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JANUARY 26, 2009
Recession Batters Law Firms, Triggering Layoffs, Closings
By NATHAN KOPPEL
The Wall Street Journal
For years, the law firm Heller Ehrman LLP used a goofy coat of arms inside its offices: a laurel wreath, the scales of justice and a Latin quotation, elvem ipsum etiam vivere. Rough translation: Elvis Lives.
In late September, Heller Ehrman went the way of Elvis. Just two years after its most profitable year ever, the freewheeling San Francisco firm expired, closing its doors after 118 years in business.
After upending a succession of U.S. industries, the recession has arrived for U.S. law firms, which have long seen themselves as partially insulated from economic downturns. In December, Thelen LLP, another large San Francisco firm, also shut down for good, citing recessionary pressures. Later that month, Thacher Proffitt & Wood LLP, a 160-year-old New York firm, announced that it was closing. Dreier LLP of New York is dissolving after its founder was arrested for fraud.
Pay cuts and layoffs are becoming commonplace. This month, Clifford Chance laid off more than 70 lawyers in London; Cooley Godward Kronish LLP fired 50 lawyers and 60 other staffers; and Akin Gump Strauss Hauer & Feld LLP let go of 65 staff members across the U.S.
In November, New York legal giant Cravath, Swaine & Moore LLP announced it was reducing year-end bonuses for junior lawyers, and that it wouldn't raise its billing rates in 2009. Latham LLP, one of the nation's highest-grossing firms, said in December that associates would not get raises in 2009 -- a move followed by many other firms.
"More firms are in a fragile condition than I've ever seen," says William Brennan, a law-firm consultant with Altman Weil Inc. and formerly chief financial officer at two large Philadelphia firms.
Profits, on average, were down 8% to 12% across the industry last year, after 15 years of consistent profit growth, says Peter Haugh, managing director for the Legal Specialty Group of Wachovia Wealth Management.
Throughout the industry, business has dropped off in such key practice areas as mergers, public offerings, and corporate finance. Litigation, often counted on to carry firms through downturns, has become less profitable as clients increasingly settle big cases, forgo lawsuits altogether, or pressure firms to discount their fees, lawyers say. Some practice areas, such as bankruptcy, however, are robust.
Lawyers and consultants say they expect profits to continue slumping this year. "Given the pressure on the industry now, I would expect that more firms could dissolve in 2009 or seek a white-knight merger," says Terry Conner, managing partner of Dallas-based Haynes and Boone LLP, which so far appears to be faring better than many firms.
When Best Assets Walk
Many law firms are susceptible to the phenomenon that led to Heller's collapse. Their main assets are their senior lawyers. Job hopping used to be relatively rare among such lawyers. But lawyers with big books of business now commonly shop themselves to more profitable firms that can offer larger compensation packages.
"Law firms are not the kind of companies that do well in adversity," says Jonathan Landers, a partner at Milberg LLP, who has represented banks in law-firm dissolutions. "Their best assets are their most mobile assets. When bad things happen, people get nervous and they start to look around."
The economic downturn has prompted lawyers to jump to firms perceived to be more financially stable. If enough partners head for the exit, a firm can crater in a hurry.
"The marketplace is so intensively competitive that when firms encounter financial difficulty, the best and brightest lawyers immediately say, 'I don't want to take a risk with my clients and my compensation,' and they jump quickly to a less risky platform," says Mr. Brennan, the consultant. "Within weeks a firm can go from having financial difficulty to having a run on the bank."
The story of Heller's collapse, pieced together from the accounts of more than two dozen lawyers, underscores the vulnerability of midsize firms specializing in corporate defense work.
Many firms with roughly 200 to 600 lawyers see themselves as susceptible to losing talent to larger, better financed competitors. As a result, they push hard to grow and to increase profits, which can alienate longtime partners who do not share the urge to grow.
