Seal of the United States District Court for the Southern District of New York (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

July, 2012

In the last month or so, BigLaw was jarred by two disruptive events:  First, there was the tragic collapse of Dewey & LeBoeuf and the second, the reasoned decision issued by the United States District Court for the Southern District of New York in the Coudert bankruptcy holding that the “unfinished business” doctrine, commonly known as Jewel v Boxer, applies to New York law firm partnerships and that it does so with equal weight to both matters billed on an hourly basis as well as contingency fee work.  Both events have chilled the lateral partner market.

Added to that is the fact that liquidators of imploded law firms are also desperately seeking recoveries for creditors and are therefore anxiously investigating potential breach of fiduciary duty claims against former partners of the law firms, and, like Jewel claims, the reach of these claims is likely to put the law firms these former partners subsequently joined into their cross hairs. Deep pockets and all of that.

These events are occurring in the open for all to see. Unfortunately, too many managing partners, lateral hiring partners, law firm general counsels and risk managers have neither taken note nor taken adequate steps to protect their firms.

In light of recent events, law firms will be woefully remiss if they fail to include in their standard agreements for lateral partners language protecting and indemnifying the firm from Jewel v Boxer and breach of fiduciary duty claims.  If the firm has hired a lateral partner from a firm that is going through the throes of imploding, a la Dewey or if a lateral partner comes from a law firm that subsequently unwinds unexpectedly, there is some reasonable likelihood that the hiring firm will be targeted as a defendant should the liquidators of the defunct law firm form a reasonable basis to assert such claims.  The issue is that there is almost always a likelihood that such claims are lurking about. These skulking claims are all of the more problematic because they are typically not asserted for a couple of years after a law firm implodes.  When the pain comes, law firms should preserve the right to share some of that pain in a reasoned and rational way.

Law firm liquidators typically spend the first several months of their tenure tending to the gargantuan tasks of shutting down the law firm.  They simultaneously undertake a “sources and uses” analysis to determine what potential sources exist for payment of administration expenses and obligations due to creditors.  Because expenses and creditor typically far exceed the amounts available from monetizing accounts receivable and works in progress, successor law firms are more frequently found to be routinely available resources for adding to the honey pot. And nobody is more motivated to add to the honey pot than law firm liquidators whose fees are often contingent on maximizing recoveries; a primary resource for them has been pursuing clawbacks and claw forwards.  They are unrestrained by market place considerations which dampen the appetite of viable law firms to  go after other competing law firms who have hired laterally from its ranks because they would inevitably subject themselves to the very same claims, as they continue to drink the Kool Ade and hire laterally.

The problem is that it takes law firm liquidators an extended period of time to get their hands around the behemoth of the law firm that once was and is no longer. For example, one of the tasks typically undertaken by the liquidators is recasting the firm’s balance sheet and profit and loss statements retroactively, to among other things, determine when the law firm was first insolvent from a technical bankruptcy point of view.  Any payments made to partners during the insolvency period are gratuitous transfers and are subject to clawbacks. Determining the date of insolvency is both art and science and often requires extended analyses. Similarly, determining where former partners went and which firm assets (in the form of client files, other partners and associates) also takes time. Thus, we most often see that these claims are filed en masse upon the expiration of the statute of limitations, which is two years from the date of filing.

Here is the rub:  Law firms typically prudently pay new lateral partners in whole or in part during the course of that partner’s initial tenure at the law firm on a performance basis. One of the key drivers is most often cash generation and the metric law firms use in calculating the new partner’s entitlement is the law firm’s historical profit margins. To be sure, those margins do not include clawbacks. Thus, the typical scenario is that the new lateral partner is timely rewarded for production, with the law firm completely oblivious to the very real likelihood that two years or more down the road, law firm liquidators will be sending the law firm a due bill for all of the profits earned by the law firm (not just the new partner’s distributions) for unfinished business based on either Jewel v Boxer or breach of fiduciary duty claims. Successor law firms have not yet been the target for recovery of voidable transfers made during the insolvency period made to the new partner during his prior tenure at the now defunct law firm.

Thus, the new firm is in the unenviable position of having to pay twice for the same revenue generation: First, to the lateral partner and thereafter to the estate of the former law firm.

