Illustration by Daniel Liévano

WARNING SIGNS THREE DECADES OF DATA REVEAL HOW BIG LAW’S GREATEST FAILURES UNFOLDED, AND WHAT WE CAN LEARN FROM THEM.

BY LIZZY MCLELLAN AND GINA PASSARELLA WHEN LECLAIRRYAN REACHED THE point of no return in August, finally to a collabo- acknowledging its plans to dissolve af- ration that was ter months spent bleeding partners, it billed as the firm’s sav- came into focus that the firm’s aggres- ior but ultimately became sive expansion had actually contributed yet another source of debt. And to its demise. those debts don’t include capital con- The firm had promised partners tributions as high as $100,000 per The de- more than they were worth and signed person, collected from as many as 50 tails of LeClair- expensive leases on understaffed offices. ex-partners who now seem unlikely to Ryan’s collapse are It missed budget in 2011 for the first ever be repaid. unique, but its trajectory is far time, but not the last. When new lead- Even as the firm’s debt grew, some from it. As recently as Sedgwick in ership took over in 2016, there was talk were given bonuses to stay, 2017 and as far back as Finley Kumble of “righting the ship,” a former share- sources have said. A select few part- more than three decades ago, over- holder recalls. Any attempts to do so ners with guaranteed contracts kept ambitious law firms have ended up in were too late. enjoying a high level of compensation trouble. Nearly all were growing head By the time it closed, LeClairRy- while others took pay cuts. Even in its count and revenue in the years leading an had borrowed $15 million from a final year, the firm boasted of its plans up to their demise. But an analysis of 10 lender, nearly half of which remained to change the industry with its new, up- years of data leading up to a dozen dif- as debt in bankruptcy. It owed more dated model, dubbed “ 2.0” ferent firm collapses shows that in most than $8 million to UnitedLex, ­related by leadership. cases, profits per failed to keep

The American Lawyer | November 2019 23 pace with the costs of expansion, leaving Failed firms all had firms overburdened by the mounting debt that helped fuel their growth. something in common, As recently as 20 years ago, the Janis Meyer says: “They had major law firm dissolutions could be counted on one hand. But in the wake of expectations that couldn’t the dot-com bubble burst, and then the be fulfilled.” Great Recession, they began to pile up. Even economic recovery couldn’t stem the tide. Growing financial and client one or more of three issues: expanding pressures forced firms to rethink their too quickly, failing to manage costs and strategic vision, and many chose growth. generally poor leadership. Some followed the wrong path. “When the money got tight, those Each failure was another chapter people who had huge practices and por- in an unfolding story, whether it was a table business left. But had there been firm dissolution or a firm welcoming stronger leadership, that might not have absorption by a larger entity as finan- happened,” says Les Corwin, a partner at cial pressures grew. Some firms grew Eisner whose practice includes law firm head count by hundreds of lawyers in bankruptcies and dissolutions. Corwin just a few years before they met their places much of the blame of law firm end. Others invested in specific prac- failures on a lack of leadership. tices, looking to become the go-to firm External factors, including a reces- for an industry or legal service niche. Janis Meyer, the former general sion, can accelerate a firm’s demise, but And a few ended up under investiga- counsel of Dewey & LeBoeuf, which typically are not at the root of its prob- tion—or worse—for questionable busi- filed for bankruptcy in 2012, describes lems. Collapsed firms “had not grown ness practices. the common thread between failed in the right ways,” says Mary K Young, But they all had something in com- firms simply: “They had expectations a consultant at Zeughauser Group who mon: a strategy developed in the best that couldn’t be fulfilled.” previously worked in the marketing de- of times that didn’t consider what the A number of consultants say law partment of , which dissolved worst of times might hold. firm failures can often be traced back to in 2011.

PRELUDE TO COLLAPSE In the decade before firms closed their doors, costs often rose at an unsustainable rate, making profits harder to maintain.

