John Morley (Yale Law): The Fall of Weil

Normally, John, you and I sit down with leading experts on a topic, some of the top people on that particular topic. Today, maybe that person is you. Sadly, yes. While Godchel, this firm has been around for almost a hundred years, prestige firm, billions of dollars in revenue, what's happened? In a matter of days, it seems like almost even hours. It's collapsed. It's announced that it's dissolving and winding up its operations. It's stunning. It's stunning. And we've actually spoken you and I separately about how and why law firms collapse. And we're going to talk about that today. But I guess first off, we're very surprised. We're surprised by the way this happened, not that it happened to while. No, sadly, I'm not surprised. So, as you mentioned just a moment ago, ten years ago, I wrote an article called Why law firms collapse. And the article opens with a kind of stylized vignette that was synthesized from three dozen long firm collapses that I studied over the years. And it describes the rough process of a law firm collapse. And I reread that this morning. And when I found out that while was collapsing this afternoon, I thought it unfolded almost uncannily according to script. And it doesn't make me happy to say that, but it was amazing how predictable this all was. Yeah, I'm tempted to add levity to our conversations, but we should get on the table that this is people's livelihoods. This is great amounts of value. This is a lot of disruption happening all at once. What is and we're going to talk in detail, I hope, about exactly the ways in which this will create difficulty for people. I mean, I think it's really important for the world to know exactly how challenging this is going to be for the firm and its partners. It's sad to think about. But when I say this is predictable, what I mean is just that there is a pattern for how these things play out. And it has a logic to it. And while has followed the pattern almost exactly. Well, why don't we talk about this? Do you have a name for your thesis? Is this the law firm implosion John Morley thesis? So it's it's it's based on an article that I published several years ago in the business lawyer called why law firms collapse. And it makes sense of the collapses of many different law firms. At that point, there had been about three dozen law firm collapses that I studied. I looked at bankruptcy records. I looked at news reports. I interviewed people and I identified a general pattern that played out again with remarkable predictability in this case. Yeah, when we spoke in the past, there were other very big names, other Tony law firms that were profitable, were successful, were prestigious, and then were no more. Yeah, that the astounding thing is that law firms can collapse just incredibly quickly. So let me just point out what's really unusual here. Okay, what's unusual is not that a business suffers financial distress. Lots of businesses suffer financial distress. What's unusual is this speed and force with which law firms respond to that distress. What's also unusual is that while was not even in financial distress, not even mild forms of financial distress, its profits were literally increasing from millions per partner. Millions of dollars per partner and they were going up every year and they still collapsed. To think about it this way, Delta Airlines suffered financial distress. General Motors suffered financial distress, Amazon, Uber lost money for decades, and none of those businesses collapse. Delta and General Motors even filed for bankruptcy and yet there's still flying planes and making cars, but law firms never go through even the mildest forms of distress and manage to survive. There's something uniquely fragile about law firms. This is the inability to take outside equity capital. It's related to that, but not quite the same thing. You'd ask me a moment ago if there was a name that I would give to the my hypothesis for why law firms collapse. I guess if I could sum it up, I would say it's what I call the run on the bank hypothesis and I've identified peculiar structural features that make law firms uniquely vulnerable to runs on the bank. John, maybe we can take a quick walk down memory lane and discuss some of the law firms that have had large collapses and what if anything we can learn from those. So there's been lots of them over the years. This is a recurring phenomenon from which it's possible to discern patterns. I think the first really big law firm collapse was a firm called Finley Cumble, which went from being from zero to being the fourth largest law firm in America in a pattern of I think like in a period of like 10 years or something. It had just this explosive growth and then it blew up overnight in the first big law firm collapse. It came to be known as Finley Crumble. There are many other law firms that have collapsed over the years a good example. The most prominent example of this day remains Dewey in the buff, which collapsed soon after the financial crisis after a combination between two firms. In the years since I wrote my paper, there have been many more law firms that have collapsed being a McCutchen collapse. The partners moved a bunch of partners left and then about two thirds of those who remained moved on mass to Morgan Lewis. The most recent major law firm collapse was one called struck and struck in the van, which had agreed investment management practice and a great bankruptcy practice. And basically what happened there was once the bankruptcy practice left the firm became unsustainable. Other names include Seenan Blakey, Howrie, Thienen, I'm sorry, Thienen, Brobeck Flager and Harrison, heller Irman, there's a whole bunch of them. That said, I mean, nothing in this conversation is to suggest that all law firms are doomed to fail. In fact, it's surprising how robust law firms, especially the biggest ones, have proven. That's right. Look, we're going to talk about an analogy between law firm collapses and bank runs, but basically law firms are like banks in the era before deposit insurance. So before there was budget deposit insurance and bank regulation, there were banks and some of them collapsed, but not all of them did. Most of them were able to remain stable most of the time. So it is with law firms. So long as a firm is not out of equilibrium, it can continue operating even under these relatively fragile structural conditions. Is it fair to us to say, John, that if you wanted to compare major law firms with major corporations, major corporations are more likely to have to go through a bankruptcy or restructuring, but the consequences may be less dire. That's a great way of putting it. Law firms are less likely to fall off the table, but more likely to shatter when they hit the ground. Well, maybe we can talk about first the thesis, the run on the bank, how it's worked in the past. Yeah, so the thesis is that law firms are structurally vulnerable because of partner ownership. The way to think about this thesis is it's not an explanation for why particular law firms enter financial distress to begin with. It's an explanation for why law firms tend to respond so violently. Even to mild forms of financial distress, the way I put it is it's not an explanation for why a vase gets pushed off the table. It's an explanation for why it shatters when it hits the ground. It's an explanation of why law firms are structurally brittle in the same way that a glass vase might be. The frag, the fragility comes from the fact that law firms are owned by their partners and the partners can freely leave. In being owned by