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What is the Fair Market Value of a Full Service Commercial Law Firm?


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Jerome Kowalski

Kowalski & Associates

February, 2012

 

 

A short piece in today’s the Wall Street Journal caught my eye: The Journal reported that a report was just issued that “estimates that top U.K. law firms are worth between $711 million to $4.1 billion, with Magic Circle firm Allen & Overy leading the pack.”    The report the Journal made reference to was brief and from Europa Partners which stated that it had just completed its second annual valuation of UK based law firms and found that “Law firms are valuable businesses; six of the top ten by value are large enough to be included in the FTSE100 if they were listed.”

I wonder.

When I went to school, I learned that the definition of value was “the price a willing buyer would pay a willing seller, each negotiating n good faith and neither under duress.”  Well then, is there a willing buyer out there for any of these firms?  We don’t see any. The Alternative Business Structure, sometimes called the Tesco law, does allow for non-lawyer ownership of law firms in the United Kingdom and Wales. But, as I predicted some time ago, there aren’t any non-lawyer buyers lining up or kicking the tires for large commercial law firms. With the top ten magic circle firms valued in the eye-popping range of $711,000,000 to $4,200,000,000, I suspect that more than a few equity partners at these well heeled law firms would be seriously thinking about cashing in their chips if there were a willing buyer out there. I know you would. I certainly would.

We have all learned the hard way that lawyers, trusted business advisers to the global markets, have concocted the silliest business model for their own business.  In any other endeavor, a business owner invests capital, sweat equity and builds a viable enterprise and looks forward to an exit strategy, where he or she could sell the business or perhaps leave it to his or her children. Lawyers can do neither. If they are lucky, they get to retire voluntarily when they are ready (not when they are forced to) and then simply get their own money, namely, their capital contributions, back over a period of years. Maybe a nice dinner with a couple of partners is thrown in as well. But no premium and no premium for having built a successful business. Anti-nepotism rules typically preclude a bequest of a partner’s ownership rights to his or her offspring.

More painfully, a large commercial law firm has less than zero value on liquidation or winding down.  In fact, such scenarios have been enormously costly for partners in such law firms.

Well, then, what is a commercial law firm worth? Nothing, really. I have no idea what Europa Partners’ valuation methodology was, but whatever methodology was deployed, it certainly couldn’t result in a fair market value with the standard textbook definition of value.

The Achilles’ heel in valuing a law firm is that its most valuable assets, its working partners, ride that old elevator down every night and in this age of partner free agency, there is only a hope and a prayer that these assets will return the next day to contribute to the production line. Our colleagues across the pond do have an advantage in maintaining some value for these assets in some respects in that the rules in the UK do allow for “garden leaves,” under which a withdrawing partner can be compelled to spend many months after he or she withdraws from a law sitting at home enjoying the garden or just sucking wind. But, in most of the United States, Rule 5.6 of the Model Code of Professional Conduct bars a lawyer from entering into any agreement which restricts him or her from practicing law. No restrictive covenants here.

But, I digress.

The point is as we go through the wrenching changes wrought by The Great Recession, clever lawyers, with a bit of self interest should be thinking about re-designing the entire business model of law firms and the delivery of legal services. While the American Bar Association dithers with little bits of the non-lawyer ownership of law firms issue for no good or productive reason, the market – and clever lawyers – will develop a new structure which create a new structure for the delivery of legal services, which will have real value, be saleable and scalable. Our LPO competitors have already figured out how to do so and may be soon eating our lunch. And their enterprises have real value.

© 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.

 

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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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                                                                                      Jerome Kowalski

                                                                                      Kowalski & Associates

                                                                                      December, 2012

 

Some time ago, I wrote that even in the era of alternative fee arrangements and value billing, it remained essential for lawyers to record time.  I’ve been asked to revisit the issue and still come to the same conclusion, perhaps even more forcibly. There are myriad reasons that compel this conclusion.

First, despite the continued proliferation of AFA’s and value billing arrangements, the American Bar Association Model Rules of Professional Responsibility does not specifically permit for pure value billing.   Accordingly, well informed lawyers must be exceedingly careful in drafting their AFA agreements so as to meet the Model Rules.  But, even in a carefully drafted AFA, with both parties negotiating in good faith, some courts have continued to hold that fixed fees are unethical and unenforceable, requiring a plaintiff law firm suing a client to prove the value of its services based on the hours actually billed.

Sure, as others observed the old model of the client getting in your cab and all that you were concerned with was that the meter is running, but the taxi driver didn’t really care where you’re going no longer applies. In the old days, it was just about getting your fare. Today, you need to be far more concerned about where your client is going, but you need to keep that meter  ticking away for a variety of reasons, not all of which relates to collecting your fare at the end of the ride.

Just yesterday, the Delaware Chancery Court, in a derivative case in which plaintiffs’ counsel obtained a judgment of some $375,000,000,000, the court awarded plaintiffs’ counsel total fees of $285,000,000 (no, those are not typos).  The fee award came to a staggering $35,000 an hour.  Defense counsel argued for fees of less than $14,000,000.  Clearly, the battleground was neither the plaintiffs’ counsel’s customary and hourly fees nor the amount of hours billed to the case.  But, in order for these plaintiffs to celebrate a huge payday, they were required to submit a written application, which included details of its hourly billing, Similar rules exist in every bankruptcy court in the nation, which approves every fee application for every professional, save for those rare instances for which the court previously approved either a fixed or contingent fee.

