A DIRTY LITTLE SECRET

The Wall Street Journal’s front page headline tells only part of story: “Legal Fees Cross New Mark: $1500.” The February 9 article lists the range of partner hourly rates at some big firms: Proskauer Rose from $925 to $1475; Ropes & Gray from $895 to $1450; Kirkland & Ellis from $875 to $1445; and so on and so on and so on.

That’s great if you can get it, but most firms can’t. The 2016 Georgetown/Thomson Reuters Peer Monitor “State of the Legal Profession” tells a second part of the story: realization and collection rates have plummeted. How much a firm bills doesn’t matter; what it actually brings in the door does. In 2005, collections totaled 93 percent of standard rates. By the end of 2015, it was down to 83 percent.

The Music Stopped, Almost

Annual standard hourly rate increases have blunted the profit impact of declining collections, but trees stopped growing to the sky about ten years ago. Except in bankruptcy courts. That’s the third element of the story and the profession’s dirty little secret: one of the most lucrative big law practice areas has no client accountability for its fees. Even worse, the process facilitates pricing behavior that spills over into other practice areas.

Take the recent Journal article. Where did the reporters get the detailed hourly rates for the firms it identified? A note at the bottom of the chart reveals the answer: “Source: Bankruptcy court filings.” If managing partners exchanged their firms’ hourly rates privately, it would raise serious antitrust issues. But in bankruptcy, publicly filed fee petitions do all of that work for them.

It gets worse. In bankruptcy, no one forces attorneys into the discounting that produces the current 83 percent overall average collections rate. Remember the infamous “Churn that bill, baby” email involving DLA Piper a few years ago? That was a bankruptcy case. Traditional mechanisms of accountability are ineffective. Unlike a solvent corporate client, a company in trouble has little leverage in dealing with its outside counsel. Until it emerges from a Chapter 11 reorganization, the days of minimizing legal expenses to maximize shareholder value are suspended. If it winds up in Chapter 7 liquidation, those days are gone forever.

At the same, time, the lawyers handling the bankruptcy have little risk. They get paid ahead of everyone else. Lawyers for creditor committees are a theoretical check only. They, too, get paid first and the members of the exclusive club of big law firm attorneys reappear. Their roles may change — debtor’s counsel in one bankruptcy may be creditors’ attorney in another and the liquidating trustee’s lawyer in yet another. In none of those capacities is there any incentive to rock the long-term, “paid-in-full hourly rate” boat.

More Theoretical Accountability

The U.S. Trustee receives all attorneys’ fees petitions before courts approve them. The Trustee can object, but it doesn’t have sufficient resources to analyze detailed line item time and expense entries on the thousands of pages that firms submit. The Trustee issued new guidelines that became effective for cases filed after November 1, 2013. Perhaps they will make a difference. But in the end, they are still guidelines and the final decision on attorneys fees resides with the bankruptcy judge.

As hourly rates have increased to the $1500 level that the Journal highlights, courts have given their rubber stamps of approval to the trend. Rather than challenge the high rates that all firms charge, bankruptcy judges determine merely that they are “reasonable and customary” because, after all, comparable firms are charging them for comparable work. The circularity is as obvious as the resulting payday for the lawyers. Someday, media attention and popular outrage may force meaningful change that has yet to occur.

Worse Than It Seems

Considering the 83 percent collection rate in the context of the nearly 100 percent rate for bankruptcy lawyers yields an insight relevant to the fourth and final part of the larger big law firm story. In particular, the current 83 percent collection rate is deceptively high. If a firm’s average is 83 percent and its bankruptcy lawyers collect close to 100 percent, then firms with large bankruptcy practices have non-bankruptcy clients pushing some practice areas into deep concessions off standard rates.

Likewise, combining this fact with two conclusions from the Georgetown/Thomson Reuters Peer Monitor Report produces ominous implications for such firms:

— “Demand for law firm services…was essentially flat in 2015,” and

— Bankruptcy experienced the largest negative growth rate in demand by practice area.

Unless the country heads into a recession that few economists expect, the continuing reduction in bankruptcies will drive overall average collections dramatically lower. That’s bad news for big law firms with significant bankruptcy practices.