their partners, law firms are very different from other kinds of businesses. Most businesses, Delta Airlines, General Motors, Uber are owned by investors, law firms by contrast are owned by their workers. What this means is that the workers are acutely sensitive to declines in profits. It also means that the lawyers are acutely exposed to certain forms of liability and both of those forces reward partners for leaving early and punish them for leaving late. Let's start with the first of those two, the fact that law firm partners are uniquely exposed to declines in profits. What happens is one partner leaves the firm for any number of reasons. In Mike Ayello's case, the motives appear to be complicated, some mix of grievance about the governance of the firm and his compensation. Remind us who's Mike Ayello? Mike Ayello is the very senior rainmaker at while whose departure to Kravath a week ago started the firm's final death spiral. So what happens is when one partner leaves, that partner takes business with him and the firm is left with fewer revenues because the business has gone, but many of the same costs. The firm is still paying the same office leases that it was before Ayello left, for example, it still might have pension debt outstanding, it has employees, associates and staff who it's got to pay. So the firm has fewer revenues, but the same costs and as a result, it becomes less profitable. That means that the partners in the aggregate have to experience a reduction in compensation. Some of their compensation might be, the compensation of some partners might be held the same, but the compensation of the rest has to go down. That's just simple arithmetic. Therefore, this was the partner who was bringing in some of that upside, some of that extra profit that was being shared to retain the other partnership. That's right. And again, because the firm is stuck, when the first partner leads, he'll reduce the firm's expenses as well as its revenues, because the firm now no longer has to pay that guy his partner draw on the other hand, but but but often he'll reduce the revenues more than the expenses because it takes a bunch of clients and yet the firm has to still has to pay the lease on that guy's corner office. Got it. And he's probably not taking all the associates who are that are also huge expenses. Exactly. Or the staff or the copy machines or the pensioners or any of the other debt or the bank debt that the law firm might have. And so once the firm's profits decline, then the next partner becomes more likely to leave because that part instead of being paid two million years now getting paid 1.9. And so if another firm comes along and offers him 1.95, he can get a raise now, whereas previously he could not. So then the next partner becomes more likely to leave and then the next partner and then the next partner and so on in a spiraling cycle of decline that becomes a kind of run on the bank. John, what about liability because we talked about some costs. What about liabilities? Yeah, so this is also connected to worker ownership and it's another reason why partners leave an aspiring cycle to resembles a run on the bank. So by virtue of being partners rather than mere employees, the partners face unusual forms of liability that reward them for leaving early and punish them for leaving late. The most important one is a form of liability called fraudulent transfer liability. This is a basic and widely used element of American bankruptcy law. And it says basically a debtor can't give away assets on the eve of its bankruptcy. You don't want a corporation giving away money to its friends and its shareholders and then filing for bankruptcy the next day and leaving the firm as a burnt out shell with creditors getting nothing. So the creditors can call back money if the firm has given it an exchange not for reasonably equivalent value. Well, it's horn book law that a dividend on equity is a kind of giveaway firm is not obligated to pay distributions on equity. So if you choose to pay a dividend to stockholder at it to stockholders at a moment when you're insolven or on the eve of bankruptcy, you've given money away to the detriment of creditors. That's not true of wages because wages are a payment on a contract that a firm is required to pay. But distributions on equity, those are discretionary. So this is impacting the partners that are left and not the associates, right? So Apple or Berkshire Hathaway haven't paid dividends in decades and they don't have to because it's discretionary. Well, in bankruptcy and law firm bankruptcy is the partners inevitably show up and say, oh, well, judge, this was this was salaries for us. These were wages. And the judge says, I'm sorry, you were partners of the firm. You were owners. These were distributions on equity that the firm didn't have to pay. And the reason that so the reason that rewards partners for leaving early and punishes them for staying late is that that form of liability only commences once the firm becomes insolven. And it only extends back two years prior to bankruptcy. So suppose that while we're to become insolven today, but it didn't actually cease operating for another six months, all of the distributions to partners in that intervening six months would potentially be caught back by a bankruptcy court. So if you're a partner at while and you're looking at, you think there's a 50% probability that the firm will file for bankruptcy in the next six months, you have to apply a 50% discount to every dollar compensation you expect to be paid over that period. Let's talk about holdups you've written about this. How does it apply in this bank run situation? What happens is that as a firm gets closer and closer to collapse, each partner's departure becomes marginally more significant until finally at the very end, one or two partners can credibly threaten the destruction of the entire firm. So the most famous example of this, or I think a really illustrative example of this, was Mort Pierce, who was a partner at Dewey and LeBuff. And this has been reported in James Stewart's fantastic article in New Yorker about the collapse of Dewey and LeBuff. Mort Pierce at that time was earning something on the order of five million dollars a year, which at that time felt like just an absurd amount of money. And he went to Steve Davis, who was then the chair of Dewey and LeBuff and said, "I want you to increase my compensation to eight million dollars a year and pay me a one-time lump sum of $60 million or else I'm leaving and I'll destroy the firm." That's exactly what he did. They couldn't pay him $60 million. Now, here's the crazy virtual. A law firm partner can credibly threaten to move, even if another firm is offering them less than what he's currently making at his current firm. And the reason is that, as a firm enters the debt spiral, people who stay have to discount the compensation. If the discounted by the expectation that will be called back from you, so if I'm being paid a million dollars a year and the firm has a 50% chance of collapse, it's really only worth $500,000 to me. So if another firm shows up-- More or less, because you have to consider your lifetime earning capacity. Well, I can move to another firm, but yeah, I got a discount, any compensation I'm getting by the probability it'll be taken from me. So if another firm comes along and offers me $800, well, in normal times, the chair of the firm that I'm currently at would just call my bluff and say, "Fine, you want to move for $800? I'm offering you a million. Do it." And of course, I won't do it. But if the firm's on its last legs, I