When BigLaw Fails: Howrey

You might have missed it, but last week, but Howrey, the 50th largest law firm in the United States and a major player in Washington D.C. litigation, voted to dissolve.

Steven Pearlstein of the Washignton Post has a nice postmortem that hypothesizes what went wrong:

Howrey expanded too much too fast, its overhead expenses growing even faster than its revenue....

Fixed costs are a challenge for all law firms, but particularly so for litigation firms such as Howrey that can’t count on a relatively steady flow of work from corporate clients — leases to review, mergers to handle, securities filings to make. Revenue in the litigation business tends to be lumpy. You get paid only when there is a case to be tried and then often only after the trial is over. Howrey, in particular, had come to rely increasingly on revenue from such contingency fee cases, which rose to $35 million in 2008 and then fell to $2 million a year later.

Pearlstein also notes that Howrey ran into conflicts of interests problems as it grew, as well as a weak partnership in general that was not as committed to the firm itself as the partners were committed to themselves. This paragraph in particular struck me as interesting:

For me, it is of symbolic and substantive importance that law firms are no longer partnerships in the strict legal sense. Most, like Howrey, had transformed themselves into “limited liability corporations” or “limited liability partnerships,” a new hybrid form of business organization. Unlike old-fashioned partners, those in an LLC or LLP are shielded from individual responsibility for the liabilities of the firm. That means that they are apt to be less careful in making decisions about what risks and expenses to take on, knowing they do not face the prospect of losing all of their net worth.

This seems to be yet another instance where the respective bar associations rubber-stamped fundamental changes to the legal profession without fully digesting the consequences. When state legislatures started adopting the LLC and LLP business formats, law firms were some of the first on the boat (at least on the latter), and I wonder if anyone actually voiced opposition, claiming there was intangible value in the general or limited partnership structure (I'm not sure about this, nor am sure how law firms that operate as corporations play into it - will have to research in the future). But I will say that it's clear many intangible values in the legal system got left on the side of the road as excess baggage on the speedy voyage to multinational, 1000-firm behemoths.

But what about the future of the BigLaw model? As the Howrey example suggests, large firms dependent on big-money litigation to see profits have a volatile existence. It also seems to me that such firms are going to be more dependent on ace litigators who may have incentives to use the firm's resources to build their reputation and then spin off on their own when their own value exceeds that of their peers.

This seems, to me, like a problem stemming from law firms trying to run themselves like normal businesses. Law is analogous to sales in that your rainmakers rake in clients that the entire firm benefits from. However, a routine salesman has little power to leave because his future success is tied to continuing to sell the product, which is ultimately company property. Law doesn't work that way; the "product," the rainmaker's loyal and devoted service, is not really unique property of the firm. Thus, such a model fails. The cynic in me thinks that people realized this a long, long time ago and that's why law firms went towards partnership structures (liability for each others' debts promotes cooperation; tighter controls on people leaving) while other businesses incorporated as a matter of course, but I digress...

But what about transactional law firms? Surely, there's a BigLaw future for the white shoe operations that handle securities filings, mergers, etc., isn't there? For the most complex scenarios, yes. But my hunch is that transactional business profits will dwindle in the coming years as automation becomes an even greater force in the legal profession. If places like legalzoom can offer wills now, what's to say Fortune 500 companies won't figure out how to simplify all the transactional business they have to do? Securities filings are fairly standardized anyway. With more sophisticated electronics, I can't see 500+ attorney firms being a necessity for large companies in the future to do their routine transactional stuff. Heck, every company on the NYSE/Nasdaq/Amex would benefit if someone found a way to cut out the white shoe lawyers, and with increasingly-impressive computer technology, I'm sure someone will find the armies of Harvard and Columbia grads completely unnecessary.

Remember that most BigLaw have higher operating costs and overhead to even play the game, thus making them more susceptible to significant shifts in revenue. A solo P.I. attorney can feed his family on one or two juicy settlements. Not so at the top firms.

With it appearing that 2010 may have seen the peak of law school applications, perhaps it's time to ask if we're also seeing a peak in large law firms. I honestly don't know for sure, but given the confluence of certain events, it seems like a good possibility.

For further reading on this topic, I'd recommend a recent post over at the Legal Dollar citing the recent demise of several big firms and how to look for stability in a law firm.