The issue with breach of fiduciary claims is far more devious and invidious. Among other things, we know full well that the rule is that a partner may not solicit a client, associate or partner to join him or her at a new firm until he or she has given notice. Nor can a partner share with another law firm confidential billing and collection information of his or her current law firm, Yet, we can all take judicial notice that no sane partner on the prowl will accept an offer from a new firm before he or she has received adequate assurances from his or her clients will be following him or her. Similarly, every hiring law firm demands assurances that the clients will indeed be coming along. By the same token, when a group leaves a law firm simultaneously to the same new climes, it is readily apparent that a partner, typically the group leader, has engaged in actionable recruiting of partners and associates prior to giving notice. The new law firm is clearly complicit, since it almost always interviews partners in the group at length before an offer is extended and even where associates are first interviewed after the partners give notice, it is more often the case than not that these associates were advised by law firm partners to start packing – again, actionable conduct. Even where the successor law firm gives a potential lateral recruit written admonitions not to violate any fiduciary obligations or partnership agreements and somehow feigns ignorance of any fiduciary breaches, at best, it is most often clear that it has simply engaged in willful (and often dubious) blindness and may be subject to some serious claims.

Dewey broke the mold in oh so many ways

Dewey’s implosion was unprecedented in too many ways to count.

One unique aspect of the Dewey collapse was its failure to hold a formal dissolution vote. One Dewey law firm leader, when asked about a formal vote of dissolution as the firm was plainly at the tail end of its death spiral, blithely and rather incredibly denied that the firm was going to vote to dissolve, even Quixotically asking his interlocutor, “why would he do that?” even as he presumably was actively looking for a new home and subsequent to the time that he issued an email in his official capacity to other partners encouraging them to leave. The answer to the question sort of seems obvious:  The reason you would take a dissolution vote is because the law requires you to do so and the firm’s managing partners, as fiduciaries of other partners as well as of the firm’s other creditors, have a duty to call for such a vote as the firm, in fact, is actually in a state of very real dissolution.

The issue may well be that Dewey’s leaders, very smart lawyers one and all, may well have wanted to protect their colleagues and themselves from Jewel v Boxer claims. You see, these claims arguably first arise once the partnership votes to dissolve.  In Coudert, the only partners (and their new law firms) sued for unfinished business profits were those who left after the dissolution vote. I certainly have no information to support the notion that this was the reason for the failure to formally vote to dissolve Dewey.  But, if this was the reason for the ploy, it seems unlikely that it will succeed.  First, it may be that a court of equity may determine that Dewey went into formal dissolution as it stumbled through various critical paths:  For example, when Dewey leadership tried to auction off pieces to other law firms, when those efforts failed, when the firm’s then sole managing partner advised the partnership in January 2012 that the firm was basically insolvent in that it couldn’t pay its debts when due, the date of the bankruptcy filing or some other earlier date. We are in largely uncharted waters here, folks.

But, the refusal to take a formal dissolution vote solved nothing and protects nobody. Every former partner and most of their new law firms are still subject to breach of fiduciary claims, violations of the partnership agreement and violations of the Revised Uniform Partners Law. Those in management are presumably more at risk.

Simply arguably eliminating Jewel v Boxer claims still leaves the door wide open for breach of fiduciary duty claims. We do not suggest that Jewel claims preclude breach of fiduciary duty claims. They are all still out there.  In short, it doesn’t matter whether you call it a “tax” or a “penalty”.  A clawback is still a clawback.

Protecting law firms who hire partners laterally

In light of all of the foregoing, it is critical that any law firm which hires laterally must include indemnities from new partners from both Jewel v Boxer and breach of fiduciary claims.  The full nature, scope and content of these indemnities must be left to the sound business judgment of law firm leadership.  It is likely that the amount of the precise amount for particular indemnities will first be the subject of negotiation after issue is formally joined on the claims.  Those indemnities should be standard issue in every lateral partner agreement. Every single one.

All such agreements should require binding confidential mediation and arbitration.

Moreover, as we continue to watch even an already bankrupt Dewey continue to fall, law firm risk managers must be engaged in active discussions with its insurance carriers to see what insurance might be available with regard to potential future Deweys and partners who leave those sinking ships to join new law firms. It may be too late to insure Dewey-related claims, but it isn’t too late to seek coverage for the next generation of imploded law firm refugees. These claims are certainly outside the scope of standard issue malpractice claims, but may well be within the scope of fiduciary insurance coverage or errors and omissions policies.  The real problem here is that most often, these claims specifically exclude work done by a partner at a former law firm.

