The Pathology of Failed Law Firms

As of this writing, Dewey & LeBoeuf LLP filed for bankruptcy protection on May 28, 2012 and is closing its doors. After trying to cheat death by running through an elixir of mergers, lateral hires, and guaranteed contracts, it was not able to sustain viability as an international law firm that once boasted more than 1,300 lawyers in 12 countries. It failed to consider the consequences of its growth, visions of Bali Ha'i, and incompatible cultures. Overstated financial results didn't help matters either. (Dewey says that its numbers, which were restated by The Am Law Daily, were and are accurate and are due to methodological differences.) From January through April, the firm has lost over one-third of its 300 partners amid a confluence of issues including a mounting debt crisis. As a last ditch effort Dewey tried and failed to find a merger partner. Most of the remaining partners left in May.

As of the filing date, Dewey's Statement of Assets and Liabilities revealed a negative net-worth of $52 million. This figure does not include “fee” accounts receivable (which rapidly declines in value after the filing); work-in-progress (that will need to be collected by the bankruptcy trustee from other law firms); or contingent liabilities (e.g., facility leases). One can easily see that the partners will be subject to clawbacks, and an experienced bankruptcy trustee will attempt to clawback partner distributions from not only 2011 but also 2010 and earlier years.

The stories of its downfall continue to evolve; however the speed with which this downfall occurred was astonishing, leading many, including me, to believe that chinks in Dewey's armor had begun to appear during the past two years if not longer. The speed of Dewey's decline also shows how fragile seemingly strong law firms are.

It was with great fanfare in 2007 that the firms of Dewey Ballantine and LeBoeuf, Lamb, Greene & MacRae merged; consider their combined press release: “This strategic combination will create a premier New York law firm with extensive global reach,” said LeBoeuf Lamb's Chairman, Steven H. Davis. “The quality, scale and scope we will offer as a combined firm will enable us to continue attracting the most prominent clients and to address complex and challenging legal issues our clients face on a national and global basis. Combining our strengths and collective resources into one organization advances LeBoeuf Lamb's goal to broaden and deepen our practice offerings and global presence, add highly skilled and dynamic lawyers and continue to focus on increasing profitability.”

“Dewey Ballantine has been focused on growth for some time, and this combination with LeBoeuf Lamb is an especially good fit. LeBoeuf Lamb brings a practice and industry focus that complements and enhances our areas of practice to create a powerful array of offerings for clients,” said Morton Pierce, co-chair of Dewey Ballantine. “Clients will benefit from significant additional resources from a firm with a presence in nearly every key international financial and commercial center, and we believe this combination is to the advantage of everyone at the firm and our clients worldwide.”

Interestingly, the press release also stated that the two firms “share a similar heritage and evolution, which is underscored by the firms' compatible cultures, values, and visions.”

The cultures of the two firms were, in fact, quite different and that led to problems and all too frequent finger-pointing, as we have seen. And let us not forget the failed merger talks between Dewey and Orrick, Herrington & Sutcliffe LLP in early 2007. There were a number of issues including differing cultures, financial commitments, and who would lead the combined firm. Dewey was already leaking partners prior to the Orrick discussions. Seemingly, Dewey was already a firm with considerable challenges.

And what became of the quotable leaders of the two firms? Davis was removed as head of the firm and is subject of an investigation by the D.A.'s office, and Pierce bolted for White & Case LLP.

A few of the problems that faced Dewey were unique, while others were not. Nor is Dewey alone; more than 10 large and prominent firms have failed in the past decade including Howrey & Simon; Thacher Proffitt & Wood; Heller Ehrman; Thelen Reid & Priest; Jenkens & Gilchrist; Coudert Brothers; Brobeck, Phleger & Harrison; and Altheimer & Gray.

This article focuses on the pathology of failed law firms.

Resistance to Change

Lawyers are exceptional people. They are exceptionally smart. They are also exceptional in their ability to resist change. Once the mind has set out to do something, or has been in the habit of doing something, changing it is very difficult. “It's the way we do things around here” is a common cultural theme among law firms. When you add group dynamics, change becomes even harder.

We all have stories of when a firm made a collective mistake with its people or strategy. Unfortunately, the firms in which we work are imperfect. Noted author Dr. Karl Albrecht developed “Albrecht's Law” in 1980 after years of studying organizations. Albrecht's law states that “intelligent people, when assembled into an organization, would tend toward collective stupidity.” This law rings true in many situations. Very intelligent lawyers often inadvertently collude to fail by becoming embroiled in internal politics and personality dysfunctions to the exclusion of focusing on what is best for the firm.

