Monthly Archives: January 2013

BANKRUPTCY AND BILLABLES

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Let’s replace a recent Am Law Daily headline — “Judge Slashes Fees in Dewey Bankruptcy” — with this: “Golden Age for Bankruptcy Professionals Continues.”

In bankruptcy proceedings, lawyers get paid ahead of everyone else. If they didn’t, insolvent debtors would go without representation. But that doesn’t explain why high-profile bankruptcies have become increasingly lucrative for lawyers. An absence of accountability does.

Professional compensation in bankruptcy matters comes from a dying entity’s estate. As the client disappears, so does close scrutiny of its legal bills. In its place, the United States Trustee reviews bankruptcy fee petitions, as does the supervising judge who eventually approves them. But both offices have limited capabilities and a restrictive mandate.

Low-hanging fruit

The limited capabilities arise from an understandable reluctance to second-guess lawyers’ strategies and, more importantly, the deployment of manpower to execute them. As a result, post-facto review of fee petitions usually focuses on obvious abuses.

For example, at the recent Dewey & LeBoeuf fee hearing, Judge Martin Glenn criticized $550 per night stays at the Waldorf-Astoria, private car expenses for driving around Manhattan, and excessively vague time entries. But the sanctions were minimal. According to the article, the court reduced a restructuring expert’s $250,000 request by “$4,455 in fees and $9,175 in expenses in addition to the amount Glenn axed [$4,400] during the hearing.”

Dewey’s lead bankruptcy attorney, Al Togut, wasn’t in court for a tongue-lashing over certain of his firm’s “excessively vague time entries” and “a page of expenses related to car rides,” according to the Am Law Daily. But at the end of the day, Togut, Segal & Segal’s $4.7 million bill for five months of work emerged largely unscathed, save for “$57,139 in fee cuts and $1,378 in expense cuts after consultation with the U.S. Trustee’s office, which had objections to several of the fee requests.”

The real money

The real story isn’t unique to Dewey’s professionals. In fact, small boutique firms such as Togut’s probably conduct their cases more efficiently than big firms that can throw armies of bodies at any problem. But all such attorneys benefit from extraordinarily high hourly rates that result from the absence of a competitive market and the perverse incentives of a billable hour regime.

That’s where the restrictive legal standard for approval enters the picture. In particular, the fees sought must be reasonable for the services rendered. However, law firms in the select club of prominent bankruptcy practitioners use publicly available information, including other firms’ fee petitions, to set hourly rates for their own personnel. Voila! The relative uniformity of such rates makes them “reasonable” — including the $700 an hour associate and the $300 an hour legal assistant.

The key players in this tautological circle don’t compete on hourly rates. What economists call conscious parallelism is far more lucrative for them. Because there’s no paying client searching for better value in response to rising legal costs, that potential market-driven constraint disappears. When Weil Gotshal submitted a $430 million fee petition for the Lehman bankruptcy, it listed 40 partners with hourly rates of $1,000 and some senior associates at $800 to $900 an hour.

The market gone awry

Defenders argue that complicated restructuring matters require talent and skill comparable to trying a big case or guiding a large transaction. After all, in 1978 Congress specifically made that determination in adopting a new compensation standard for bankruptcy lawyers. Today, they say, the market sets everybody’s rates. That position would be more compelling if hourly rates for bankruptcy attorneys were the result of a well-functioning market, but they aren’t.

If big law firms already competed on price in bankruptcy cases, they wouldn’t fear the transparency that the U.S. Trustee proposed last summer. The Trustee wanted firms to disclose whether they use a differential fee schedule — charging one rate for attorneys working on bankruptcy cases and a lower rate for the same attorneys working on other matters. More than 100 big firms united in strenuous opposition to that idea.

It’s easy to see why they objected. Especially in recent years, paying clients have demanded discounts and alternative fee arrangements to reduce legal costs. In bankruptcy, it’s not happening. Where else can firms charge more than $400 an hour for first-year associates, which Weil Gotshal sought for many such newbies in the Lehman case?

Add incentives for inefficiency and abuse that accompany the billable hour regime generally and the consequences become even more ironic: one of the most lucrative pockets of the profession reaps outsized rewards from the carcasses of distressed enterprises (and those enterprises’ creditors).

The entire system is uniquely vulnerable to creative innovation. Someday, it will arrive. But then again, for those currently reaping the greatest rewards, someday always seems to be somebody else’s problem.