In a case decided just last May, noted New York attorney Thomas Puccio successfully prosecuted a class action on behalf of New York City police entitled Scott v City of New York officers and thereafter filed a fee application for some $2,000,000, based on reconstructed time records. Puccio’s award was knocked down to $515,000,  The reason:  Puccio and his colleagues did not keep detailed contemporaneous time in derogation of Second Circuit rules which provide:

 “All applications for attorney’s fees, whether submitted by profit-making or non-profit lawyers, for any work done after the date of this opinion should normally be disallowed unless accompanied by contemporaneous time records indicating, for each attorney, the date, the hours expended, and the nature of the work done.”

As one commentator on this case observed:

“This issue arises because the lawyer for New York City police officers, who successfully sued New York City for overtime violations, sought over $2 million in attorneys’ fees. He submitted a 96-page attachment to the fee motion reflecting more than 2,000 hours of work. But these were not contemporaneous records. The lawyer acknowledged that “the entries were prepared instead ‘by my office working with outside paralegal assistance under my general supervision'” and that “the paralegals based the entries on ‘an extensive database of incoming emails maintain by my law firm in a computer folder.'” In other words, the time records in support of the fee application were prepared after the case ended, not contemporaneously. The time entries were also riddled with errors and mistakes.”

The simple point is not simply that keeping accurate, detailed and timely time records is not simply the gold standard, it remains the only standard.  Yes, virtually every lawyer abhors the notion of justifying his or her daily existence in twelve minute increments, and, yes, we all now know we sell valuable services not hours, time accurate, detailed and timely record keeping still remains with us.

But, there is more.

We have also recently learned essential the need to engage in project management, particularly in AFA engagements. Project management requires maintain GANT, PERT or similar charts, identifying critical paths and projections of the time necessary for each player to reach each critical path. Each player must also provide estimates as to when he or she will reach each critical path. No project manager can effectively carry out his or her responsibilities without tracking  in real time the time expended by each player. And at  the end of the day, in order to measure the profitability of the project and the efficiency of each player, an analysis of the time expended is a vital, indeed, essential tool. Lessons learned in the required post mortem of every completed project leads to more informed decisions on future pricing. Indeed, many RFP’s require law firms to describe their project management programs.  Some clients also require that the project management software be available to the client on an extranet.

Time management is also an essential tool for risk management.  In a recently well publicized case, a counsel at a large law firm was arrested for allegedly defalcating with many millions of dollars of client escrow funds.  While all of the facts are not in, it appears that the alleged perpetrator was handling work for some regular firm clients, not recording their time and privately charging the clients for his work.  These moonlighting activities ultimately apparently required the alleged perpetrator to deposit funds in an escrow account.  Since the matter was not recorded on the firm’s records, the young lawyer apparently went across the street and opened an escrow account in the firm’s name and he was the sole signatory.  The funds in this escrow account seem to have disappeared, with the law firm being the subject of claims for the funds as well as a failure to adequately supervise the alleged miscreant. It may well be that if this lawyer’s time charges were more carefully monitored, the entire problem may well have been avoided.

While you cannot always foil a determined and clever thief, requiring lawyers to account for all of their time, including non-billable time does serve as a deterrent.  Yes, banks with security cameras and guards stationed on the banking floor do get robbed.  But, some number of thefts are deterred.

Finally, I have long advocated that finders, minders and grinders all need to be equitably compensated.  In this more perfect world, lawyers who make contributions to the firm by entertaining clients, blogging, attending conferences, speaking at seminars, writing important articles, as well as those lawyers who toil away at pure client services or engage in the thankless task of managing the enterprise, are entitled to compensation for their efforts.  These efforts shouldn’t be simply recalled anecdotally, but recorded on a timely basis.

So you’re still incredibly annoyed about recording your time in twelve minutes increments, I am afraid  you’re just going to keep sucking it up. You’re probably equally annoyed about developing creative methods of pain and pleasure to assure timely compliance with time keeping requirements, but that annoyance is not quite going away either.

As they say, there’s an app for that:  A wide variety of timekeeping programs allow a timekeeper to toggle on and off at his or her computer time working on client matters.  And for the road warrior, there are IPad, IPhone and Android apps that you can also toggle on or off and the information is downloaded to your mainframe or your cloud.

The Law Firm of the Twenty-first Century isn’t your granddaddy’s law firm. But it still requires detailed, accurate and timely time keeping of all of your activities.

© Jerome Kowalski, December, 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

A Cost Way Too High to Pay: The New York Times on the Price of Law School Tuition


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                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             December, 2011

David Segal of The New York Times today continued with his hard hitting series exposing the continuing crisis in American legal education. In his current piece, entitled “The Price to Play Its Way,” Segal features The Duncan Law School in the Appalachians (why there is a need for a law school in the Appalachians in a grotesquely over-lawyered nation is a separate question. I’ve addressed elsewhere.  I have also covered  Segal’s previous revelations concerning law schools revelations about legal education being akin to the non-existent Emperor’s new clothes elsewhere in this blog.

