Watch for falling dominoes

I don’t think Detroit’s automakers scored a $17 billion care package from the White House because anyone seriously thinks the cash will staunch the gaping holes in their business models and turn them into American Toyotas. More likely, the US government feared a massive ripple effect throughout the faltering wider economy if even Chrysler went belly-up, let alone GM. As the analysts at Stratfor put it last month, when the patient (the economy) is on life support, you don’t give it a healthful purgative that puts it into a coma.

There’s something instructive about this development for the legal industry as well. You’ve been reading a lot, here and all over the blawgosphere, about the recession’s impact on law firms. Today brought us one of the grimmer forecasts, and when it comes from Prof. William Henderson at the ELS Blog, you need to take it seriously. Bill looks at massively over-leveraged US law firms and sees bad things ahead:

[W]ith the potential for historically low collection rates, a large proportion of Biglaw firms are in one hell of a vise.  Salaried lawyers represent fixed costs.  And even if you lay them off, managers are under intense pressure to pay a reasonable severance (e.g., 6 months pay) to preserve the firm’s reputation for an eventual recovery.  Further, firms with the most human capital leverage will nonetheless be stuck with vast expanses of Class A office space under lease terms negotiated during the salad days.  If Biglaw revenues go down 20% for the fiscal year, which is certainly in the realm of possibility for many firms with large capital market practices, profits could dive by 50% or more.

Similar to what happened at Heller Ehrman, the grim financials could put the firms in violation of their bank lending agreements, see Drew Combs, Why Heller Died, The American Lawyer (Nov. 2008), thus requiring partners to pony up more cash.   Sensing trouble, lawyers with the most options start heading for the doors, initiating a sudden and rapid death spiral.  In short, there is good chance that several hallowed Biglaw firms, particularly those with weak balance sheets, will cease to exist sometime in early to mid 2009.

Large firms, especially those in the US that were deeply committed to corporate work, look most vulnerable to the rising economic winds. But really, I don’t see any size or type of practice in Canada, the US or the UK that won’t take some kind of hit from the recession, anywhere from a glancing to a body blow. The question is whether the collective force of those hits will be enough to seriously stagger the private bar as a whole. If not, then we’ll muddle through alright. If so, well….

Vehicle manufacturers are at the heart of the auto industry, but of course they’re not its sole residents. Surrounding them is a circle of  parts suppliers, local dealerships, service depots, used car showrooms, and other ancillary businesses. Then comes a further concentric circle of dependent businesses like gas stations, car rental agencies, transport truck companies, satellite radio installers, and so on — not to mention all the businesses that depend on employees of these inner-circle companies to buy, rent, visit or consume their products and services. Fear of a domino effect through these circles was a powerful argument in favour of government help.

Likewise, although private law firms lie at the heart of the legal industry, there are many other ancillary industries, companies and institutions whose own business models assume a certain level of spending and productivity by the private bar. While we might understandably fixate on the ups and downs of law firms of all shapes and sizes, we should also keep an eye on the long lines of dominoes radiating out from the private bar, because some of them look none too steady either.

Bill Henderson links to an insightful post by Michael Cahill at PrawfsBlawg, who raises the spectre of a “legal education bubble.” The problem of law school tuition increases have usually been passed on to big law firms, which are supposedly poised to pay law graduates (or some of them, anyway) equally high salaries; but if those firms stumble or fall, who’ll help new grads dig themselves out of debt? Not only that, but with credit still mostly frozen, who will lend law students that tuition in the first place? And with fewer private-law jobs available at any salary, Michael worries, when does a law degree slip below the cost-benefit line? If even some of these consequences come to pass, the legal education industry will be looking at a major contraction of its own.

Then there’s legal publishing. If both firms and schools are forced to cut back, law book publishers have a new set of problems, because that’s basically their entire marketplace. Those that have branched out into online legal research will find little help, because they haven’t really diversified: the markets for e-research are pretty  much the same as for books. Legal periodicals depend heavily on advertising from law firms and their suppliers. I’ve already heard of planned cuts to law firm marketing and advertising budgets for 2009, and suppliers like software companies are going to find it harder to sell upgrades and new releases when people are more willing to hold on to their older versions and wait for prices to fall. And so forth.