TWO YEARS TO WHAT?

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It’s no panacea. It may not even be a good idea. But in a recent New York Times op-ed, Northwestern Law School Dean Daniel B. Rodriguez and NYU law professor Samuel Estreicher endorsed a proposal allowing students to sit for the New York bar exam after only two years of law school:

“[I]t could make law school far more accessible to low-income students, help the next generation of law students avoid a heavy burden of debt and lead to improvements in legal education across the United States.”

The state’s top judge told a gathering of “legal educators, practitioners and judges that the concept deserves serious study,” according to the National Law Journal.

Sorting out the facts

If the New York proposal is adopted, what aspects of legal education might change? No one really knows, but the answer may be: less than some people think. That alone doesn’t make it a bad idea, but it could produce unintended consequences, too.

Most students who leave law school after two years will still have staggering debt. The average private law school graduate incurs $125,000 in loans; for public schools, it’s $75,000. Lopping off one-third would help, but it would still leave graduates with significant five-figure burdens.

No degrees

Unfortunately, the current discussion isn’t about eliminating the third year altogether and awarding JD degrees after two years, although it should be. ABA accreditation requirements block that definitive innovation. So do most law schools because many of them couldn’t survive the resulting loss of third-year tuition revenues.

Would a student who has already sunk $100,000 into two years of legal education decide that passing the bar alone was sufficient reward for that investment? Only if the value of the degree itself was worth less than the cost of a third year to get it.

Improving the third year

Finally, even assuming that many students availed themselves of the two-year option, how would most deans respond? In their op-ed, Rodriguez and Estreicher suggest that schools might improve third-year curriculum so that students would stay. But couldn’t schools do that now? Only a handful do.

Perhaps inadvertently, Rodriguez and Estreicher implicitly make the real point: only the threat of losing significant third-year tuition revenues will dramatically change most deans’ behavior. Deans may say that they’re in the business of trying to get students through law school economically, but when they have opportunities to act accordingly, few seem to make the effort. That’s because they’re actually in the business of maximizing their schools’ short-term metrics, including revenues and U.S. News rankings.

The decades-long explosion in tuition costs is one example. Another one appears in the Times op-ed, where Dean Rodriguez identifies his school’s “accelerated program that lets students pursue a three-year course of study in two years, allowing them to take the bar and enter the job market a year earlier.”

Rodriguez doesn’t mention that rushing through in two calendar years (thanks to summer classes and course overloads) won’t save students a penny on their total tuition expense. It’s two years for the price of three because, the school’s website observes, “The Law School prices tuitions based on the degree pursued rather than the length of enrollment.”

In fairness to Dean Rodriquez, he inherited the accelerated JD program and its pricing model from his predecessor, David Van Zandt. Among the program’s stated — and more dubious — goals has been to attract students who otherwise might not have gone to law school at all. Just what the profession has needed, right?

Taking chances with other people’s lives

Given their business models, many law schools seem likely to counteract any loss of third-year tuition revenues with larger entering classes. After all, that adjustment requires less work than improving curriculum, and total applicants overall still exceed the number of available spaces. Moreover, if the two-year option became popular, lowering the price of a legal education by one-third should increase demand, although the profession doesn’t need that, either.

What’s the correct approach to all of these unknown possibilities? According to the NLJ, Verizon’s general counsel Randall Milch urged throwing caution to the wind: “Analysis paralysis is our worst enemy here. If we are going to overanalyze, we’re never going to figure this out. In my opinion, we have to move and see what happens.”

There’s nothing quite like observing a real-life experiment on someone else.

THE CULTURE OF CONTRADICTIONS

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In an ironic twist, the latest Client Advisory from the Citi Private Bank Law Firm Group and Hildebrandt Consulting warns: “Law firms discount or ignore firm culture at their peril.” Really?

Law firm management consultants have played central roles in creating the pervasive big law firm culture. But that culture seldom includes “collegiality and a commitment to share profits in a fair and transparent manner,” which Citi and Hildebrandt now suggest are vital. For years, mostly non-lawyer consultants have encouraged managing partners to focus myopically on business school-type metrics that maximize short-term profits. The report reveals the results: the unpleasant culture of most big firms.

Determinants of culture

For example, the report notes, associate ranks have shrunk in an effort to increase their average billable hours. That’s how firms have enhanced what Hildebrandt and CIti continue to misname “productivity.” From the client’s perspective, rewarding total time spent to achieve an outcome is the opposite of true productivity.