I leave it to professional liability professionals to craft an insurance based solution.  But be forewarned, time is short; the next law firm implosion may be around the corner.

An important note: Those law firms which carefully assesses its likelihood of liability, includes the amount of exposure into its calculus (and may even have appropriate insurance) and then eschews the need for an indemnity, while extending a viable offer, puts itself at a competitive advantage for a desirable candidate. However, it does so at some risk and eliminates the ability to tell all comers that these indemnities are required of all lateral partners. At the same time, if a law firm picks and chooses which lateral candidates should be required to provide indemnities, there may be some explaining to do of and when it comes to pre-trial discovery in the inevitable Jewel or breach of fiduciary duty claims rears its head.

Is this a fight you really want to get into?

It isn’t very surprising that every Jewel v Boxer and breach of fiduciary duty claim previously brought under these circumstances involving BigLaw has settled prior to trial. Many settle before the first pleading is served. The balance settle well prior to trial. Several are still pending in the pleading phases in Thelen and in Coudert with the antagonists vowing to fight on to trial and through the appellate process, never to give in. Never. We’ll see.

The real problem here is the fact that pretrial discovery will be brutishly invasive and certainly expensive.  Remember, that the Jewel v Boxer rule is that the plaintiff has an entitlement to recover the profits not the gross fees from unfinished business. Thus, discovery will necessarily include minute details of a law firm’s most sensitive and confidential pricing and profitability information, stuff that even in the most transparent of law firms do not regularly share even with partners.

Sure, we all love confidentiality agreements and protective orders and advocate for them all of the time both to the courts and to our skeptical and justifiably paranoid clients. But, today, the shoe is on the other foot: Do you really want this information disclosed to your key competitors even under a protective order?  Can you, dear advocate, feel safe with a protective order? Bear in mind that at trial, the veil of confidentiality comes off and should any of these cases ever come to trial, the world at large will be informed of your most sensitive information, with journalists, bloggers and pundits at the ready in the courthouse to report information never previously having seen the faint light of day.

Is it time for some rule changes?

While getting the American Bar Association and fifty-one agencies to change extant provisions of the Model Code of Professional Responsibility is a Herculean task, which, at best, would proceed at a glacial pace, it is time to at least begin to consider those issues.

First, since the skein of precedent and statute in the area of fiduciary laws governing partnerships is a foolhardy a mission hardly imaginable, let’s for the moment, at least, forget about undoing Jewel v Boxer under the rubric of amending a century or more of common law and statutory mandates and suggesting that we are simply modifying rules of professional conduct. Instead, an initial focus should be on the question of lateral partner movement. We all know what the rules say and we all concede that these rules are far more honored in the breach.  A new set of rules are critical and should, even reluctantly, yield to the realities created by the marketplace: Partners are free agents, just as law firms freely de-equitize partners and otherwise treat them as employees at will. Market realities create lateral movement.  The marketplace also has required client solicitation before partnership withdrawal, disclosure of historical billing and collection history and even solicitation of associates and other partners. The ethical rules need to be amended to yield to these market realities. The issue here is not those fiduciary rules of partnership described in the Jewel line of cases and in the Coudert decision. Rather, the rules that need to be addressed relate to those fairly unique to the profession; namely, those rules primarily regarding client solicitations in a free agency market.

More significantly, given the likelihood of a torrent of post Dewey Jewel v Boxer and breach of fiduciary claims, as well as a next round of similar claims from the inevitable next BigLaw failures, the rules should require that all disputes between law firms and their successors and assigns be arbitrated before a panel of those appointed in each jurisdiction to review lawyer conduct.

Until the rules are actually amended, BigLaw should consider acting on its own: I would propose a compact by and among the nation’s largest law firms under which any disputes among the signatories of the compact, inter se,  be finally resolved through mediation and then arbitration by a designated panel of arbitrators,  consisting of retired jurists as well as present and past BigLaw partners.  This compact should specifically bind the signing law firms as well as their successors and assigns.  It would take only a relatively small number of numbers of law firms to seize such an initiative and then some prodding to get other law firms to join in.