can say, "Pay me $1.5," which after the discount will work to $750, or else I'll move for $800. Okay, so you're saying it's not just greed, it's actually rational price setting. When I first heard this example, I thought, "Oh, this guy knows what leverage is because he's probably an incredible negotiator, and he's maximizing his leverage." Your point is he may be doing that, but he may also just be effectively valuing the value of his future earnings at the existing firm. That's right. So rational, it's not even particularly mean or self-interested. These partners are trying to keep them--they're not trying to improve their position. They're just trying to stay in the same position. So return to the mathematical example. If I'm being offered $800 by the next best firm, and I go and demand $1.5 after the discount, it's only $750. I'm willing to stay for a $50,000 pay cut, and all the risk that comes with it, I'm being generous by asking only for $1.5 million. Well, what about that $60 million lump sum? Well, that's a little much, that might be on the leverage side of the negotiation. That very well might be. Yes. Well, what did happen today with Woa? So the leaders of the firm did a video call in which they announced that the firm was going to wind up its operations. I think it's a little unclear whether the firm intends to hold a formal vote to dissolve, and either way, the firm plans to do an orderly wind down. So what we understand at this early stage from news reports is that the firm plans to continue operating for another month or two, basically, while its partner has transitioned their clients to other firms. Well, and it sounded like based on what you were just saying prior that they likely won't be able to get distribution payments for the work done in that period. It's really sad and it's even worse than that. So sure, if I have clients who are paying me over the two months, it takes me to leave while all of that money is going to remain with the firm and potentially its bankruptcy estate. If it ends up filing for bankruptcy, I'm not going to see a dime of that. What's more is that we're now talking at the end of October, and the ordinary pattern of a law firm partner compensation is that a firm will pay out modest draws to partners on a monthly or quarterly basis that amount to about 50% of the partner's total expected annual compensation. And then the firm will make a lump sum payment, a much bigger payment, usually around mid-January after the books for the prior calendar year have been settled. What this means is that the partners of a while have basically worked for 10 months out of the year, 2026, and half of their compensation corresponding to the 10 months is going to get sucked into the bankruptcy. So if you're a while partner, you just lost nearly half of your compensation for the year. It's just gone. That's a whole lot of wealth that just went out the door. Why would there be a deficit at the end of the calculus? These law firms do have some expenses. They have a building lease. They have software contracts. And they otherwise run a little bit more lean than other large, multi-billion dollar businesses. Why is there this deficit? Why do you think the deficit would be that big that would swallow the entire or a large portion of this unpaid amount? There's a few reasons. So let me just observe that so far as we know, while doesn't have large bank debts, and that's a really interesting fact that I think we should talk about in a moment. But while does have a lot of what in bankruptcy partners would be called trade debt, presumably it does. So it has vendor contracts to Lexus, Nexus and Westlaw. It has lease obligations. It might have pension obligations, health care for its employees. The employees will also have already have accrued wages of the staff and associates, which under bankruptcy law get priority over many other forms of obligations. And as you said a moment ago, law firms tend to to run pretty mean on cash. They distribute almost all of their cash at the end of every year, and they're continuously distributing it throughout the year. So there's usually not a lot there. And when you consider that the firm's lease obligations probably last for decades, the potential liabilities on those lease obligations are tremendous. And so even if there are no financial creditors here, there are enough landlords and trade creditors to eat up whatever cash is there. You mentioned that there's little debt. Is that unusual for a law firm of this size? It's a little unusual. Actually, most law firms have a modest amount of debt because law firms have fairly cyclical cash flow cycles, right? They collect at the end of the month and then also disproportionately at the end of the year. They tend to have revolving lines of credit that operate a lot like credit cards. You can borrow money this month, then you pay it back, then you borrow it again next month. And so even very healthy law firms will often have a certain amount of revolving credit lines to fund their cash needs over the course of a year, while it appears not to have really done that or at least not to have borrowed a lot of money on those revolving credit lines. And yet it collapsed anyway. I think this highlights one of the most interesting implications of my thesis, which I called out back in that original article several years ago. And that was that law firms don't really collapse in response to debt or even in response to insolvency. A law firm can collapse even when its profits are increasing. And here's the reason why law firms have freakishly robust capital structures. They're highly fragile, even as they also have these incredibly robust capital structures. It's the strange paradox. They have robust capital structures because their largest expense, namely partner compensation, is not actually an expense at all. It's a discretionary distribution on equity that they could choose not to make. Or imagine if Apple didn't have to pay half of its employees. That would be an incredibly, incredibly robust capital structure. And so even substantial debts ultimately aren't that substantial in the grand scheme of things if we look at a law firm's overall capital structure. If we believe the run on the bank hypothesis, what really matters is not debt or insolvency. What matters is relative profitability. I say relatives. That's right. It's not their absolute profitability that matters while illustrates that perfectly. They were making on average, I don't know, something like five million dollars per partner a year. Huge profits. But their relative position relative to their peers gradually deteriorated. 