Likewise, the report notes that along with the reduction in the percentage of associates, the percentage of income (non-equity) partners has almost doubled since 2001. Hildebrandt and Citi view this development as contributing to the squeeze on partner profits. But income partners have become profit centers for most firms. As a group, they command higher hourly rates, suffer fewer write-offs, and enjoy bigger realizations.

From the standpoint of a firm’s culture, a class of permanent income partners can be a morale buster. That’s especially true where the increase in income partners results from fewer internal promotions to equity partner. Comparing 2007 to 2011, the percentage of new equity partner promotions of home-grown talent dropped by 21 percent.

Lateral culture?

In contrast to the more daunting internal path to equity partnership, laterals have thrived and the income gap within most equity partnerships has grown dramatically. “Lateral hiring is more popular than ever,” the report observes. In contrast to the drop in internal promotions, new equity partner lateral additions increased by 10 percent from 2007 to 2011.

This intense lateral activity is stunning in light of its dubious benefits to the firms involved. The report cites Citi’s 2012 Law Firm Leaders Survey: 40 percent of respondents admitted that their lateral hires were “unsuccessful” or “break even.” The remaining 60 percent characterized the results as “successful” or “very successful,” but for two reasons, that number overstates reality.

First, it typically takes a year or more to determine the net financial impact of a lateral acquisition. Most managing partners have no idea whether the partners they’ve recruited over the past two years have produced positive or negative net economic contributions. For a tutorial on the subject, see Edwin Reeser’s thorough and thoughtful analysis, “Pricing Lateral Hires.”

Second, when is the last time you heard a managing partner of a big firm admit to a mistake of any kind, much less a big error, such as hiring someone whom he or she had previously sold to fellow partners as a superstar lateral hire? These leaders may be lying to themselves, too, but in the process, they’re creating a lateral partner bubble.

Stability?

The Hildebrandt/Citi advisory gives a nod to institutional stability, mostly by observing that it’s disappearing: “The 21-year period of 1987-2007 witnessed 18 significant law firm failures. In recent years, that rate has almost doubled, with eight significant law firms failing in the last five years.” If you count struggling firms that merged to stave off dissolution, the recent number is much higher.

In a Bloomberg interview last October, Citi’s Dan DiPietro, chairman of the bank’s law firm group, said that he maintained a “somewhat robust watch list” of firms in potential trouble, ranging from “very slight concern to oh my God!”

Cognitive dissonance

Here’s a summary:

Culture is important, but associates’ productivity is a function of the hours they bill.

Culture is important, but associates face diminishing chances that years of loyalty to a single firm will result in promotion to equity partnership.

Culture is important, but lateral hiring to achieve revenue growth has become a central business strategy for many, if not most, big firms. It has also exacerbated internal equity partner income gaps.

Culture is important and, if a firm loses it, the resulting instability may cause that firm to disappear.

As you try to reconcile these themes, you’ll understand why, as with other Hildebrandt/Citi client advisories, the report’s final line is my favorite: “As always, we stand ready to assist our clients in meeting the challenges of today’s market.”

THE LAW SCHOOL STORY OF 2012 — DEANS IN DENIAL

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Doubling down on a losing hand is rarely a good move. Case Western Reserve University Law School Dean Lawrence E. Mitchell generated a flurry of criticism — including my earlier post, “The Lawyer Bubble” — for his November 28, 2012 op-ed in the New York Times. On January 4, 2013, he took to the airwaves in a Bloomberg Law interview. It made me wonder whether he hears his own words as he speaks them.

Mitchell has made himself the poster child for deans in denial — the law school story of the year. It emerged in a big way last June when, for the first time, the ABA released meaningful jobs data. Nine months after graduation, only about 50 percent of the law school class of 2011 had full-time, long-term jobs requiring a legal degree. Deans everywhere began dissembling, as reported in the Wall Street Journal.

Sometimes offense isn’t the best defense

As the growing lawyer bubble made headlines, a handful of wise deans followed the lead of University of California Hastings School of Law Dean Frank Wu, who had previously acknowledged, “The critics of legal education are right. There are too many law schools and too many law students and we need to do something about that.”

In contrast, Dean Mitchell went on offense, most recently in a 15-minute interview with Lee Pacchia. To his tenuous op-ed points, Mitchell added a few more.