$1,200,000 Revenue Per Lawyer $800,000 Cost Per Lawyer

$700,000 $1,000,000 $600,000

$800,000 $500,000

$400,000 $600,000

$300,000 $400,000 $200,000

$200,000 $100,000 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 -10 -9 -8 -7 -6 Years Before Collapse Years Before Collapse Data from ALM Intelligence

24 November 2019 | americanlawyer.com Before 2008, Young says, “you could that gross revenue is not a clear indica- years out from collapse—an average bury a lot of issues.” But since the tor that a firm is approaching failure. 12% jump after several years of growth Great Recession, firms have nowhere The data, available through ALM Intel- at a more modest 4% average clip. Head left to hide them. ligence, shows some unsurprising com- count growth fell to 3%, on average, in mon threads, including a drop-off in the year after that sudden increase, then GROWING REVENUE, GROWING DEBT head count and profitability in the year declined 3.5% and, ultimately, 8.2% in Bill Brandt has worked on a number of or two before a firm’s closure. Naturally, the year before firms closed their doors. law firm dissolutions, including How- mass departures are often the first pub- Revenue per lawyer at the average failed rey, (2008), Coudert lic sign that a firm is in grave danger. firm fell 2%, then 3%, in the last two Brothers (2005) and Dewey. He says What may be more surprising is that years of full operation. law firms run into trouble when they many of the dozen firms were growing Several of the 12 law firms saw no lose focus on the fundamentals—the in head count and revenue right up un- meaningful growth in profits per law- blocking and tackling, as a football til lawyers began heading for the exits. yer in the decade before their demise— coach might say. Several even saw revenue per lawyer as revenue per lawyer grew, costs per “You need to keep getting clients, climb in those years. On the surface, lawyer grew right along with it. This working for those clients, getting paid these firms appeared to be growing and was the case at , Wolf by those clients,” Brandt says. thriving, surpassing peers on the Am Block, Sedgwick and LeClairRyan, ac- Instead, firms that ultimately fail Law 200 rankings. cording to ALM Intelligence data. rush to grow rather than using an ap- But across these 12 firms, cost per In many cases, trouble was also propriate level of caution. They open lawyer kept going up, at an average brewing beyond the publicly reported accounts for clients that will never pay, rate higher than the annual growth in financial numbers. Brandt says. They fail to collect, and profits per lawyer. By the two years LeClairRyan, for instance, reported their realization rates plummet. Then, preceding collapse, the average failed gross revenue growth for 2013 and he says, they borrow from the to firm saw profits per lawyer decrease 2014. But according to court records, it make partner distributions, building up 5.9%, then 25.8%. All the while, costs missed budget each of those years. debt based on receivables that aren’t were still rising—1.3% and 7.1%, re- At nearly all of the failed firms, ma- likely to arrive. spectively, in the two years before col- jor debt was building. An examination of financial data for lapse, on average. Brobeck Phleger & Harrison had 12 now-shuttered law firms in the de- The biggest leap in head count for $90 million in debt when it closed in cade leading up to their collapse shows the failed firms tended to occur three 2003, The American Lawyer affiliate

Bingham Brobeck Coudert Dewey Heller Ehrman Howrey Jenkens & Gilchrist LeClairRyan Sedgwick Thacher Thelen Wolf Block

1,500 Head Count

1,200

900

600

300

0 -6 -5 -4 -3 -2 -1 0 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 Years Before Collapse Years Before Collapse

