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Leverage is Back: The Return of the Pyramid Business Model for Law Firms, with a Twist


English: Great Pyramid of Giza.

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Jerome Kowalski

Kowalski & Associates

February, 2012

 

Yesterday marked the 35th anniversary of my admission to the bar. The day passed quietly, without note or fanfare. But it did cause me to reflect on how things have changed.

In 1976, when I graduated from law school, there were some basic covenants to which all subscribed: If you did well in college, you got in to law school; if you worked hard in law school, you got a job at a good law firm; if you worked very hard as an associate, had the tenacity, appropriate degree of intellectual rigor and good humor, managed not to offend for the term of your clerkship, you were promoted to the partnership and looked forward to lifetime tenure, a sinecure from which you could not be removed and would not dream of leaving until you entered your dotage. Many, if not most, large law firms had a lockstep system of compensation for associates and partners. The AmLaw 200 listings, the source of more tall tales than any gathering of fishermen at a tavern, would not surface for a decade. Lateral partner movement was as rare as hen’s teeth. If a law firm partner in those days suggested that the firm should de-equitize partners so that the firm’s numbers would look better, he would be directed to a psychiatrist for emergency treatment. Partnership had real meaning, it was not an at will employment status and partners would not for a moment think of themselves as free agents, available to the highest bidder. Partners were proud owners of the enterprise. There was genuine esprit de corps, mutual respect, pride, loyalty and genuine collaboration.

These ruminations were prompted by the piece recently written by my friend, Professor Steve Harper, entitled “The Lateral Bubble,” a must read for anyone toiling away at or near BigLaw. Frankly with all of the buzz in the blogosphere and elsewhere concerning Harper’s piece, it seems that all have read it already or pretended to have done so, at the very least.

Professor Harper, no fan of partner free agency, observes that partners are no longer proud owners of the enterprise. Rather, he observes that BigLaw’s “currently prevailing business model encourages partners to keep clients in individual silos away from fellow partners, lest they claim a share of billings that determine compensation. Paradoxically, such behavior also maximizes a partner’s lateral options and makes exit more likely. In other words, the institutional wounds are self-inflicted.”

Harper quotes admiringly another recent article by Ed Reeser and Pat McKenna entitled “Crazy Like a Fox” in which the authors articulately demonstrate in cogent fashion how meaningless the Profits Per Partner metric is  (disclosure: Ed Reeser is also a good friend of mine and has been an occasional contributor to these pages; Ed and Steve do not know each other, but I can assure you that they are kindred spirits in every possible respect).

Say Reeser and McKenna:

“Over the last few years there has been a dramatic change in the balance of compensation, to a large degree undisclosed, in which increasing numbers of partners fall below the firm’s reported average profits per equity partner (PPP)…Typically, two-thirds of the equity partners earn less, and some earn only perhaps half, of the average PPP.”

In 2010, I wrote about the emergence of a three tiered caste system for associates in BigLaw:  Firms now employ “partner track associates”, “non-partner track associates” and “staff lawyers”.  The partner track associates are those from the best schools, with the best grades who toil away the hardest and whose academic credentials are touted to clients and potential lateral partners. Non-partner tracks associates are those who fared a little less well, and who have a fairly short shelf life. The staff lawyers are those who are most akin to day laborers, who float from gig to gig, often paid subsistence wages and receive no benefits.

Well, then, what’s good for the sauce for the goose  is good for the gander. Partner ranks have now evolved into a new three tiered caste system as well:  Highly compensated equity partners, a second tier of less handsomely paid equity partners and a great swathe of contract partners. As Harper, Reeser and McKenna observe, the ratio of compensation from the most highly compensated equity partner to the lowest is staggering; in some firms it’s ten or twelve to one.  The ratio for most highly compensated equity partner to the lowest level of contract partner is often even greater.

While we may have thought that The Great Recession brought about the demise of the leverage model for law firms and that the new model for the Twenty-first Century Law Firm is an inverted pyramid, the good news, folks, is that leverage is back and the pyramid has similarly returned to its old footings.  Except that the pyramid is no longer one with a broad base of associates and partners decreasing in number at each higher level of the edifice. With the devolution of associate ranks to the caste system, the refusal of clients to pay for first and second year associates and clients’ not permitting law firms to mark up and sell at a profit the work of temporary staff lawyers, associates no longer make up the base of the pyramid. Rather, it’s the ranks of contract partners who lie at the base of the pyramid and support those at its summit. As those at the top need more support for their compensation requirements, some equity partners find themselves cast into supporting roles keeping the rich and famous comfortably enjoying the view from the top. If more financial support is needed, partners are simply de-equitized, move down a notch and then fill out the base of the pyramid. Partners deemed insufficiently productive are asked to leave. The notion that partners are owners of the enterprise is gone.

Ample anecdotal evidence from the field corroborates the return of the leverage model, albeit at the nominal partner level. We have heard from scores of managing partners that those at the partner at the partner ranks busier than ever, working longer hours and grinding out the work as never before. Equity partner compensation at the pinnacle is at eye popping numbers.

The only issue not yet adequately addressed is the future of the pyramid when those at the top see the lush neighboring pyramid across the expanse with a taller peak, more lavish accommodations emitting a siren call for all those who want even more. Collapse of the structure comes not from erosion at the supporting base, but rather from the loss of the pinnacle.

Keeping the structure erect and enduring simply requires a return to the days of yore when all partners truly felt like they were proud owners of the enterprise, and a return to feelings of genuine esprit de corps, mutual respect, pride, loyalty and genuine collaboration.

© 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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The Coming Invasion of the Body Snatchers: Are Offshore Law Firms Going to Invade the United States?


English: The United States Esperanto: Loko de ...

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                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             December, 2011

 

They’re coming.

The coming months and the coming years will mark an increased invasion of foreign based law firms and other providers of legal services into the United States.  They will likely be coming from all corners of the world. And, they will be looking to snatch your business.