Back in 2011, an icon of the bankruptcy bar, the late Harvey Miller of Weil, Gotshal and Manges, defended his firm’s approach to legal fees: “The underlying principle is, if you can get it, get it.”

Miller isn’t around anymore, but his unfortunate credo for a noble profession survives — for now.

[NOTE: The trade paperback edition of my book, The Lawyer Bubble – A Profession in Crisis (Basic Books) — complete with an extensive new AFTERWORD — will be released on March 8, 2016 and is now available for pre-order at Amazon and Barnes & Noble.]

ANOTHER COMMENDABLE CONDUCT AWARD

Big law bankruptcy attorneys may have finally killed their golden goose. We’ll never know if less hubris and more thought might have prevented the U.S. Trustee from releasing new attorney compensation guidelines that surely have prominent members of that bar squirming. Those guidelines earn my latest “Commendable Conduct Award.” Starting November 1, we’ll see how many judges have the courage to apply them.

Restraint in the race to $1,000 an hour billing rates to maximize short-term profits might have served practitioners better in the long run. Likewise, more discretion in responding to media inquiries about the lucrative bankruptcy law world might have been wiser than Weil, Gotshal & Manges partner Harvey Miller’s stunning comment to the Wall Street Journal in 2011: “The underlying principle is, if you can get it, get it.”

Flying Under the Radar

The bankruptcy practice in big firms is unique because there’s no real client putting the usual counter-pressure on attorneys seeking to enhance their personal wealth. It’s the billable hour regime at its worst.

Outside bankruptcy, corporate clients everywhere are pushing back on big law firms’ hourly rate increases, refusing to pay for high-priced first-year associates, demanding budgets, scrutinizing attorney activities, and generally seeking greater economy in the delivery of outside legal services. Bankruptcy attorneys have little comparable accountability. They simply set their rates, decide what tasks to perform, and assign manpower as they see fit.

Hello and Good-bye

Unlike corporate clients who dangle the prospect of long-term relationships and future business to encourage their outside attorneys to be more efficient, bankruptcy practitioners have a series of one-shot engagements. When the current proceeding is over, their bankruptcy “client” of the moment disappears, never to return.

Bankruptcy petitions are also vehicles for law firm oligopolists to share pricing information. When most senior big firm bankruptcy partners request $1,000 an hour, it becomes the reasonable and customary rate. But even more remarkable are the $400 an hour and up rates that they can often get for junior associates — the same ones who add so little value that real clients refuse to pay for them at all.

Theoretical Oversight

The U.S. Trustee reviews fee petitions. But to date, those efforts have amounted to quibbling over obviously suspect expenses, such as $500 hotel rooms when cheaper accommodations were available or taking limos when taxis were a reasonable alternative.

Likewise, attorneys representing competing interests in the bankrupt’s estate — creditors, for example — can object to the fees of other attorneys in the proceeding. But none has any incentive to rock the lucrative hourly rate boat in which they all sit. Bankruptcy judges have the final word on attorneys’ fees petitions and they routinely rubber-stamp them.

Now It’s Becoming Real

When the U.S. Trustee first proposed the new guidelines, big firm bankruptcy lawyers throughout the country united in opposition. The most strident objections were to the idea that firms should reveal hourly rates for comparable non-bankruptcy associates and partners working for real clients.

Were firms worried about providing data that would allow the U.S. Trustee and supervising courts to compare hourly rates sought in bankruptcy with those resulting from a market that is at least somewhat more competitive? Soon, we’ll find out.

The new forms accompanying the guidelines require, among other things, that firms reveal the “blended hourly rates” of their personnel in 10 different categories ranging from equity partners to paralegals. In addition to the blended rates sought in the fee petition, firms also must disclose their firmwide (or, in some cases, office wide) blended rates for each category.

A Step on the Road to Transparency

The new guidelines aren’t perfect and attorneys will manipulate them. Budgets are optional. Hourly “step rate” increases are automatic as attorneys gain seniority. Attorney categories are too broad, with a single category for all equity partners and with associates grouped into categories covering three years. An especially large loophole allows firms to report either the “billed” or “collected” comparable hourly rate. (Real clients request discounts from standard hourly rates, and they often get them.)

