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For Law Firm Liquidators, There’s a Lot of Gold in Them Thar Hills Aside from Jewels


Super Pit gold mine at Kalgoorlie in Western A...

Super Pit gold mine at Kalgoorlie in Western Australia is Australia’s largest open-pit mine (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

June, 2012

 

There may be trouble ahead

 

            Marshalling the assets of a law firm that has imploded and paying its creditors requires an admonition similar to that often given to vacationers:  Pack half as much clothing and bring along twice as much money as originally planned. In the case of too many failed law firms, the value of the remaining assets is often half or less than originally estimated, the amount of liabilities is often a multiple of those originally anticipated and the length of the process takes many years longer than projected. A principal focus of those charged with marshalling assets of defunct law firms (as well as former partners of the law firm who are personally incentivized to maximize assets recovered not coming out of their own wallets) is therefore maximizing the value of estate assets marshaled.

Rarely has the gap between assets and liabilities of a failed law firm been as wide as they appear to be in Dewey & LeBoeuf’s case: As of the filing date, Dewey reported liabilities of $315,000,000 and assets of $215,000,000, with fees due from clients accounting for most, if not virtually all of the latter. A more detailed filing of assets and liabilities is expected in about 45 days. Previously, in the Howrey case, the subsequent more detailed statement of assets and liabilities posted after filing and after more detailed study contained stunning decreased assets and whopping increases in liabilities.  As one expert noted, the Dewey accounts receivable are unlikely to yield as much as forty cents on the dollar. Nor does this calculus include the likely enormous costs of bankruptcy administration, which will come off the top and certainly aggregate eight figures, once the shooting is done. The listed debt also does not include amounts purportedly due to former employees under the  WARN Act (which may amount to many millions more), amounts due to landlords for rejected leases (again, likely am eight figure amount) or amounts due to former partner under deferred compensation agreements, which may add as much as an additional $100,000,00, if these claims are allowed. Finally, no listing of potential malpractice claimants have yet been publicly identified. Law firm failures beget malpractice claims and with Dewey being self insured for $2,000,000 per claim, the exposure to Dewey will be considerable in the aggregate.  We assume that prior to filing for bankruptcy relief, Dewey identified every potential claim then known or suspected to exist against Dewey to its carrier, since its coverage is extended on a “claims made” basis and it was in Dewey’s best interests to identify each potential claim to its carrier while coverage was still in existence. The public record does not disclose whether “tail” insurance was obtained (in the absence of tail coverage, former partners are in for some more serious real pain).   With secured debt amounting to some $225,000,000, there doesn’t seem anything left for unsecured general creditors. Ed Reeser, a brilliant analyst,  succinctly observed that Dewey is likely a zero asset estate.  No previously reported case of an imploded law firm has the incentive to find assets to pay down debt been greater. Here, former partners looking at a world of pain, are even now scrambling to limit or divert that pain.

Much public discourse on the subject has focused on the “unfinished business doctrine,” often referred to as Jewel v Boxer claims.  These discussions have recently been raised by several decibels since Judge Colleen McMahon of the United States District Court for the Southern District of New York recently rendered a comprehensive, well reasoned and thoughtful opinion in In re Coudert which she held that Jewel v Boxer principles applied in New York, an unsurprising result, given a fair amount of prior authority to the same effect in New York and no contrary authority.

The likely coming battlefields

As the lawyers who were formerly partners at Dewey & LeBoeuf lawyer up (if the firm’s general counsel gets her own lawyer, will that mean that the lawyers’ lawyer has a lawyer?), we address briefly the additional claims and defenses that these professionals are likely focusing on during these warm spring days.