First, we have the acknowledged intention of UK based behemoth Herbert Smith (1,500 or so lawyers) to re-open a United States office, after an absence of two decades. The new office, expected to open within the year will be populated by both United States and foreign qualified lawyers. Jonathan Scott, a senior Herbert Smith lawyer announced that the new New York City office focused on dispute resolution, including international arbitration and investigations.  Following the Watergate era admonition to “follow the money,”   the premium fee yielding dispute resolution and internal investigation practices seem extremely likely areas for firms like Herbert Smith (and AmLaw 100 firms) to continue to exploit.  The issue, of course, is that as the supply of high end law firms having the capacity to deliver quality dispute resolution work and internal investigations on a global scale and the competition for this work  continues to grow, price competition will ineluctably come in to play.

The British invasion is not new, nor will it end soon. British Magic Circle firms have invaded and have taken an increasingly dominant role in the US market for almost two decades.  London, which seems hell bent on being the Imperial home for the lawyers to the world, has already sent formidable firms here, including Clifford Chance, Linklaters, Allen & Overy, Freshfield, and Lovell Hogan. The last British invasion on these shores began with the Beatles in 1963 and last I heard, Mick Jagger and Paul McCartney are still playing to sell out audiences. The point is that, based on my count, fewer than 20 of the UK’s 100 largest law firms have taken to the US stage at this writing.

As the market in the Euro Zone continues to stagnate, law firms in that market will likely look to the American market as new sources for revenue. One recent example is Ireland’s A&L Goodbody, which long had a single lawyer outpost in New York, announced just yesterday ambitious plans to open a Silicon valley branch and reinvigorate its New York operations.   The Germans may not be far behind.

From the other side of the globe, the real game changer may well be the announced merger of   China’s King & Wood and Australia’s Mallesons Stephen Jaques. As announced in The Asian Lawyer , “[t]he combined firm will number some 1,800 lawyers, and is positioning itself clearly as an alternative in the region to the large U.S. and U.K. firms that have traditionally dominated major cross-border deals.”  It matters little if the combined entity will soon open a US office (although my raw guess is that they eventually will), the combined firm will be competing directly with both AmLaw 100 and Golden Circle firms for core cross border work.

As I previously observed,  “the profession must be mindful of the Chinese business model, which seems to be the Chinese asking foreigners to come to China and perform a service or build a product, followed by the Chinese saying “let me see how you do that.” That in turn is followed by “teach us how to do that,” and ultimately “okay, we now know how to do that on our own, so you can leave and we will do so on our own.’”

The West has not only taught Chinese law firms how to practice law in the Western style, but, the West has also taught the Chinese to operate globally and on the global expanse. Indeed, the two largest law firms in China, Dacheng and Yingke, are preparing to open bases in London. The United States will not be far behind.   Broad & Bright, one of China’s leading law firms with 60 lawyers,  is set on moving to the West.  It is now in merger talks with 2,900 lawyer Clifford Chance.    Since you have by now read the Broad & Bright web site through the link above, you know that Broad & Bright has acted as counsel in China for some of the world’s largest corporations and on its surface, does not need Clifford Chance to funnel more work to its offices. Broad & Bright is one of those rare firms that can easily be a net exporter of legal services. Thus, should the Clifford Chance talks fail, it would not come as much of a surprise that Broad & Bright (or a similar sized and placed Chinese law firm will simply say “okay, we now know how to do this on our own and we don’t need a Western law firm to open our own international law firm.”

LPO’s, sometimes called “non-traditional law firms”  have watched their gross revenues increase almost ten-fold over the last five years, to an estimated $2,500,000,000 in 2012 with some estimating a doubling of that number by 2015.  As I have said in the past, it is a major mistake to simply think of LPO’s as limited resource providers of ancillary services to law firms and corporate legal departments. Rather, they are alternate providers of legal services, which can provide a full range of legal services to United States consumers of legal services at an enormous price advantage. The only areas in which these entities are precluded from competing directly with United States law firms are appearing in judicial proceedings, signing legal opinion letters or otherwise directly providing advice to a corporation on American law.  A number of LPO’s, particularly on the Indian sub-continent, have affiliations of one form or another with Indian law firms.

The thin barrier preventing LPO’s from grabbing even more slices of the legal spend pie will easily evaporate.   There are a variety of different means for those affiliates to establish or acquire a United States law firm.  Thus, an LPO could easily establish a very real law firm branch office in the United States, populated by US duly qualified lawyers which in term could make eviscerate the thin boundary which would give these offshore entities the ability to offer the full array of legal services – including appearing in judicial proceedings,  signing legal opinions and direct counseling,

LPO’s, owned by offshore entities and owned by either US investors or by US law firms are sprouting United States branch offices like weeds. Those US branch offices already have the infrastructure in place to function as full service law firms, often with technology already in place that is complete state of the art. And there are many a small or medium sized law firm that would presumably welcome the capital and assured revenue stream from a successful well capitalized offshore LPO to buttress its own sagging fortunes.

In 2011, United States law firms met the challenges of reduced legal spends and new competition through reducing headcounts,  merging to create more critical mass and consolidating back office and support funtions, or by shutting their doors. Professor Steve Harper avers that in 2011 there were a total of 43 law firm mergers. Those shutting their doors, often with disastrous consequence to the firm’s individual partners, include the splashy Howrey implosion, Florida based Yoss, LLP as well as Ruden McCloskey (which didn’t quite go down without a fight) , New York’s Snow Becker and Krause, Atlanta based Shapiro Fussell Wedge & Martin, Los Angeles based Silver & Freedman, Denver based Isaacson Rosenbaum,  foreclosure mills Steven Baum and David Stern and150 lawyer Austin based Clark Thomas & Winters.  And there are more than a few commentators who suggest that  Arnold & Porter’s acquisition of the remnants of Los Angeles based Howard Rice and Bryan Cave’s acquisition of Denver based rapidly shrinking Robert Holme & Owen largely staved off the closures of the acquired firms.  A similar suggestion arguably applies to McKenna long’s “acquisition” of Luce Forward, with the former plainly planning on doing a material house cleaning of the latter.

Well then, Ollie, that’s a fine mess we’re in.