Change is risky, after all, since it involves doing something that isn't already working ' and even practice areas or partners that have grown lackluster still have some clients. However, resistance to change and its resulting inertia explain why industry innovation so often seems to be driven by newcomers rather than by profitable and “white shoe” incumbents. Consider the likes of Axiom, Clearspire, LawVest, CPA Global, and many others who are considered unconventional competitors or in some instances, industry disrupters.

Weak Leadership and Management

Inept and weak management have played crucial, if lesser known, roles in law firm failures. It's what happens when people with no business management skills try to run a law firm. Law firms do not generally accept and nurture broad-minded managers skilled in running large-scale operations. And lawyers, being themselves, generally do not want to be managed. A former head of Bain Consulting compares managing lawyers with herding tigers (not cats). This situation is further exacerbated by a lawyer's inability to learn from his or her clients. Law firms are a complicated and challenging business.

Thankfully, we have some new thinking and strategy in law firm management and leadership. Consider the rare move by Pepper Hamilton LLP by hiring Scott Green as chief executive officer to take over management of the firm. Green is not a lawyer. Not only will the normal management functions (finance, IT, marketing, etc.) report to Green, but the legal functions of the firm such as practice group leaders and office managing partners will also report to him. Such a move is not without its challenges, but Green has an impressive background in both the legal services and investment banking sectors. Having an MBA from Harvard and being a CPA also doesn't hurt. Nina M. Gussack, chairwoman of Pepper Hamilton's executive committee, stated that the firm wanted someone who could provide relentless attention to the firm's strategic goals while also working on day-to-day management issues. In this context, the firm adopted a management model in use by its clients.

Denver-based Brownstein Hyatt Farber Schreck made a similar move in late 2010 when it hired Blane Prescott as its new CEO to focus on building the firm's strategy and market position. Additionally, more and more firms are hiring non-lawyers as project management leaders to manage cases.

Free Agency Partners

Free agency partners create a cultural imbalance in firms. Attorneys have been defecting to rival firms willing to promise them million-dollar paydays. The word greed also comes to mind. Compensation is the not the glue that binds law firms. I know some former attorneys who talk about a firm's culture that had been disintegrating ' in part because an increase in the hiring of laterals had created a highly competitive environment where attorneys were not fully integrated into the firm. Ultimately, relationships are the glue that binds law firms. Without strong relationships among firm attorneys, and between them and their clients, firms crumble. Here's the thing about law firms ' their assets are their people. These assets walk out the door every day, and the key is to make sure that the good ones come back in the morning.

Poor Financial Health

Any firm can succeed in spite of itself if there is enough money (profits) to spread around. Law firms have been facing financial pressures for years, and the problems become exacerbated during an economic downturn. There are many causes of poor financial performance including: poor billing and collection practices, low realization, underproductive lawyers, lack of capital, excessive debt load, overexpansion, unfunded retirement plans, and excessive overhead.

Excessive Client Loyalty to Individuals

This is one of the most persistent problems facing law firms. There are a number of factors to blame for this issue including leadership, compensation, trust, training and development, succession planning, and the like. Free agency partners covet their client relationships.

K&L Gates LLP, which has expanded significantly during the past few years, seems to understand the importance of integration and the concept of firm clients. Its “Our Practice” webpage states: “In 2011, 461 of our 500 largest clients used lawyers in two or more of our offices, and 15 of our 20 largest clients used lawyers in 10 or more of our offices. The average number of offices engaged on projects by the firm's 20 largest clients was 13.6. For our 100 largest clients, which represent 34.4% of total firm revenue, the average number of offices engaged was 10.3.” It would be even more interesting to see similar statistics regarding its practice groups.

Lack of Strategy or Failure to Execute on Strategy

Successful firms know what they can do, and they do it well. They resist the temptation to expand into areas where they lack the expertise, resources, and partner commitment to succeed. At the same time, firms invest heavily in those areas where they excel. Peter G. Peterson, co-founder of the Blackstone Group once stated “When I was at the University of Chicago Graduate School of Business, I had Milton Friedman as a professor. He worshipped free markets and was also a powerful advocate of Adam Smith's concept of comparative advantage: Focus on those things you do better than others. That has been enormously helpful in defining our business strategies.” http://money.cnn.com/galleries/2008/fortune/0804/gallery.bestadvice.fortune/3.html (Incidentally, this author is not related to this Peterson).

Last, the other people to worry about when firms fail are the secretaries, word processors, accountants, paralegals, mailroom folks, the receptionist and other hard-working staff who depend on your firm for their livelihoods. Some of them may find new jobs if they can follow the attorneys to their new places of employment, but most firms do not require incremental staff support when adding laterals. These are the lives most damaged. And as for the Dewey & LeBoeuf wind down ' it's proving to be a long and nasty fight.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm, Maxfield Peterson and a member of this newsletter's Board of Editors. For more than 20 years, Peterson has advised law firms on strategic planning, M&A, compensation and financial management. He can be reached at [email protected].

