Dewey & LeBoeuf LLC files for bankruptcy

Dewey & LeBoeuf LLC filed for bankruptcy.

The reason for why the firm went bankrupt is that it switched from being a partnership to being an LLC. Partnerships don’t go bankrupt except under extreme circumstances. When a partnership’s profits decrease, the payouts to partners simply go down proportionately. And partners will do anything possible to avoid a bankruptcy because they are personally liable.

Dewey & LeBoeuf changed to an LLC so that they could pay massive salaries to chosen shareholder/employees using borrowed money. The result is that those shareholder/employees walk away rich (although without a guaranteed future source of more millions unless they can get hired at a high-level position with another law firm, which might happen or might not), and creditors get left unpaid. It also sucks for the junior employees.

Did it really benefit society to change the rules to allow law firms to become LLCs? I don’t think so. Law firms don’t need access to capital in order to invest in anything value-creating such as R&D or building new factories. They just use the money for zero-sum or even negative-sum competition purposes involving poaching rainmakers from other firms.

Comments

[Peter A]

It didn't benefit society when Goldman became a public corporation either. Law firms, I-Banks and consulting firms should probably be required to be partnerships.

[Black Death]

According to the article, the whole thing seemed like a house of cards - one little puff of a chill wind and it all came crashing down. Of course, as you say, if this had been a partnership, the partners would have all been liable for the debts, so this probably would not have happened. There were about 300 LLC-partners, and about three-quarters of them found jobs, probably pretty good ones, although probably not at the astronomical salaries they thought they would make at Dewey & LeBoeuf (but they weren't going to get paid, anyway). And I suspect that a fair number of the partners who haven't taken new jobs may be retiring. But the "little people" - the non-partner lawyers, especially, but also many of the other employees, are mostly going to get screwed. Apparently most of the money is owed to banks and is almost certainly unsecured. Any banker who make these loans without a personal guarantee from the partners is a complete fool, but it's not likely that anything too terrible will happen to them. Maybe Obama will bail them out. He seems to enjoy doing it.

[Dexelpred]

(1) The change to being an LLC had nothing to do with paying the guarantees to star partners. The problems with changing to an LLC are that the bonding effect of reputation is less when there's less incentive to monitor, because partners don't share ratably in the losses.

(2) The problems with Dewey antedated the guarantees. The only reason the guarantees were promised was to stem the reputational problems, which would have led to even more rainmaker defections.

(3) "Shareholder/employees"? You do know it wasn't a C corp, right?

[HS: You know, you are right, I was confusing the LLC with the PCs that they had in Arizona and in which the partners were called shareholders.]

[Dexelpred]

HS: Ah, I see. Per the Rules of Professional Conduct, US law firms cannot have shareholders. The big change to entity law in this regard is the passage of the RULPA, allowing limited liability.

The two reasons to have a law firm, in the first place, as opposed to a bunch of long-term contracts, are: (1) to bond reputation; and (2) to deal with the "peak load" problem (i.e. the need to throw a lot of bodies at something like discovery, or an M&A deal.)

Once reputation is shot, the firm, as an economic entity, doesn't make sense. Dewey's reputation was shot, and so now there is no reason for them to exist as a firm. The bankruptcy will be about who gets their accounts receivable, a priority fight over their real estate, etc. The interesting part will be seeing whether the creditors can continue to collect as against business originated at Dewey that moves to new firms.

[Ed]

I suspect that this was deliberate, basically a scheme for that particular generation of partners to plunder the firm.

[WRB]

"It didn't benefit society when Goldman became a public corporation either. Law firms, I-Banks and consulting firms should probably be required to be partnerships."

Very true. Brown Brothers Harriman bank is one of few remaining partnerships and guess what - they did not need any bailout money.

[Ray Campbell]

Law firms that grow for the sake of growing (like partners who want their salaries to grow for the sake of it) are doomed to fail. The legal market is too fragmented and there is too much competition to hold onto clients who are being gouged.

