February 2, 2011 4:24 PM
Experts: For Howrey, Mass Departures to Winston Could Breach Debt Obligations
Posted by Julie Triedman
[Update/Change, 2/3/11, 8:30 a.m. - The fifth paragraph of the original version of this article, which included a reference to the volume of work Howrey lawyers had at the end of 2010, has been removed from the story.]
With Winston & Strawn extending offers to three-quarters of Howrey's remaining partners, the likelihood that the struggling firm will breach its default covenants grows, law firm bankruptcy experts say. Liability issues for Winston and ex-Howrey partners may also be a concern.
Four lawyers with expertise advising on large-firm dissolutions--but no personal knowledge of Howrey matters--point to the spate of partner departures from the firm as supporting their belief that Howrey may be in a dire situation. In just the past few weeks, the firm has lost seven partners, with five joining Morgan, Lewis & Bockius and others jumping to Dewey & LeBoeuf and Venable.
The rapid loss of a significant number of partners is a critical issue for firms with secured lenders. Such firms are generally bound by default covenants that are triggered if a certain percentage of partners--10-15 percent is typical--leave within a single quarter.
While specifics aren’t known, it’s likely that Howrey is bound by such a covenant given that—according to one recently departed partner and a November 2009 Uniform Commercial Code filing—Citibank is a secured lender to the firm. Combined with those partners who have left recently, even just a few dozen partners accepting Winston’s offers could put Howrey in danger of defaulting on its obligations to Citibank.
Contacted by The Am Law Daily, Howrey CEO Robert Ruyak declined to comment for this story, but in previous reports he said the wave of departures was part of a planned firmwide restructuring.
Meanwhile, lawyers who have advised on other firm break-ups say that the steps that Howrey and Winston are taking now may increase future financial risks for both parties if Howrey does fold.
Winston’s approach to pursuing Howrey talent--making offers to individual partners rather than doing the same with blocks of partners or negotiating a merger--won't shield Winston from potential claims by Howrey's former employees, landlords, and other creditors, if Howrey ends up in bankruptcy court, say these experts.
Winston & Strawn managing partner Thomas Fitzgerald did not respond to an e-mailed request for comment.
"The courts are smart enough to know if you brought over 75 percent of partners, and you just spent the past three months looking over the firm's books, you've assumed successor liability," says Jonathan Landers, a bankruptcy lawyer who joined Milberg in 2009 and in the past advised on a number of large firm break-ups, including those of Thelen; Brobeck, Phleger & Harrison; and Heller Ehrman.
Others echo his view. "Winston's got some exposure here," says Robert Hillman, an authority on law firm break-ups and partner mobility at the School of Law at the University of California at Davis. Creditors have good grounds to claim that "when you take three-quarters of a firm's partners, you've just taken everything, including the liabilities."
The wave of partner defections also makes it difficult for a dissolving firm to resolve its financial issues through an orderly wind-down rather than a bankruptcy or court-supervised liquidation, Hillman says: "When you have a sudden mass exodus of partners, it becomes much, much more difficult to manage the process and control the consequences."
Even before the most recent departures and Winston’s mass offers, Howrey was hemorrhaging partners. At least 70 left the firm in the past year and a half. As of Wednesday, the firm's Web site listed some 220 equity and nonequity partners.
As far as financial obligations to be resolved, Howrey’s appear to be substantial. Former partners say the firm faces some $35 million in secured debt. According to one former partner who left after the start of 2011 and spoke to The Am Law Daily on condition of anonymity, the firm was unable to clear its credit line with Citibank last fall despite getting two extensions. In the end, partners were told, some $25 million was rolled up into term debt, while another $10 million credit line was linked to contingency fee income. That line does not need to be cleared until the fees come in, the former partner says.
A global firm's long-term financial commitments go far beyond the secured debt, however. In Howrey’s case, those commitments include leases on 16 offices scattered around the world and obligations to a large number of employees.
If history is any guide, Landers says, lease debt alone could range from $20 million to $60 million for a firm of Howrey's size. If the firm dissolves, the obligations to employees would include those spelled out in the federal Worker Adjustment and Retraining Notification Act, as well as severance packages and accrued vacation pay.
In Howrey's case, those commitments could apply to some 400 nonpartner lawyers as well as hundreds of staffers worldwide. As a point of comparison, in the Heller bankruptcy--which affected a similar number of lawyers and offices--former employees claimed $32 million in back pay and WARN damages; Heller settled for around $20 million, one lawyer with knowledge of the settlement says.
Meanwhile, any receivables that the firm might use to pay those claims are fleeting, say the experts interviewed by The Am Law Daily. In its initial report about the Winston offers, sibling publication The Recorder quoted Howrey insiders as saying that firm management told the partnership that it had some $100 million in accounts receivable heading into 2011. But the real recovery is likely to be a great deal smaller, the four experts say.
"It's a given that there will be a meaningful discount, anything from 20-50 percent," says a bankruptcy partner at another firm who asked not to be identified because of the possibility that he could become involved in the Howrey matter. Landers says that in the case of Heller, the firm’s receivables "dropped precipitously."
That's because the incentive to push for that money on both sides diminishes: clients no longer feel as much pressure to pay, and former partners are often not as pushy on collecting fees, especially if they believe the money won't benefit them and may go to creditors, bankruptcy lawyers say. They add that former partners are more likely to press for payment on bills that will benefit their new firms.
Experts note that partners will also have to share any excess liability if Howrey dissolves. Many former partners are currently focused on getting back their large capital accounts--which one former partner pegs at 35 percent of total compensation for equity partners above the lowest tier.
They might be waiting a long time--says Hillman, especially if the endgame is bankruptcy, Hillman says: "Here's a bulletin for them--they're the last to get paid."
From the January 2011 issue of The American Lawyer:
Rescues Gone Wrong?
Litigation launched by the estates of two bankrupt firms illustrates the perils of plucking partners from sinking ships.
From The Am Law Daily:
Howrey Vice-Chairman Heads to Dewey & LeBoeuf
January 18, 2011
The Story Behind Howrey's Very Bad Year
October 27, 2010
The Am Law 100: Alternative Fee Reality
May 13, 2010
Howrey's Looming Partner "Layoffs"
March 11, 2010
The Am Law 100: Howrey's PPP Plunges 35 Percent
February 22, 2010
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