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Lateral Law Firm Partner Movement in This Winter of Our Discontent

Law Building

Image by University of Saskatchewan via Flickr

 

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             November, 2011

 

With the lateral market heating up at year end, a quick reference guide for essential due diligence for law firms looking for successful lateral partner candidates and for the candidates themselves

Not quite like the precisely predictable annual migrations of the swallows of Capistrano, this winter will mark a greater movement than usual of law firm partners as partners are likely to seek lateral moves in numbers not seen in many years.  As recently reported by Citibank, many law firms are looking for lateral partners to meet recently declining revenues. Many partners are looking for lateral opportunities because of the opposite side of the same coin:  Declining profits per partner are taking large chunks of change out of their own pockets and, accordingly, they are looking for greener grass in other pastures.

Added to this are serious disruptions  at many firms caused by law firm partners who have engaged in various departures from acceptable behavior, such as one law firm partner who is alleged to have engaged in improprieties resulting in a $32mm loss to his law firm; another law firm which appears to be exposed to clients’ claims arising out of improper tax shelters promoted by a former partner; and the recent tragic tale of a BigLaw partner who allowed a client to launder some $19,000,000 in apparently improperly obtained funds through his firm’s escrow accounts. Some of these claims may be covered in whole or in part by insurance.  But these events are, in the very least, major disruptors, since nobody enjoys his or her income reduced by another’s improprieties and management diversions in dealing with the attendant issues keeps management’s hands off the till, which must be held steady in these stormy waters.

An increasingly significant additional disruptor is the disproportionate number of AmLaw 200 firms with rock solid middle market practices who are aspiring to elbow their way to be among the rarified few at the very top of the food chain whose practices involve the “bet the company” cases where $1,000+ hourly fees and waves of assault troops are deployed, without particular reference to the cost of the particular project.  These middle market law firms often have a fair number of productive partners with commendable and substantial practices of many years standing, but their middle market practices, while yielding many millions of annual fees to the law firm, simply do not fit the firm’s aspiration to serve only the titans.

The final disruptor is the fee pressure imposed on law firms in general, as the legal spend for outside counsel continues to diminish and, at the same time, competing vendors, not always traditional law firms, compete for pieces of the diminishing pie. More significant practice areas have become commoditized, putting more pressure on firm profitability.

            The short fact is that there are more partner resumes floating around than in many, many years. And all of these folks are looking for places to land the day after their final distribution for 2011 clears.

Hiring lateral partners falls someplace between a high end art auction and a cattle auction.

While I have previously discussed the due diligence essential for a law firm to identify a lateral partner as well as the due diligence in which a lateral candidate should conduct, given the likelihood of more lateral movement than in many years, there are some essential basic points that require repetition and emphasis.

  1. Client conflicts.  After the initial meet and greets, the lateral should be asked to disclose his or her fifteen or
    twenty largest clients. The law firm should disclose its 100 largest clients. The law firm should obviously conduct a thorough client conflict review. All too often, the client conflict check is left as one of the final steps in the vetting process.  Huge mistake.  The exchange of client information must be one of the very first steps in the process.  And a thorough client and adverse party check should be among the second steps in the process. If a client conflict makes the deal a non-starter, so be it – but this is something easily enough determined early on.  There are times when a client conflict is less than obvious, such as when identifying adverse and related parties. I was involved last winter in an unfortunate situation in which a firm spent months recruiting a nine lawyer group, during which all of the disclosures were exchanged and deals were ultimately made. Literally, as the laterals were packing their boxes and preparing to move in the next day or so, the law firm’s conflicts department began to input all of the laterals’ detailed client matters, only to find that there was a serious conflict between one of the firm’s major clients and one of the lateral’s large clients.  The conflict could not have been discerned by any cursory review of a client list.  Yet, the conflict was irreconcilable.  The firm was compelled to withdraw its offer and the lateral had to go back to his management and essentially say “never mind, I think I’ll stay for a while.”

          2.      Historical Financial Performance.  As I discussed elsewhere, a thorough review of prior years’ performance is essential – both for the candidate and the law  firm.  Trendlines are of the essence. Has a major client or business segment been lost?  Is the graph showing a steady downward, upward or straight line?  A guide for a lateral candidate’s review of a law firm’s financial reports is available here.

