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Protecting a Law Firm’s Crown Jewels


Protecting a Law Firm’s Crown Jewels.

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Protecting a Law Firm’s Crown Jewels


English: Replicas of Polish crown jewels, made...

English: Replicas of Polish crown jewels, made in 2003. Polski: Repliki polskich klejnotów koronacyjnych wykonane w 2003 roku. (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

June, 2012

 

The problem with the law firm business model, we are told repeatedly, is that its principal assets, namely, its productive partners, go down the elevator every night and may not return the next day. The issue arises out of our arrival to an era of law firm partners as free agents and a lack of institutional loyalty, a subject about which there is much railing.

But, those partners who take the elevator down and out and don’t return the next day are taking with them valuable assets that are the property of the law firm and which law firms as well their lenders and landlords need now consider preserving and protecting.  I refer to unfinished business that law firm partners take with them to new law firms. The simple fact is that the profits derived from unfinished business of a client of law firm partnership is the partnership’s asset, just as are the outstanding accounts receivable, work in process, furniture, artwork and equipment.  And, I’m not just referring to law firms in dissolution. These are recoverable assets of healthy thriving law firms.

One of the results of the recent spate of law firm bankruptcies was to alert lawyers that upon the dissolution of a law firm, profits from unfinished business can be clawed back under the doctrine now known as Jewel v Boxer. Judge Colleen McMahon of the United States District Court for the Southern District of New York, in a much publicized well reasoned and articulate opinion in the Coudert case explained the basis of the unfinished business doctrine. The essence of her ruling is that “A departing partner is not free to walk out of his firm’s office carrying a Jackson Pollack painting he ripped off the wall of the reception area.” Profits from unfinished business are akin to the Pollack painting and departing partners are statutorily obligated to return both the painting removed from the wall and profits from unfinished business. This has been the law in New York for a century.

Under the Uniform Partnership Act, absent an agreement to the contrary, a partnership goes into dissolution upon the death or withdrawal of a partner.   Thus, all modern partnership agreements typically provide for the continuation of the business of the partnership upon the death or withdrawal of a partner and these agreements go on to describe the rights, entitlements and obligations of the partnership and the partner on a going forward basis.  The overwhelming majority of law firm partnership agreements are completely silent on the issue of unfinished business that follows a partner that withdraws from a law firm. But it is completely within the fabric of the partnership fiduciary relationship, as articulated in Meinhard v Salmon, and further expounded upon by Judge McMahon, for law firms to require departing partners to account to the partnership for profits from unfinished business even absent a dissolution of the partnership. Moreover, the agreement can further obligate a withdrawing partner to inform his or her new law firm that profits from unfinished business belong to his or her former law firm. Fancy that. I know this is probably a shocker to most readers, but it’s clearly the law.

Intuitively, most lawyers will simply shudder when reading this. Their reaction, when I have previously spoken of this, is to instinctively say that this can’t be so; it constitutes an impermissible restriction on a lawyer’s ability to practice law, unbridled by covenants not to compete.  The Jewel v Boxer line of cases, as well as the long parade of authority cited by Judge McMahon makes clear that the unfinished business doctrine does not trample on that issue, even in New York which is completely restrictive on the prohibition barring any form of covenants not to compete and certainly not in states like California which does permit some restrictions in limited circumstances.

We certainly now know from Coudert and Dewey & LeBoeuf that principal assets of a law firm are unfinished business (although, in fairness, these claims were pursued in a host of other major law firm bankruptcies, with a tad less fanfare).   For the first time of which I am aware, in Dewey, the firm’s secured creditors have actually purported to take a security interest in the proceeds of unfinished business claims.

Thus, the question now emerges: Why shouldn’t law firms include in their partnership agreements provisions requiring withdrawing partners to account to the firm for unfinished business even absent dissolution?  The ancillary question is why wouldn’t lenders and law firm landlords mandate such provisions as a condition of borrowing or tenancy?  The short answer is that in due course, these provisions are likely to be standard fare.

Let’s turn to the likely effects on lateral partner recruiting.