The American Lawyer | November 2019 25 “It doesn’t take a whole lot Sources describe LeClair- Ryan’s compensation system of debt to cause turbulence as opaque and overly compli- in a firm if the cultural cated, not to mention the cuts that came in the firm’s later cohesiveness isn’t there.” years. Many lawyers at the —Jay Benegal firm were aware of the guar- anteed contracts some col- leagues were granted, but their The Recorder reported at the time, in- exact terms were a closely held cluding $40 million it borrowed from secret, sources say. Citibank about a year before it dissolved. When problems become When Coudert Brothers closed in more obvious and partners 2005, it owed $23 million to its bank are caught by surprise, it only creditors, Citigroup and JPMorgan hastens a firm’s demise. Le- Chase & Co., and after paying that off gal industry consultant Brad the firm still listed $18 million in li- Hildebrandt, who has been abilities in bankruptcy, The American the trustee on at least eight Lawyer reported in 2006. law firm dissolutions, includ- Thelen owed Citibank $60 million ing Shea & Gould and Wolf when it decided to dissolve in 2008. Block, says the issue is made Heller, which dissolved the same year, worse by the increasing pace had about $72 million in liabilities, of lateral movement through- about three-quarters of which was out the industry. owed to Bank of America and Citibank. Not only do law firms Howrey, which closed a few years sometimes guarantee money later, had $25 million outstanding on to lateral partners who fail its credit line from Citibank, and when to deliver, but those brought it became apparent that the firm might in laterally usually have less not be able to pay that back, the rela- loyalty to the firm when con- tionship with the bank soured, The ditions worsen and it’s more American Lawyer reported in 2011. important than ever to retain Dewey had over $245 million in li- contributions from partners and use productive lawyers. abilities when it filed for bankruptcy credit minimally, aiming to pay off “There can be warning signs with protection, including $76 million in debts quickly, Benegal says. unhappiness in the partners,” Hildeb- debt to its primary secured creditor, “They boast about the fact that they randt says. “It’s a lack of confidence that JPMorgan Chase. have credit exposure, but they don’t uti- I think develops over time, and then ev- Bingham McCutchen, whose merg- lize the credit exposure they have,” he ery other little issue exacerbates it.” er plans with Morgan, Lewis & Bockius says. “They take pride in the fact that fell apart in 2014 after the departure of they don’t really need to use it. It may WHEN GROWING PAINS more than 100 partners in 18 months, have been an exception pre-financial BECOME FATAL had reportedly accumulated $100 mil- crisis, but it’s not an exception now.” At some firms, unhealthy expansion lion in debt. But that doesn’t mean firm failures focuses too much on a single practice Before the recession, law firms were have ceased. area or industry. Brobeck, for instance, more willing to borrow money to finance “It doesn’t take a whole lot of debt to went all out to develop tech clients their growth, Sanjay Benegal, a senior cause turbulence in a firm if the cultural and found itself in trouble when the vice president and legal industry special- cohesiveness isn’t there,” Benegal says. dot-com bubble burst. Wolf Block ist at Citizens Commercial Banking, says. The problems that plague failing was heavily reliant on real estate work, “If you look at the golden era of the firms often include opacity about firm which tanked in the Great Recession. legal industry, 2001 to 2007, firms were financials, consultants say. A lack of Thacher Proffitt & Wood, which very comfortable borrowing,” he says. transparency, especially when it comes ­collapsed in 2008, focused on mort- But many firms have since changed to compensation, can have far-reaching gage-backed securities work when that their habits—more now rely on ­capital effects on a firm’s culture. practice was at its peak.