3.    Business Plan.  Both the lateral candidate and the law firm should have a business plan and each should familiarize himself or himself with the other and make sure they mesh. Is, for example, the law firm about to embark on a major hiring campaign or is it looking to be acquired or merge with a firm of equal size?  If that’s in the cards, the firm you will ultimately be working for won’t be the same one you are negotiating with.

4.       Responsible vs. Originating Partner.  In reviewing the list of matters a potential lateral partner is bringing, carefully review whether the lateral partner candidate is in fact the responsible partner for the bulk of the work he or she is bringing with him or her. In these continuing finder, minder and grinder allocations of profits, partners are sometimes wont to overstate their roles.  Thus, a corporate lawyer with a close relationship with a client that has a rewarding penchant to engage in litigation, may be receiving a great deal of current credit for the litigation fees generated by the client.  But, when the rubber meets the road, the client may well leave a great deal of its litigation work behind under the care and feeding of litigators who have been doing work on particular matters for years. By the same token, an outstanding service partner, who may have been performing the same type of work for particular clients for which another partner may be taking the originating credit for historical imperatives, is often likely to walk away with that client’s business, since clients are largely indifferent to “origination” or “responsible” partner nuances. Clients simply prefer to call the lawyer they have known for years and who the client knows will get the job done.

5.      “Why have you decided to leave your law firm?”  Every interviewer asks this question and every lateral candidate has a rote response.  The recent instance of a lawyer joining a new law firm the day before he was apprehended for allegedly absconding with some $2,500,000 in client funds held in the trust accounts of his former firm, suggests that the response to the question requires more than unblinking acceptance of any rote response.

6.   Prior litigation. Most, but not all, law firms include in their questionnaire for lateral partners questions concerning prior litigations in which they have been named as a party. In the case of one disgraced former BigLaw partner, who not only had an impressive number of law firms at which he served, he also left a long trail of litigation, most sounding in malpractice, in his wake. I don’t know if his last stop, before pleading guilty, asked the question, but if the firm did, it does not appear to have either been fully answered or whether somebody thoroughly read the answers. Similarly, every lateral candidate should be informed of pending or threatened litigation in which the firm is involved.

7.    Fiduciary Relationships. Every lateral law firm questionnaire typically asks if the candidate serves as an officer or director of any corporation or LLC.  Few ask if the lawyer serves as a fiduciary, such as an executor, guardian or other legal representative of another party.  Serving in such capacities, which is not an automatic disqualifier, frequently involves managing the financial affairs of another party, which is not covered by any standard malpractice policy. The firm should obtain a solid understanding of the lawyer’s role and impose standard checks and balances to assure that all funds are properly monitored and disbursements subject to a triple set of signatures.  In addition, the firm should also be sure it has adequate fidelity and E&O coverage.

8.     Unfinished Business.  I recently discussed the long arm of Jewel v Boxer clawbacks. Under this doctrine, if a firm dissolves, the revenue derived by a partner of the defunct firm as well as the revenue derived from his new firm based on matters begun at his current law firm are assets of the defunct firm. Some mistakenly believe that Jewel v Boxer is an aberration of California jurisprudence. It is, for better or worse, good law in New York and elsewhere. The point is that if you, as a hiring or managing partner have a large pile of resumes of partners from a given law firm and you are hearing troubling news about the financial affairs of that law firm, stand up and take note.  Be aware that a lateral coming from that firm, should it fail, will be the payee on your firm’s accounts payable schedule for the duration of those matters.

9.    Google.  Conduct a Google search for every lateral candidate and ask about any entry that is of any concern to you. Similarly, every lateral partner candidate should conduct a Google search concerning the law firm and ask the hard questions where appropriate,

10.    References.   Every firm asks for at least three references.  I have yet to meet (as I doubt you have) any lawyer who would provide anybody other than one who would provide a reference that might make a mother blush. Dig a little deeper.  Seek out former partners and adversaries.  And ask the tougher questions. The candidate should ask about the last four or five partners who left the firm and should not hesitate to reach out to them. Sure, there may be some sour grapes, but there will also be some newly acquired wisdom.

11.   Know the Market. Cattle prices are fixed by the market and are easily accessible. Similarly, there is literally a bluebook for checking on market prices for fine art. Partner compensation is similarly market driven. A lateral candidate with a known amount of portable business has a fairly good sense of what his or her compensation should be in any given market.  If he or she doesn’t know, he or she can figure it out fairly quickly (and if you don’t know, just call me).  Lateral partner compensation bears virtually no relationship to PPEP.  If a law firm offers a partner compensation dramatically disproportionate to the market, politely decline and move on.  Similarly, a lateral candidate demanding compensation materially above the market is probably not going to be a colleague whose company you enjoy.