20 years ago, while it was a very top firm, now it's fallen many places. Over the years, it gradually fell many places in the profits per partner ranking. And relative profits matter because the key driver of a law firm collapse is lateral movement. And if you can get paid more at Simpson Fatcher, it doesn't matter whether you're making five or ten or 15 million dollars a year. At while, if you can make more at Simpson Fatcher, you will move. And it's the most productive ones that are getting those offers. It often is. The way I put it is that it's often the partners who are net contributors rather than net takers from the firm. That's not the same as the most productive partners, but it's often the point. So the most productive partners aren't necessarily net contributors. If I bring in 20 million dollars a business a year and take out 21 million in compensation, it's going to be hard for me actually to move to another firm even though I'm a major rainmaker. But if by contrast, I'm bringing in 20 million a business a year and only getting paid five, then probably I can move to another firm because I'm a major net contributor. And so that's really quite damaging because it means that the people who are leaving are often the ones who are keeping the thing afloat. Yeah, that's right. You mentioned kind of the robust cash flow of the law firm model. It kind of reminds me of our conversation with John Quinn when he was talking about expanding Quinn Emmanuel from a smaller firm to this global litigation powerhouse. He talked about, we asked about the expense of expanding of bringing in new partners and he sort of shrugged it off saying, well, these partners are are coming to the firm with a lot of revenue. You can keep a firm together at virtually any level of profitability. So long as each partner is getting paid an amount roughly proportional to their market value, right? A partner won't leave unless she can make more money by moving to another firm and usually substantially more money. Yeah, just moving is a cost and moving. Yeah. That's right. It needs to be not a hundred percent of what they're currently making, but a hundred plus x percent in order to account for the cost of moving. So as long as you can get somewhere in the zone between a hundred percent and a hundred plus x if you can if you can compensate them somewhere in that zone, you can reach a kind of equilibrium where people won't move. And so I think John Quinn's point was to look, if I can accurately calculate the market value of a partner, then I'm not going to encounter a run on the bank because I'm not underpaying people and therefore exposing myself to a risk that I'm going to collapse. You saw this by the way recently at Wachtel Lipton. So Wachtel was famously until very recently a lockstep compensation firm, which creates winners and losers. Some people produce at a higher rate than the lockstep compensation. Some people produce at a lower rate, which gives an incentive to the people who are producing at the higher rate to leave. And so in order to stop itself from entering a death spiral, Wachtel had to move to and eat what you kill system in order to create that equilibrium. I was just describing where people are being paid just enough that they won't move to another firm. Well, I want to talk a little bit later about why Wachtel wasn't able to compensate. But before we get to that, there are a couple of other factors in the model that that can exacerbate the run. And one are the specific ethics rules. I think I referenced one earlier. But maybe you could speak to this. Yeah, there's two sets of ethics rules that are relevant here. One is the set of the rules that requires a law firm to be owned by its partners. Yeah, we've talked a lot about this. We've talked a lot about that. But that's actually in some ways less interesting here. The more interesting rule is the set of rules. I think it's in rule 5.6 that prohibits a lawyer from signing an agreement that would prevent the lawyer from moving firms basically to put it a little bit crudely and limited restrictive covenants on departures. Exactly. You can't do that in law firms. You can do it in accounting firms. You can do it in physicians partnerships. You can do it in engineering firms or marketing advertising firms. But you can't do it in law firms. And that makes law firms unusually vulnerable to the spiraling cycle of decline. To be clear, this is the claim here that this is to protect the clients. If a client needs your services, you should be able to do it even if you have to leave the firm. Yeah, that's the argument. If a client has a lawsuit ongoing, the client has a right to engage whatever lawyer the client wants, even if the lawyer has moved firms. And look, there's occasionally good reason for this. Suppose, for example, you and I have a law firm together and you take on something. So would I? You take on some big client whose it has interest adverse to my client. And now we either have to fire your client or fire my client or I have to leave the firm. And if I have to leave the firm, it's important that my client be allowed to follow me and that I not sign some restrictive covenant. It's going to leave my client in the lurch. That's the argument, right? But in this case, it weakens the structure because you can't build in this. I don't know what would you call it like speed breaker just to slow the Exodus? Yeah, that's right. So in the United Kingdom, for example, this restriction on covenants, on non-competes and other covenants, not the move, don't apply. There are, there's no equivalent to rule 5.6 in the United Kingdom. And as a result, you've never seen a major loss from collapse like this in the United Kingdom. The other rule also doesn't apply to the United Kingdom that law firms in the UK can now also take equity capital from non-loyers. Yeah. And actually that really illustrates the truth of my hypothesis. So a few years ago, there was a publicly traded investor owned law firm in England and Australia called Slater in Gordon. And Slater in Gordon did an acquisition of another firm that was never even a law firm. Actually, it provided a mix of medical services and legal services to people who got injured in car accidents. And it turned out that the firm had overstated its value with the result that Slater in Gordon had massively overpaid for this asset and it had huge debts that it couldn't service. So what happened? Slater in Gordon filed for bankruptcy. It reorganized its debts, it wiped away its equity, turned its junior debt into new equity, and it continued operating. It broke into two different firms, one in Australia, one in the United Kingdom, and it continued operating. In other words, it did what General Motors and Delta airline did. And it was capable of doing that because the partners were not equity holders. Imagine what would happen if you tried to do a reorganization in a bankruptcy at wild dot shawl. And you went to the current partners and said, your equity is here by wiped out. We're instead going to give all of the equity to the landlords. The partners would just leave. They would just leave. You can't, you can't do that in a law firm. Yeah. Yeah. So at Slater in Gordon, the investors had contributed money in order to buy their shares. And the money was stuck inside the business. They couldn't pull it out unilaterally just because the firm had gone bankrupt. By contrast, the key asset of a law firm, the labor of partners, can be easily withdrawn unilaterally by any partner at any time. Yeah. We could have certainly imagine other structures that might make this more robust, but those aren't currently, not currently within the guidelines of ethics rules. Yeah. That's right. I think if law firms could be owned by investors, they would be a lot less vulnerable to these forms of collapse. To be clear, that doesn't mean we should allow law firms to be owned by investors. Investor ownership of law firm is a complicated and multifaceted thing. And it's effect on the risk of law firm collapses is only a minor piece of it. But if our goal were only to prevent law firms from collapsing, that would be one reasonable way to do it. Look, another strategy would be allowed to allow lawyers to sign covenants and other contracts that would prevent them from moving. That would be another way to slow down the pace of collapse. Let's get into the nitty gritty about while what you mentioned, one major partner moving to Kervath. What were the what were the drivers of this run on the bank? So I think the really important background here is that while's profits while's