It is a standard practice in lateral partner recruiting for a law firm to prepare a pro forma analysis of income and expenses derived from a lateral candidate. In analyzing this pro forma, law firms make informed decisions as to the likely profitability of any candidate. With the recent unfortunate spate of law firm failures and the increased recourse to Jewel v Boxer recoveries, I have regularly counseled every law firm client to include in its pro forma examination a projection of any possible unfinished business remittances and to pay particular heed to this analysis when   there is evidence that the candidate is from a law firm suspected to be in difficult financial circumstances. In doing so, it must be remembered that Jewel v Boxer remittances are only for the profits derived from the unfinished business. Even the former partner can bill for his time in a unique metric, as Judge McMahon noted, based not on standard hourly rates, but based on his or her “efforts, skill, and diligence.” Thus, neither the former partner nor his or her new firm is forced into indentured servitude.   They are simply barred from deriving a profit for any of the particular matters the new partner brings along with him or her.

This last point require some emphasis: it is only the particular discrete matters that fall into the rubric of unfinished business. As Judge McMahon said in Coudert:

“’ Unfinished business” must be distinguished from “finished business” – business that has been completed prior to dissolution (the merger done and documented; the lawsuit tried to verdict or settled). If a firm has finished a piece of business but has not collected its fee, in whole or in part, the resulting receivable is, obviously, an asset of the firm. If the firm liquidates, the fee has to be collected for the benefit of the members of the firm in liquidation. Jackson v. Hunt, Hill & Betts, 7 N.Y.2d 180, 183 (1959). 23 “New business” is an entirely new contract or engagement to do a piece of work. New business that is contracted for and undertaken only after a partnership dissolves – even business from a client of the dissolved firm – is not an asset of the dissolved firm, because a partnership has no more than an expectation of obtaining future business from a client. For that reason, the attorney who conducts the business and collects the resulting fee owes no duty to his former partners to account for any profit he may earn. Stem, 227 N.Y. at 550; see also Conolly v Thuillez, 26 A.D.3d 720, 723 (3d Dep’t 2006); In re Brobeck, Phleger & Harrison LLP, 408 B.R. 318, 333 (Bnkr. N.D. Cal. 2009) (applying California law). Retainers from former clients on new matters – even matters, like appeals, that are related to finished representations – have been treated as “new” business and are not subject to the duty to account. See, e.g., Talley, 100 N.Y.S.2d at 117-18 (no duty to account for fees earned on appeals from matters originally handled as partnership business).5

Between “finished business” and “new business” lies unfinished business: executory contracts to perform services, begun but not fully performed by the partnership on the date of its dissolution. Unfinished business is presumptively treated as a partnership asset subject to distribution.”

 

Thus, the new firm must make an informed decision as to whether it is prepared to make an investment in the new partner and his or her clients until it can start earning a profit on those clients coming along.  The cost of the investment is largely an opportunity cost; namely, the lost opportunity to bill profitable time on different clients and matters.

Will this dampen the lateral partner market?  Quite likely, but, frankly, not in a material way, I suspect and certainly not long term as such contractual provisions begin to metastasize, at the instance of lenders and landlords, as well as law firm leadership, separately incentivized to dampen the enthusiasm of profitable and productive partners to seek a higher bidder. In due course, there will likely develop an open market in which firms will both be remitting and collecting unfinished business remittances.  And, I am sure, the market will ultimately require law firms to simply arrive at negotiated deals early on as valuable free agents rise to their highest level and less productive partners eased out the door.

These results are all inevitable. Well informed lawyers will counsel lenders and landlords on these issues and these clients, who have bargaining leverage will require unfinished business recoveries as a staple of law firm partnership agreements. Law firms will being compelled to pay unfinished business remittances will in turn take steps to keep its assets corralled by requiring the same of its partners.

In coming months, law firm leaders will be sitting across the table from lenders and landlords requiring law firms to include unfinished recoveries in their partnership agreements. Partners will be presented with proposed amendments to their partnership agreements containing these provisions.

Now is the time to begin considering your bargaining position.

© Jerome Kowalski, June, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310

 

Citibanks’ Fourth Quarter Report on Law Firm Profitability: Bleak, But, on the Bright Side, That’s As Good As It Gets


Citibanks’ Fourth Quarter Report on Law Firm Profitability: Bleak, But, on the Bright Side, That’s As Good As It Gets.

