation. Decision paralysis is not a viable position if the firm wants to avoid the situation spiraling out of control.

Restructure Operations and Renegotiate Commitments

Concurrent with reductions in force, leadership should review the appropriateness of compensation arrangements for those who will remain. This includes a review of cash and benefits of all personnel. Partners who have served the firm well and loyally in the past and who are well liked but whose practices have declined cannot be overpaid. This same rationale extends to all lawyers, all timekeepers and all staff. As difficult as it might be, compensation is too significant a component of the overall cost structure to be glossed over. A cautionary note ' this process must be done judiciously, as the job and real estate markets will improve and in so doing give employees other options if they believe they are under-compensated.

Major restructuring beyond personnel must include office space and technology. Both are expensive commitments and are integral to operations. Both also involve contract obligations of varying lengths. Warehoused space and technology are expensive and might have little alternative value ' that is they are dead weights that will require extensive work to resolve.

There are many other vendors providing services to a law firm. Each agreement will need to be reviewed and renegotiated as appropriate. Many law firm contractual arrangements will have default terms and acceleration clauses in them. These are very common in lease and debt agreements. Care must be taken to avoid triggering default conditions as this can quickly cascade across contracts, vastly complicating the situation. This process can overwhelm a management team. Experts who have invested in analysis tools and best practices in this area can accelerate this review, freeing management for other matters. In our experience, most vendors are willing to renegotiate once they are convinced that it is in their best interest to do so.

Conclusion

Law firm failures are always sad because they entail dramatic hardship for many loyal and competent employees who did nothing to deserve such a situation. The fallout in personal and financial devastation can be mitigated if a firm moves decisively. Gaining the advice of experts who have traveled these paths before can shorten management's learning curve and reduce the likelihood of misdirected efforts. Time is of the essence to survive.

William F. Brennan is a principal with legal management consultancy Altman Weil, Inc., specializing in law firm finance, mergers and acquisitions. He assists financially distressed law firms to successfully restructure their operations. Contact him at [email protected]. Copyright ' 2012 Altman Weil, Inc., Newtown Square, PA, USA.

Dewey & LeBoeuf LLP, the 20th largest law firm in the country according to the 2012 NLJ 250, is in the process of dissolving with a future bankruptcy declaration almost certain. According to the firm's management, in 2011 it had more than $900 million in revenues with average profits per equity partner of about $1.8 million. The Am Law Daily reported that those statistics were substantially overstated and had to be restated to $782 million in revenue and $1.04 million in average profits per equity partner, still impressive statistics for a law firm. (Dewey says that the former numbers were and are accurate and are due to methodological differences.) How could such a prominent law firm end up in such a mess?

If Dewey's situation is consistent with other law firm financial crises, it fell victim to a series of different issues that individually might have been manageable, but together may prove to be insurmountable. Typically law firms in crisis face more than one of the following critical challenges:

• Loss of key clients;
• Loss of key partners;
• Regulatory or legislative change affecting key practices;
• Excessive reliance upon debt;
• Overhead expenses out of control;
• Overly rich benefits provided to former partners via an unfunded partner withdrawal entitlement;
• Compensation systems not perceived as equitable or pay levels significantly below market;
• Loss of confidence in firm Leadership/Management;
• Inattention to client/practice concentrations;
• Failure to react to market shifts;
• Reliance on billing rate increases at twice the rate of inflation as primary means to increased profits.

The occurrence of one of these problems, if corrected quickly, is unlikely to cause a law firm to fail, but the simultaneous convergence of two or three, or an inability to adjust quickly, can spell doom for a law firm ' a business structure that relies primarily on the shared trust of its co-owners and thin capitalization.

A strong economy can mask serious underlying financial problems. Firm leaders are convinced that generating more revenue (often by charging more and working harder) is the path of least resistance to address a cash flow shortfall. In a recessionary economy all firms feel greater financial stress, and firms that have not been prudently managed will be severely challenged. The protracted economic malaise of the legal profession during the past several years has caused many law firms, including some of the largest in the country, to literally have to fight to survive.