First, we start with one of New York’s seminal cases, Graubard Mollen v Moskovitz. In that case, the law firm of Graubard Mollen sought to ensure that it would continue to have the benefit of the substantial client base of name partner Moskovitz, who was approaching retirement age. Thus, the firm entered into an agreement with Moskoviz under which Moskovitz received substantial compensation in his final three years with the law firm and agreed that Moskowitz would insure that his largest clients would remain with the law firm upon his retirement.  At the conclusion of the three year wind down and payout, Moskovitz joined another law firm (ironically, LeBoeuf, Lamb, Leiby & MacRae) and took all of his major clients with him. Graubard Mollen sued for breach of contract and breach of fiduciary duty. The contractual claim was given short shrift by the court given the ethical proscriptions extant regarding contractual proscriptions on limitations of a lawyer to practice law. But the court held that it was a breach of a partner’s obligations to law firm to have met with and solicited clients he originated to join a new firm he plans on joining. Moscovitz was alleged to have met with his major clients to solicit them to join him at his new firm and to have even brought along LeBoeuf partners to at least one of those meetings, all while he was still a partner at Graubard and before he announced his plans. Such conduct, if proved to be true, was actionable and subjects the straying partner to damages.

In Gibbs v Breed Abbott,  the chairman of a law firm’s trusts and estates department decided to leave his firm and solicited another partner to join him at a new firm. These two partners, during their interviewing process, provided their new firm with detailed billing and personnel information concerning associates they proposed to bring along with them. The court assessed these former partners with damages of some $1,861,045. The award was made because of the improper solicitation by one partner of another to leave the firm and the providing of law firm personnel and billing information to a prospective new law firm.

Of course, we also must pay particular homage to Judge Cardozo’s admonition in Meinhard v Salmon, in which the noted jurist set forth the enduring standard that partners, and most especially managing partners, are “held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior… the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd.”

While Professor Steven Harper regularly takes BigLaw to task because of the “corporatization” of the practice, its focus on short term profits, distracted attention to metrics, top down management and more, Meinhard remains the law and I assume that Steve Harper takes some comfort in that.

Longstanding substantial authority also provides that a law firm partner holding a management level position is barred from seeking alternative employment without first resigning from his or her management role. Managing partners who failed to heed this basic maxim have confronted serious claims, as have the firms they ultimately join.

There seems little reasonable doubt here that Dewy partners, fleeing for safety, solicited other partners and associates to join with them in new safer climes, proprietary law firm information was shared with prospective new employers and management partners actively sought new positions without first stepping down from their management roles. The rather unique eleventh hour pronouncement by Dewey senior management “encouraging” partners to leave may well be actionable in and of itself, since no authority exists which we have found that permits a managing partner to promote massive breaches of fiduciary duties, particularly in the absence of any dissolution vote. Said management at the time when most of the horses had already left the barn, “Dissolution vote?  Why would we do that?”    Perhaps because the New York Partnership Law seems to mandate doing so under these circumstances and the rights and duties of the parties are thereafter described. We have little doubt that the standards of conduct actually practiced by management level partners will be scrutinized through the prism described by Judge Cardozo, particularly where issues of lack of candor and inadequate management oversight seem evident from the limited record made public thus far.

Lawyers, long trained to follow the money, have always asserted Jewel v Boxer claims against both former partners and their new law firms.  Thus to the extent that that these breach of fiduciary claims are pursued, they will doubtless often name as additional parties defendant the new firms which former Dewey partners call home. Procedural conundrums will likely ensue as Dewey partners are presumably subject to mandatory arbitration, while successor law firms are not.

To be sure, breach of fiduciary claims against former partners of an imploded law firm have rarely been instituted and as far as we can determine none have ever been tried to conclusion. All seem to have settled either under the threat of litigation or after suit was actually instituted. In all events, the real battleground has now been clearly identified here; namely the clawbacks, clawforwards and potential claims against the dozens of law firms that provided lifeboats for Dewey partners. And the need to maximize assets available for distribution to creditors has never been greater.