Segal’s basic premise is that law schools are unnecessarily over priced because of capricious rules and grotesquely unnecessary requirements promulgated by the American Bar Association’s Section on Legal Education and Admission to the Bar. In order  to comply with the ABA’s outmoded requirements, Duncan is required to maintain a fairly bare boned library at an annual cost of $175,000, while in truth, that cost can be eliminated virtually in its entirety through the use of computer terminals and a Wi Fi installation, just as most law firms have done.  The largest expense item for Duncan is maintaining the ABA mandated 16 full time faculty members, along with three adjuncts, which soaks up 75% of Duncan’s budget.  In Segal’s previous installment, Segal described how law school graduates acquire no practical lawyering skills at law schools, largely because they are taught by full time faculty who rarely have spent a nanosecond practicing law.  The result, Segal explained is lowered hiring by law firms and a general refusal by clients to pay for the hours spent during a lawyer’s first two years of employment, during which he or she is largely engaged in the basic skills of lawyering.

Duncan apparently endeavors to run a lean machine, charging tuition of only $28,664 per annum. With housing and other costs, that tab could run to $50,000, Segal reports.

[Update:]  On Tuesday, December 20, 2011, two days the Times article appeared, the ABA withdrew its provisional accreditation of Duncan .

[Update:   On December 22, Duncan sued the ABA claiming antitrust violations. As reported in local media “The lawsuit, according to LMU officials, alleges the American Bar Association denied the Duncan School of Law provisional accreditation as a means of limiting the number of law schools, and therefore attorneys, across the country.” After reading the entire series by David Segal – you can start here – I leave it to the reader to insert an appropriate bon mot ].

Segal’s report comes on the heels of a report issued by Dean Jim Chin of the University of Louisville, in which Dean Chin said, as reported by The National Law Journal:

 “Using the debt standards set by mortgage providers as guidelines, Chen concluded that law graduates need to earn three times their law school tuition annually to enjoy what he termed “adequate” financial viability. That assumes they borrow only the amount of their law school tuition and lack additional debt — a conservative assumption, Chen said.

Thus, graduates of relatively low-cost schools charging annual tuition of $16,000 would need to earn $48,000; graduates of schools charging $32,000 would need to earn $96,000; and graduates of schools charging $48,000 would need to earn $144,000.

To maintain a “good” level of financial viability — meaning they could easily secure loans and would be very financially secure — graduates must earn six times their annual tuition, Chen calculates. That means graduates of $16,000-a-year schools would need to earn $96,000; graduates of $32,000 schools would need to earn $192,000; and graduates of $48,000 schools would need to earn $288,000.

To maintain “marginal” financial viability, graduates of $16,000-a-year schools would need to earn at least $32,000; graduates of $32,000 schools would need to earn $64,000; and graduates of $48,000 schools would need to earn $96,000.

According to the National Association of Law Placement, new law graduates earn, on average, $68,500.”

Thus, using Chen’s algorithm, Duncan graduates would need to earn $144,000 to maintain adequate living standards and $288,000 for better standard of living. Neither one of those numbers appears to be within Duncan Law School’s grasps.  And Duncan is not alone, it only was featured by The Times as this week’s poster child.

Chen’s paper is an interesting follow on to the paper written by Professor Herwig Schlunk of Villanova in 2009, using pre-recession data, in which he included only  pre-recession in which he looked at the value proposition of law school.  The title of Schlunk’s work says it all:  “Mamas: Don’t Let Your Babies Grow Up to Be Lawyers.”  and since Schlunk wrote his paper, starting salaries for lawyers has decreased by approximately $10,000 and law school tuitions have increased by approximately 10%.

Law school professors seem to be doing considerably better.  Their median pay is $120,000 to $150,000; with some “superstars” earning more than $300,000.   By any measure, that’s not bad pay for teaching three courses a week, writing the occasional hour and taking on unlimited clients for private gigs and getting to charge those clients premium fees, after all a “professor” skilled or not, gets to bill at the highest end of the food chain.

Segal suggests that this entire exercise is part of the ABA’s guild system, creating artificial barriers to entry, while forcing law firms to bill young associates at $300 an hour, so that they can get paid a sufficiently high salary in order to pay off their artificially high student loans.  The real problem with this circular reasoning is that the music seems to have stopped playing and there are way too few seats for the players to pounce upon. NALP reported that only 60% of 2010 law school graduates actually found jobs requiring a law degree and, as noted, their median salary was only $68,500. It’s highly unlikely that universities will do the right thing by closing down their law schools since law schools and medical schools are second only to athletic programs in bringing the cash home to universities. Law professors are most unlikely to blow the whistles on their own safe perches, with but a few notable exceptions, such as Brian Tamahana.

Professor Larry Ribstein of the University of  Illinois School of Law, never a big fan of Segal, is a proponent for simply deregulating the practice of law. Ribstein got up even earlier than I did today and, read Segal’s piece and quickly posted at length on his sensational blog, “Truth on the Market” as follows:

 The NYT article typically fails to articulate the causes and cures of our over-priced legal system beyond the commonplace that the ABA somehow manages to restrict competition. Segal blames the law professors, finding comfort in the scam-bloggers’ simple-minded denunciation of high-priced legal scholarship. But since Segal doesn’t explain how a bunch of eggheads sitting around writing useless articles came to control the ABA, he sounds like he’s blaming the mosquitoes for banning DDT. This narrow focus isn’t surprising given Segal’s mission, which not to analyze or educate, but to entertain with simplistic narratives and pithy quotes.

So what’s really happening? The cause of the current situation, as I make clear in my Practicing Theory, is obviously the practicing bar, a powerful lawyer interest group with an incentive to keep the price of legal services high. Lawyers operate not only through the ABA but also local bar associations. Legal educators (law professors, law school and university administrators) come into the picture because they manage the key instrument for doing so — the academic institutions that keep the price of entry high. If the lawyers really wanted to make law school cheaper and more “practical” they could do it in an instant.

