· .'
invest in lli to sta~ (omp'etitive
our f te: How to avoid a future of financial ruin
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2012
Mike Tfotter discusses which changes to your firm's
growth.l~trategy and partner obligations can safeguard
it agailst financial failure
Why are a gTwing number of prominent American corporate law firms collapsing? Among the large
firms that hare closed are Brobeck, Coudert Brothers, Arter & Hadden, Heller Ehrman, Thacher
Proffitt, W0"'rlock, HowreY, and now Dewey & LeBoeuf. Some major firms have merged into other
major finns perhaps to avoid a similar fate.
Large and hi~hly-leveraged law firms like those that have failed a~ a relatively recent phenomenon in
the United states. The largest law finnin America- in 1960 was Shearman, Sterling & Wright with 125
lawyers. In Aiuanta, Georgia. the largest firm had 21 lawyers.
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The !inns
smaU, partly beca.-1helr
clients did not need more legal assistance Ulan they were
alreadyrecernng and partly because, as general partners in a general partnership, each partner was
responsible ~or all of the firm's liabilities. No one wanted to be in a general partnership with partners
he did not kliow well and trust implicitly.
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The risks of being a partner in a larger US partnership were reduced by the advent in 1945 of the first
legal malpraO~~iceinsurance policies. The risks were further reduced by the adoption of limited liability
partnership I ws in various states during the 1990s. A partner in such a partnership, absent an
agreement to the contrary, is not liable for the obligations of the firm unless he is responsible for the
malpractice Jr misconduct giving rise to the obligation or unless he has personally guaranteed some
of their firm's,obligations.
As a result 0 these developments, the risks to partners in large law firms for the malpractice or
misconduct
f one of their partners have been significantly reduced.
Growth was . Iso encouraged by the increasing national and international markets for American
goods and s rvices (which greatly increased the size and complexity of US companies), and by the
great expan ion of corporate law departments that often preferred to use a small number of firms
nationwide t provide outside services in particular areas of practice.
more than 2 other American law firms reporting in excess of 1,000 lawyers each.
Causes of mancial instability
As major bu iness practice firms have become larger, many of them have also become increasingly
unstable. W y has this instability occurred?
The primary problem is that there is not enough high-paying legal business available to law firms to
produce the compensation that so many partners at major law firms now expect.
Consequen~ly, to improve their financial performance, many firms have decided to grow the size and
scope of th4ir practices by employing or bringing into their partnerships lawyers with established
books of buriness and by opening new offices in new locations.
The adoptio
of the strategy of expansion by hiring laterals has been facilitated by the availability of
professional malpractice insurance and the ability to organise limited liability partnerships.
At the sam~ time, law firm partners with books of business have been seeking to improve their
individual fimancial positions by accepting lucrative compensation arrangements from such firms.
American B r Association Model Rule 5.6, which has been widely adopted by the governing bodies of
the various tate Bars, provides that
"A lawyer s all not participate in offering or making: (a) a partnership, shareholders, operating,
employme t, or other similar type of agreement that restricts the right of a lawyer to practice after
termination of the relationship except an agreement concerning benefits upon retirement".
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The Comme t on Rule 5.6 states in part that:
"An agreeme t restricting the right of lawyers to practice after leaving a firm not only limits their
professional
utonomy but also limits the freedom of clients to choose a lawyer".
As a result 0 the unlimited free
law firms, la
agency enjoyed by the partners and lawyer-employees
of American
ers with portable books of business are able to move from one firm to another, taking
'their' clients with them to another firm that offers better compensation and/or working conditions.
Free agency has also facilitated the growth of large firms into much larger ones geographically. It is
difficult to oPrn new offices nationally or internationally without the assistance of well-known and
highly-respefed
local attorneys. Most firms expanding geographically have done so by staffing a
portion of their new offices with laterals from local firms.
Under these circumstances, it is not surprising that there has been an extraordinary amount of lateral
movement b tween major US law firms by partners seeking better financial or practice arrangements
or escaping
ncertain ones while their firms have been seeking to increase their revenues and
profitability.
The lateral iring trap
The researc
of Professors William Henderson and Leonard Bierman
indicates that, between 2000
and 2007, 0 er 33 per cent of the partners in Am Law 200 firms had moved to their firms from other
firms (many of which were other Am Law 200 firms)."
Is it possibl
for major law firms to stabilize themselves while deterring the cherry-picking of their
most produ tive lawyers by their competitors? Could Dewey & LeBoeuf have stood still and survived?
I doubt it.
Under the p esent rules of the game, once a firm's competitors are able to recruit a few of its most
productive ~artners, other top partners are likely to follow suit. Therefore, over time, major law firms
must either prow stronger or fail.
There is a s,lmallgroup of business law firms that have been able to avoid the lateral hiring trap. Most
of them are already at or near the top of the profession in competence, compensation and reputation.
Most have
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nly one class of partner, have eschewed high leverage and lateral hiring, have focused
on high-qu lity service rather than on volume, have remained relatively small, and have exercised
great cauti n in expanding. These are the firms that all the others would like to emulate."