In the past, in most law firm implosions, after much finger pointing, threats, recriminations, anger and infighting, claims against former partners and their new law firms have been resolved using a relatively straightforward calculus:  Clawbacks from former partners were calculated on the basis of an algorithm in which certain factors were included.  These included fixing the date when the firm was first actually insolvent from applying bankruptcy law definitions, which, in Dewey’s case may be at or about the very beginning of the merger between Dewey and LeBoeuf, the amounts actually paid to each partner during that period, the role played by each partner in management and finally, the net worth of each partner. Al Togut, Dewey’s bankruptcy lawyer, a capable seasoned veteran of similar wars, who first emerged on these battlefields as counsel for the creditors’ committee in Finley Kumble in 1988, is intimately familiar with this calculus, which was utilized first in Finley Kumble.  Clawforwards – the Jewel v Boxer claims — are also relatively easily calculable and have until now always been settled since successor firms have been disinclined to take the litigation risk. That may change as the Coudert antagonists (and Seyfarth Shaw in the Thelen bankruptcy) are battling it out, seemingly looking to go the full fifteen rounds.

But Dewey may well change all of the rules; it was not simply be too big to to fail, it may be too big to fail in the relatively orderly way others before it failed.

© 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

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Trending for Law Firms in 2012: What to Expect This Year


Trending for Law Firms in 2012: What to Expect This Year.

Trending for Law Firms in 2012: What to Expect This Year


United (States) Parcel Service.

Image by matt.hintsa via Flickr

                                                                                      Jerome Kowalski

                                                                                      Kowalski & Associates

                                                                                      January, 2012

 

Thirty items affecting the legal profession that are guaranteed to dominate the headlines in 2012

It is that time of year when you are entitled to know what to expect for this new year.  Accordingly, here is what the hot trends for 2012 will be:

  •  Continuing decline in legal spend on outside counsel.
  • As law firms continue to more efficiently and timely bill for matters and, the trend of law firms whittling away at their inventories (WIP), while not being able to replace that inventory because of the lethal combination of  reduced headcounts and  reduction in the legal spend, lenders to law firms will require more stringent reporting and will in some instances, reduce available credit lines.
  • Deleveraging of work with partners and other senior lawyers billing increased hours and the trend towards the inverted pyramid model continuing.
  • Law firms establishing subsidiaries to engage in services complementary to their services, including e-discovery, document review, legal staffing services, investment advisory services for high net worth clients and the like.
  • Congress, the courts and the judicial conference will make serious progress about modifying e-discovery rules, bringing down their current gravity defying costs as well as dampening down the torrent of spoliation claims and the attendant Herculean tasks companies need to take to avoid these claims.
  • Given weakening retail sales and decreased demand for most commercial real estate, buyers will emerge to take advantage of attractive pricing on some properties, perceiving real value opportunities.  Private equity funds will move in to this arena in a big way.
  • Increased  focus on collaboration, within the law firm, vertically with clients and horizontally with vendors of support services and co-counsel. Extranets will be enhanced and new technologies will emerge to provide greater transparency and real time feedback and collaboration.
  • More paperless offices.  With the bulk of communications now being electronic and the expected decline in timely services from the United States Postal Service likely to increase the trend of communicating electronically, law firms will be incentivized to go completely paperless. Incoming snail mail will be scanned and digitized. The huge cost of storing paper documents will evaporate.
  • Increased use of outside facilities management companies for mail, fax, reproduction, IT, bookkeeping and legal records departments.
  • Law firms will make more investments in technology than in people. The IT hotspots are knowledge management, software to farm information for the purpose of responding to RFP’s, making an AFA proposal, based on prior similar work handled by the firm and for project management purposes.
  • Every lawyer will tuck an IPad under his or her arm and no lawyer will attend a meeting without opening one. Continued development of apps for lawyers will simply make this tool not only essential, but a lawyer not having an IPad at the ready, risks a serious loss of credibility.
  • Tough times often brings out the worst in some folks.  Last year’s small spike in BigLaw partners and even other law firm personnel who engaged in defalcations of client funds will sadly probably continue.  Look for more headlines of such tales.  Law firms will be well served to now tighten controls and checks and balances regarding client finds.
  • There will be periodic announcements by a partner at a BigLaw firm stating “after 25 rewarding and wonderful years with my former firm, I have decided to open a solo practice so that I can work more closely with my clients.”  Sometimes these announcements will be sincere and genuine.  Sometimes these announcements really mean “I’ve been on the job market for almost a year since I was asked to leave my former firm.  I haven’t been able to find a new slot and my firm wants me out right now, so I may as well give this a try.”
  • Virtual law firms, such as Clearspire and Rimon will continue to grow and gain real traction and increased market credibility.