Gillian Hadfield’s suggestion to Segal of alternative accrediting bodies is one possible future world, but there are others. The route to all of these worlds isn’t simply changing the law school accreditation system (accreditation is pervasive throughout the education world), but changing the system of lawyer licensing which maintains the current one-size-fits-all approach. But how to do that when the powerful lawyers’ guild has maintained its grip on the process for almost a century?

As I have discussed (Practicing Theory, Law’s Information Revolution, Delawyering the Corporation, Death of Big Law) the answer lies in the current rise of technology and global competition, which are combining with the soaring costs of legal services to crack the foundations of the current regulatory system. Systemic changes such as changing the choice of law rules regulation of the structure of law practice and changing the intellectual property rules governing legal information products (Law’s Information Revolution, Law as a Byproduct) could hasten this process.

Reform of law school accreditation ultimately will come along with significant changes to lawyer licensing whether lawyers and law professors like it or not. Regulation of legal services will be unbundled, with only core legal services (however that comes to be defined) subject to anything like the current level of regulation, and other areas regulated at different levels or deregulated altogether. [Emphasis supplied]

Both Segal and Ribstein have, in my opinion, missed the train.  The market abhors guild type rules. That’s why even in tightly controlled economies, there are always black markets.

As I have suggested a number of times, the market for providing legal services is already widely deregulated. The Duncans of this world have only a very short half life and even top tier law schools will continue to suffer serious body blows as the demand for BigLaw associates will continue to wane.  Duncan-type law school graduates will largely be competing at a distinct competitive disadvantage with thoroughly unregulated Internet based providers of legal services, which do not need to post their bar admission certificates on their web sites. At the same time, BigLaw will be competing, again to its competitive disadvantage, with offshore unregulated alternative providers of legal services, which are continuing to grab sizeable market share and are indifferent to the requirements of having an ABA sanctioned law degree or even an American bar admission. The market – consumers of legal services – large and small are equally indifferent as to whether these providers of legal services have an ABA accredited education or even a bar admission.

Regulators are largely indifferent to the Internet based providers of legal services. Forty-eight of the fifty states have greeted ubiquitous ads by these Internet providers with a gaping yawn. The State of Washington early on began a proceeding against LegalZom.com, which was settled by requiring Legal Zoom.com to include a disclaimer on its advertising that it does not provide advice [sic].  That little side step. Stands in sharp contrast to a Missouri court’s holding. After submission of evidence from both sides, the court found that LegalZom.com is in fact actively practicing law.  LegalZoom.com got out from under that ruling by another two step:  The Missouri case was brought by several class action firms, which promptly settled with LegalZoom.com, under an arrangement in which LegalZoom will make some small changes in its advertising and operations and, presumably, the class action plaintiffs’ counsel will cash a check for legal fees. LegalZoom.com is now doing battle with North Carolina in order to obtain approval for a prepaid legal serviced plan, not unlike that being offered by competing Rocketlawyer.com.

The academies won’t solve their problems by opening branches abroad.  India already has over 900 law schools.

As John Kennedy famously said in 1961 in accepting personal blame for the Cuban Bay of Pigs fiasco, “Victory has a thousand fathers; defeat is an orphan.”  The law school tuition crisis, say the law schools, is the fault of the profession, which needs to charge high hourly rates to sustain the BigLaw model.  Academics point a finger at the ABA.  Law firms seem pretty indifferent; they are just cutting back on new hires and starting salaries, for those lucky enough to grab the brass ring, don’t support tuition loan amortization, food and shelter.

© Jerome Kowalski, December, 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 .

LPO’s Have Become Legal Project Outplacement Firms: They Are Outplacing Legal Work from Traditional Law Firms


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                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             October, 2011

 

 The guild rules designed to govern the practice of law and create barriers to entry by unlicensed professionals have been completely trammeled.

As the legal spend continues to decline, competition for the ever diminishing budgets for outside counsel continues to fiercely escalate.  Today, we again address the stiff competition coming from offshore legal project outsourcing.  Frankly, United States law firms, the American Bar Association and regulatory agencies governing bar admissions and the unauthorized practice of law seem completely clueless as to what is actually happening in the marketplace.

The LPO industry is a growing behemoth.  Still barely in its infancy, LPO’s will likely reach revenues of $2,500,000.000 next year.  That may seem a pittance compared to he $180,000,000,000 revenues derived by law firms, but revenues for LPO’s continue to grow exponentially, while law firm revenues remain largely flat.

LPO’s initially entered the market by focusing on the processing end of legal work.  As Jeff Carr, general counsel of FMC Technologies, has frequently noted, legal work falls into one of four buckets:  Processing, counseling, advocacy and content.  LPO’s got their noses into the tent by offering to handle the processing component arguing, quite correctly, that US law firms were ill equipped to handle large volume processing efficiently, while LPO’s, staffed by low paid foreign lawyers and aided by state of the art technology, could perform these services at a small fraction of the price of large law firms, allowing these law firms to focus on the other more lucrative buckets, for which these firms were far better suited.

At the outset, LPO’s marketed their services to law firms, offering to serve as their subcontractors. Law firms, in turn, often simply “marked up” the fees charged by LPO’s, on the rubric that the firms were assuming some level of supervision and risk and, well, it was a pretty easy way to make a couple of extra bucks. In short order, sophisticated clients, dealing with sophisticated LPO’s,  entered into direct contracts with LPO’s, having general counsel use the services of LPO’s directly.  Corporations, the ultimate consumers of LPO services, used their economic prowess to extract favorable pricing from LPO’s and often then directed their outside law firms to utilize the services of LPO’s with which the corporate clients had favorable pricing arrangements.  These LPO’s were essentially “designated subcontractors.”