Heller, which last year numbered more than 600 lawyers, had been following such a path. Management believed the firm needed to get bigger and more profitable in order to compete against industry-leading firms with more than 1,000 lawyers.
According to Eric Redman, a former Heller lawyer, the stated logic became: "There is room for big firms and tiny firms, but firms in the middle will get crunched ... the idea was we had to move in the direction of being a really, really big and profitable firm to survive."
For years, Heller had been known for its relaxed vibe. Public service and diversity were greatly valued. Heller lawyers knew their firm was not the most profitable, but they believed it was one of the more convivial. "At Heller, we knew we were not making the last dollar," says Robert Werbel, a former shareholder, as Heller called its senior lawyers. Profits were spread relatively evenly among shareholders, in contrast to wide pay disparities found at many firms that embrace an eat-what-you-kill compensation system.
Robert Rosenfeld, an antitrust litigator whose bushy hair and beard drew comparisons to Leon Trotsky, was Heller's chairman in the mid-to-late 1990s. He liked to pad around Heller's downtown San Francisco office with his shoes off, occasionally venturing into a hallway to let loose a scream -- just to blow off steam. Lawyers say he was reluctant to adopt harder-edged business practices, such as firing or demoting less-profitable partners.
But by the mid-2000s, Heller had become more bottom-line oriented. It relied heavily on large-scale lawsuits, such as representing Microsoft Corp. in antitrust litigation or the Big Four accounting firms in securities suits. It was highly lucrative work but episodic. When cases settled, Heller's profits could dip. That put it at a competitive disadvantage to firms that were more balanced, with offices in many locations and broader expertise.
New Focus on Growth
Matthew Larrabee, who became chairman in 2005, pushed hard to beef up the corporate department and to expand Heller's presence abroad. The 53-year-old antitrust lawyer envisioned a firm of 1,000 or so lawyers with a much bigger footprint outside the West Coast. He paid close attention to the firm's profitability -- a key to recruiting star lawyers.
Most of the firm's managers shared those goals. But many rank-and-file shareholders were leery of the idea, and the costs associated with it. "There were tensions between the imperative of growth and the core values of the firm," former senior lawyer Norman Blears says.
In a prepared statement, Mr. Larrabee said: "We worked extraordinarily hard to grow our business and improve our performance, because we needed to generate more work in an increasingly competitive market ... we might have been better served by starting that effort even earlier."
Disagreement surfaced over whether the firm should expand to London. At a 2006 retreat in New York's Waldorf-Astoria hotel, Mr. Larrabee argued that London was a vital outpost for any firm with global ambitions. But Heller had lost money in Asia for years, and lawyers were skeptical that a big London office could be profitable.
Senior lawyer Stephen Bomse made light of the tensions by staging, at Rockefeller Center's Rainbow Room, a takeoff on "Macbeth." He called it "Matt-Beth," a play on Mr. Larrabee's name. It featured a mock policy-committee meeting in which two actors were at each other's throats. One yelled that the firm must expand internationally, while the other preached restraint.
Heller eventually opened a modest London outpost, which proved a success. The firm ended 2006 on a high note, with its partners earning $1 million, on average, for the first time in its history.
But its financial condition worsened in 2007. That winter and spring, over 45 days, it lost about one-quarter of its litigation business due to settlements, including its defense of Microsoft in the antitrust litigation and Ernst & Young LLP in securities litigation.
Some Heller lawyers saw this as more than a temporary blip. They believed large-scale litigation matters -- the sort that can occupy 30 or more lawyers for years and that had been the key driver of Heller's growth -- were permanently on the wane, as companies increasingly used mediation or adopted other cost-saving measures.
'You Need to Leave'
When Heller lawyers gathered for a retreat in March 2007 in Santa Barbara, Calif., some had grown anxious about the firm's finances. Mr. Bomse staged a mock opera about the firm's struggles. It featured professional opera singers and members of the Santa Barbara orchestra, and cost the firm more than $200,000, according to a member of the firm's executive committee. During the performance, lawyer David Goodwin says his wife turned to him, aghast at what she imagined the cost to be, and said, "This is a poorly managed firm. You need to leave."