profits had been increasing steadily, but at a much slower pace than those of its competitors. In other words, its profits were increasing, but its relative profits were declining. And that had been going on for many years. While has this amazing debtor side bankruptcy practice, it's a very specialized practice. There aren't very many of those in the world. It also had a really great transactional practice years ago. And as a result, while entered the financial crisis in a pretty strong position, its bankruptcy practice represented many of the large financial institutions that went bankrupt in the financial crisis. And it did very well. But it didn't make the investments in private equity, that other top tier transactional law firms were making after the financial crisis. And as a result for that and other reasons, its relative profitability steadily declined. So while was a perfect case for a potential run on the bank, because as I said a moment ago, and as I said in that article many years ago, the key determinants of a law firm's vulnerability to collapse is its relative profitability. I think also while had, again, I'm just looking at the news reports, it had an unhappy governance culture. The governance was highly centralized around a couple of players, Mike Aiello and Barry Wolf. I gather that there was a lot of unhappiness about their influence within the firm. There was a lot of tension about expansion strategy and other elements of strategy. And so the firm was vulnerable because people didn't have strong, non-financial reasons to stay. One of the things, as I would say, the culture, they had invested in the culture amongst the parties at least. So contrast while with Wakatell. So Wakatell recently experienced a number of partner departures, but did not think and do not think that Oakfeld is at any serious risk of collapse for two reasons. One is that Wakatell remains really, really profitable. It's lead over its next, yeah. It's always been the most profitable firm for a very long time and it continues to occupy that position. Yes, Kirkland analysis is nipping at its heels, but Kirkland has a much more highly leveraged business model. In any event, partners at Wakatell are making so much that there aren't many other firms that could offer to pay them more. So it's relative profitability is still quite strong. The other thing is, Wakatell still has a very strong culture. Still just has one office. It has a very strong story about who the firm is. They have a very focused prayer area, the founder of the firm, Marty Lichten, is still coming into the office on a regular basis. And so for that reason, I think Wakatell, notwithstanding the troubles it had lately is not at any serious risk of collapse, whereas why all because of the weakness of its culture and its decline in relative profitability was at much more serious risk of collapse. I mentioned that the firm hadn't invested after the financial crisis and in growing certain practice groups that have proven to be very lucrative. Was there a fragility in their in the concentration of their legal practice? Yeah, so when business generation is widely distributed, a firm tends to not to be strongly damaged by any particular partner's departure. But when business generation is highly concentrated, things get messier. A firm can simultaneously become more fragile and less fragile, less fragile because when non-business generators leave, you don't really care. More fragile because when the handful of mega players do leave, it's catastrophically damaging. And that's what we saw with the departure of Micah Yellow. He left into several other partners in associates and a lot of business with him. And when you lose a huge chunk of your business and one fell swoop like that, it's really damaging. And he would talk about it. Yeah, one way to think about it is while didn't have a diversified portfolio and had concentrated portfolio. And so when one of the loans went sour to return to the bank analogy, it started to run. Could a firm with this run of the bank model shrink by focusing on a few of the remaining crown jewels and attempting to cut the rest? Yeah, a really good example of a firm successfully pulling that off is Boyce Schiller. So Boyce Schiller entered a period of distress for a number of reasons. David Boyce, the founder of the firm, was growing older and contributing less to the firm. Boyce had also taken on some controversial representations that many partners of the firm didn't like. And as a result, people began leaving. It was unclear for a long time, whether that firm was going to survive. But ultimately did. And it continues in business today. And the reason was that they were capable of chopping a lot of partners and a lot of associates and office space. Boyce Schiller didn't have a really big Manhattan office. It didn't have a big office piece. It presumably had not taken on a lot of debt. I'll also say Boyce Schiller was a litigation only firm. And litigation only firms tend to be more robust for a number of reasons. One is that they tend to be less star driven. Boyce was relatively star driven. But but the big star David Boyce was never going to leave because his name was on the firm. Also litigators have a harder time moving than transactional lawyers. Transactional matters tend to be briefer in duration. And so it's easier to port them over to other firms. So Boyce had structural features that made it more capable of cutting costs than firms like like while. Got it. Some of these prior issues with law firms have revolved around leadership transitions. Was that part of the wild issue as well? Yes, the background is that Barry Wolff who'd been the chairman of the firm for a long time was due to step aside and be replaced by a Ramona knee, a partner in Boston who did private equity work. And one of the kind of shocking elements that emerged in recent news reporting is that she decided a couple of months ago that she was not in fact going to become the successor to Barry Wolff but she left the firm kind of in limbo from a leadership perspective. Leadership transitions are a fragile moment for many law firms and they've been the trigger for partner runs in many other firms. A good example is Brobeck Flager and Harrison. So Brobeck was a San Francisco based firm that collapsed just after the dot com bubble burst in the early 2000s. And the immediate cause of the collapse was the departure of a man named Tower Snow, who was a mage brain maker and who wanted to be the chair of the firm and wasn't able to be. Another good example is a firm called Oldheimer and Gray which was based in Chicago and which collapsed after the chair of the firm. A guy named Jerry Chico left the firm to run for Senate. When you have a leadership transition you often have both the potential departure of a mage brain maker and also a potential loss of confidence in the governance of the firm by many of the partners who remain. And I imagine the increased risk that the biggest names at the firm may wish to fight it out for control. Yeah, exactly. There's a lot of big egos here obviously and they can't all be at the top of the heap. And so when the time comes to designate someone at the top of the heap is potentially going to be departures that happen as a result. Another major I don't know motif amongst these law firm collapses. The big ones that we've discussed involve mergers either mergers that succeeded or involve mergers or attempted mergers, sometimes a connection that actually a connection, sometimes a combination. Sometimes a combination that proves to be less valuable than it was originally