LPO’s are well capitalized and are investor owned. These two factors provide LPO’s with enormous advantages over law firms.  Their technology tends to be light years ahead of that typically  used by traditional law firms.  They are not bound by much of the expensive baggage weighing down traditional law firms, like expensive midtown office space or paying off outmoded technology  cquired years ago.  I have had the privilege of meeting and working with some of the world’s best LPO’s.  I’ve uniformly found the leaders of these LPO’s to be exceptionally bright and astute business leaders.

But, even as the ABA Ethics 20/20 Commission dawdles with merely tinkering Model Rule 1.1 of the Model Rules of Professional Conduct by making some minor revisions and expanding the Rule’s comments to provide the guild’s belated imprimatur to the LPO industry, the facts on the ground have created new realities.  Perhaps only an idealist might believe that the Model Rules are designed to do anything more than create artificial barriers to entry.  Any realist recognizes that free market forces rendered the attempt to be of no moment.

The fact is that LPO’s are working hard to get in to each of Jeff Carr’s four buckets. At a recent Global LPO Conference, much of the discussion by LPO leaders was about inroads they were making in these buckets.  One LPO leader chaired a panel in which he encouraged the industry to re-brand itself, since calling the industry Legal Process Outsourcers created the misimpression
that it was focused only on processing.  I, for one, view the industry as simply providers of legal services.  Period.

Another LPO leader boasted about serving as a processing outsourcer on multi-district related litigation in which the lead counsel and the corporate general counsel concluded that the time was ripe to file some 61 motions for summary judgment in related cases across the country.  Lead counsel estimated the cost of preparing these motions to be in the area of $1,500,000.   The LPO offered to prepare these motions for approximately $350,000.  The motions were in fact ultimately prepared in India and revised and edited by lead counsel; the client saved nearly $1,000,000.  Welcome to the advocacy bucket.

These alternate providers of legal services have for long been preparing routine corporate, real estate and financing documents.  Welcome to the content bucket.

And these providers of legal services have been providing basic and sometimes even advanced legal research to support both general counsel and outside counsel in their counseling functions.

The fact is that the only areas in which these providers of legal services are precluded from active participation are in connection with actual court appearances and signing legal opinions. The workaround here is rather obvious and likely inevitable.  All that an LPO needs to do is to establish a U.S. law firm, populated by duly admitted American lawyers, which will own the equity of the law firm (obviously to circumvent the bar against non-lawyer ownership of law firms), and have these captive law firms contract with the LPO to have the latter handle all of the firm’s “processing” requirements – inclusive of every one of the four items in the bucket, save for court appearances and the signing of legal opinions. Control over the nominal U.S. law firm would be maintained by the LPO, which will have the captive law firm sign a promissory note for the funds it has advanced to capitalize the firm. (After all it has sometimes been said, not completely in jest, that the largest owner of law firms is Citibank, the premiere lender to law firms, which has some 650 law firm clients and 38,000 lawyer clients).

My friend and professional colleague, Bruce MacEwen, writing as Adam Smith, Esq., recently noted that the LPO’s are “smart, stocked with top talent, well-funded, strategically astute, and not the least bit afraid to break some china.”   My only disagreement with Bruce is that these folks won’t be content to simply break some china.  I believe they are planning on walking away with the china closet.

At the end of the day, traditional law firms will need to consider developing their own LPO, aligning with an existing LPO or, perhaps finding some different lines of work.

One final cautionary important postscript:  LPO’s typically carry about $5,000,000 in E&O insurance. In a world where we already have one claim pending against a prominent law firm  redicated on errors allegedly committed by its LPO subcontractor in connection with a matter that may involve some $380,000,000, Quite clearly, LPO’s need to materially beef up their coverage, law firms and general counsel need to examine any LPO’s coverage and law traditional law firms should use their own expanded insurance coverage as an important marketing tool as they will increasingly compete toe to toe with these alternate providers of legal services.

In all events, as Paul Lippe of Legalonramp.com so cogently observed, non-traditional law firms may well eat the lunches of many traditional law firms and these traditional law firms must now take notice and action.

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

Alternative Business Structures: Here’s a Great Idea: Let’s Get Some Private Equity Funds to Invest in Large Commercial Law Firms and We’ll All Make a Ton of Money!


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 Jerome Kowalski

Kowalski & Associates

April, 2011

 

 

Frankly, I don’t think so.  An investment with Bernie Madoff might have been a better idea.

 

Recently, the media is chock full of virtually daily reports concerning the impending changes in the United Kingdom concerning the October 2011 kick off date when non lawyers will be permitted to invest in law firms; the so-called Alternative Business Structure (“ABS”) model, sometimes called the “Tesco laws,” a non de guerre inspired by the international consumer goods  retailer of that name. Moving at its typical glacial speed, even the American Bar Association is now looking in to adopting the model.

The ABS model is virtually naively simple in its genesis:  Allow non-lawyer investors to invest and acquire ownership interests in law firms, with large law firms then using the proceeds of that investment to grow the firms, with investors reaping substantial profits. Except that I frankly don’t see that the model has any commercial viability for large corporate commercial law firms. Others also question the financial viability of this model.