Lawyers in private law practice tend to forget sometimes that they serve a more complex and important function in this industry than mere sellers of legal services. They’re also buyers of private law practice supplies, everything from students to books to software to newspapers to photocopiers to recruiters to memberships and much more. In The Elastic Tournament, Profs. Henderson and Marc Galanter point out that “large law firms have become immensely fragile institutions.” But really, the entire legal services industry is a fragile ecosystem, and if the center should ever give way, the domino effect could be extraordinary. And I don’t think anyone’s preparing a bailout package for that.

The new leverage

Bad news on the economic front continues to pile up — you don’t need the links from me — and the legal profession is finding its ride increasingly bumpy as a result. Wachovia’s legal specialty group reports that partners in large law firms are bringing in less revenue for the first time since approximately the Industrial Revolution. But it also points out an overlooked fact: despite all the talk about associate layoffs, it’s staff that’re really taking the hit at firms, down 18% in September alone. That suggests a couple of things: that some firms really are taking steps to retrain or otherwise hold onto their associates (and there’s good reason to do so, says Bruce MacEwen), but also that these firms aren’t looking as far down the road as maybe they should.

Looking down that road are the good people at The American Lawyer and Legal OnRamp who, with the assistance of consultant Rees Morrison, recently conducted a survey of in-house counsel members of Legal OnRamp. The survey (disclosure: I made small contributions during the design process) asked in-house lawyers about their relationships with outside counsel and their predictions about how those relationships and in-house practices will evolve over the next five years. Topics of inquiry included client satisfaction surveys, value billing, outsourcing, commoditization, automation, consolidation, and social networking.

The thrust of the results is that in-house lawyers aren’t especially happy with outside counsel in terms of service, partnering and communication — nothing new there — but are surprisingly tentative about predicting major change in how they go about acquiring services from these law firms. Very surprising, actually, as Michael Grodhaus says in reference to another study “in which 32% of 600 corporate executives predicted significant changes in law firm billing practices over the next two years. … So in the face of what is likely to be the worst financial crisis in this country since the 1981-82 recession — two-thirds of these corporate executives expect to continue to be billed by the hour for legal services just as they have always been? Where are their shareholders?”

The AmLaw/OnRamp survey results are here, the analysis by Rees and AmLaw’s Aric Press  is here, and Paul Lippe’s analysis at Legal OnRamp is here (members-only on that last one). All insightful stuff, and worth your time. For me, though, the takeaway is found in Aric’s introductory AmLaw editorial, summing up the big-picture view of the changes underway in the legal services marketplace. He identifies, correctly I think, four trends driving change — client pushback, talent upheaval, technological disruption and the Legal Services Act — and forecasts both fundamental change (farther down the line) and disaggregation of legal services (probably a lot sooner) to come. He closes with this concise but powerful state-of-the-nation on change in the legal marketplace (emphasis added): Continue Reading

E-document ethics and the rise of regulation

It’s been a great week for conversations with Law21 readers, because I’ve also had a terrific correspondence with John Gillies, head of Practice Support at Cassels Brock in Toronto. John brought to my attention an opinion issued this past summer by the New York City Bar Association regarding lawyers’ ethical obligations to retain and provide clients with relevant electronic documents.

The obligations set out in the opinion, while not unreasonable in any broad sense, set a markedly higher standard of conduct than many firms are currently maintaining. I think they’re noteworthy for two reasons: one, because firms with offices in New York (which include many global giants) are now bound by these standards (which could well become the de facto standard in other jurisdictions); and two, because we’re going to see a lot more of this: regulation of lawyers’ conduct regarding their work and their clients.

The NYC Bar asked itself the following questions:

What ethical obligations does a lawyer have to retain e-mails and other electronic documents relating to a representation? Does a lawyer need client permission before deleting e-mails or other electronic documents relating to the representation? When a client requests that a lawyer provide documents relating to the representation, may the lawyer charge the client for the costs associated with retrieving e-mails and other electronic documents from accessible and inaccessible storage media?

Read the whole opinion for the complete answer — it’s not long — but the gist is that standards that currently apply to storage and access of paper documents apply equally to e-documents. That might sound like common sense, but think about the impact. The electronic documentation that any given client matter produces is massive: emails to clients and colleagues, draft versions of memos, timekeeping records, Blackberry messages, and so on. If you printed out every e-document and added it to the case file (and please don’t), that file would be about ten times higher.