That year, several valued Heller lawyers jumped ship to more financially stable firms. (Mr. Goodwin left in 2008.) Concerned about the eroding litigation business and the threat of more defections, management began firing shareholders considered a drag on earnings, and awarding a greater share of profits to big business generators.
Some lawyers fumed when Robert Hubbell, the firm's managing shareholder, presented data indicating that work hours were 15% lower on Fridays than on other days of the week. Management's message: Work a full Friday.
Heller's litigation business remained slow last year. Headhunters and partners at competing firms circled Heller, asking lawyers if they would be willing to move their practices elsewhere.
Heller's management focused on trying to merge with a bigger, stronger competitor, concluding that it was the only way the firm could stay alive amid continuing lawyer defections. At a shareholder gathering last spring in Colorado Springs, Colo., Heller's chairman, Mr. Larrabee, said the firm had plenty of choices of merger partners, according to lawyers who were there. Last summer, Baker & McKenzie LLP, one of the nation's largest firms, emerged as a serious candidate. But after weeks of negotiations, the deal cratered in August, partly because of business conflicts. Heller lawyers had sued many of Baker's clients.
A new suitor soon emerged. On Aug. 21, Heller gathered 40 key lawyers at the San Francisco Ritz-Carlton to discuss its potential white knight: Mayer Brown LLP, an 1,800-lawyer firm. The mood was upbeat.
But another problem cropped up. Robert Fram and Robert Haslam, whose intellectual-property group was among the firm's highest grossing, had said they were considering heading to another firm. Heller attorneys implored Messrs. Fram and Haslam to stay. If they left, some lawyers believed, the Mayer deal would crumble.
M. Laurence Popofsky, a Heller lifer who was the firm's chairman from 1988 to 1993, recalls telling Mr. Fram over lunch: "People's pensions are in jeopardy. Employees are at risk....If you do this and don't give the merger a chance, you will hurt an awful lot of people."
Mr. Fram says Mr. Popofsky and others tried to persuade him to stay. But his team, he says, didn't want to join Mayer and then jump ship if they were unhappy. "We didn't feel like that was something we were ethically comfortable doing," he says. On Aug. 29, Mr. Fram informed Heller that he was leaving.
Two weeks later, in a conference call, Mr. Larrabee told his fellow managers that the Mayer deal was off, says one lawyer who was on the call. "There was a stone silence on the call," this person says. "Then, voices came from 12 different phones: 'Why?' " Mr. Larrabee said that Mayer had grown nervous about Heller's financial state.
In a statement, Mayer Brown said that "various issues, including client and practice conflicts," stood in the way of a merger.
"On that call, we turned to 'what next?' " recalls the lawyer who was on it. "There was not an answer."
Heller distributes its income to shareholders at year end. As a result, at the beginning of each year, it has to tap a bank credit line to pay salaries, rent and other expenses. As revenue rolls in, it pays down the credit line. It is usually finished by August.
Last year, however, revenue dropped off so much that it had trouble paying down its loan. By September, its debt hovered around $30 million, according to a lawyer knowledgeable about the finances. The formal departure of the intellectual-property group on Sept. 14 put Heller in breach of a loan covenant that limited the number of shareholders who could depart in a 12-month period.
On Sept. 26, with banks controlling how Heller spent its money, shareholders voted to dissolve the firm. "Employees were crying about it," says Michael Charlson, a former shareholder. "There was an amazingly profound sense of emptiness."
Heller hoped to wind down outside of federal bankruptcy court. But on Dec. 29, after failing to reach agreement with its lenders about terms of repayment, it sought Chapter 11 bankruptcy protection.
Most of Heller's shareholders have landed at other large firms. But as of December, more than 300 former Heller employees, mostly nonlawyers, were still looking for work, according to a report by Heller's dissolution committee.