26 November 2019 | americanlawyer.com These firms may have had a strate- out to be a little less than was prom- Hayse says. The factor that stood out gic vision behind their niche focus. But ised,” Brandt says. from the rest was a Chicago partner be- in the end, lacking diversification made Some of the firms with strong prac- ing indicted for tax fraud, which resulted them “more vulnerable to external forc- tices might have been better off staying in “a tremendous amount of litigation es,” Dan DiPietro, chairman of the law compact. against the law firm.” firm group at Citi Private Bank, says. “The overall reputation of those That partner joined the firm “because After the recession, firms were caught firms suffered even though they retained of a very, very aggressive growth pro- between a rock (the need to diversify) some of those high-end practices,” DiPi- gram,” Hayse says. “The Chicago office and a hard place (the need to differenti- etro says. “There was a diminishment of is such a good example, because the firm ate from peers and excel in a few areas). the firm’s overall reputation by picking had a growth plan, and had never once “There is a danger to growth that up middle-of-the-road practices.” talked about expanding into Chicago.” is poorly conceived and poorly imple- Geographic growth has also tradi- mented,” DiPietro says, “but there is tionally come with real estate expenses. BACK FROM THE BRINK also a danger to staying as you are if the And several firms failed after signing In discussing the causes of LeClairRy- world is changing around you.” leases for space that would allow for an’s collapse, numerous sources pointed Still more firms, hungry for growth growth before they knew whether those to decisions made by co-founder Gary but without a strategy, find themselves investments would pay off. LeClair and others in his circle that “just throwing things up against the “What often causes a bankruptcy is couldn’t be undone by new leaders who wall and seeing what sticks,” Young the stretch-out and over-extension of took over three years ago. (LeClair has says. These firms pick up laterals and leases,” Brandt says. “People enter into not responded to requests for comment small groups for the sake of growing, these long leases … without looking at on the firm’s dissolution.) and they fail to identify unsuccessful of- the underlying issue of realization rate.” Consultants suggest this is indica- fices that should be seen as sunk costs. Roger Hayse, a consultant who helped tive of one of the main reasons behind “Firms expanding geographically Texas-based Jenkens & Gilchrist with its firms’ misguided business decisions. will say, ‘We go where clients really wind-down in 2007, says that firm’s de- “A law firm without a strong leader need us,’” Hildebrandt says, but small mise could be traced to over-expansion. with a clearly defined mandate is on the offices can create problems due to a “There were a number of factors precipice of disaster,” Corwin says. disparity in economic performance that came together, all working together The same could be said for firms across a firm’s footprint. against the law firm’s long-term health,” that have a great leader but no plan for Over the past 20 years, law firms passing the reins. For instance, when have been creating new norms for size. 250-lawyer Testa Hurwitz & Thi- But that doesn’t always mean greater beault closed in 2005, observers point- profits. Compared with other businesses, ed to founder and chairman Richard law firms don’t get large enough to ben- Testa’s death in December 2002 as a efit from economies of scale, Young says. pivotal moment. “As they get bigger, they have more “That was an amazing firm—an in- revenue and less profits to invest,” she stitution in , making good mon- says. “Technology and marketing and ey,” Corwin says. But it didn’t have a business development are becoming succession plan. so important to being successful that Despite the abundance of caution- they’re actually spending more per law- ary tales, consultants say some firms yer” as they grow. have found a way back from the brink. The data bears this out. At each of Hayse mentions Kaye Scholer as the 12 firms analyzed, costs per law- an example. The firm found itself in a yer continued to climb even as rev- bind in the early 1990s, when work for enue per lawyer and head count grew. a client led to the federal government Brandt says it’s possible to grow profits through a well-thought-out expansion “A law firm without a strong strategy. But in the case of Big Law’s failed firms, the strategy was lacking. leader with a clearly defined “They were promised books by mandate is on the precipice people they merged with. Upon further evaluation, some of those books turned of disaster.” —Les Corwin

The American Lawyer | November 2019 27 28 FINLEY KUMBLE firm in the country inthecountry firm before itdissolved November 2019| The fourth-largest and went into bankruptcy. Over three decades, firms have fallen apart for an assortment ofreasons. Over threedecades, foranassortment have firms fallenapart LAW FIRM COLLAPSES 1988

SHEA &GOULD Greenberg Traurig discussions with before itclosed. Shea &Gould was inmerger 1994 americanlawyer.com DONOVAN, LEISURE, closed aftermerger talks with Orrick, & Herrington NEWTON &IRVINE Sutcliffe fellthrough. Founded in1929, it 1998 2001

DOT-COM CRASH BEGINS to pay partners, and merger talksnever Brobeck borrowed PHLEGER & HARRISON materialized. BROBECK 2003 voted todissolve three TESTA, HURWITZ The 250-lawyer firm Malpractice claims Richard Testadied. firm thatoncehad firm years afterfounder and debtfelleda & THIBEAULT BROTHERS 600 lawyers. COUDERT 2005 2007

GREAT RECESSION BEGINS convicted offraud, and the firm paid and thefirm Two lawyers were Chairman Matthew Chairman the IRS$76M. JENKENS & GILCHRIST dissolution was Larrabee said Larrabee unavoidable. EHRMAN HELLER 2007 THACHER PROFFITT & WOOD The firm’s structured DREIER finance practice A year after the firm was hit hard by the imploded, Marc financial crisis. Drier pleaded guilty to fraud.

THELEN HOWREY BINGHAM SEDGWICK The firm pointed to A relationship with MCCUTCHEN Sedgwick’s demise economic factors Citibank soured and Morgan Lewis hired could be traced to including “reces- partners voted 149- 750 lawyers and staff expansion, infight- sionary pressures.” to-1 to dissolve. as Bingham closed. ing and instability.