Here are some highlights of the opinion’s specifics (emphasis added throughout): Continue Reading

Credit crisis: You ain’t seen nothin’ yet

We’re already seeing some dominoes start to wobble in the legal community, as the short- and medium-term impact of the financial crisis becomes clearer. If you’re a law firm CFO or a law student nearing graduation, you probably won’t like what’s coming. But it looks to me like there are much bigger pieces likely to fall very soon.

Let’s start with the dominoes. Here’s an article from the Fulton County Daily Report about the impact of the credit crunch on law firms’ lines of credit, something I mused about last week. Lawyers who traditionally have not made accounts receivable a priority should read this:

Some banks are increasing their scrutiny of law firm loans, attaching more covenants and conditions and looking ahead to how well firms can collect their receivables in the coming year. According to some bankers and consultants who focus on law firm lending, a lag in collection time is pushing firms not just to borrow more money but also to increase holdbacks on partner compensation and, perhaps, decrease overall profit distributions.

Dan DiPietro, client head of the law firm group at Citi Private Bank, said his employer still views lawyers as a good credit risk — despite the crisis coursing through the markets and the collapse or merger of clients that supply billable hours to many of the nation’s law firms. … “What has changed is our focus and discipline on pricing and making sure that we’re pricing with the view that this is not a standalone credit facility but is generating other revenue. … In this market, there’s a huge focus on overall returns.”

Like many banks, Citi looks at firms’ cash flow, receivables and work in progress when assessing their creditworthiness and how much cash to advance on revolving or long-term lines of credit. … Citi is giving existing loans a higher level of scrutiny and is looking more closely at firms on an individual basis to assess how the economic turmoil might affect their receivables.

Then there’s law students, the vast majority of whom wouldn’t be able to meet tuition and living expenses without student loans — loans that are suddenly looking very dicey, according to an article in the National Law Journal: Continue Reading

The future of law firm branding

My semi-monthly column is up and running at Slaw. As always, I recommend you go read it there, because I guarantee you’ll find other very cool stuff at Canada’s best legal blog. If you haven’t visited lately, you might not know that Slaw has added great new bloggers like Dave Bilinsky, David Canton, David Fraser, Nick Holmes, Patricia Hughes and Omar Ha-Redeye to its roster. Go read my column there today. Continue Reading

Associates and the bad table

The opening words to a sporty 60-second video montage at Cadwalader’s US student recruitment site are: “Make no mistake about it. A career at Cadwalader is not for the faint of heart.” So it would seem, following news that the firm cut 96 lawyers on Thursday, an astounding purge that surpasses Sonnenschein Nath & Rosenthal‘s recent 37-lawyer, 100-staff cut, and comes several months after Cadwalader’s January move to drop 35 lawyers.

The most recent pink slips were handed out largely in the firm’s formerly high-flying capital markets and global finance groups, which have been brought low by the real estate finance and securitization market’s struggles, and were given almost entirely to associates.There’s no small amount of schadenfruede about Cadawalader’s position to be found in the blawgosphere at the moment, much of it based on this February 2007 article in the New York Law Journal, with the built-for-irony title: “Does the future belong to Cadwalader?”

But “layoffs” (read: you’re fired, but it’s not your fault) are likely to become more frequent at the largest firms (DLA Piper announced a few in London this morning) for the totally understandable reason that the really hot parts of the economy that powered these firms over the last few years have gone really cold.

What’s funny, though, is that during these hot streaks, when associates were so hard to find and cost so much, I quite clearly remember many law firms ruing their decisions to chop associates the last time an overheated economy tanked. All those associates we fired, they said, shaking their heads, if we’d held on to them, would be able to help us now. Perfectly right, of course — and yet, now that the short-term pain of lower profits looms again, the long-term gain of associate investment apparently becomes hard to remember.

Coincidentally, today also saw the release of the American Lawyer‘s midlevel associate survey, which paints a bleak but familiar picture of associates’ waning interest in partnership or indeed any long-term law firm goals. Interestingly, though, the fear of layoffs hasn’t much to do with this, nor do issues of salary or even “work-life balance” (a term I intend to put “in quotes” until it goes away). What’s driving associates away from firms is that the work stinks. Continue Reading

Victims of their own success

After two weeks away from the blogosphere, my RSS feeder has 756 unread posts for me to look at, not including my daily updates from Dilbert, Slumbering Lungfish, and the Astronomy Picture of the Day. One of those 756 posts appeared at LegalWeek’s Editors’ Blog and concerned UK managing partners’ cluelessness and complacency about the impact of the Legal Services Act, particularly regarding the coming ability of UK law firms to go public.