Even so, the U.S. Trustee deserves credit for moving a dark corner of the profession from opacity to translucence. Free market devotees — of which big law has many — should embrace the changes. So far, big firm partners have resisted them vehemently.

The governing principle for too much of the large law firm world has become “if you can get it, get it.” Perhaps many of those espousing that view are about to “get it” in a much different way than they have in the past.

HOURLY RATES: PLEASE DON’T READ

For a long time, big law’s high-flying hourly rates remained under popular radar screens. Not anymore. On the heels of Jamie Wareham’s $5 million move to DLA Piper, The Wall Street Journal recently added “Big Law’s $1,000-Plus an Hour Club.”

Will big law leaders react with shame and embarrassment to such disclosures? Doubtful. Most partners will defend their rates as market-driven. As Weil, Gotshal & Manges’s bankruptcy partner Harvey Miller told the Journal bluntly: “The underlying principle is if you can get it, get it.”

He’s not alone. According to the article, “the average law-firm partner now asks $635 an hour and bills $575.” Ashby Jones’s companion online report quoted a law firm management consultant’s prediction that $2,000/hour for top partners could be only five years away.

“Get it if you can” is unworthy of a noble profession and a dangerous business plan. Some clients pay enormous rates to those who, as one in-house lawyer put it, are worth it. But rising resistance to $500+/hour associates creates problems for big law’s leveraged pyramid. At $1,000/hour, 2,000 partner hours generate $2 million in gross revenues, which is a lot less than these marquee players pocket annually. When younger attorneys’ hourly rates multiplied by their billables (less salary and bonus) no longer make up the difference, clients squeezing the bottom will dramatically reduce profits at the top. Along the way, the effort to preserve equity partner earnings will exacerbate the most unpleasant aspects of big law culture.

Another fault line runs through today’s high rates: Taxpayers are bearing some of those fees directly, not just through price elasticity curves that push some legal cost increases into the consumer price of a client’s goods or services. For example, last May, Harvey Miller’s firm had received $16 million in legal fees for work on the GM bankruptcy that taxpayers funded. With hubris that ignored the public’s financial contribution, Miller defended his resistance to discounts from Weil Gotshal’s reported rates of $500+/hour for associates to more than $1,000/hour for some senior partners: “If you had cancer and you were going into an operation, while you were lying on the table, would you look at the surgeon and say, ‘I’d like a 10 percent discount’? This is not a public, charitable event.” He was only half-right.

Similarly, Congress is now investigating legal fees that the federal government has paid to firms representing Fannie Mae and its former executives. When shareholders sued the company in 2004, each defendant retained separate counsel. That’s typical because a single attorney’s simultaneous representation of multiple defendants can create conflicts that inhibit zealously advocacy on behalf of any particular client. In such circumstances, indemnification agreements usually obligate the company to pay its former executives’ separate lawyers, as well as its own.

Normally, none of this would be controversial, but Fannie Mae isn’t normal. When it collapsed in 2008, the government assumed control. Taxpayers are now footing the legal bills — really big ones — for defending the company and its former executives in the pending lawsuits. The Times reported:

“The amount advanced by the government to pay legal bills for Fannie Mae and its former executives was a well-kept secret for more than two years. But the bills add up quickly. In the main lawsuit [overseen by Ohio attorney general Mike DeWine on behalf of two state pension funds that owned Fannie Mae shares], 35 to 40 lawyers representing Fannie defendants attend monthly conferences by the judge.”

It’s a tragic irony. In Ohio, state and local workers have taken to the streets in protesting budget reductions that would reduce their wages and end collective bargaining. Meanwhile, the attorney general leads a lawsuit against Fannie Mae and its former executives while federal taxpayers — some of whom are Ohioans — finance the defense that creates big paydays for a relatively few lawyers.

I don’t know these attorneys or their hourly rates. But generating national bipartisan outrage isn’t a good development for them or big law generally.

Sunlight can be a disinfectant, unless you’re a vampire.