12.   Practice Integration Plans. I have too often heard managing partners complain that lateral hiring is a hit or miss proposition.  When I inquire about the firm’s disappointments, I always ask what the firm did to integrate the lateral partner in to the firm’s practice, the response is that the lateral partner was given an orientation to the firm’s IT system and was taken to a number of lunches by various partners.  I am afraid that this just doesn’t do the trick.  A practice integration plan is a carefully crafted written plan jointly prepared by the candidate and the firm laying out in detail how the lateral partner will be fully integrated into the fabric of the firm, maximizing synergies, making the lateral and his or her client base a vital organ of the firm, while simultaneously marketing his or her services to both other partners and clients of the firm. Failure to prepare and execute a practice integration plan assures that you will have more misses than hits.

Follow these important steps and you will end up with either an exquisite masterpiece or a prize steer.

© Jerome Kowalski, November, 2011.  All Rights Reserved.

 

Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at jkowalski@kowalskiassociates.com .

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8 Responses

  1. Good explanation, Jerry. Numbers 4 and 12 relate to the relative reliability of claimed “portable” business. I’ve coached a fair number of laterals over the years; I’d say they bring about half what they claim. I don’t think they’ve intentionally overstated it as much as that they’ve failed to do any analysis or objective assessment of it.

    They look at their historical run rate for origination, discount it by an arbitrarily low percentage, and use that as their entry claim to the new firm. If someone says they’re bringing $2 million with them, I’d get that broken down by matter type and client, which seems obvious, but I’d also look at the specific nature of the cases, transactions or advisory fees, and ask the specific status of each, and the basis for projecting each forward for the duration the candidate projects it.

    Will that type of case or transaction, at the described stage of maturity, really run another year at the projected rate? For advisory fees, on what business problem are they based? Is that problem an emerging one, suggesting a lengthy future arc? Or is it one that’s becoming played-out, and projecting a heavy advisory role seems unfounded?

    Finally, ask, “Have you discussed this move — and your projections of their likely need for your services — with these clients?”

    While no clients will guarantee anything, if your business relationship is as solid as you’re telling your prospective new partners it is, they’ll be OK with this discussion, and will make sure you don’t over-represent yourself. This may be when you find out something that you would have learned eventually, but they tell you now because it’s germane to your planning. For example, “Well, Mike, I know you’ve been handling all our product liability cases in the mid-Atlantic, but we’re about to announce a new regional counsel structure that will affect you. We’re not finished with our planning yet, so I can’t be more specific, but to be safe, you might be more conservative in your projections.”

    That should give you a more realistic assessment of legacy business the candidate claims, and project its likely rate of decline. For this illustration, let’s say that $800k of the $2 million will likely expire over the second half of the coming year.

    Now, what’s the basis for claiming a $2 million run rate into the future, i.e., how will the candidate generate new business to replace the work whose likely expiration we’ve already calculated?

    Some years ago, the leading market researcher in the law space told me that during the boom years, most firms had an annual client attrition rate around 20% (due to company acquisition or dissolution, the underlying problem going away, cases settling, etc.). Whether that’s now higher or lower, I don’t know, but it’s unlikely to have become zero. Let’s be generous and say this candidate’s attrition will be only 10%. That means that some portion of the other $1.2 million will go away, too. We just can’t pinpoint it.

    Let’s not ignore that the former firm will pull out all the stops to try to keep as much of that partner’s business as possible, so he or she now has a very well-informed competitor working from the inside of the client. They’re unlikely to fail completely.

    After all this, we end up with the candidate perhaps having roughly $1 million left from his or her portable origination. Unless he or she can tell you specifically where another $1 million will come from, you should plan to have a very uncomfortable conversation a year from now with your former star.

    The bottom line is that most lawyers with big books of business acquired it under optimal demand conditions that no longer exist, and therefore may not have the selling skills required to generate anything near that amount under the far less favorable conditions that will last for the rest of his or her career.

    Lateral recruitment is expensive. Between salary, recruiting fees, travel expense, and the time of all the lawyers involved in the recruitment, we’re talking serious money. I’d encourage one more small investment: hire a sales expert to evaluate the candidate’s portfolio, skills, and ability to back up any business projections.

    As a former headhunter, I’d want that assessment before I’d be willing to present a candidate to my client.

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