As of this writing, Dewey & LeBoeuf LLP filed for bankruptcy protection on May 28, 2012 and is closing its doors. After trying to cheat death by running through an elixir of mergers, lateral hires, and guaranteed contracts, it was not able to sustain viability as an international law firm that once boasted more than 1,300 lawyers in 12 countries. It failed to consider the consequences of its growth, visions of Bali Ha'i, and incompatible cultures. Overstated financial results didn't help matters either. (Dewey says that its numbers, which were restated by The Am Law Daily, were and are accurate and are due to methodological differences.) From January through April, the firm has lost over one-third of its 300 partners amid a confluence of issues including a mounting debt crisis. As a last ditch effort Dewey tried and failed to find a merger partner. Most of the remaining partners left in May.

As of the filing date, Dewey's Statement of Assets and Liabilities revealed a negative net-worth of $52 million. This figure does not include “fee” accounts receivable (which rapidly declines in value after the filing); work-in-progress (that will need to be collected by the bankruptcy trustee from other law firms); or contingent liabilities (e.g., facility leases). One can easily see that the partners will be subject to clawbacks, and an experienced bankruptcy trustee will attempt to clawback partner distributions from not only 2011 but also 2010 and earlier years.

The stories of its downfall continue to evolve; however the speed with which this downfall occurred was astonishing, leading many, including me, to believe that chinks in Dewey's armor had begun to appear during the past two years if not longer. The speed of Dewey's decline also shows how fragile seemingly strong law firms are.

It was with great fanfare in 2007 that the firms of Dewey Ballantine and LeBoeuf, Lamb, Greene & MacRae merged; consider their combined press release: “This strategic combination will create a premier New York law firm with extensive global reach,” said LeBoeuf Lamb's Chairman, Steven H. Davis. “The quality, scale and scope we will offer as a combined firm will enable us to continue attracting the most prominent clients and to address complex and challenging legal issues our clients face on a national and global basis. Combining our strengths and collective resources into one organization advances LeBoeuf Lamb's goal to broaden and deepen our practice offerings and global presence, add highly skilled and dynamic lawyers and continue to focus on increasing profitability.”

“Dewey Ballantine has been focused on growth for some time, and this combination with LeBoeuf Lamb is an especially good fit. LeBoeuf Lamb brings a practice and industry focus that complements and enhances our areas of practice to create a powerful array of offerings for clients,” said Morton Pierce, co-chair of Dewey Ballantine. “Clients will benefit from significant additional resources from a firm with a presence in nearly every key international financial and commercial center, and we believe this combination is to the advantage of everyone at the firm and our clients worldwide.”

Interestingly, the press release also stated that the two firms “share a similar heritage and evolution, which is underscored by the firms' compatible cultures, values, and visions.”

The cultures of the two firms were, in fact, quite different and that led to problems and all too frequent finger-pointing, as we have seen. And let us not forget the failed merger talks between Dewey and Orrick, Herrington & Sutcliffe LLP in early 2007. There were a number of issues including differing cultures, financial commitments, and who would lead the combined firm. Dewey was already leaking partners prior to the Orrick discussions. Seemingly, Dewey was already a firm with considerable challenges.

And what became of the quotable leaders of the two firms? Davis was removed as head of the firm and is subject of an investigation by the D.A.'s office, and Pierce bolted for White & Case LLP.

A few of the problems that faced Dewey were unique, while others were not. Nor is Dewey alone; more than 10 large and prominent firms have failed in the past decade including Howrey & Simon; Thacher Proffitt & Wood; Heller Ehrman; Thelen Reid & Priest; Jenkens & Gilchrist; Coudert Brothers; Brobeck, Phleger & Harrison; and Altheimer & Gray.

This article focuses on the pathology of failed law firms.

Resistance to Change

Lawyers are exceptional people. They are exceptionally smart. They are also exceptional in their ability to resist change. Once the mind has set out to do something, or has been in the habit of doing something, changing it is very difficult. “It's the way we do things around here” is a common cultural theme among law firms. When you add group dynamics, change becomes even harder.

We all have stories of when a firm made a collective mistake with its people or strategy. Unfortunately, the firms in which we work are imperfect. Noted author Dr. Karl Albrecht developed “Albrecht's Law” in 1980 after years of studying organizations. Albrecht's law states that “intelligent people, when assembled into an organization, would tend toward collective stupidity.” This law rings true in many situations. Very intelligent lawyers often inadvertently collude to fail by becoming embroiled in internal politics and personality dysfunctions to the exclusion of focusing on what is best for the firm.

Change is risky, after all, since it involves doing something that isn't already working ' and even practice areas or partners that have grown lackluster still have some clients. However, resistance to change and its resulting inertia explain why industry innovation so often seems to be driven by newcomers rather than by profitable and “white shoe” incumbents. Consider the likes of Axiom, Clearspire, LawVest, CPA Global, and many others who are considered unconventional competitors or in some instances, industry disrupters.