I am quite sure that we have been fairly thorough and inclusive. If you think we left anything off the list, please let us know by commenting below. Similarly, if you think we are wrong about any of the above, post a comment.

It’s going to be a challenging year.  Please fasten your seatbelts, hold on to the handrail and make sure that your arms and legs do not extend outside your car. We are in for an interesting year.

© Jerome Kowalski, January, 2012.  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 .

Citibank’s 2011 Mid-Year Survey of Law Firms: Instead of Giving Its Customers New Toasters, Citi is Telling Many of its Law Firm Customers that They May Become Toast If They’re Not Careful


                                                           

                                                                                                      Jerome Kowalski

                                                                                                     Kowalski & Associates

                                                                                                      September, 2011

 

My, my, how things have changed.  When I was a kid, banks would induce prospective customers to open a new account by giving away a toaster to new customers. Today, Citibank is warning some of its law firm customers that they may be toast, or at least the may be seriously singed in the current economic climate.

I refer, of course, to the 2011 mid-year report by Citibank on the economic conditions of the profession.  Citibank’s law firm lending group, led by Dan DePietro, is uniquely suited to provide an in depth analysis of  the financial conditions of the profession, since it serves some 600 law firms and 58,000 lawyers in the United States and the UK, by far the leading lender to the profession. We start with the good news:  Says Citi “For the first half of 2011, revenue was up 3.7 percent across the industry. The increase was driven by strong inventory levels coming into 2011, increased rates, a 1.8 percent growth in demand and likely improvement in realization.”  The bad news:  Expenses are growing at a faster rate and the rate of increase in expenses is outstripping revenue growth.

As Citibank noted, one  portion of expense growth is attributable to those law firms which engaged in what many see as the  silliness of associate “Spring bonuses,” an artifice designed to stem the metastasis of associate attrition.   That carcinoma is far better treated by taking less expensive and more productive steps to assure associate job satisfaction and otherwise improving the quality of life for associates. Not a single lawyer left his or her firm because it wasn’t providing Spring bonuses.  Yet scores left within nanoseconds after  their Spring bonus check cleared.  Simply put, Spring bonuses do not get associates to stay a little bit longer.

Citi also reported that AmLaw 50 firms reported that realizations were beginning to return to pre-recessionary times.  Before we toss out the confetti, bear in mind that this refers only to AmLaw 50 firms; moreover, it does not address the real concern about a still stagnant economy, the continued volatility in the capital markets, the continuing fear of a double dip recession and the coming tsunami should the current turmoil in the Euro Zone erupt into utter chaos.  Add to those unknown factors, Citi notes that “headcount was flat,” and expenses continue to increase at a rate of 4.7%, which obviously exceeds the rate of revenue increase.  Citi put it to us straight: “the economy appears to be in for a protracted period of slow growth.”  Frankly, in light of the light of Citi’s
litany of gloomy statistics, even this mild bit of optimism strikes the informed reader as being unwarranted exuberance, unsupportable by economic realities.

Inexplicably, Citibank viewed it as a positive sign that many firms increased their “inventory” be retaining a larger portion of WIP (that is, for the uninitiated,  recorded but unbilled “work in progress”).  In reality, stale WIP may be theoretically billable, but rarely collectible.

There are other significant factors in the marketplace, not specifically addressed by Citibank which must further dampen any enthusiasm:  First, law firms have too long delayed making needed investments in infrastructure.  The need to make these investments is becoming increasingly crucial, indeed vital,  as alternate vendors of legal services continue to gain market share.  One of the only ways to meet this competition is through acquisition of state of the art technology.   Failure to meet this challenge, these alternate vendors will eat many law firms’ lunch within five years.

Citibank also foresees a period of significantly increased lateral movement, as  organic growth becomes more difficult to achieve, productive performers will jump ship from underperforming firms, and underperformers will be eased off the gangplanks.  I’m afraid Citi is missing part of the boat here in that it does not address the fact that taking on laterals requires substantial investment in ramp up and other expenses, while reduction in headcounts will reduce revenues (although there is always a short term illusory positive blip in ramp down).  In essence, Citibank is reporting that we may be in for a period of cannibalism as firms eat each other’s flesh.