Citibank’s Fourth Quarter Report on Law Firm Profitability: Bleak, But, on the Bright Side, That’s As Good As It Gets


Citigroup Center
Citigroup Center (Photo credit: LifeSupercharger)

Jerome Kowalski

Kowalski & Associates

February, 2012  

                                                                   

Don’t have enough to fret about?

Citibanks’ report for law firms for the fourth quarter of 2011 is out for and there is little in it that brings cheer. It also gives some us some sense of prescience in that our 2012 forecasts seem to be being realized. Earlier observations on Citibank’s third quarter report and its mid year report, all read in sequence, paint a rather unhappy portrait.

Consistent with what we all have all been seeing in recent weeks as law firms begin announcing results for 2011, last year generally saw a barely perceptible rise in revenues (4.1%) and continued rising expenses. The continued escalation on the expense side is of some serious concern as law firm managers continue to devote substantial energy to irradiate an ever metastasizing wave of expenses, with the wave of rising expenses seemingly unstoppable.

Here is some of the other disturbing news:

  • Citibank noted that in the second half of 2011, demand for legal services, “particularly in transactional work, withered away and has yet to bloom again.” In our view, we do not see transactional work flowering soon because of the moribund capital markets, the decline in asset value and the business world’s disinclination to take risk in uncertain times.
  • The report notes that profits per equity partner at the law firms surveyed rose an average of 3.3% in 2011. However, by hewing to the PPEP artifice, the report does not report how much of this increased profit was derived by de-equitazation, “shortening of the collection cycle,” expense deferrals or other accounting legerdemain. While Citi did report that “equity partner head count grew only marginally, reinforcing the view … it has become a lot harder to become an equity partner and remain an equity partner.”
  • While hourly rates increased slightly, realizations declined. Of course, that’s like the law firm partner who, when asked what his hourly rates are replies “$1,000 an hour when I can get it, but that’s rare, otherwise it’s $450.”
  • Headcount grew marginally more than demand, resulting in a decline in productivity.
  • In order to get to the modest increase in PPEP, law firms slogged the living daylights out of their accounts receivable. Well, that’s good for the take home pay for partners in 2011, but it adds to the challenges of 2012, since both demand is weak and there is less A/R in inventory to turn into cash in the current year.

What does this all mean for the current year? Citi tells us “all said, not a bad year and we suspect likely to be the new definition of a good year for the legal industry at least for the foreseeable future.”  In other words, this is about as good as it gets. By that, could it be that like Jack Nicholson’s character, could we find happiness in this somewhat addled state?

Citi is also telling law firms that it’s time to trim the herd again in order to increase productivity and realizations. So, I am afraid that we will see another round of layoffs, lateral moves, de-equitizations, and mandatory retirements. If you are a partner in law firm, pay very close attention to how your firm is doing, since there is a strong likelihood that we will sadly see some law firm failures; you need to be prepared and not caught by surprise.   And if you are a vendor or service provider to law firms, look for cutbacks and a longer remittance cycle.

© Jerome Kowalski, February, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310.

It Shouldn’t Suck to be an Associate at a Law Firm, Part II


It Shouldn’t Suck to be an Associate at a Law Firm, Part II.

It Shouldn’t Suck to be an Associate at a Law Firm, Part II


Front page of the first issue of The Wall Stre...

Image via WikipediaImage via Wikipedia

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             January, 2012

                                                                            

Today’s Wall Street Journal  features a piece entitled “Law Firm Keep Squeezing Associates,” which will likely engender some great buzz on the blogosphere serving the law firm associate population and, in all likelihood, a yawn from law firm partners. This article comes on the heels of the second annual extravaganza, attendance for which is appropriately limited to but a few elites, entitled “The Annual Spring Bonuses Follies.” In all events, I would suggest that perhaps law firm partners and law firm leadership ought to take a closer at some of the issues raised in the Journal.

The Journal generally addressed the well worn issue of fewer openings at BigLaw and fewer job prospects for recently graduated law students. Anecdotal evidence suggests hiring is down about 30% (a fact we also have observed as generally true). The Journal also mentioned the longer and rockier road to partnership.