What oversupply?

For example, he said, “It’s not clear to me that there’s an oversupply problem at all.” As support, he cited low-income people who go without legal services. Pacchia asked him how debt-ridden graduates paying Case more than $40,000 in annual tuition could take on such work full-time.

It’s a mistake, Mitchell responded, to “measure the worth of higher education by the dollar return on the investment.” Perhaps he has a point, but it’s not really an answer. Earlier in the interview, Mitchell said this about high tuition cost: “Ninety percent of my class receives financial aid. The mean offer is $25,000 a year.” Critics focus on the sticker price, he said, “but law schools discount fairly heavily.”

What proportion of those financial aid packages is grants, rather than loans that can’t be discharged in bankruptcy? Mitchell didn’t say, but here are two clues.

In his op-ed, Mitchell reported accurately that overall average private law school student debt is $125,000. In his April 3, 2012 blog post, he boasted that Case graduates have “almost 22 percent less debt than graduates of other private law schools.” The resulting arithmetic implies that Case’s financial aid packages result in average student loan debt of about $100,000 for its law graduates.

Cost spiral

In another defense of soaring tuition, Mitchell argued that, in 1985, medical school was four times more expensive than law school. So what? In the intervening 25 years, law school tuition has caught up with and, in some cases, surpassed that of medical school. Does that make sense to anyone other than Mitchell?

He also said that schools must pay top dollar for law professors because their opportunity costs are high: they could be making big bucks in big firms. But the only relevant question is, do they want to?

Mitchell’s own experience may provide a partial answer. His CV lists six years as an associate at three different New York law firms from 1981 to 1987. Sometime during that period, he said, it became “hard to get out of bed in the morning and I didn’t like going to work.” So he “took a two-thirds pay cut and went into teaching.”

How about decent jobs?

Throughout the year, Mitchell travels the country, “like Willy Loman in Death of a Salesman,” meeting with hiring partners of big law firms. He interviews his students and writes personal letters of recommendation to help them get jobs. Doesn’t the need for such efforts tell him something?

Yet for all of Mitchell’s laudable sales pitches, Pacchia noted, the Law School Transparency Project reports that 38 percent of 2011 Case Western graduates were still unemployed or underemployed nine months later.

“I haven’t myself taken a snapshot a year out,” Mitchell said, “but I’ve talked to my admissions staff about this a lot and I suspect if you looked a year out, things would change dramatically. I’m really confident if you looked a year and a half out, they would.”

Mitchell offered no supporting data, but he “suspects” and is “really confident” that, eventually, things will turn out just fine.

Optimism untethered to reality

Why is Mitchell convinced that things are better than the available facts suggest? Because, for example, most of his 1981 Columbia Law School class took jobs in big law firms. Ten years later, his class reunion book revealed that “almost nobody was at a law firm.”

It’s hard to know where to begin dissecting Mitchell’s anecdote, but start with the fact that his students aren’t graduating from Columbia Law School.

Just another business

Finally, Mitchell observed, “Of course, we’re running a business at the end of the day.” Without acknowledging the destructive impact of short term business-type metrics, such as the annual U.S. News & World Report rankings, he argues that “using business sense in managing law schools is going to help us get some of these problems under control.”

Until Mitchell and many other deans with similar attitudes get past denial over what is happening to the profession, they’ll never reach, much less overcome, the subsequent stages of grief — anger, bargaining, depression, and acceptance. Perhaps another reading of Death of a Salesman will help.

THE BIG LAW FIRM STORY OF 2012: DEWEY & LEBOEUF

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Question #14.A. in the Wall Street Journal’s year-end quiz on December 28, 2012:

“True or False:

Before law firm Dewey & LeBoeuf LLP filed for bankruptcy in May, it was sued by a janitorial services company saying it was owed $299,000.”

Answer: True.”

This small item brought to mind reports of a January 2012 meeting where Dewey & LeBoeuf’s former chairman Steven H. Davis is said to have described the firm’s financial condition: profits in 2011 of $250 million, but more than half was already committed to pension obligations and IOUs to partners for shortfalls in prior years’ earnings. Together, partners would have to devise an action plan. “You have to own this problem,” he allegedly told them.

Who owns the problem now?

One simplistic narrative suggests that Davis himself should bear most of the blame for everything that went wrong with the firm. But in Dewey docket filing #654, his attorneys recently cautioned against such a rush to judgment.