The Citibank is silent with respect to one important feature of great interest to law firms; that is, how open will Citibank make its own coffers to law firms in a  market it characterizes as one “of
protracted slow growth,”  particularly as Citibank is likely to take a some form of haircut in the Howrey bankruptcy.

My own sense is that Citibank will undertake a greater degree of vigilance in reviewing its own existing credits and in extending new credits.  And, as it did in Howrey, where Citi loses confidence in the credibility of its borrowers, it will more quickly pull the plug.

Okay, so what’s the takeaway?

Here’s my views:

1.   In many respects Citibank is functioning very much like a typical consultant.  By that, I refer to the classical definition of a consultant:  Somebody who takes off your watch and then tells you what time it is.  There is little that Citibank has told us that we didn’t already know, but when somebody smart tells you something that should be obvious, the listener tends to stand up and pay attention.

2.  As we approach the fourth quarter, it is imperative for management to start planning for the coming storms and share with the partnership that management has taken a look at the sonar and  advise the partnership how the firm proposes to weather the inevitable storms.  The cruise ships of old always had two captains:  One who appeared in dress whites and instilled  confidence in the passengers; the second was a seasoned and wizened sailor who worked tirelessly at the helm to bring the ship to port. Law firm partners need to have the confidence that its ship of state has both on board and the captains need to enjoy the confidence of all stakeholders.

3.  In days of yore, pressure on profits resulted in simply billing existing clients more hours. These days are gone. General counsel, aided by purchasing agents and corporate project
managers are more likely than ever to put an early stop to inflated hours.  They also have alternate providers of legal services whispering into their ears, “we can do this better, quicker and cheaper.” Firms need to figure out how to do so as well.  This may require the firm to form a strategic partnership with an alternative provider of legal services or create its own subsidiary or affiliate. In all events, despite some great advances in technology, you still can’t produce a product at cost of $100 and sell it at $80 and then make up the difference in volume.

4.  Firms cannot delay infrastructure investment any longer.  That may require biting the bullet and investing firm profits in essential infrastructure and simply swallowing the dubious ignominy of a short term drop in PPP. If you take this route, issue a press release early on announcing that the firm has such a high degree of confidence in its own future, it is making a substantial investment in its  own future, foregoing short term PPP in favor of  long term growth and viability. Alternatively, private equity firms are prepared to invest in a state of the art legal processing law firm affiliate, but will obviously be a significant equity participant in the profits of that venture. The paradox of this essential new technological infrastructure is that it will result in the delivery of legal services at costs lower than currently prevail in BigLaw, but is made essential by the mounting competition of alternative providers of legal services.   The ethical rules precluding non lawyer ownership of law firms play no role here. (Professor Larry Ribstein of the University of Illinois School of Law very recently conducted a compelling online symposium on the de facto and de jure deregulation of the practice of law).  Indeed, Clearspire, a breathtaking new model law firm is built entirely a new model, owned in essence by non-lawyers. The result is that Clearspire offers an array of quality BigLaw legal services by BigLaw trained lawyers, primarily at fixed fees and bills at a fraction of BigLaw rates. An important warning here:  Do  not look to private equity as the safety net that will allow BigLaw to weather the coming storm.

5.   We know what many of the unknowns are.  Gaze carefully over the horizon and be mindful of oncoming unknown unknowns.  As Captain Smith of the Titanic said “We do not care  anything for the  heaviest storms in these big ships. It is fog that we fear. The big icebergs that drift into warmer water melt much more rapidly under water than on the surface, and sometimes a sharp, low reef  xtending two or three hundred feet beneath the sea is formed. If a vessel should run on one of these reefs half her bottom might be torn away.”  We may have survived the big storms, but if we permit the fog to cloud our vision, we might sink.

© Jerome Kowalski, September, 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 .

The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?


The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?.

The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?


The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?.

The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?


The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?.

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