Despite admonitions concerning the imprudence of predicting the future by such luminaries as John Kenneth Gailbraith (“the only purpose served in making predictions about the future is to lend credibility to astrology”) and Yogi Berra (“the future is hard to predict because it hasn’t happened yet”), I tremulously suggest that we are certainly likely to see the following over the coming months:

  • Continued merging of middle market law firms to create larger regional or super regional law firms.
  • Further reducing headcount and support staff.
  • Acquisitions by foreign law firms or alternative providers of domestic US based law firms.
  • Some US law firms meeting the invasion of foreign law firms and alternative legal service providers by counter-attacks, landing branches on foreign shores, despite the known risks attendant to that approach.
  • Enhanced collaboration, both vertically between the law firm and its important institutional clients, as well as horizontally with alternative providers of legal services as well as with law firms to which the client may have downsourced work to.
  • Increased price competition for premium work as well as increased commoditization of other lines of work.

We are in for some challenging times.  Most well managed law firms will continue to survive and thrive. Some law firms will inevitably appear on lists published next December of law firms that sadly didn’t make it.

© 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 .

Essential Elements for Interviewing a Law Firm Lateral Candidate


English: One_Over Interviewing

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                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             December, 2011

 

About thirty years ago, I was assigned to be a second seat on a complex multi-party securities fraud case.  Among the many lawyers working with us on the defense side was a partner (let’s call him Tom here) at an AmLaw 50, who was a widely respected litigator with 25 years of experience. In fact, shortly before the case was scheduled for trial, this lawyer was nominated to serve as a judge on the United States District Court for the Southern District Court.  A month or so before the case was scheduled for trial, the lawyers for the dozen or so defendants met to begin planning for the trial and dividing up the various pretrial and trial tasks.

As the meeting started, Tom looked around the room and said plaintively “fellas you got to help me out here. I’ve never tried a case before. I’ve got lots of deposition and motion experience and some evidentiary trial experience in connection with injunctions, but I’ve never even seen a jury trial”  Yes, we all stared in disbelief. Five or six of the seasoned trial lawyers in the group took Tom aside and gave him a four day crash course on jury trials.

The case was duly called for trial and in the six weeks of trial, Tom, who had a high degree of innate intelligence, acquitted himself well, although I can’t say the same about his client who was found liable for serious damages. A few weeks later Tom’s nomination was confirmed. He attended judge’s school, went on to serve with distinction and ultimately became chief judge of the district.

The story comes to mind in connection with an interesting and provocative article by Mark Herrmann of Above the Law in which he discusses different interviewing techniques for lawyers being considered as lateral candidates at law firms. Herrmann first discusses the two standard techniques, resume based interviewing and second, behavioral based interviewing. The former is straightforward and is one in which the interviewee is asked about items on his resume. The second involves asking candidates about experiences in their lives and how they handled them.

The issue is even more timely, following a recent piece by Professor Steve Harper entitled “Fed to Death” in which Harper recounts, among other things, that injudicious lateral hiring of partners has caused the implosions of many major law firms.

A correspondent to Herrmann, Alessandro Presti suggested to Herrmann an entirely different approach. As recited by Herrmann, Presti

 “… suggested giving an applicant a relatively non-technical contract and asking the applicant to interpret it or identify issues that the contract left open. This might give insights into the applicant’s ability to identify issues and analyze them. Once the applicant identified the issues, you could explain that your client wants to launch a new product and ask whether the contract permits this. This would force the applicant to synthesize information and present it, thus demonstrating communications skills.”

While not utilized often, I have in the past fact seen this approach taken.

A couple of years ago, I arrived at the office of a managing partner of an AmLaw 200 firm for a scheduled meeting. He greeted me in the reception area and asked me to excuse him for a moment or two, since he had to conduct an interview of senior real estate associate who was being considered by the firm.

I was initially annoyed, thinking that I would have to cool my heels for 30 or 40 minutes as he conducted the interview.  Instead, he returned and collected me within five minutes. I complemented him on his efficiency in conducting such a quick interview. He explained that he simply started the interview and would conclude it in an hour. He went on to explain that he gave the associate a term sheet for a lease and a draft lease and advised her he would be back in an hour, at which time, she should mark up the lease and he would then discuss her markups when he returned. This was a first for me and I complemented him. He said that he’s been using this technique for a six months. He invited me to join him when he went through the second  substantive part of the interview.

We came in to the conference room and saw a clearly flustered lawyer on the telephone shouting at her headhunter.

She then sat across the table from the MP and slid her markup across the table. The MP began asking her questions about her comments in a mixed style of a partner reviewing an associate’s work and an adversary conducting a negotiation. When he got to the third page, he asked her about an issue that she missed entirely. She was silent for a moment and then tried to
explain that she just wasn’t given enough time to do a thorough review. He said, “you know, here, we are always working under time pressures.” She burst into tears, collected her things
and left. He turned to me and said, “too bad, she’s not going to work out here. Her legal work was pretty good but if she thinks this was pressure, wait until she has to deal with an SOB client or adversary.”

As we approach what will surely be a busy recruiting season, particularly at the partner level, we owe a debt of gratitude to Herrmann for opening up this subject for careful consideration. Much has been written about the essential need for due diligence, not enough has been addressed concerning testing the technical skills of lateral candidates.

Years ago, a fast growing law firm recruited a litigator who had an outsized ego and boasted an enormous book of business.  Once on board, he pitched none other than Donald Trump to handle a significant case.  He neglected to mention to The Donald or his partners that his only jury trial experience was a one day minor Civil Court case. Unlike Tom, he did not have a table full of experienced trial lawyers to guide him along and his hubris precluded him from confessing to his partners that he lacked real trial experience or from asking his experienced partners for a helping hand. He also assuredly did not want to share any “responsible partner credit”  with anyone. The case went to trial and received an inordinate amount of publicity.  The result was embarrassing; The plaintiff prevailed but the jury awarded damages of $1.00, which the court duly trebled.  The tabloids had a field day with this. This lawyer did conduct second jury trial several years later. In that second trial, he appeared pro se, defending himself of defrauding clients of millions of dollars.  This second time, he didn’t fare as well and his subsequent time in prison may have tempered some of his hubris.

So what do you ask a lateral candidate?  I would suggest a combination of resume, behavioral and real life discussion.

