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March 4, 2011 2:52 PM

An Expert in Law Firm Breakups Looks at Possible Howrey Scenarios

Posted by Julie Triedman

As a handful of partners left for new firms this past week, and there was no news on the outcome of a potential Winston & Strawn deal, Howrey's remaining 80-odd partners were reportedly planning to vote on winding down the firm next week. On Friday, we talked to Robert Hillman, a law professor at the University of California at Davis School of Law and an authority on legal issues arising from law firm breakups, about the various scenarios Howrey could face. (Hillman has no personal knowledge of the Howrey situation.)  

What is the difference between a dissolution and a bankruptcy? And what causes some firms to wind down in an orderly fashion while others enter bankruptcy? 

 They're different concepts. A dissolution occurs whenever a law firm shuts down its operations. It's a private business matter and is governed by partnership law, generally requiring a majority or two-thirds vote of the remaining partnership, most often by a numerical head count, although sometimes the vote is based on equity percentage share. A bankruptcy falls under the bankruptcy statute.

Dissolution isn't the end of a firm. If Howrey dissolves today, it will still exist next week. After dissolution is declared, the firm goes into a winding up phase, where you take all the unfinished business at the time of dissolution and finish it. Once that work is done--it can take years--the firm terminates.

The other half of the ledger is you are supposed to take an accounting of all your liabilities and apply the fees against those claims. That's where a bankruptcy might come in. A bankruptcy occurs when a firm's assets and revenues are insufficient to cover the liabilities--the big ones being leases and malpractice claims.

Many dissolutions are accomplished without a bankruptcy because revenues are sufficient to cover liabilities. And in an orderly wind-down outside of bankruptcy, partners may be able to recover their capital accounts if the assets are more than sufficient to cover the liabilities.

Most law firms facing a breakup want to dissolve without filing for bankruptcy. Why is that?

 Firms want to control their own fate. Once you file for bankruptcy, you lose that control. The firm's fate is in the hands of the trustee. And bankruptcy also means you've failed. It's stigmatizing. It means you have economic problems, and that's not good news for partners, who are very likely to lose their capital accounts. In a bankruptcy, partner claims go to the end of the line, just like equity investors do in a corporate bankruptcy filing. For creditors, bankruptcy is an obvious signal that they're not likely to collect a dollar on a dollar. And experience has shown that collections and revenues both fall precipitously after a firm goes bankrupt and that malpractice claims rise. So revenues will be affected negatively. But on the flip side, the process maximizes what will be available to creditors, because their interests are protected.

It seems even the threat or rumor of a bankruptcy can tip a firm that's undergoing an orderly wind-down into bankruptcy court. For instance, when Heller Ehrman's main banks learned that it might file for bankruptcy back in December 2008, (as we reported here), they reportedly swept all of Heller's cash out of the firm's accounts, leaving the firm's wind-up committee unable to pay staff. The same banks reportedly refused to renegotiate Heller's debt. That led to the firm's filing. So given that reality, what can firms do to make sure their wind-up phase stays out of court?

The main conditions are that there be no big surprises; that the firm does a lot of careful planning about how to wind the firm's business up; and that creditor claims do not spin out of control.

Most firms appoint a wind-up committee of partners who will oversee the process. That way, there's still a management structure in place to make sure revenue the firm is owed is collected and applied to creditor claims. The worst case, in fact, is when the firm dissolves and everybody leaves. Then there's likely to be a big fight over the distribution of fees that are collected.

Sometimes, what ends up happening is you dissolve thinking you're going to manage things, then suddenly the picture becomes bleaker and you are forced to file.

That sounds like Heller and like Thelen. Thelen, for instance, voted to dissolve in October 2008, and was ultimately forced into Chapter 7 liquidation proceedings nine months later (as reported here) when a landlord reportedly forced the issue.

Right. Sometimes firms voluntarily initiate the bankruptcy process because they can read the tea leaves. Sometimes they are forced into it eventually.

If the Winston & Strawn deal to take on most of the remaining partners falls through, is Howrey more likely to have to enter bankruptcy?

Not necessarily. If the Winston deal stalled, and consequently people continued to work at Howrey for a while, that could allow the firm to wind up in a more orderly fashion. There's more of a firm left to handle the work that is left.

 

Contact Julie Triedman at jtriedman@alm.com

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