This theme was picked up by Paul Lippe in a (members-only) post at Legal OnRamp, where he acknowledged that successful law firms don’t have much incentive to explore innovative private equity options. But he argued that other kinds of firms will, such as old run-down name firms needing to overhaul, solid midsize firms looking to break out, and stable firms with contentious partnerships. Paul’s money quote:

Whether any of these firms will ever truly “Go Public” I would question; but certainly they can access the capital markets in ways that create liquidity and competitive advantage. The point is (and some lawyers seem almost congenitally incapable of understanding this) that disruptive innovation never comes from the super-elite, and doesn’t have to. The disruption will come from an outsider, but will quickly impact the elite – think Honda and General Motors over the last 40 years, think JetBlue and United Airlines. If these scenarios sound fanciful, remember they are exactly was has happened in a dozen other industries that have been impacted by a combination of global competition and private equity.

Here, with some amendments and additions, is the response I posted:

True enough; as the saying goes, revolutions don’t normally start inside the castle. But I think this is kind of the problem, because in the legal services marketplace, the castle is huge — it encompasses much of the kingdom, in fact. Most law firms consider themselves to be “successful,” which greatly reduces the number of “unsuccessful” firms that would be naturally motivated to try something innovative. Continue Reading

Conflicts and the law of unintended consequences

The Recorder reports this morning on the rising number of law firm requests that clients sign broad advance waivers (or blanket waivers) that would allow the firms to act against those clients on future unrelated matters. Firms, looking to maximize the amount of business they can take on, are trying everything they can think of to get around conflict of interest rules. Clients, reasonably enough, won’t sign anything that could impair their interests down the road if they can help it.

Clients’ responses to these requests vary according to the size and leverage of both firm and client. Large clients routinely blow them off, because they can — the lawyers need their business more than the clients need these particular lawyers. Smaller clients have less leverage, so if they want to hire big firms, they pretty much have to live by the terms those firms dictate. I can see a couple of trends emerging from this, neither of which is good for large firms and both of which reflect the unintended consequences of size.

First, when a firm is so big that it has to go begging for the right to sue the client in future, the client will correctly diagnose this as a vulnerability that can be exploited. Instead of simply refusing these requests, clients will start calculating just how much (or little) they actually risk by granting such a waiver, and how much the firm has to gain by it. The client might then say to the firm, “Sure, we’ll grant you the waiver — and in return, you’ll knock 15% off all your fees and pick up the costs of a new extranet system.” Large firms’ vulnerability to conflicts is going to cost them at the bargaining table. Continue Reading

Your invisible professionals

So here’s a typical situation: I’m assigning an article for one of our CBA publications on a law firm practice topic — say, business development, or extranet use, or associate retention efforts, or what have you. And I want to find interviewees with knowledge and expertise to speak with our writers for said article. So one of the first places I’m inclined to look is within law firms themselves, to speak with the professionals in charge of these areas.

Except I can’t. Because with few exceptions, law firm websites do not list biographical or contact information for their non-lawyer professional staff. According to most law firms’ websites, even some of the largest and most challenging to operate, their offices contain lawyers and nobody else — all the day-to-day operations that sustain the firm, from accounting to marketing to IT to knowledge management, apparently happen independently, as if by magic.

Here’s a partial list of the key professionals within law firms who are rarely mentioned on firm websites:

  • Chief Administrative Officer
  • Director of Associate Retention
  • Director of Business Development
  • Director of Finance
  • Director of Human Resources
  • Director of Information Technology
  • Director of Knowledge Management
  • Director of Marketing
  • Director of Student Recruitment
  • Head Law Librarian
  • Webmaster

In fact, almost the only non-lawyer professional you’re likely to find on a law firm website is the Director of Media & Communications, if only because that person’s name shows up at the bottom of press releases. Then again, it’s just as likely the director’s name won’t show up — it’ll be the more junior media liaison who’s supposed to get all the calls from the press.

If this were just an inconvenience for media types like me, then you could almost forgive this oversight, despite all the lost opportunities to promote the firm’s name in the legal and business press. But the real damage, I think, is to the morale and status of these staff members, who work just as hard and take just as much pride in their craft as any lawyer, but who receive no public recognition from their employers. Continue Reading