Weak Leadership and Management

Inept and weak management have played crucial, if lesser known, roles in law firm failures. It's what happens when people with no business management skills try to run a law firm. Law firms do not generally accept and nurture broad-minded managers skilled in running large-scale operations. And lawyers, being themselves, generally do not want to be managed. A former head of Bain Consulting compares managing lawyers with herding tigers (not cats). This situation is further exacerbated by a lawyer's inability to learn from his or her clients. Law firms are a complicated and challenging business.

Thankfully, we have some new thinking and strategy in law firm management and leadership. Consider the rare move by Pepper Hamilton LLP by hiring Scott Green as chief executive officer to take over management of the firm. Green is not a lawyer. Not only will the normal management functions (finance, IT, marketing, etc.) report to Green, but the legal functions of the firm such as practice group leaders and office managing partners will also report to him. Such a move is not without its challenges, but Green has an impressive background in both the legal services and investment banking sectors. Having an MBA from Harvard and being a CPA also doesn't hurt. Nina M. Gussack, chairwoman of Pepper Hamilton's executive committee, stated that the firm wanted someone who could provide relentless attention to the firm's strategic goals while also working on day-to-day management issues. In this context, the firm adopted a management model in use by its clients.

Denver-based Brownstein Hyatt Farber Schreck made a similar move in late 2010 when it hired Blane Prescott as its new CEO to focus on building the firm's strategy and market position. Additionally, more and more firms are hiring non-lawyers as project management leaders to manage cases.

Free Agency Partners

Free agency partners create a cultural imbalance in firms. Attorneys have been defecting to rival firms willing to promise them million-dollar paydays. The word greed also comes to mind. Compensation is the not the glue that binds law firms. I know some former attorneys who talk about a firm's culture that had been disintegrating ' in part because an increase in the hiring of laterals had created a highly competitive environment where attorneys were not fully integrated into the firm. Ultimately, relationships are the glue that binds law firms. Without strong relationships among firm attorneys, and between them and their clients, firms crumble. Here's the thing about law firms ' their assets are their people. These assets walk out the door every day, and the key is to make sure that the good ones come back in the morning.

Poor Financial Health

Any firm can succeed in spite of itself if there is enough money (profits) to spread around. Law firms have been facing financial pressures for years, and the problems become exacerbated during an economic downturn. There are many causes of poor financial performance including: poor billing and collection practices, low realization, underproductive lawyers, lack of capital, excessive debt load, overexpansion, unfunded retirement plans, and excessive overhead.

Excessive Client Loyalty to Individuals

This is one of the most persistent problems facing law firms. There are a number of factors to blame for this issue including leadership, compensation, trust, training and development, succession planning, and the like. Free agency partners covet their client relationships.

K&L Gates LLP, which has expanded significantly during the past few years, seems to understand the importance of integration and the concept of firm clients. Its “Our Practice” webpage states: “In 2011, 461 of our 500 largest clients used lawyers in two or more of our offices, and 15 of our 20 largest clients used lawyers in 10 or more of our offices. The average number of offices engaged on projects by the firm's 20 largest clients was 13.6. For our 100 largest clients, which represent 34.4% of total firm revenue, the average number of offices engaged was 10.3.” It would be even more interesting to see similar statistics regarding its practice groups.

Lack of Strategy or Failure to Execute on Strategy

Successful firms know what they can do, and they do it well. They resist the temptation to expand into areas where they lack the expertise, resources, and partner commitment to succeed. At the same time, firms invest heavily in those areas where they excel. Peter G. Peterson, co-founder of the Blackstone Group once stated “When I was at the University of Chicago Graduate School of Business, I had Milton Friedman as a professor. He worshipped free markets and was also a powerful advocate of Adam Smith's concept of comparative advantage: Focus on those things you do better than others. That has been enormously helpful in defining our business strategies.” http://money.cnn.com/galleries/2008/fortune/0804/gallery.bestadvice.fortune/3.html (Incidentally, this author is not related to this Peterson).

Last, the other people to worry about when firms fail are the secretaries, word processors, accountants, paralegals, mailroom folks, the receptionist and other hard-working staff who depend on your firm for their livelihoods. Some of them may find new jobs if they can follow the attorneys to their new places of employment, but most firms do not require incremental staff support when adding laterals. These are the lives most damaged. And as for the Dewey & LeBoeuf wind down ' it's proving to be a long and nasty fight.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm, Maxfield Peterson and a member of this newsletter's Board of Editors. For more than 20 years, Peterson has advised law firms on strategic planning, M&A, compensation and financial management. He can be reached at [email protected].