anticipated. What's going on here? This really, I think, illustrates the apness of the bank run analogy. So often when banks are in distress, they go searching for merger partners as well. We saw this during this financial crisis, and this is how we ended up with the unusual combination of Bank of America and Merrill Lynch. Bank of America, this elite Wall Street investment bank, was experiencing a run on the bank. So it went and searched for a partner in Middle America, the Bank of America, and was able to survive as a combined entity. Bank mergers work to stave off runs because it basically builds confidence in the health of the bank. The depositors of the weak bank say there will be plenty of money to backstop our claims because we're now just a small sliver of this much larger bank. And even if all of us withdrew our cash now, there would still be enough left to satisfy all of our claims. That is to say all of us from the fragile bank. It's a similar phenomenon in law firms. The theory is that if we're now instead of being part of a 1,200 lawyer firm or part of a 3,000 lawyer firm, then the marginal impact of each partner's departure becomes much smaller and it becomes easier to sustain a practice. A really good example of a firm saving itself in this way was Pat and Boggs. So about 15 or 20 years ago, Pat and Boggs was experiencing a partner run. And it went in search of a merger partner. And while the search was going on, the chair of Pat and Boggs went around to each of the partners at the firm and said, will you please stay, I'm going to try to find a way to make this stop. And he was able to do it. And eventually the firm merged with Squire Sanders, which is now we have the firm Squire Pat and Boggs. Another example is Bingham McCutchen. So Bingham McCutchen ultimately ceased operations. But after the firm had bled a lot of partners, they engineered not a merger but a mass movement of them. We're about two-thirds of the partner moved partners moved over all at once to Morgan Lewis. Same basic concept. Right. And a slightly different one. I guess the analogy to M&A would be instead of a merger, you have a sale of assets. Sale of assets, yeah. Yeah, exactly. Talk to a partner today who's firm went through a merger. He wasn't one of the big rain makers who was brought in on early negotiations. He said his first conversation was the managing partner saying, we want to do this merger. It's essentially a done deal. We need your equity vote. And if you don't, it's going to be come public that it was a failed merger and that's going to create a problem for the firm. I've heard actually several stories like this, they're crazy, but but completely believable. But completely believable. And here with while there was a conversation about a merger in my right with Wilkie. There was there was also conversations about merger with fresh mergers with fresh fields and link layers or at least that's been reported in the press. I mean, while it was in a really tough position, because what it really needed was another firm that was both very large and also not really present in New York. And there just aren't that many of those left. This is why it did not surprise me at all that they went after link layers and fresh fields. But for a variety of reasons that I don't fully understand UK firms. That's right. So Sherman and Sterling, for example, was not really experiencing a run, but its relative profitability was declined. Sherman and Sterling had a history very similar to Wiles where they went from being a super elite firm to moving 10, 12, 15 spots down the rankings in the time since the financial crisis. And I think they saw the writing on the wall and got ahead of it and merged with ANO, Ireland and Overy, which was delighted to merge with Sherman and Sterling because it gave Alan and Overy a really strong New York present practice. And even though those were very geographically diverse firms, it turned out that the geographies didn't overlap very much and the clients didn't overlap very much. Wiles was a much tougher case because there just aren't so many mega firms out there anymore that don't have strong New York presences. One also has to wonder, Wiles has this debtor side bankruptcy practice and I don't really know, but I wonder whether that made a merger difficult. You know, there aren't many really big debtor side bankruptcy practices. You know, to handle, sorry, to handle the bankruptcy of a big debtor, you need a lot of people and it's really lumpy. The bankruptcy comes in, but you can't necessarily keep a steady flow. It's like Feast or Famine. It's kind of a slightly risky practice to take on. It also creates lots of conflicts. Because if you represent lots of creditors, it's hard for you to represent lots of debtors. And so I wonder whether that group was an obstacle in the merger negotiations for a while. Really? Yeah. Even though it's a very different group. Yeah. You don't want to bring in the crown jewels and then find out that it conflicts out a bunch of your most valuable clients. Yeah. And it may well have been the healthiest part of the firm. I've seen no reason to believe that that part of the firm was not thriving. It's just, it's hard to move that without upsetting the other aspects of a firm's practice. And from our conversations in the past about AI and perhaps what AI may be doing disrupt a number of industries. Unfortunately, I suspect that practice will be very much in demand at some point in the future. Yeah. I'm sure it will. What do you think is going to happen in the interim? Maybe we can start with the partners. So the partners will leave one by one in search for new firms. And they're going to do that as quickly as they can. And the reason is because they don't want their compensation between now and the time they move to get sucked into a wild bankruptcy. The partners are basically working for free until they're able to move because whatever they bring in between now and the time they move is just going to get sucked, sucked up by the creditors. And so no partner wants to do that. They're going to keep doing it in order to keep their clients happy, but they're all going to be looking to get out as quickly as they can. What about the managing partner? Does he or she have to go down with the ship? Not necessarily. There's been talk that Ramona Nee who was on deck to become the managing partner, but didn't actually become the managing partner that she couldn't move any day. And indeed, there have been other situations where managing partners move. So returning to boys, she'll are Nick Gravante, who I think, if I remember correctly, was the chair of that firm moved while he was the chair to Cad Walleter. So it can happen. It can totally happen. And indeed, it's going to, it's going to happen. So the partners will move. And I guess the question is, well, what becomes of the associates and the staff? The answer is, well, they're essentially no different than the associates or staff of any other business that's shutting down. You know, like when a retail firm has a going out of business sale, there are a few people who stick around in order to make sure that the product gets sold. But most of them leave as quickly as they can. And that's what the associates and staff will do. Some of them will follow partners to other firms. Some of them will just be out of the job. It just seems like a recipe for the most disruptive transition possible when all the major players are so incentivized to leave and to leave immediately. Yeah, it's right. So often people ask me, like, does the collapse of the beloved firm really do the world any