Law firm failures are not that uncommon as indicated by this list of Am Law 200 law firms that failed during the past two decades:

• Altheimer & Gray;
• Arter & Hadden;
• Bogle & Gates;
• Brobeck Phleger & Harrison;
• Coudert Brothers;
• Heller Ehrman;
• Howrey LLP;
• Jenkens & Gilchrist;
• McKee Nelson;
• Morgan & Finnegan;
• Pennie & Edmonds;
• Shea & Gould;
• Thacher Proffitt & Wood;
• Thelen Reid & Priest;
• Wolf, Block, Schorr and Solis-Cohen.

Can a firm be saved when it is facing multiple critical threats to its existence? The answer is yes ' if the firm acts quickly and decisively.

The primary steps in an effective rescue plan are:

• Stop the bleeding;
• Restore trust in leadership;
• Retain key partners;
• Shrink to a profitable core operating size;
• Restructure operations and renegotiate commitments.

Stop the Bleeding

The underlying cause of the fiscal crisis must be addressed directly. Cash flow and liquidity are the primary concerns for the law firm to continue operations and survive. Usually a financially distressed firm will begin this process on its own, but it often balks at taking all of the steps that are required. A third-party adviser can provide needed objectivity, facilitate the process and “take the heat” for what can be very painful and difficult decisions.

In Altman Weil's crisis management work, we help firm leaders prioritize which payments must be made to continue operations, and which non-critical obligations can be deferred. Every law firm CFO is capable of making those distinctions without any difficulty. The challenge is implementing this process and dealing with the public relations issues for those payees who have been relegated to the “non-critical” list. Oftentimes these issues affect long-time vendor relationships and friendships that may include vendors who are also clients and those who have personal relationships with one or more partners.

Restore Trust in Leadership

We have found that all too frequently the firm's leadership has understated the extent and magnitude of the fiscal crisis, and has projected optimistic results that did not materialize. Rather than “confront the brutal facts,” they have not fully understood the magnitude of the issues the firm is facing, misinterpreted the financial data and/or have attempted to boost morale by portraying a rosier picture of future operating results wherever possible.

For example, as partners leave for greener pastures elsewhere the lawyer head count decreases so that even if revenues decline, the “revenue per lawyer” statistic might increase due to the lag time in collecting receivables and the lower head count. Clearly, the decline in revenues is not good and portraying it as if it were because “revenues per lawyer” increased would be misleading.

Once leadership loses the confidence of the firm's lawyers there is no choice but to change the leadership team. There is no time for the existing team to regain the trust of the lawyers. This is another area where the need for swift, decisive action may be best served by an independent expert who can guide the partners to consensus on new leadership at a time of high tension and crisis.

Frequently, the most qualified and respected individual is unwilling to make the sacrifices required to accept a “battlefield promotion.” Other viable candidates must be identified and consensus built around their elevation. In addition to assuming substantial potential risk as a leader of a law firm that might implode, the partner's clients and law practice will certainly suffer from less attention as the partner focuses on the firm's survival. Here is a telling paradox: Those very clients are the lifeline for the partner if the firm does not make it, as the market seeks lawyers who have sizable, profitable, portable and strategically important clients.

A willingness to make large personal sacrifices and dedication to the law firm are essential qualities of aspiring leaders. Some call this statesmanship or stewardship. Whatever one wants to call it, finding a leader who will place the firm's interests and preservation above all else is an absolute requirement for a successful turnaround. Once the selection process is complete, an announcement should be made that includes the new leadership's honest assessment of the situation and an outline of the process going forward. Clear and forthright communications from this point forward are paramount.

Retain Key Partners

The importance of listening to the concerns of partners and eliciting their input cannot be over-emphasized. The partners have to believe their concerns are being heard, considered in a thoughtful and careful manner, and that appropriate action will be taken.