Review with a litigator some of the cases he’s worked on.  Pick up the identity of those cases from a Google search, if he or she hasn’t given you a list of cases he or she has worked on. Ask for the details that went on in strategizing the case, why certain motions were made or not and how the case was staffed, including the precise role played by the candidate.

Then pick up a recent case that landed on your desk and ask the candidate about his or her reactions to the claim (of course, being careful not to divulge client confidences).  Challenge him or her on some of some of the theories advanced. Inquire about how he or she envisioned litigating the case.

Ask about some of the adversaries he or she has dealt with.  Telephone one or more that you or your partners may know and mention casually that you ran into the candidate and ask about his or her skills and demeanor, being sure to couch the conversation as being prompted by idyll curiosity.

Ask transactional lawyers the same types of questions.  Inquire about deals worked on in the past.  Describe a pending deal (hypothetical or not) and ask how he or she would structure the deal.

A very similar approach should be taken with regulatory lawyers.

I know all of this sounds a bit gruesome and perhaps overbearing. But, if you are doing things right, your lateral partner questionnaire is overbearing and the ubiquitous use of these questionnaires have made them simply part of the pain a lateral must bear in making the move.

Explain at the outset, either directly or through your headhunter, that part of your firm’s recruiting process entails these procedures, so that there are no surprises.

Steve Harper is right in that lateral hiring may be fatal when not done well. Every managing partner can recite instances in which a lateral was a disappointment. And every managing partner knows full well that taking on a lateral involves substantial risk and investment. That risk must be managed carefully and tempered by a careful and thorough detailed vetting of the candidate. The future well being of your firm rests on working through this process with great care, vigilance and diligence.

© 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 .

 

Law Firms Going Global: A Baedeker Guide


English: Blank globe, focus on Africa. Deutsch...

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                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             December, 2011

 

 

Packing your bags and jetting off to new offices abroad

 

Thomas Friedman told us a couple of years ago that “The World is Flat.”  The annual AmLaw reports on law firm profitability strongly suggests that as law firms go global, taking advantage of the new flat world,  profits seem to soar.  But perhaps globalization is not all that it’s cut out to be. And, even if it’s for your firm, going global requires heightened diligence and vigilance.

A recent article in The Economist, subtitled “Globalisation slows profit growth for many law firms” concludes that going global dampens and slows profitability. The Economist suggests that global expansion can be an expensive mistake.

Foreign Offices as Revenue Enhancers?

I recently reported on the The National Law Journal’s Managing Partners’ Breakfast Meeting.  As I noted, the panel leading the discussion consisted of Tom Mills of Winston & Strawn, Alice Fisher of Latham and Elizabeth Stern of Baker & Mackenzie, each of which served as their respective law firms’ Washington offices managing partners.  Each firm represented on the panel was global and certainly eminently profitable.  Winston & Strawn has 15 offices, of which seven are outside the United States.  It reported gross revenues of $717,000,000,  868 lawyers and profits per partner for 2010 of $1,385,000.  Latham boasts 31 offices, of which 19 are abroad. Latham’s gross revenues for the same period of $1,929,000,000, earned off of the backs of 1,939 lawyers.  PPP at Latham for the period was $1,995,000.  Baker, which has a June 30 Fiscal year, reported revenues of $2,104,000.000 produced at 68 offices, of which 58 are outside the United States, where 3,768 lawyers work. Baker reported PPP of $1,125,000.

Baker & Mackenzie stands apart. For more than 30 years, Baker’s business model was unique in that it consisted of a web of dozens of offices throughout the world. It has consistently been at the top of the heap of AmLaw 100 firms in terms of headcount and at or near the top of the heap in terms of gross revenues. It has never ben at the top of the AmLaw listings in terms of either profits per partner or profits per equity partner.  The Baker model has been, for decades, to be the “go to” firm for matters international.  While PPP of $1,125,000 is nothing to sneeze at, it is substantially lower than the firms that make up the AmLaw top ten. Coudert Brothers, a firm founded in 1853, pursued a similar strategy of pan globalism. By 2006, it had 650 lawyers spread around the globe in 28 offices.  In that year, after years of declining revenues and profitability, Coudert dissolved and filed for bankruptcy. A significant number of Coudert partners joined Baker, following aborted discussions between the two firms aimed at a merger.

All of the panelist attributed a great deal of their respective firms’ growth to their firm’s global platforms. Earlier, The Economist reported on the growing trend of law firm globalization and some of the technical difficulties for law firms which seek to leave their native shores and set up beachheads abroad (certainly a worthwhile read for those firms seeking to go global).

Going global is not the unique province of AmLaw 200 firms. Two hundred lawyer Atlanta based Smith, Gambrell & Russell maintains an office in Frankfurt.  One hundred and seventy Cleveland based Benesch, Friedlander, Coplan & Aronoff  maintains an office in Shanghai.  And there are many others.

The single most important metric of the success of a law firm’s offshore branch office is whether it is a net importer or exporter of legal services.  Most law firm foreign offices are net importers of services.  Despite this disappointing result and reality, law firms continue to plant foreign offices in a fashion most akin to the Nineteenth  Century urge by industrialized nations to engage in blatant and boisterous colonialism. The analogy is most apt, as you will see below.

But going global is rife with additional landmines, some of which are described below. .

Can Global Collaboration be Accomplished?

First, as I recently wrote, the key to future success for law firms is collaboration. Cultural and language differences, as well as an army of 1,000 or more lawyers in a dozen or more nations poses some serious obstacles to advancing a culture of collaboration. In addition, the nature of the attorney – client relationship varies widely from nation to nation. In some cultures, lawyers are trusted business advisers and confidants. In other cultures, lawyers are mere scriveners.  In some areas of the world clients treat lawyers as an obstacle to getting business done and dissembling when dealing with one’s own lawyers is commonplace.