For example, they assert that during the 12-month period immediately preceding the firm’s bankruptcy filing, “fifty-one partners received a higher distribution than Mr. Davis,” who, the say, got $1 million. Is that the behavior of a self-aggrandizing villain?

No names, please

The firm’s July 26, 2012 “Statement of Financial Affairs” (docket filing #294) identifies Dewey partners only by employee number, but it offers a window into some of those 51 highly paid partners. The dollars that some received as the firm imploded contrast sharply with Davis’s January admonition that they should “own the problem.”

For example, Dewey partner 06780 received more than $6 million in draws and distributions between May 31, 2011 and May 21, 2012. Starting in January 2012 alone, that partner received the following:

1/3/12:     $391,667,67 – Partner Distribution

1/3/12:       $25,000.00 – Partner Draw

1/11/12:    $250,000.00 – Partner Distribution

2/3/12:       $25,000.00 – Partner Draw

3/1/12:        $25,000.00 – Partner Draw

3/14/12:     $391,666.67 – Partner Distribution

4/4/12:       $264,166.67 – Partner Distribution

4/4/12:         $25,000.00 – Partner Draw

5/21/12:      $264,166.67 – Partner Distribution

5/21/12:       $25,000.00 – Partner Draw

The May 21 payments totaling $289,000 occurred shortly after the firm’s cleaning service had filed its complaint seeking approximately that amount for services rendered through April 30. A week later, Dewey filed for bankruptcy.

Dewey Partner 06512 received distributions of $2.8 million in January 2012 alone, accounting for a big chunk of the more than $6.5 million in draws and distributions that this partner received between May 31, 2011 and May 21, 2012.

Dewey Partner 86059 received $3.4 million in draws and distributions from May 30, 2011 to May 8, 2012, including more than $1 million after January 30, 2012.

Overall, 25 top Dewey partners received $21 million during the final five months of the firm’s existence. During the last seven months of 2011, the same group of 25 had already received another $49 million.

Stated another way, of the $234 million distributed to all partners during the 12 months preceding the firm’s bankruptcy, the top 25 (out of 300) received more than $70 million. Someday, we might learn how much this select group also received from the proceeds of the firm’s $150 million bond offering in April 2010.

Fungible money

Complementing the “Davis-as-sole-villain” narrative, another current theme is that the recently approved partner compensation plan proves that former partners are, in fact, “owning the problem.” That may be true for most of the more than 400 who will return a combined $71 million to the Dewey estate. But consider another set of facts.

Back in May, former Dewey partner Martin Bienenstock had just resigned from the firm when he gave a wide-ranging interview to the Wall Street Journal. Reporters Jennifer Smith and Ashby Jones asked him whether “it was safe to say that the firm used credit lines to pay partners, at least in part.”

Bienenstock answered: “Look, money is fungible. The $250 million in profits [for 2011] were real profits. Instead of using it to pay partners, a lot of it went to pay other things, like capital that other partners were due, and pension payments to retired LeBoeuf lawyers.”

In the same interview, Bienenstock said that at the end of December 2011 the firm had drawn down $30 million of its $100 million revolving bank credit line. As the firm disintegrated during the first five months of 2012, it tapped another $45 million.

You may be wondering whether any former Dewey partner’s contribution under the recently approved “clawback” plan may be, at least in part, simply returning money that the firm borrowed and then distributed to that partner as the firm collapsed. Perhaps one answer is Bienenstock’s retort that “money is fungible.”

Collateral damage

Another answer is that any time a bankrupt’s liabilities exceed its assets, the shortfall comes from somebody. Those victims wind up “owning the problem,” too. In addition to partners who lost their capital and didn’t receive a fair share of distributions in 2011 and 2012, unsecured creditors became involuntary lenders who will never be repaid in full.

Which takes us back to Dewey’s cleaning service. Even with their outstanding April invoice of $299,000, ABM Janitorial Services apparently kept working into May. According to Dewey’s July 26, 2012 “Schedule of Creditors Holding Unsecured Nonpriority Claims,” ABM’s claim had grown to $346,000 by May 28.

How much will ABM  recover? Dewey & LeBoeuf’s December 31, 2012 “Amended Confirmation Plan Disclosure Statement” predicts that general unsecured debtors will get between a nickel and 15 cents on the dollar.

The saga of Dewey & LeBoeuf isn’t over, but it’s the big law firm story of the year. And it’s a sad one.