What can
0
her major firms do to avoid the lateral partner rat race? Should Model Rule 5.6 and its
progeny be modified or repealed to increase the stability of major law firms? Does the rule exist to
protect indi idual lawyers, law firms or clients?
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It clearly doe n't protect law firms. It is less clear that clients are the beneficiaries, although they may
be in some c rcumstances. The impact on clients is at least disruptive and distracting - in some cases
it can be sub tantial.
It is clear tha individual lawyers are the principal beneficiaries. As you would expect, there is
tremendous fupport among individual lawyers for retaining Model Rule 5.6. Who doesn't want to be
a free agen?
However, th
growing risks to firms and their partners and the inconvenience for clients arising from
the current e vironment suggest that some modifications of the rule may be worth considering.
Buying into the firm's future
One thing thrt major US law firms could do to maintain their stability without a modification of the rule
would be to beqUire that all of their partners guarantee the firm's obligations (bank debts and leases)
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in total or in roportion to their financial participation in the linn.
It is likely th t partners would think twice about leaving for another firm if there was a possibility that
their existin
firm would fail while their guaranties remained outstanding (and their departure might
increase su h a possibility). Such requirements have not been treated as a violation of Model Rule
5.6 or of the similar rules adopted by the Bars of various American states.
Of course,
anks and leasers routinely require such commitments from the partners of small and
medium-siz
d firms to discourage promiscuous moves that would undermine the financial strength of
their debtor,
so this would not be something new or unexpected.
But, if majo firms do so too, fewer firms would fall apart. Each existing partner would be expected to
make such
commitment. The firm's ability to attract lateral partners would, however, likely be
undermined because many lateral candidates would be unwilling to assume such an obligation,
especially if other firms did not impose such a requirement.
For a very f w elite American firms, part of the answer has been lockstep compensation. For those
partners wh
have committed a substantial portion of their careers within such a system, leaving
before retir ment would mean leaving some of the income forgone in prior years on the table, rather
than receivi g the benefits of such a system in their later years of practice.
In the curreIt environment, it would be very difficult for most firms without a lockstep system to put
one in Plac now. Changing the rules in the middle of the game is difficult to accomplish.
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Issues to onelder
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Should a pa ner who packs his bags and moves 'his' clients to another US firm for purely economic
reasons be
ntirely free to do so?
Should empl yment contracts between a lawyer and his firm be a one-way street - the firm has to
pay in acco1ance
Should a fir
reimbursing
with the contract, but the lawyer can leave without consequences at his whim?
be able to impose some requirements on a moving partner such as responsibility for
xpenses incurred as a consequence of his move, or refunding the bonus or guarantee
he received for joining the firm in the first place?
Often avarice is not the most important issue. If a partner concludes that his clients cannot be
adequately
erved by his existing colleagues and they are unwilling to bring in someone who could do
so, shouldn' he be entitled to move to a firm that can better serve his clients' needs?
The client m y be unwilling or unable to pay the increasing rates required by the partner's existing
firm, but ma be happy to continue using its existing lawyer (or lawyers) at existing or lower rates at
another firm. Should the lawyer be permitted to move to another firm in order to maintain his client
relationship.
Client contli ts may arise that preclude a partner from continuing to represent one or more of his
clients. Or a partner may not get along with some of his important colleagues or may not be paid
fairly. Under such circumstances, shouldn't a partner be entitled to move to another and more
amiable firm.
Of course,
ajor US law firms are not ignorant and defenseless. If they make
bad choices, why
should they e protected against their own mistakes? If they are unable or unwilling to provide
sufficient op ortunities and a healthy working environment, shouldn't they have to pay the
consequenc s?
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Another issu;e worthy of consideration is the issue of agency law and the fiduciary duty of agents to
their
law firms an
Partners are agents of their law firms, and clients enter into their engagements with
not with individual lawyers.
I believe ag,ncy law requires that partners discharge their duty of loyalty to their firms that would at a
minimum pr hibit a partner planning to leave his firm from discussing his departure with a client of the
firm (regardl ss of the partner's relationship with the client) or with employees of the firm, until the
firm had be n notified of his intentions and had the opportunity to protect its interests. I suspect that
many depa ing partners are not so scrupulous and might have liability to their former firms as a
result.
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It's time
for
th
American Bar Association to give serious consideration to the impact of Model Rule
5.6 on the leg I profession and its clients, and to consider modifications to the rule that would improve
the character stability and reputation of our profession.
Michael H. Trotter s a partner in the corporate and business practice group at US law firm Taylor English
Endnote
1.See'~A~n=E~m~~~~~~~~~~~~==~==~~~==~~~====~~====~~~~~==~~
William Henderso
and Leonard Bierman, Georgetown Journal of Legal Ethics, Vol. 22, Issue 4, Fall 2009
------2. For further info mation, see Declining Prospects,
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Michael H. Trotter, CreateSpace Independent Publishing Platform, August 2012