Impacts of Local Upheavals on the Firm as a Whole

Second, in discussing strategic planning with attendees of the recent conference as well as with managing partners I regularly meet with, I was rather shocked to learn that virtually no global law firm has a disaster recovery program in the event of a disaster in a major foreign branch.  The greater a law firm’s footprint, the more likely one of those footprints may well land on a landmine. Disasters may be of a natural kind, such as an earthquake on Japan (from which Japanese branches of foreign law firms are still reeling).  Local disasters may be politically inspired, such as in the instance of a regime change or as is now taking place in Russia.  Or, most critically, a disaster may well be the consequence of local financial upheaval.  Of course, the most foreboding crisis is the continued upheavals in the Euro zone; should the Euro collapse, the consequences will be devastating at every level.  But, oddly, while lawyers are trained to always contemplate sundry adverse contingencies as they counsel their clients, I have yet to meet a law firm that has a plan in place should the Euro collapse.

The ability to exercise management and fiscal control over a global expanse is also problematic, as recently shown in the instance of a practice leader in an Asian branch of a US law firm who allegedly improperly pocketed million of dollars of client escrow funds resulting in a loss to the law firm of a claimed $32,000,000.  I do not, of course, suggest that purely domestic law firms are immune from partner defalcations, as recent press reports demonstrate.

In addition, going global necessarily results in substantial additional overhead costs, tax issues and subjects the law firm to compliance with foreign rules, which are often extremely xenophobic.

Foreign Offices Spinning Off to Compete with the Mother Ship

At the NLJ Managing Partners Breakfast, there seemed to be a general consensus that Asia provides the greatest opportunity for law firms, with most speakers, both on the panel and in the audience, suggesting that China still offered the greatest opportunity. However, another suggested that the profession must be mindful of the Chinese business model, which seems to be the Chinese asking foreigner to come to China and perform a service or build a product, followed by the Chinese saying “let me see how you do that.”  That in turn is followed by “teach us how to do that,” and ultimately “okay, we now know how to do that on our own, so you can leave and we will do so.”  A leading managing partner, suggested, only perhaps slightly in jest, that “in a couple of years, these managing partners meetings will only be attended by Chinese managing partners.”

This is not a uniquely Chinese phenomenon. As firms hire local lawyers, train them in the ways of BigLaw practice and allow these lawyers to bond with the mother ship’s clients, the allure to these lawyers to spin off and form their own firm, taking the clients with them may be irresistible.  These local lawyers have gained the clients’ confidence and demonstrated their ability to deliver high quality legal services. They are fully aware that they can set up shop, unburdened by the groaning weight of BigLaw overhead and offer materially lower rates, while pocketing a vastly higher percentage of the profit for their own benefit.  This has already occurred a number of times and will certainly occur in the future. A BigLaw firm, having invested substantial sums in the branch office then confronts a Hobson’s dilemma:  Cut its losses and get out of Dodge or invest even more money locally and hope to save both face and its prior investment.

More Offices = More Conflicts of Interest

Having lots of lawyers in many countries is neat and certainly does provide some nice bragging rights.  However, it also makes the potential of conflicts of interest far more serious and the ability to thoroughly vet new clients and matters almost impossible.  Global corporations do business all over the world using different business structures and under a variety of names, not always even English.  This point was driven home for me as a partner at a global law firm recently related an incident that caused great embarrassment and some serious erosion of his relationship with one of his largest clients; a global Fortune 100 company..  As he related to me, he was visiting with the client general counsel seeking to further enhance the relationship and hoping to get some more business.  The two dined in the corporate dining room and upon returning to the GC’s office, the client thumbed through the batch of mail that was left for him while they dined.  One particular large envelope, marked “Urgent” caught the GC’s eye and he opened the envelope, examined the contents, and turned to the law firm partner and said, “Jim, I know you would like to leave here with some juicy new business. We just got served with papers in which there is a major claim of patent infringement on one of our major products. From what I see in these papers, the other side is looking for $1,500,000,000 in damages. I want you to handle this case and treat it as a ‘bet the company case’, with no holds barred, especially since you know the lawyer on the other side.  They are your partners in Belgium.”

FCPA and Securities Fraud Risks

Pay to play is an element of trade that does not have its roots in the New World.   Rather, bribery, corruption or other forms of baksheesh is the way of life in most of the world.  Similarly, tax fraud is in the national DNA of many countries. And financial and accounting irregularities are rife in certain parts of the world. There is always a likelihood that local companies or branches of global companies located abroad routinely engage in this type of conduct. Of course, much of this conduct may run afoul of the Foreign Corrupt Practices Act.  Of course, in the event of a law firm’s client being accused of a violation of the FCPA arising out of the conduct in a nation in which a law firm has a branch, there is terrific opportunity for that law firm to conduct the required investigations and defend the follow on domestic prosecutions and litigations in the United States, charging premium rates.  But in my view, sooner rather than later, a global law firm will likely be charged with FCPA violations, either because a client takes an “advice of counsel” defense line or because of a zealous regulator, prosecutor or a qui tam plaintiff.

I wonder how many law firms have written policies in place regarding steps to be taken when member of the firm that the client is engaged in systematic FCPA violations. I certainly haven’t found any.

One of the great varieties of exports that China sends to these shores are securities class actions predicated on an apparent Chinese sense that disclosure rules don’t really apply to them. Again, while some law firms are profitably enjoying defending Chinese companies because of this Chinese penchant, to the extent that law firms have been involved in the representation of the issuer, as with FCPA claims, it is only a matter of time that a global law firm will be named as an aider or abettor.

Structuring an International Law Firm

Most U.S. based global law firms are organized as a single partnership.  Others are organized as Swiss vereins, which are essentially an association of membership organizations formed under an umbrella formed under Swiss Law.  Global accounting firms have long been organized as vereins, largely for tax purposes and to help insulate the firm as a whole from liabilities incurred in discrete jurisdictions. Peter Kalis the eminent leader of global K&L Gates (39 offices, 16 abroad, reported gross revenues of $1,055,500,000, PPP of $930,000 and 1.763 lawyers) has been a vocal harsh critic of law firms that are formed as vereins. Kalis’ singular objection is the vereins “debased the financial results upon which [AmLaw] ranking rests.”  My own view is that too many AmLaw firms debase those rankings by gaming their own reported numbers. The accounting profession, as noted, has long been an adherent of verein systems and it has never been suggested that these firms do not accurately report on their own revenues and profits.