Waves of litigation brought by law firm liquidators seem inevitable.  A uniquely qualified panel of arbitrators are perhaps the most efficient way to handle these issues. At the same time, this panel could also be designated to be the forum in which disputes among partners inter se, as well as between a partner and his or her former law firm can be most efficiently finally resolved.

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 Jerome_kowalski@me.com or at  jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310

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

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

Jerome Kowalski

Kowalski & Associates

June, 2012

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Now is the time to begin considering your bargaining position.

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

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

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

Jerome Kowalski

Kowalski & Associates

June, 2012

There may be trouble ahead

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

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

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

The likely coming battlefields

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

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

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

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

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

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

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

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

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

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

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

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

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

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Dewey (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

May, 2012

The current state of the public record suggests that Dewey & LeBoeuf began its ill fated trip to disaster years ago. It appears that by last winter, the partners knew that a brick wall was hurtling at them at 200+ miles an hour. The question nobody has yet asked is whether the firm could have been steered to safety at that late date.  I would suggest that with capable leadership, enjoying the confidence of the firm’s partners, associates and other stakeholders and a collaborative approach by the full partnership it was possible to avoid the oncoming brick wall.

The starting point would necessarily be the firm’s October, 2011 partners’ meeting at which the partners were first told that about a third of the firm’s 300 partners had special deals under which their compensation was guaranteed at fixed lucrative amounts, not pegged to the firm’s profitability. The net effect was what Professor Steve Harper and others called a fatal “partnership within a partnership” and a Ponzi scheme. Much ink and much of the Internet ether has already been spent on why this dubious compensation scheme just doesn’t work and I won’t add to that discussion here. The point here is that reasonably intelligent lawyers, hearing a state of facts that commands a single conclusion, namely, that their law firm was on a catastrophic course, had the capacity to make critical flight or fight decisions. It appearing that no viable or credible stay and fight decisions were presented, a critical mass of vital partners chose to begin heading for the exit ramps.

The survival course that was actually foisted on the gathered leaders had no appeal. The “Plan” was to reduce headcounts, including at the partner level, by some 5% and foist a deferral of guaranteed compensation agreements. That cannibalism just doesn’t instill confidence since any reasonably intelligent lawyer would (and apparently many if not most did) conclude that this “plan” sounds dumb and other personal options should be explored. The flaws in this “plan” were essentially a lack of confidence in the incumbent leadership, an historic lack of transparency in management which did not appear to be changing in any way, kicking the can down the road with a hope for a change in luck was recognized as the foolhardy aspiration of dice rollers on a losing streak, a fear of being kicked under the bus in inevitable subsequent partner reductions as the “plan” inevitably spun into failure.

Instead, the only viable plan required (a) a complete, detailed mea culpa  from the firm leadership; (b) a demonstrable and credible guarantee of  full transparency by firm leadership with a new reliable form of governance with appropriate checks and balances in place; (c) a detailed explanation of the disastrous personal consequences to each partner if the firm should implode; (d) implementation of a public relations crisis management plan;  and (e) a signed pledge by each partner to stay the course.

There was no acceptance of responsibility by incumbent management.  Rather, months later the firm’s managing partner was unceremoniously tossed under the bus.  The previous clandestine management style was replaced by an apparently equally stealthy “office of the chairman.” Partners did not fully appreciate that massive escapes to the exit doors were more likely to be collective defenestrations.  Subsequent media disclosures were replete with, shall we say, dissembling, to be kind.  And public claims and denials by the partners of the existence of a pledge made for mirth.

Would this plan have worked? It was only tried once before when the New York office of a national law firm (the New York office was itself previously a proud stand alone law firm)  confronted with the fact that the law firm was destined for implosion because of claimed improprieties at other branch offices. The New York office adopted each element of the plan outlined above, with resounding success. But would this plan have worked for Dewey & LeBoeuf? We’ll never know. But we do know the “plan” it chose was an abject and tragic failure.

© Jerome Kowalski, May, 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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Stock footage taken at Beaumont Hospital. 14:18, 28 October 2006 (UTC) (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

May, 2012

The horrific death spiral of Dewey & LeBoeuf, which started within the firm in October of 2011 and debuted its public spectacle in March, 2012, continues to evoke gasps and cries from all observers and participants. The latest horrors, not unexpected, are the loss of hundreds of jobs and the disappearance or dramatic reduction of thousands of pensions.  To be sure, more ugliness lies ahead: Draconian financial penalties to partners and prosecutorial inquiries of potential criminal liability for some key Dewey players.