harm? If all those partners move to other firms, isn't the world as well off as it was before? Yeah, sure that firm is gone, but there's as much value being generated in the legal industry in the aggregate as there was before. And my reply to that is that's not exactly true. And even if it is, there are still distributional consequences that are worth thinking about. So it's not exactly true because moving is really painful. It's really hard. A lot of clients will get lost, supposed that there are three partners that are all serving the same clients and two of them move to one firm and the third of the moves to a different firm. Are they going to be able to keep that matter together? One of them is going to lose that relationship. At least. Maybe they all will. Maybe they all will. What if that client was only working with those three partners because the firm had other capabilities that the client was interested in? Well, now that firm might not work with any of the lawyers that it worked with before. Also, like, you know, people, when I interviewed lawyers about law firm collapses, they used words like death and divorce to describe the difficulty of moving to that emotional. Yeah, really emotional. Some of the partners might even go personally bankrupt. So this is less of a risk than it used to be because of the elimination of an unusual form of liability called unfinished business liability. This was where even after they lateraled, they had to continue paying the old firm. This form of liability was absolutely bonkers. When New York eliminated it, the New York Court of Appeals eliminated it in the bankruptcy of a firm called Thielum about 10 years ago. So what it said was that if a partner moved to a new firm after the firm dissolved, then the partner had to return to the old firm, not only the billings that the partner generated before moving, but also any buildings that the partner generated on matters that were outstanding after the partner moved. So if I'm working on a lawsuit for a year and three months into the suit, I moved to a new firm. I have to return to the old firm, not only the three months that I build before I moved, but also the nine months that I built after. It was crazy and it resulted in a lot of partners going personally bankrupt or suffering serious financial distress. So Mike Lee, the U.S. Senator from Utah, lost his house in the bankruptcy of Howrie while he was sitting as a U.S. Senator. There was a famously a partner I forget his name and I wouldn't repeat it even if I remembered it, who was profiled on above the law, a partner from Dewey and Mabuff who had to file for personal bankruptcy after the collapse of that firm because he faced so much liability coming out of it. I was saying that the Dewey case involved many of the partners taking personal liability for the lease. I don't think that happened in Dewey, but that did happen in several other collapses including Brobeck. So what happens is as a firm deteriorates, the partners try to hold it together and law firm lenders and landlords are savvy to the phenomenon that I've described. They know that spiraling cycles of departure can begin a death spiral and so loan and lease obligations typically have covenants that get tripped when more than a fixed number of partners departs over a fixed period of time. So what happened in Brobeck is that the partners were leaving and then the landlord showed up and said, "Hey guys, too many partners left, you just trip the covenant." And so then the partners in Brobeck said, "We can hold this together. What do you need from us?" And the landlord said, "I want personal guarantees from every one of you." So then they did it and then the firm collapsed anyway which meant they were now personally on the hook. Yeah. It was really sad. Yeah, that's tough and it also sounds like you're saying that some of the lawyers who got out a little bit earlier weren't on the hook for those liabilities. So the craziest thing about unfinished business liability was that it only applied to lawyers who left after the firm dissolved. So if you left 30 seconds before the firm dissolved, you didn't have any liability. If you left 30 seconds after it, you got hammered. And it was just amazing to watch these law firms naively declare a dissolution without realizing that by so doing, they were saddling all of their remaining partners with all this liability. Could they have done a mass retiring 10 minutes before? Like you said, they could have done an asset sale which was exactly why Brobeck, I'm sorry, being a McCutchen engineered the mass move to Morgan Lewis rather than declaring the dissolution of the firm. Being a McCutchen said, we've negotiated a mass move for all of you. Get out now. Let's just leave the firm still operating as a burnt out shell. We won't dissolve it at all and the unfinished business liability won't fall you. So that I predict is what will happen here. And could they stand up their own new firm and have that buy out the or lateral the the lawyers if they're not able to find what do they call it a night in shining armor in time? Yes. So one of the most hilarious law firm collapse stories ever was when a group of partners left a firm called Dixon Carlson and Campilo, a little firm in in California. And the partners of this little firm said, screw you, we're going to dissolve today before you leave and before accepting your resignations and as a result, saddle you with unfinished business liability. So that's what they did. They dissolved and then reorganized the next day without the new partners. And it worked. The department of a spite bankruptcy or a spite dissolution. Yeah. And it worked and it's saddled all of those departing partners with unfinished business liability. Well, what about what's going to happen to this? You mentioned that they have or at least they had the the Tony debtor practice. I mean, and Ron GM, the biggest bankruptcies of our of my lifetime, we're all handled by while what's going to happen to that that practice? I don't know. I think the big question is, can they hold it together? Can they move it as a unit? I bet they'll be able to, but it's going to take a really special firm to absorb it, one without a lot of creditor representations, for example. I don't, I don't really know, but they're going to be trying hard to keep it together because as I was saying a moment ago, there's only a few firms in the world that can handle the bankruptcy of a really big debtor and it relies on scale and the scale only works if they can keep the thing together. So they're going to be trying hard to do that. I mean, good luck to them. Is this storied bankruptcy law firm likely to go through bankruptcy? I don't know. Let me say a couple of things. The first off, I'd said that they might wait to dissolve in order to avoid unfinished business liability. I want to be clear that because New York has eliminated unfinished business liability for everything other than contingent fee matters, there may not be a lot at stake in when the firm declares a dissolution because to be clear, the firm can continue to operate even after it's dissolved so long as it's winding its business down. So there's not actually that much at stake. They have other offices. Would New York law still govern? If the firm is a New York partnership, as I assume it is, then yes, New York law would govern. It's the internal affairs doctrine. It's presumably, I presume, I don't know, but I presume that it's a New York limited liability partnership. So your question is, will it file for bankruptcy? The answer is, I don't know. Many collapsed law firms