Partners with vitally important clients, and their associated revenue, have the most options in terms of moving to another firm. In order for the law firm to have any chance for success, those partners and their clients must be retained. The firm's leaders must maintain an open, candid and constructive channel of communication. These partners want actions that will help them demonstrate to their clients that the firm can survive and their legal needs will be properly serviced. The firm must demonstrate a deep and thorough understanding of the situation and a pragmatic, decisive approach to recovery.

Fair and competitive compensation is not the most important short-term consideration. However, a realistic path to this end is absolutely necessary. Competitors move swiftly with lucrative pay offers and promises of resources to partners in troubled firms. An extensive lawyer recruiting industry assists these efforts. A troubled law firm's leaders must spend their “trust capital” quickly to hold those partners until cash flow recovers. Then they can replenish that capital by delivering results.

Shrink to a Profitable Core Operating Size

Difficult decisions often have to be made to save the troubled law firm. The first step is to identify a core set of clients, practices, offices and lead partners that will form the surviving law firm. This is the inner ring. Surrounding this group are the essential lawyers, paralegals and other timekeepers that service this business. This is the second ring. Finally the appropriate administrative support group and infrastructure is wrapped around creating the third ring. All else is redundant. Usually this will result in a smaller law firm.

Unfortunately, the execution of this outcome is far more complicated than the more straightforward number crunching. Some personnel may be marginally profitable ' that is they cover direct costs and contribute something to indirect costs that cannot be relieved in the short term (such as long-term leases). And here exists another paradox where locked-in costs stymie efforts to achieve a reduced core size. Yet another challenge may come from clients who may require a portfolio of services from their law firm. Some of those services may not be core, but are essential to retain important clients. Often those services are less profitable and will require some creative re-engineering to improve.

The business of law is currently dominated by people and compensation expenses. Restructuring will affect the lives and livelihoods of many individuals. It is one thing to release an individual in a market where realistic alternate job prospects exist. This past economy was and in many ways continues to be an enormous challenge in this respect. We have counseled many leadership teams on these issues as they struggled with business and moral implications of their decisions. The right course varies by firm and the immediate circumstances of their situation. Decision paralysis is not a viable position if the firm wants to avoid the situation spiraling out of control.

Restructure Operations and Renegotiate Commitments

Concurrent with reductions in force, leadership should review the appropriateness of compensation arrangements for those who will remain. This includes a review of cash and benefits of all personnel. Partners who have served the firm well and loyally in the past and who are well liked but whose practices have declined cannot be overpaid. This same rationale extends to all lawyers, all timekeepers and all staff. As difficult as it might be, compensation is too significant a component of the overall cost structure to be glossed over. A cautionary note ' this process must be done judiciously, as the job and real estate markets will improve and in so doing give employees other options if they believe they are under-compensated.

Major restructuring beyond personnel must include office space and technology. Both are expensive commitments and are integral to operations. Both also involve contract obligations of varying lengths. Warehoused space and technology are expensive and might have little alternative value ' that is they are dead weights that will require extensive work to resolve.

There are many other vendors providing services to a law firm. Each agreement will need to be reviewed and renegotiated as appropriate. Many law firm contractual arrangements will have default terms and acceleration clauses in them. These are very common in lease and debt agreements. Care must be taken to avoid triggering default conditions as this can quickly cascade across contracts, vastly complicating the situation. This process can overwhelm a management team. Experts who have invested in analysis tools and best practices in this area can accelerate this review, freeing management for other matters. In our experience, most vendors are willing to renegotiate once they are convinced that it is in their best interest to do so.

Conclusion

Law firm failures are always sad because they entail dramatic hardship for many loyal and competent employees who did nothing to deserve such a situation. The fallout in personal and financial devastation can be mitigated if a firm moves decisively. Gaining the advice of experts who have traveled these paths before can shorten management's learning curve and reduce the likelihood of misdirected efforts. Time is of the essence to survive.

William F. Brennan is a principal with legal management consultancy Altman Weil, Inc., specializing in law firm finance, mergers and acquisitions. He assists financially distressed law firms to successfully restructure their operations. Contact him at [email protected]. Copyright ' 2012 Altman Weil, Inc., Newtown Square, PA, USA.