The question I pose to you today, dear readers, is whether we are simply voyeurs or whether a sense of professional high mindedness should prevail so that urgent steps are taken to prevent the next seemingly inevitable law firm implosion? Did we come to the speedway pretending only to be interested in the competition but hoping for carnage or are we among those who seek to promote safety and prevent future crashes?

Dewey & LeBoeuf’s Current State of Play

The crescendo of public discourse of the Dewey disaster escalates daily. One of the most recent cogent pieces, sets forth a seemingly well informed and apparently factual exposition of the events leading up to the inevitable denouement.  Other well informed pieces analyzes the root causes of the Dewey & Leboeuf debacle.  A brief moment of levity was inserted into the mix as an avuncular former Dewey & LeBoeuf partner and department head stared straight faced into a  television news camera and calmly explained that the reasons for the firm’s implosion was that after Steven Davis, the now ousted chairman of Dewey, sat down with his partners in January and apparently revealed to them for the first time that the firm was functionally insolvent, headhunters had the gall to help partners find new positions, the media had the temerity to report on the facts and the district attorney had the audacity to conduct an investigation of serious allegations of criminal wrongdoing by senior managers at Dewey & LeBoeuf. These bon mots brought to mind the tale of the owners of a bus company who were called to task because they had employed an alcoholic bus driver who in his stupor caused a horrendous crash resulting in awful carnage. The owners calmly explained that they were not to blame.  The reason so many people were taken to the hospital was because of the fleet of ambulances that descended on the scene and the cause of so many reports of broken limbs was attributable to the zeal of the hospital’s ex ray technicians.

The fact is that since the 1988 implosion of Finley Kumble, then the world’s second largest law firm, there have been some 43 major law firm bankruptcies.  Each major law firm bankruptcy brings disgrace to the profession, disrupts lives, erodes confidence in the profession and creates a cascade of unemployment, poverty, death and disease (the rate of stress related diseases and mortality post law firm bankruptcies, reported only anecdotally, is staggering) and divorce (again, reported only anecdotally).

The blight on the profession is not simply the fact of these law firm failures, but the utter failure of the profession to address these failures and take any steps to prevent them. The appalling nature of this Ostrich like  stance is the generally accepted belief that a number of large law firm failures in the coming months seems inevitable.

The problem

The three inch thick annotated American Bar Association’s Model Rules of Professional Conduct that sits in every law firm in America is completely silent on the issue of law firm financial reporting, whether it be to the firm’s partners, its lenders, vendors or the media. The self reporting through The American Lawyer is largely recognized to be unreliable at best, or a large bad commercial joke at worst. Let’s simply look at the soft, puffing (and apparently demonstrably false) report that Mr. Davis gave The American Lawyer in March, 2012 as a prime example. Neither the firm nor Mr. Davis was called to task for gross overstatements of revenues; The American Lawyer, which derives significant revenues from theses annual reports and the hoopla leading up to them did not immediately exercise the requisite journalist imperative of rigorously subjecting Davis to the crucible of informed journalistic inquiry (although it did, to its great credit, after public disclosure of the Dewey deception, take the unprecedented step of unilaterally restating Dewey & LeBoeuf’s financial reports).

The Model  Code is also strangely silent on the issue of law firm governance. Based on what has this far been revealed and now seems indisputable, based on the public record to date,  the demise of Dewey & LeBoeuf is largely attributable to a complete and abject failure of proper governance. The tragic irony is that Dewey still boasts on its web site of its superlative corporate governance practice group. Read it now, while the web site is still up and running. If you missed it, here is a pertinent excerpt:

“Based on decades of experience in corporate law, governance, restructuring and litigation, Dewey & LeBoeuf has assembled a next generation capability to achieve clients’ goals… Our multidisciplinary approach enables us to develop special tools that allow directors and management to avoid ‘not knowing.’”

We can apparently now conclude that Dewey did not capitalize on its “generations of experience” in establishing a system for itself of checks and balances, oversight and accountability required of this generation of commercial enterprises. The firm’s culture seems to have been built on partners proudly “not knowing.” The firm’s mascot may well have been an ostrich; the firm seems to be a paradigm of the cobbler’s children going barefoot.