Some jurisdictions do not permit local lawyers to partner with a foreign firm and do not allow any law firm on their soil which have as partners who are not members of that jurisdiction’s bar.  Thus, where permissible, global firms form an affiliation with a local law firm or establish an office which is limited to advising on legal matters in which the global firm has operating offices. The latter option is the format in which Greenberg Traurig plans on opening its 34th office in Israel, a jurisdiction not otherwise hospitable to having foreign law firms operate full service offices on its shores. Nine office Mintz Levin (two overseas) has operated in Israel in this fashion for some time.

Conclusion

Notwithstanding all of these challenges, global law firms are eagerly eying opening offices in new markets such as Korea, Indonesia, Turkey, India and South America, particularly as barriers to entry are crumbling.

No, this is not a screed designed to prevent law firms from venturing abroad. Rather, branching globally requires a heightened degree of risk assessment and once a firm branches offshore, it must impose heightened controls at every level. If you are going offshore, do so with eyes wide open.

© 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

Lateral Law Firm Partner Movement in This Winter of Our Discontent


Law Building

Image by University of Saskatchewan via Flickr

 

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             November, 2011

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

I am Shocked, Shocked to Learn that Some Law Firms Puff their Own Financial Reports


Cover of "Casablanca [Blu-ray]"

Cover of Casablanca [Blu-ray

Citibank recently let the cat out of the bag, leaking a “secret” actually rather notoriously well known to the legal profession for decades: In an article appearing in the August 22, 2011 edition of The Wall Street Journal, Citibank revealed that a significant number of law firms materially misstate their profits when reporting to AmLaw. In particular, it appears that almost one-half of the top 50 law firms in the AmLaw 200 gamed their numbers when reporting to AmLaw.  While the fact is that this piece was hardly news (we addressed the issue in May of 2010), and later addressed the fact that some law firms unfortunately game the financial statementsthey distribute to their own partners.

While this “disclosure” by Citibank and The Journal ought to yield either a yawn or a response akin to that of Rick Blaine (played by Humphrey Bogart) to Captain Louis Renault in the 1942 classic, Casablanca: “I’m shocked, shocked to find out that there’s gambling going on here!”  But, remarkably the Journal piece had legs. The Journal’s own legal blogger, Vanessa O’Connell,  commented on the piece. Bruce MaCewan, writing as Adam Smith Esq., commented on the piece. Law 360 had some interesting observations. The ever eloquent and astute Steve Harper chimed in with important observations.   Jordan Furlong joined the discussion, noting that the “system inherently prone to inflationary bias.”  He further noted “We use rankings of the previous year’s self-reported partner  profitability as a surrogate for the prestige and desirability of a law firm, and what that says about our profession isn’t good.” There was enough chatter on the issue that it might have even been a “trending” note on Twitter on the issue. Based on telephone calls I’ve been receiving, the issue will continue to trend for the foreseeable future.

The question of who shoved whom first in the current round of this bout between AmLaw and Citibank, is beyond enigmatic, as Aric Press, publisher of American Lawyer magazine, impetuously, apparently, elected to re-publish a column originally written by him in 2006 in which he first took issue with the accuracy of law firm financial reporting by law firms to both AmLaw and Citibank, and dated the re-release, some might say disingenuously, August 15, 2011, prior to the Wall Street Journal piece.  I suppose only Mr. Press knows why he felt a sudden need to re-publish five year old work.

Rather than personally commenting on the entire issue of law firm financial reporting, Ed Reeser, a noted California bar leader, wrote a piece on the subject, which Ed was kind enough to allow me to reprint here.

If every law firm is misrepresenting their financial performance, and everybody knows it, does it matter?

 By Edwin B. Reeser

August, 2011

The law industry is a huge one (as we would expect), with an estimated $100 billion in annual gross revenue. Firms like Baker & Mackenzie, Skadden, Arps, Slate, Meagher & Flom LLP, and DLA Piper each hover around $2 billion in annual revenue, and virtually every firm in the AmLaw 50 is more than $500 million in revenues annually (actually the top 57 firms are over that mark).  So when the Wall Street Journal reports that a majority of the firms in the AmLaw 50 are misrepresenting their financial performance, according to sources referring to a Citibank report, it is big numbers, and big news, that more than 22% are overstating net income by 20% or more.

The article also reveals a “spat” between Citibank and The American Lawyer (AmLaw) that reflects a complicated issue over financial performance reporting with some seriously competing interests, and more than a few skeletons in the closet for both the lender and the magazine. Of course, we cannot forget the law firms that fundamentally are called out for lying about their financial performance.

We must take note that [neither] of the players here are disputing or denying that the numbers supplied by a majority of law firms are wildly out of the realm of truth.  Citibank is allegedly saying more than half of the top 50 law firms in America are materially misstating their financial performance, and that AmLaw numbers are misleading.  AmLaw is claiming it’s not their fault, they just report the numbers firms have told them.  What they have not said is “and we have known for a long time they were misleading.”

Indeed, Am Law has replied they really don’t think their numbers are that different from Citibank’s.  They both do know and have known for a long time that there are problems with the numbers reported by law firms. Doesn’t everybody?  But admitting it could prove to be uncomfortable for Am Law as the follow up question become: So why did you folks at Am Law not do anything to correct it, why did you persist in using survey results you knew or had strong reason to believe were bogus?  And of course, the lens spins back to Citibank with the same inquiries, which leads to a panoply of concerns over lending practices and decisions.

Citibank has the lion’s share of the Am Law 50, and even Am Law 100, law firm market for lending.  It has been a lucrative and relatively secure lending field, at least until the last three years.  While the banks have not typically lost serious money in lending to this sector as of yet (the Bank of America loss of $25 million due to the erroneous handling of a UCC-2 filing being an exception in the Heller Ehrman LLP bankruptcy), this is now the season for working line of capital renewal discussions, and there is growing anxiety about the dependence of law firms on their use of debt.