2008 2009 2011 2012 2014 2016 2018 2019

DEWEY & DICKSTEIN WOLF BLOCK LEBEOUF SHAPIRO LECLAIRRYAN Some said the firm Debt led to bank- The firm went from The firm had grown to relied too much on ruptcy, and CFO Joel 450 lawyers to 140 21 offices before it real estate work Sanders was later before a deal with dissolved in August. before the recession. convicted of fraud. Blank Rome.

The American Lawyer | November 2019 29 demanding millions in damages from “There is a danger to growth the firm. A bankruptcy partner who had joined via merger two years prior pro- that is poorly conceived and posed a plan to reach an agreement with poorly implemented.” the government. That partner, Michael Crames, later became a firmwide manag- —Dan DiPietro ing partner, and Kaye Scholer continued to operate until it merged with Arnold & “This becomes particularly trouble- Porter in 2017. Crames was not available some when a firm has a bad year or to comment for this story. when there is an economic downturn “The firms that are successful in and simply not enough money to keep turning things around and getting everyone happy,” Meyer says. back on their feet are led by quality Brandt says the next recession is not leaders,” Hayse says. “If you’re start- likely to be as catastrophic as the 2008 ing to have financial trouble and the financial crisis for the economy at large, people at the top still are not effec- including law firms. But it “may speed tive leaders, then your future does not up the demise of a couple hangers-on.” look bright.” The firms that are most likely to So, what does a quality leader look fall off, consultants say, are those al- like? Young says firm leaders have to stay ready struggling with realization, those in touch with their clients and stakehold- that have built up significant debt, and ers, never losing track of what those peo- those whose expansion has lacked fo- ple want. They need a vision for where cus. Litigation-heavy firms and those the firm will go next. And they need to lacking countercyclical practices may be transparent about business decisions it will shine a bright light on which suffer, Brandt says. Another red flag: that impact those clients and stakehold- firms have survived recent years thanks wavering relationships with lenders, ers—compensation in particular. to decent market conditions alone. Corwin says. “Trust is the glue that holds most “When you see the downturn come, Still, the demise of any such firm organizations together, particularly which we think we’re on the lip of, I has its roots in a legal industry that has when there are a bunch of owners,” think there’s going to be a lot of law changed over the years, witnessing the Young says. “If your compensation sys- firms that are going to be in crisis and rise of the in-house legal department tem isn’t transparent and well under- they’re not going to survive it,” Hayse and the resulting changes in client de- stood, you don’t have the trust.” says. “I think you will see more law firm mand, Brandt says. Hildebrandt says this lack of trust failures in the coming recession than “A recession will exacerbate that leads to the mass departures that often you did in the last one.” somewhat, but it’s not a watershed spell the end of a firm. Of course, Hayse says, he hopes his event. The watershed event has been “You have to lay a dissolution pretty prediction is wrong. But productivity happening on a steady basis for 35 much at the feet of the people leading and realization rates are still far from years,” he says. the firm,” he says. Poor leaders, he says, pre-recession levels at many firms, and But it’s not all doom and gloom. are worried more about themselves their leaders have not taken the neces- DiPietro notes that the 2008 financial than the firm. They allow the business sary steps to adjust to that reality. crisis hit everyone. Still, “many firms to incur too much debt and commit “Unfortunately, law firm partners not only survived, but thrived.” to excessive lease holds, and they don’t in general have worked hard and de- “You have the ability to manage ex- tell partners about the firm’s problems. veloped high expectations for com- ternal risk,” he says. The latter can seriously damage morale pensation. At the same time, there are With that in mind, he says, firm when things get bad. partners whose practices are not as leaders have some questions to ask “If the partners want to stay togeth- profitable as others,” says Meyer, the themselves: “How strong is your cul- er,” Hildebrandt says, “you can save a former Dewey GC. ture, how balanced is your practice mix, law firm.” That puts firms in the difficult po- and have you made the right decisions?” sition of trying to maintain compen- ANOTHER STORM COMING sation for highly productive partners Email: [email protected] and The jury’s still out on when the next re- while eliminating low-performing [email protected]. Ben Hancock and cession will hit. But whenever it arrives, practices. Ben Seal contributed to this report.

30 November 2019 | americanlawyer.com