Of the two score and some firms that failed over the past three decades, all have seen complete failures of appropriate governance, inaccurate financial reporting and excessive leverage and debt.  Some, like Dewey have fallen victim to excessive compensation paid to laterals.  More have flawed partner compensation systems.

The Solution

The need to address these issues could not be more urgent. To rely on the sloth of the ABA to urgently address these issues, then followed by fifty-one local bar rule making deliberative bodies, which collectively makes the ABA seem lightening-like, would require the complete suspension of disbelief. To suggest that large law firms could be brought into line fearing disciplinary action by state disciplinary bodies would require the confidence of a naïf.  Despite the three inch thick annotated tome that comprises the Model Rules, the overwhelming number of disciplinary actions brought by these bodies only relates to escrow account defalcations and disbarments of convicted felons. Witness the fact that the current public record shows an ongoing criminal investigation of Dewey managers, as well as seemingly clear evidence of deception by some of these lawyers, some rather facially convincing prima facie evidence of securities fraud by the firm as an issuer of securities, violations of fiduciary obligations to partners, violations of statutory duties to employees and violations of rights owed to the pension beneficiaries of the firm. Certainly, there may well be complete defenses to each of these matters and I invite my many Dewey readers (or their counsel) to provide them below. But the real point is that while investigations by disciplinary committees are secret, we each can sleep soundly tonight assuming that no such investigation has commenced.

Rather.  the solution to this clear and present danger of future large law firm failures must come from BigLaw itself and its stakeholders, including law firm lenders, institutional clients and the academy.

What is required is for law firms to retain independent professionals who would annually conduct a stress test, having full and unfettered access to all of the firm’s data and information,  and then report to the firm and its partners (equity and non-equity) that (a) the firm has adequate procedures in place to provide adequate oversight of its management group; (b) an appropriate system of accountable governance is in place; (c) the firm’s financial reporting (audited or not) fairly states the firm’s financial condition as of the reporting dates; (d) the firm’s general counsel is timely provided with all information necessary to discharge his or her duties and that he or she has full and open access to all relevant information as well as the ability to report any concerns to a full governing body; (e) the firm has an appropriate risk assessment and management officer, adequately performing the require objectives of that office; (f) the firm has an appropriate mechanism in place to avoid conflicts of interest and to otherwise insure full compliance with all applicable ethical rules, laws and regulations, (g) the firm maintains adequate insurance coverage; and, finally, (h) no set of facts was discovered that raises any apprehension that the firm is at risk in continuing as a going enterprise. Any failures or suggested improvements in any of these areas should also be described in detail. Similarly, any deficiencies detected in previous reports and the adequacy of any steps taken to ameliorate those deficiencies should be further described. Should management of the law firm elect to discharge the independent professional because of any disagreements in interpretation, the professional should be contractually bound to disclose those facts to the partnership.

There may well be other items that should be included in these reports and suggestions will doubtless appear in the comments section below. If you have a thought, feel free to pony up.

I would further propose that the independent professionals conducting these tests prepare at least two forms of reports: The first being the detailed report described above and the second a summary form which might be made available to clients and prospective clients, lateral candidates and law schools as part of a NALP disclosure. Every one of these stakeholders has a simple right and need to know that the firm will be there next year.

As I suggested, it is extremely unlikely that any regulatory body will timely and efficiently create a mandate for these reports. Rather, a forward looking well managed law firm will certainly see the universal benefit and advantage of having such reports issued to provide comfort and assurances to its stakeholders and to avoid being tarnished by the reputation of a failed law firm.  The reports would be potent marketing and recruiting tools. These reports would certainly be most beneficial to top down management style law firms and those that operate in a black box.

I could certainly also see institutional lenders and clients routinely requiring their borrowers and counsel, respectively, requiring these stress tests, particularly as they have been seriously burnt by previous law firm failures and certainly as to lenders, they may correctly feel that what’s sauce for the goose is sauce for the gander.  It will, I suspect, take only a very small number of lenders and important clients to make these reports a required norm; indeed, mandatory. Similarly, it will take only a handful of the AmLaw 200 to come forward and proudly offer these reports to make their annual production an industry requirement. The market will require nothing less.  The implosion of a law firm casts a pall on the entire profession and creates a blot on every large commercial law firm. Those blots can be avoided by having  large law firms don the Teflon that these stress tests should provide.

© Jerome Kowalski, May, 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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