Underwriting will probably be tougher, covenants will almost certainly be more numerous, interest rates may be higher, maximum loan amounts may be lower than prior years, and demands for increased partner capital could be higher.  And tolerance for baloney in the numbers from “creative” modified cash basis accounting practices could be headed towards zero.  The Howrey LLP  bankruptcy is probably the wake up call.  Why?  Because the typical approach of lending, say 60 percent of the receivables base, and expecting to be able to comfortably collect all of the outstanding working line didn’t work (there is still more than $25 million outstanding). The “no brainer” credit became a “brain damager” problem with full recovery dependent on future contingent fee collections; and as previously reported the law firm turned on its lender and blamed it for its inability to make pension and employee severance payments by holding back on the extension of more credit.  Remember the parable of the frog and the scorpion?)

The “crack pipe of debt” is now more widespread in the industry than ever, in some cases out of control, and thus threatens the viability of a greater number of law firms.  The use of debt is corrupted to arguably inappropriate uses beyond the working needs of the business (distributions to partners of uncollected income is only one of them).

What is not addressed, but lurking under the surface, is the way some law firms have made use of personal lines of credit to partners from the same banks that finance their working capital
lines, to finance capital contributions, all of which capital will be lost in most law firm failures and for which the individual partners will still have liability for unpaid balances due to the lender.  Then, of course, there are the personal lines of credit to lawyers to pay for their annual living expenses as they wait for yearend draws and distributions, which in a failing firm do not arrive or are subject to clawback to pay creditors in a bankruptcy. And the car and home mortgage loans to the lawyers.  And we cannot forget the handling of the law firm pension plan accounts, which are a terrific fee
generator for the banks. There is a lot more money in play than just the aggregate of the working lines of capital, or secured term loans to the law firms.

Am Law is struggling in the new age of information to maintain its profitability, and this survey of comparative law firm financial performance is a franchise, it defines it.  If the survey is discredited, and Am Law with it, what will the damage be financially to AmLaw?  It is too soon to tell, but the risk is that it could be significant.

Citibank is struggling with – well the list is so long we can just leave it with Citibank has more than a few challenges of its own in the current business environment.

But what is really powerful is that both sides will, in the defense of themselves, be incented to spill the beans about how misleading the majority of the most prestigious law firms in the nation are
with their financial performance reporting.  That is not very promising for impressing clients, or recruiting talent, or for the prospect of future stories about large law firms.  This could be the opening
chapter in a revealing series from many sources on what leadership, governance and decision making law firms have adopted.

I  was asked “If every law firm is misrepresenting their financial performance, and everybody knows it, does it matter?”  My opinion is that not every law firm is misrepresenting their financial
performance, and that yes it does matter.  If it didn’t matter, there would be no need to do it.  I think that is a fair message for Citibank to convey to their law firm clients.  Citibank may not have relied on the creatively presented numbers given to AmLaw when making their business decision to lend.  I don’t believe that top law firms would provide anything other than the “real” financial performance numbers to their bankers.  But I do believe that deliberately releasing false results for publication is corrosively damaging on a wide range of issues beyond reputational, and can incent law firms to undertake imprudent business decisions that destabilize their business, increasing risk and jeopardizing the credit extended to them. That is a fair and relevant concern for a bank.  You are free to differ.

But there is another troubling question that this now public tiff has released.  When the question of absence of veracity legitimately surfaces as characterizing law firm financial reporting, it quickly spreads to, “And what else have you been saying, and to whom, that you knew was untrue?”

Edwin B. Reeser is a business lawyer in Pasadena specializing in structuring, negotiating and documenting complex real estate and business transactions for international and domestic corporations and individuals. He has served on the executive committees and as an office managing partner of firms ranging from 25 to over 800 lawyers in size.  Ed can be reached at edwin.reeser@att.net

The views expressed herein are solely those of the author.

Alternative Fee Arrangements, Value Billing and Metrics in a Dwindling Marketplace for Legal Services: Are We All Marching to the Beat of the Same Drummer?


Bass drummer at New Orleans "Tumble"...

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Value Billing and Alternative Fee Arrangements:  What are we Really Talking About?

 

A Client and a Lawyer Walk in to a Bar. 

The client says “we want you to provide us with value billing.”  The lawyer says “we’re big believers in alternative fee arrangements and have very sophisticated AFA programs.”  The client says, “Okay, how much are you going to reduce your rates?”

 

                                                                                      Jerome Kowalski

                                                                                      Kowalski & Associates

                                                                                      December, 2010

When it comes to value billing, are clients and lawyers speaking the same language?

  

In 1985, while still actively practicing law, I defended a claim brought by a diversified Fortune 500 Company against my client, a relatively small manufacturer of fluidized bed heat treating furnaces. These furnaces are, among other things, designed to harden certain ferrous metals for greater endurance. For example, many of the metals in automobiles require enhanced hardening beyond their natural state. This enhanced hardening is achieved by heating the metals above 1,200 degrees Fahrenheit for fixed periods of time. The breach of warranty claim was straightforward:  The plaintiff purchased such a machine for $103,000 and it claimed it did not function as warranted. It wanted its money back. An AmLaw 100 firm prosecuted the case.  The lawyer handling the case has since become a federal judge, while I sit from my perch here and jot my musings.

Early discovery in the case and my client’s own engineers’ inspection of the device at the plaintiff’s facility led us to quickly conclude that the problem was that the plaintiff’s personnel were simply not properly operating the equipment. Our conclusion was not surprising: In 50 years of business, no customer had ever successfully prosecuted a breach of warranty case against my client.  To be sure, this 1,000% batting average was not the result of outstanding lawyering; rather, my client had an excellent product and high quality control standards.

In a very early settlement conference, my client offered to provide the plaintiff’s personnel with additional training at no added charge and further offered to refund the full purchase price plus some portion of the legal fees if an independent academic expert mutually acceptable to the parties reported that the device was in fact not operating as warranted. The plaintiff’s division head summarily rejected the offer and in an expression of refreshing candor conceded that his division was not meeting net revenue expectations and he needed to get rid of both the machine and the personnel needed to operate the unit if he were to get close to meeting his division’s net revenue projections.

Against this backdrop, my client’s CEO called me and told me that he could resolve the case quickly. His company had received an order from a different customer that required the purchase of $10,000,000 worth of refractory brick (that is brick that can sustain consistent high heat, such as you will find in your own fireplace) and that our plaintiff, through a different division,  was one of the nation’s three largest manufacturers of such refractory. My client was prepared to issue a PO for this refractory to the plaintiff, while still providing the promised additional training.