[Dexelpred]

"(2) The problems with Dewey antedated the guarantees"

I meant to write predated, not antedated.

[Firepower]

I'm truly shocked THIS post gets less commentary than a post about smartphones.

That said, the LLC craze is a legalist boondoggle and loophole foisted upon society by a corrupt gang of Oligarchs ruling like feudal lords - lawyers and their kind.

They have found new ways, to make even bankruptcy pay.

[KLO]

The hard thing to know is whether Dewey would have collapsed anyway. The law firm model is inherently unstable, because it relies on paying a large group of free agent partners nearly as much as any one of approximately 50 or so similar firms is willing to pay them. For several years the market overvalued lateral partner talent, placing firms in something of a quandary. Do you overpay some of your existing talent to prevent them from leaving, thereby preventing a stampede of your best talent out the door? If so, how do you prevent a stampede by every other partner who, by definition, must be getting underpaid? Dewey decided on an agressive strategy that allowed it to overpay new lateral partners and overpay existing high-level partners, all while keeping the existing lower-level partners happy. To do this, Dewey needed to borrow a lot of money in the hopes that they could keep this whole house of cards stable for as long as possible. It didn't work, and it went out with a bang.

At the same time, had Dewey done nothing, it likely would have lost its best partners to other firms willing to overpay them, which would have lead to a stampede of partners from the top down. Basically, the law firm model, which relies heavily on loyalty over money for stability, no longer works in an era when all anyone cares about is money. The only things keeping any lawyer at a firm any more are: (1) basic human inertia; and (2) the belief that no other firm is willing to pay as much as one's current firm.

[David G]

Issue is much more complicated than form of entity. General Partnerships may elect limited liability status usually with the filing of a simple document, and I believe that most law firms in the US that started out as general partnerships have filed the necessary document to elect limited liability status. Some of the larger firms have become partnerships under Delaware law to embrace that state's substantial body of business friendly law. Many law firms are also C Corporations whose shareholders are all lawyers (except as otherwise permitted in D.C.). Key is whether there are any significant obligations like bank debt and office and equipment leases that require personal guarantees. Larger firms can avoid personal liability of its partners by posting CD's for lease security deposits, if any are required, and pledging accounts receivable and other assets to secure any bank lines of credit and term loans.

[David G]

Issue is much more complicated than form of entity. General partnerships may elect limited liability status usually with the filing of a simple document, and I believe that most law firms in the US that started out as general partnerships have filed the necessary document to elect limited liability status. Some of the larger law firms have become Delaware partnerships to embrace that state's body of business friendly law. Many law firms are also C Corporations whose shareholders are all lawyers (except as otherwise permitted in D.C.). Key is whether there are any significant obligations like bank debt and office and equipment leases that require personal guarantees. Larger firms can avoid personal liability of its partners by posting CD's for lease security deposits, if any are required, and pledging accounts receivable and other assets to secure any bank lines of credit and term loans.

[alonzo portfolio]

"whether the creditors can continue to collect as against business originated at Dewey that moves to new firms."

??? I've never heard of this. Wouldn't this be against public policy, as effectively preventing clients from finding representation?

[Peter]

The real question is whether other BIGLAW firms will fail.

[Dexelpred]

alonzo: That's the thinking of some states, but New York seems to apply some form of what's called the "unfinished business doctrine." Google it - I think the classic case is Jewel v. Boxer.

[Mike]

If your lawyer's firm has been organized as a C corp, then you need a new lawyer, because the one you have is stupid. Firms are typically organized as professional corporations (electing "S" NOT "C" tax treatment), professional LLCs, or limited liability partnerships. These forms give the owners of the firm limited liability with pass-through tax treatment (which would not be the case for a C corporation). The big push for limited liability arose with the emergence of national/global firms, which made it very difficult to monitor what one's fellow partners might be up to in, say, Los Angeles given that you worked in the NYC office.

All that said, Dewey's downfall was caused by the same thing that plagues pretty much all the Biglaw firms: greed plus managerial incompetence.