No big law firm has managed to reorganize its bankrupt debts and survive. And the pressures that bring down law firms are often surprisingly mild. The force with which law firms break down is astonishing because it has no parallel in other types of businesses. Amazon lost money for more than 20 years.
Chrysler filed for bankruptcy seven years ago. However, both companies, like many others that suffered financial problems before them, are still shipping goods and producing cars. Law firms don't show that resilience. Most of the collapsed companies collapsed while they were still up to date with their debts and were making a profit.
Law firms die with extreme ease and astonishing speed. This theory can tell us a lot about how and why law firms collapse. It tells us that law firms can start to collapse even when a meltdown worsens the situation of their partners. This theory also tells us that debt, macroeconomic forces and the recent decline in demand for legal services are much less important in driving the collapse than we might think.
Failures in governance and social factors, on the other hand, turn out to be more important. This theory also suggests that a struggling law firm could resist collapse if it were owned by investors or if it could impose significant restrictions on its partners' withdrawals. Lawyers who run law firms can sometimes feel like more than just employees, they can feel like true partners, united by values and a deep commitment. The importance of partner ownership in the collapse of law firms is evident in the experience of Slater & Gordon, a firm based in Australia and the United Kingdom that was owned by investors.
Model Rule of Professional Conduct 5.6 requires a law firm to repay a partner's capital contribution when they retire, so that when a firm starts to go under, many partners begin to leave in the hope that they can take their capital before the company completely collapses. A public policy solution would be to eliminate rules that require law firms to be owned by their partners. Knowing the importance of relative earnings is useful because it tells us that law firm collapses shouldn't surprisingly be related to major industry-wide disruptions, such as financial crises and recessions. The preferential transfer law encourages partners to leave early because partners who raise their capital before the company goes bankrupt can keep their capital, while partners who leave after insolvency lose it.
However, unlike law firm partners, investors in a joint venture cannot apply because the corporate charter prohibits them from unilaterally withdrawing. Like Apple, which has tens of billions of dollars in retained earnings, a law firm could, in theory, choose not to distribute profits if it so wishes. Although the death of a large law firm tends to surprise the people who work for it, law firms actually collapse in surprisingly predictable ways. As my partners have told me, I am a businessman trapped in the body of a lawyer, and it turns out that the law was the business I was involved in.
The most serious liability comes from the fraudulent transfer doctrine, which allows a creditor to set aside any payment a company makes after it goes bankrupt if the company does not receive something of a reasonably equal value in return. In Why Law Firms Collapse, I argue that a law firm is fragile in part because it is owned by its partners, rather than investors. The first solution is for all major law firms to modify their partnership agreements to waive liability for pending Jewel style business claims. .