Sounds easy, doesn’t it? The plaintiff would get the full benefit of its bargain and profit from the new order.  Yet the plaintiff’s division manger refused, since his division would not be credited with the sale and he still needed to trim costs to meet revenue projections. Try as we might, opposing counsel and I, who agreed privately that the proposed resolution was sound and an outstanding commercial resolution, just could not get the plaintiff, even at its highest corporate offices, to buy in on the deal.

We nonetheless settled the case quickly thereafter. My client simply repurchased the machine and resold it within days to the United States Department of Energy for $135,000. The PO for the refractory was issued to a competitor of the plaintiff.

The litigation costs were far less than anticipated for both sides, and in today’s parlance we provided “value billing:”   We provided efficient professional services and concluded a potentially complex litigation, at a fraction of the budgeted cost.  But, did we really provide “value billing?”

This quarter century old case came to mind as I sat through the National Law Journal’s Managing Partners Conference in Washington on December 2.

The conference included much talismanic recitations of “value billing.”  Actually, the repeated catch phrase that captured my ear was the too oft cited “legal spend.”  The repeated juxtapositions of the two phrases by each presenter, extremely capable law firm leaders, to be sure, was rather straightforward:  Corporate clients were slashing expenses for outside counsel and law firms were scrambling to maintain significant slices of the shrinking pie by discounting prices.

It’s now been two years since the Association of Corporate Counsel issued its “Value Challenge” and perhaps it’s now time to reconsider the concept and perhaps re-define re-think what legal “value billing” really should mean. I readily admit to be a value billing junkie.

A principal problem in the ACC Corporate Challenge is its rather wholesale reliance on defined metrics. Professor Steve Harper, a former Kirkland partner, recently reported that reliance on metrics is frequently misplaced.  I long ago joined a chorus of others in raising the issue of the “mother” of all metrics; the much touted annual AmLaw 200 report on law firm profitability is slightly less than gospel.

The National Association for Legal Placement, which has a key part of its mandate issuing reports on the metrics of recent law school graduates issues reports on that are nothing more or less than picture perfect portraits of opacity. NALP and its constituents are unwilling or unable to answer a simple question:  “If I decide to go to law school, work my butt off for three years and incur $200,000 in debt, what is the likelihood that I will get a well paying job?  If the law schools let me know how their recent graduates managed, I could make an informed decision.”  An Indiana Jones inspired group, The Law School Transparency Project, embarked on a good faith search for this holy grail of metrics and short of an extremely unlikely national labor strike there is very little likelihood that actual metrics will ever be found.

The point here is that metrics are ephemeral, misleading, quixotic, enigmatic and too often of little assistance in getting the full measure of quality.

All of which brings me back to my original questions:  exactly what is value billing, how is it measured (or even recognized) and how should it be rewarded?

Indeed, even with the ever rising crescendo demand by corporations for Alternative Fee Arrangements over the past 30 months, corporate general counsel are still expressing confusion and uncertainty regarding the concept while law firms, eager to satisfy a dwindling client base believe they have risen to and met the Alternative Fee Arrangement challenge, remain perplexed about why they are having so much difficulty marketing AFA’s.

Metrics are simply just but one, and only one, variable in a far more complex algorithm by which value is measured.

I think we all need to get back to basics and view the issue in the context of law school:  Classroom participation counts.

Let’s posit the query in a Socratic hypothetical:  Assume a sophisticated client believes it has perfected the alchemy to turn dross in to gold.  All that it needs is the capital to finance the R&D and the assistance of regulatory specialists to gain required governmental approvals. At a networking event at law firm or through some blog postings by a law firm, the client makes the connection to obtain financing and is introduced to scientists who can serve as Scherpas through the regulatory gauntlet. Clearly, the client has already obtained value (of the most prized, sort, since it came at no cost) but now it needs to engage counsel to handle the lawyering. Corporate counsel, guided by his or her own Sherpa, the purchasing agent, issues an RFP and circulates it among the usual suspects, including the networking event host and blog poster. Five acceptable proposals are submitted, with network hoster and blogger proposing a fee schedule placing it as the second most expensive bidder in a tight race.  As John Belushi asked, “who are you going to call?”

General Counsel:  How do you answer Belushi’s question?   Hit the comment section below and share your thoughts.

The Law Firm and the Lawyer as a Marketplace for Value

            Lawyers who have achieved marketing successes have done so because they intuitively comprehend that they add value because they have developed a network of contacts and that this network is a constant work in progress. Whenever such a lawyer is in contact with a member of his or her network, his or her first instinct is to calculate in nanoseconds which of his or her other network contacts can add value to that contact. The primary skills for achieving this result is listening to the speaker and then instantaneously calculate how value can be added to the speaker by hooking him or her up with another network member and for each to develop synergies, business alliances, business solutions and more spokes attached to the hub of the marketplace for value.  No direct metric can be attached to this activity nor will immediate revenue derive from having a lawyer or a law firm function as a marketplace for value.  But the simple fact is that clients will flock to lawyers who regularly add value, even if no invoice can be rendered for the value received by the client in having commercially enjoyed the benefit of this marketplace for value.

As for law firms, it is your job to demonstrate the entitlement to a higher grade by touting your own classroom participation and the real value (not the metrics) you added to the client:

  • During your own marketing calls to your clients, show how you added real value, not just a lower bill.
  •  In responding to the RFP, don’t be shy as to expressing a willingness to meet the competition (But only meet the competition after you have first assured yourself that you can manage the engagement at a reduced fee which still yields profitability;  as more than ever, risk assessment and project management are the elixirs for survival in the AFA world).
  •  Just as the swallows head south for Capistrano at this time of year, so too does the annual debate concerning the value of client surveys fill the air.  Does your client survey ask the simple question “other than lowering our fee structure, how else can we add value?”  In your client survey submission, cite instances in which your firm added real value to a client’s business (other than simply by reducing fees); solicit suggestions from clients regarding how your firm can add value,  not just reduced metrics.

© Jerome Kowalski, December, 2010. All Rights Reserved.

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