The early player in this brave new world is London based Irwin Mitchell, which is boasting about a £50,000,000 investment by a private equity firm, with the proceeds to be used to expand Irwin Mitchell’s financially successful tort focused practice to a full smorgasbord of (less profitable) commercial services.

The ABS topic continues to galvanize the profession’s attention and will continue to do so for some time, as we in the United States watch events unfold across the pond.

There are some quite serious business obstacles yet to be adequately addressed, let alone even comprehended.

As some have noted, the proceeds of capital infusions by outside investors in large law firms will likely be applied to technology and most particularly knowledge management systems, all with a view of lowering costs to consumers of legal services. The result would be increased commoditization and reduced revenues per lawyer. Thus, the consequence of such investments may well be that unless one creates a Goldman Sachs-type leverage ratio (10,000 to 1?), an extremely unlikely result for any law firm; the investor will simply not get the anticipated return.

These capital infusions will also presumably be used to lure big name and big revenue producers and pay them NFL level compensation to get them to sign on.  However, in this era of law firm partnership free agency, there is no assurance that these big ticket producers will stay beyond the moment the firm across the street offers them more money. Nor is there any viable means to restrain these lawyers from jumping to the highest bidder.

The practices which yield the highest return still remain in the plaintiffs’ class action bar and in big stakes high end plaintiffs’ contingency cases. Massive class actions and other high end cases chew up enormous amounts of capital. Law firms which have been active in this world have already amassed substantial capital and have the internal resources to fund these cases. Some still utilize traditional institutional lending from banks at favorable rates. Others utilize litigation funding companies which do tend to charge exorbitant interest rates; but, then again, these funding companies accept all of the risk in making non-recourse loans and at the end of the day, they do not remain partners of the law firm.

The Irwin Mitchell experiment raises some questions for which we do not quite have enough facts to make any intelligent responses, lacking adequate information. For example:  Why would equity investors provide capital for a firm to enter middle market practices, where the margins are lower than in tort cases and lower than that earned at magic circle firms?   In addition, we already know from several decades of experience that the ultimate additional profit to a law firm in hiring laterals is only marginally incremental, as firms are required to pay for the ramp up of the laterals and the lion’s share of profits earned by new laterals are actually paid to the laterals, with the increase in firm-wide profits is only marginal

Other commentators, most noteworthy of which is Professor Mitt Regan of Georgetown,  have noted that outside investors in a firms would exert some degree of control within a law firm and the danger he highlights is that such investors will impair the independence of the lawyers’ judgments in directing that efficiency, rather than the clients’ best interests will be a driver in handling a client engagement, all in violation of Rule 1.1 of the Model Rules of Professional Conduct under US rules; we do know that proposed new UK rules are designed to have a different result.  Here, the UK has a distinct advantage over us in rule-making. Once the ABA concludes its deliberations and some committee proposes a new set of Model Rules, those rules will need to be mulled over by 50 separate state commissions and the District of Columbia, some of which may adopt the ABA proposals, some of which may modify them and some of which may simply reject them.

But an added impediment is the preservation of client secrets and confidences. Non lawyer investor participation in law firm management necessarily makes non-lawyers privy to such secrets and confidences, with no mechanism to police the maintenance of such confidentiality by these non-lawyers.

Some of these issues were addressed at some length in Australia in 2008, which was the first country to permit non-lawyer ownership of law firms in a report issued by Melbourne Law School and the Australian Office of the Law Commissioner.  Interestingly, Australia was the first nation to permit non-lawyer ownership and the firm that was first out on the market was Slater and Gordon, a large trans-Australia law firm, which offered shares to the public.  Slater and Gordon is primarily a tort firm and its initial public reports does report a reasonably good financial performance.  As I suggest below, a firm with that type of focus might be far more attractive to outside investors.

To me frankly, a far more alluring and potentially far more financially rewarding model, ripe for non-lawyer investment would in essence be a tort contingency fee clearinghouse.  Let’s for example take the case of James Sokolove, whose ubiquitous television US advertising cannot escape the attention of even the most casual TV viewer. In 2009, Sokolove spent a reported $20,000,000 in television advertising.  Mr. Sokolove’s business model, described in 2008 in The Boston Magazine is to be a constant presence on television encouraging potential tort plaintiffs to call in on his toll free telephone line, while maintaining a network of some 400 law firms around the country to which these cases are referred for prosecution. In 2008, Boston Magazine reported that “Sokolove’s firm is currently keeping tabs on some 10,000 open cases. Approximately 300,000 calls and e-mails come into his office each year, more than at any other firm. On behalf of his clients, Sokolove has won more than $2 billion in damages or settlements, while he and lawyers working with him have pocketed some $500 million for their trouble.”  Elsewhere, it was reported that in 2007, Sokolove spent $20,000,000 in advertising.  I have heard reports, which I haven’t been able to corroborate,  that Sokolove’s current advertising budget has increased since then by some four-fold.

But, here is a far more attractive model, even if we just use the reported information for 2008:  $20,000,000 invested in annual advertising, some modest investment in infrastructure and an ultimate revenue stream of several multiples, assuming the average life span of a tort case from inception through settlement is approximately three years.