But the big takeaway in the piece, a fact well already known to many of us, is that since the crash four years ago, associate compensation has been stagnant, while the average associate has seen an increase in his or her workload by 2.3% since 2007, which the Journal calculates to be approximately 50 additional hours a year.  The new base “normal” appears to be approximately 1,650 hours a year, which the Journal Suggest amounts to about 37.5 hours a week; the Journal relies on the besieged NALP (hardly a bulwark for full and open disclosure where employment opportunities for lawyers are concerned) for arriving at this conclusion. Yale Law School last year did its own math and concluded that in order to bill 1,850 hours a year, an associate needed to spend at least 55 hours a week in the office, with three weeks of vacation and two weeks of vacation, sick days and holidays.  Yale concludes that in order for an associate to bill in the 2,000 a year range, he or she will need to work for about 12 hours a day and three weekend days a month. And that does not accurately include time spent at departmental meetings, firm functions, commuting, serving on administrative committees, recruiting, pro bono work, griping about being overworked or otherwise shooting the breeze with colleagues, friends or family. The reality, as we all know, is that an honest time reporter needs to work in the seventy hour a week range.

But let’s get back to that additional 50 hours a year squeezed out of associates since the onset of The Great Recession. Roughly translated, at an average of $300 an hour, associates have each contributed an extra $150,000 to their respective firm’s bottom line, without their firm’s incurring any incremental cost. A few firms, in an entirely short sighted fashion, in our opinion, have bestowed “Spring bonuses,” generally topped out at $37,000, while the bulk of BigLaw firms have simply enhanced partner profitability.

The fact is that Spring bonuses have a Marie Antoinette quality about them, a sort of noblesse oblige.  As Steve Harper noted, law firms should do better. They do not enhance associate morale nor do they halt associate attrition. The temporal cure to associate attrition has been an abysmal job market. But, for those who are planning on checking out, all that many law firms have done is have associates defer packing their bags until the bonus check clears. Spring bonuses not quite as satisfying as yesterday’s passing summer breezes, the recent autumnal foliage or Thanksgiving turkey. The breezes, foliage and turkey will likely return at their respective times and seasons; Spring bonuses, who knows?  With law firm revenues rising last year at a sluggish 3% and expenses at 9%, law firms, under pressure to keep PPP at the highest levels and the bulk of AmLaw 100 firms having gotten along just fine without them, this chimera will likely evaporate.

Well then, what’s the point?  There are two: We all know that associates are law firms’ most important profit centers. We also need to be reminded that keeping the young men and women toiling away productively at 60 hours a week, during their decade-long march to the brass ring, optimally requires them to have a high degree of job satisfaction, which has nothing to do with compensation or bonuses.  For nearly a century, every study performed by every industrial psychologist and labor economist has consistently reported that when people identify the reasons they leave their jobs, they rate compensation at the very bottom of their lists.  Overwork ranks at about the same. We know how to keep associates satisfied and productive, but we largely continue to ignore long learned basic human resources principles.

So, let’s take a look at the extra $150,000 per annum each associate is contributing to law firm revenue streams.  Why not engage your associates in a dialogue as to what should be done to improve their lives. Some might suggest an increase in base compensation to help them amortize student loans (and if you hear that don’t wince and worry what the neighbors might think), some might suggest rolling the work squeeze and laying off some of those collective additional 50 hours a year on a couple of new associates. After all, if you have 100 associates, you have effectively replaced two associates by having those remaining in the galleon just row harder. Exhausted oarsmen often collapse or jump ship. The golden chains of Spring bonuses won’t keep your associates tied to their oars. In fact, even The Great Recession and the burden of student debt do not necessarily keep them in the ship’s underbelly deprived of sunlight and overworked; one associate recently left his firm to open a bike shop, anther jumped ship to simply walk across the country.

The second point is quite simply, it still shouldn’t suck to be an associate at a law firm.

© Jerome Kowalski, January, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310.

I Know You Hate Keeping Time Sheets, but Even in the New Era You Must Still Do So and Here’s Why


I Know You Hate Keeping Time Sheets, but Even in the New Era You Must Still Do So and Here’s Why.

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