Legalzoom.com  actually invites the most intriguing – perhaps, provocative – model. It purports to be an online self-help service which merely offers forms for use by consumers of legal services to deal with a variety of maters. The company’s “founding vision,” as described on its web site, “ was for an easy-to-use, online service that helped people create their own legal documents.” It loudly disclaims and denies that it provides legal services or acts as lawyers.  Rather, it provides an amazingly broad smorgasbord of forms and computer generated advice in such diverse areas as business formation, the wide variety of different legal instruments utilized by businesses on a daily basis, as well as specific legal instruments utilized in such diverse substantive  intellectual property, labor and employment, entertainment law, financing, real estate, estate planning and more. It vigorously denies that it is engaged in the practice of law, although it is the subject of a number of regulatory investigations regarding whether it is engaged in the unauthorized practice of law. It is also defending several lawsuits, including class actions in which plaintiffs are claiming that Legalzoom is engaged in the unauthorized practice of law.

Notwithstanding its strident claim that it is not engaged in the actual practice of law but is rather simply selling simple legal forms along with instructions for consumers to fill out on their own. But, as part of its offering of services, it boasts of (a) the availability of a “customer care specialist” (at 800 773-0888) to assist customers in selecting and completing the appropriate documents; (b) a “document specialist” who will automatically contact a customer by telephone “if additional information or clarification” is needed for a document prepared by the customer;   and (c) proofreading [not automated spellchecking] by a “document specialist.”  It also boasts a long running and slick advertising campaign.

Legalzoom now exists in the nether of the virtual world (yet it purportedly employs 500 people). Its board of directors of five includes four Silicon Valley entrepreneurs (who do not appear to be trained or licensed as lawyers). Its eight person management team has three members who seem have some legal training, but these folks are actually appear to be serious well credentialed  serial entrepreneurs.   It is privately held and revenue and profitability reports are not publicly available.  Yet.

It was reportedly originally funded with $2,000,000 in venture seed money and then received a whopping $46,000,000 second round of VC funding from such major VC players as Polaris Venture Partners and Kayne Anderson Private Investors.  In February, it was reported to be planning an IPO. But even before it goes public, you must wonder how many law firms with 500 employees have a $48,00,000 capital base. (yes, yes, I know, Legalzoom denies being a law firm, but to many it certainly seems to walk and talk like a duck).

Now, imagine that Legalzoom does have a successful IPO and uses part of its proceeds to open a series of kiosks and storefronts throughout the land.

[Update:  On July 22, 2011, UK based WH Smith announced an arrangement with Quality Solicitors, also of the UK under which the joint venture would open a chain of approximately 500 retail outlets in various shopping malls, manned primarily by non-lawyers, in which a host of legal services would be offered. One hundred and thirty retail outlets are to be part of the initial launch. Quality Solicitors plans on having some 50 or 60 law firms utilize these retail portals.  Some legal services will be delivered directly at the point of sale.  More complex matters will be funneled to the law firms participating in this mass marketing scheme.]

That, my friends, is the ultimate Alternative Business Structure.

And it has the capacity to be the largest provider of legal services in the land and create enormous downward price pressure on much already commoditized legal work.  And while I have no idea what Legalzoom’s long term business plan is, but if it does create a national chain of storefronts in which real live lawyers are stationed,  it has the capacity to dominate the legal landscape for the bull of legal work actually performed by most practicing lawyers in the United States.  It may not compete with AmLaw 200 firms for premium legal work, but it may suck an enormous amount of wind from a vast portion of the legal profession.

As American baseball legend Yogi Berra said, predictions are hard, particularly about the future, my own humble prediction is that these models won’t work for traditional Big Law. That’s what I said six months ago and nothing has yet surfaced to dissuade me.

The ABS or Tesco models just won’t work for Big Law.  But, they may very well for mass market, consumer oriented, commoditized practice, built on a franchise type model. Take something like legalzoom.com and open storefronts across the landscape.  The margins may be small, but they are also small at MacDonald’s, KFC and so on. Perhaps it’s time to dust off the old Jacoby & Meyers business model or the modern era Legalzoom counterpart and hawk that model to private equity investors. The returns will far exceed that which large commercial law firms can offer to outside investors. [Update:   On May 19. 2011. Jacoby & Meyers filed suit in New York and Connecticut challenging prohibitions against non-lawyer ownership of equity in law firms.  The firm suggest it will bring similar suits in other jurisdictions.]

[Update:  On May 9, 2011, several non-lawyer entrepreneurs formed a Washington DC based law firm investing some $5,000,000 of their own money in creating a new model law firm called Clearspire, LLC. (www.clearspire.com )  The firm is pursuing an entirely new model for its business, as described in The Washington Post.]

© Jerome Kowalski, April, 2011.  All rights reserved.

Do We Really Have a Shortage of ABA Accredited Law Schools?


Shreveport, Louisiana with unusual snow.

Image via Wikipedia

Just What We Need: More ABA Accredited Law Schools

                                                                                                Jerome Kowalski

                                                                                                Kowalski & Associates

                                                                                                August, 2010

 

We recently reported on what we view as the unwarranted continued establishment of new law schools at a time when the profession cannot even absorb the current torrent of graduates from existing law schools. I doubt that any pragmatist, aware of all of the available facts could possibly come to any contrary conclusion.

Apparently, there are those who think that adding even more ABA accredited law schools is worthy of consideration. The current edition of The National Law Journal reports

The American Bar Association is already tasked by the U.S. Department of Education to accredit U.S. law schools. Now an ABA committee has recommended that it should seriously consider expanding that power to overseas law schools that follow the U.S. model.

In June, the ABA’s Council of Legal Education and Admissions to the Bar appointed the committee of law professors, attorneys, judges and law deans to examine whether foreign law schools should be allowed to seek ABA accreditation. The council is scheduled to consider the committee’s recommendations in December.

The committee cited an earlier ABA report’s conclusion that state supreme courts and bar associations are under more pressure than ever to make decisions about admitting foreign lawyers as the legal profession becomes more globalized.

“Such an expansion would provide additional guidance for state supreme courts when lawyers trained outside the United States seek to be allowed to sit for a U.S. bar examination,” the committee said in its report. “Since that is a key function of the accreditation process generally, the expansion would be consistent with the historic role of the section in aiding state supreme courts in the bar admissions area.”

Completely absent from this rationale is the ever growing amount of legal work that is outsourced offshore.  Hitherto, work outsourced offshore had inherent limitations precluding offshore outsource vendors from performing substantive legal work.  Work performed offshore was limited largely limited to document review, preparation of largely rudimentary documents, subject to review by lawyers admitted to practice in the United States and some basic legal research, again subject to review and analysis by U.S. lawyers.

Should the ABA grant such accreditation, the result will ineluctably be significantly greater offshore outsourcing, this time, work of a substantive nature.  In short, an increasing number of legal work will be handled by non-U.S. lawyers. Jingoism aside, with the legal profession now at its lowest level of employment since 1991 (think about what that means:  the profession as a whole literally lost hundreds of thousands of jobs in two decades) and there being no likelihood that the profession will be able to absorb at least 20%, if not more,  of new U.S. law school graduates in the near term, the wholesale shipment of legal jobs overseas, the inevitable result of accreditation of foreign law schools will be akin to the virtual abdication of United States preeminence in automobile production to other nations.  Only here, there assuredly will never be any federal bailout.

In the interest of additional disclosure,  in the Spring of this year, there were ten law schools in a queue awaiting ABA accreditation, which are apparently already up and running (presumably in states where bar admission is not predicated on attending an ABA accredited school)  and already adding to the mass of law school graduates.

Of perhaps more curious interest,  The National Law Journal reported on August 11, 2010 that Louisiana College announced plans for the creation of Louisiana’s fifth law school in Shreveport, Louisiana.  The announced raison d’etra of this new law school is, as reported by Joe Aguilard, president of the college, the establishment of a “curriculum that recognizes the moral and religious foundations of the American legal system.”  President Aguilard went on to say “Our extensive feasibility study confirms that Northwest Louisiana is the perfect location for this new institution, and we are grateful to the representatives and officials of the Shreveport area who have worked hard to ensure that we locate there.”  More details about this law school were reported in the September 2, 2010 edition of  the Shreveport Times: http://www.shreveporttimes.com/article/20100902/NEWS04/9020337/Law-school-to-open-in-Shreveport

For those who may not be familiar with Shreveport, a truly lovely city, unfortunately ravaged by hurricane Katrina,  it is populated by some 200,000 souls.  Some will recall that 30 years ago, Shreveport was a relatively major “oil town” and the home of “oil and gas deals,” with which you will not be familiar if you are less than 60 years old. The oil business is gone now as are “oil and gas” syndicated tax shelters which then made Shreveport a mecca for lawyers and deal promoters; all of whom are now gone.  Shreveport’s current economy is largely the gambling industry, apparently ideally suited for a law school whose curriculum is based on moral and religious foundations.

Let’s give the founders of Shreveport’s new law school the benefit of the doubt and perhaps consider that they are motivated by a set of high minded ideals. Let us even suggest (arguendo, only) that there may be some altruism at the University of North Texas which believes Dallas has a jingoistic right to open a new law school in this economy because, after all, Dallas hasn’t opened a new law school since 1967.  (Can Wasilla, Alaska be far behind?)  Let us, for a nanosecond, consider the lack of facial absurdity of accrediting foreign law schools.

Is there any rational or morally supportable reason for Kaplan Higher Education, a sprawling complex of undergraduate, graduate and professional school preparatory programs, trade schools, and, yes, even an on line law school to build a new law school in Washington, DC which already hosts six law schools?  The folks at Kaplan seem to think so.

Kaplan, owned by the Washington Post, believes it has a duty to offers “important opportunities for low-income students.”  Kaplan itself is already investigation following on the heels of the United States Department announcement concerning “wasteful spending on educational programs of little or no value that also lead to high indebtedness for students”   Is that the “opportunity” Kaplan believes should further be bestowed on low income students?

This madness continues unabated. On December 7, 2010, the University of Delaware announced plans for a new law school anticipating its first graduating class in 2015. Elie Mystal of Above the Law had some choice observations concerning this fool’s errand. Apparently, one needs not be either smart or concerned about the future of a university’s students to lead a university. [Update: In May, 2011, the University announced that it was shelving these plans.]

[Update: On May 17, 2010, Indiana Tech announced the opening of a new law school – the fifth in that state. The rationales, according to the school’s trustees, is that Indiana hasn’t opened a new law school in 119 years and that the State of Indiana ranks 44th in the nation in terms of the ratio of lawyers to the general population.  There is no indication of any kind that something has happened to suddenly increase the demand for lawyers in that state]

I wish I could conjure up a clever punch line for the planned Shreveport law school, Kaplan’s desire to create more debt and unemployment for low income students or the  [abandoned]hubris at the University of Delaware but I simply cannot top the simple reported and unadorned facts.  Indiana just sucks the breath out of the observer.

© Jerome Kowalski, August 2010.  All Rights Reserved.

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