have not filed for bankruptcy. Being a McCutchen didn't file for bankruptcy. If you can work out an agreement among the creditors without filing, then there's no particular reason to file. Furns tend not to file when there's a large bank lender with secured debt because that secured lender will often get up all of the assets. If the news reports are accurate here and there's no such bank lender, then it will mostly be the landlords with perhaps a few trade creditors thrown in. While has a lot of offices, but it's not implausible to think that those creditors will be able to coordinate a resolution to this without having to go through the unpleasantness of an actual bankruptcy filing. Before we let you go, what does this say about the market? Are other firms now up on the next on the chopping block? I think that this event is very, very sobering. It's sobering because it demonstrates the truth of something I said in that article several years ago, which is that a firm doesn't have to be in financial distress, serious financial distress. It doesn't have to be installed and it doesn't have to be heavily laden with debt. We don't have to be in some kind of macroeconomic crisis like the financial crisis or the dot com bubble. A firm can collapse even on a very clear day. These are boom times for law firms. And yet, while God shall, a hundred-year-old firm is now gone in the span of weeks, I think what it illustrates is that if you are a firm that's experiencing a relative decline in profitability, you better get your house in order. You better make sure that your partners are compensated well relative to their market value. If they're a partners who are being overpaid, clut their pay, or let them go, I think that the pace of lateral movement has grown so rapid that it now puts much greater pressure, even on relatively healthy law firms, than it would have even five years ago. Firms, I've been going around for a long time, telling people how fragile law firms are. You know this from our episode with Brad Corp, where I talked about how the risk of collapse was a real thing and people laughed at it all. God, I was so struck by this and I wanted to ask you about it, but continue. It makes that fear feel so much more real. People laughed at me and they were like, come on, there's no way a firm like that would collapse. If that executive order had stuck against Paul Weiss, it would have been not in like the mild financial distress, the relative decline in profitability, while it would have been in a much more serious form of distress. It had a very store-driven, it still has a very store-driven culture, so that just a few people left the firm would have been profound at distress. It really does dramatize the seriousness of the risk that that firm fixed. And it underlines the power, the scary power that those executive orders wielded. Exactly. A question people asked me over and over and over again when I talked about those executive orders was, well fine, so the profits declined from $6 million to $5 million a year who cares. Remember how important relative profitability is. Also, there would have been many partners who couldn't continue representing their clients if the firm had those serious problems. Now look, maybe Paul Weiss should have taken the risk anyway. I think that's a point that people can reasonably dispute. My point is just to say that the risk could indeed have become existential, and I think that the collapse of while it was straights that all but the healthiest firms are potentially vulnerable. I love disagreeing with you, but on this one, it feels so true. If you had some advice for a firm who's further back in this cycle that may have time to write the ship, what would you give? I'd say a few things. I think there are long-term strategies and short-term strategies. Let's start with the short-term strategies. If you're a healthy firm, and you're in a state that has not yet abrogated unfinished business liability, and to be clear, New York, California, and DC all have, but if you're in some other state, like, say Illinois, you should adopt a waiver of unfinished business liability in your partnership agreement. Don't wait until the firm is in distress because number one, it will be a fraudulent transfer that won't. Even healthy firms should be doing this. Especially healthy firms should be doing it. You don't want to wait till you're in distress because it'll be voided as a fraudulent transfer in bankruptcy. Also, because once you're in distress, if you say, "Oh, we're thinking about doing this," it will only deepen the distress. A partner run is like a bank run in a sense that it's a self-fulfilling prophecy and anything you do to increase the cost. You have emotionally driven. That's right. And rationally driven, like, the higher the odds of the collapse, the more I have to discount my future pay for the probability that it will be taken from me. Second bit of advice is just to make sure that you're in that equilibrium where your partners are being paid their market value or just below their market value. Take a careful look and make sure you don't have people who are being overpaid or underpaid. If you have people who are being underpaid, they're flight risks. Also ask yourself, have I experienced a decline in relative profitability over the years? If so, then that's a real risk and you should be. God, John, I think you might be signaling an avalanche of true ups in partner pay that may be coming this way. Partners may be getting significant financial haircuts next year. Or raises. Again, that's essentially what happened to WakTel, right? They went from a lockstep compensation system which created mismatches between partner's compensation and market worth and it moved to what you kill compensation. A few partners left because they weren't happy with how the adjustments were taking place, but they're basically doing it a more extreme way, what I'm suggesting that any other vulnerable firm do. Let's talk about long-term strategies. What can a firm do over the long term? So one thing it can do is to try to cultivate firm level rather than partner level client royalties. A partner's departure only damages a firm if the partner can take clients with her, but if the clients are loyal to the firm, then the partner's less likely to take the clients with her. Another thing you can do is just get ahead of succession planning, build faith in the next successor, try to avoid hurt feelings. I mean, all this goes without saying and you should do it even if you're not concerned about a law firm collapse, but that's another thing you can do. Another strategy is try to build a strong firm culture, firm culture, again, something you should be doing anyway, but try to cultivate loyalty that goes beyond money. And clearly that's something that I think Wachtel has done well and many other firms have done well, and it's something that, while by all accounts, has done pretty poorly. So there's still hope, and I want to be clear that the fact that a few partners have left is not mean that the demise of the firm is inevitable. You can stop it from happening, but get out ahead of it. Look for a merger partner, adjust partner pay, try to build a strong culture. And if you do those things, you can survive. John, it's a pleasure having you as a guest instead of a coast. I won't make it a habit though. Well, thank you very much for humoring me, Joel. As I said, well, it's gratifying to be proven right. It ultimately is quite sad to watch, it's all unfold. So my very best wishes to the partners and staff and associates of, wow, God bless them and I hope they all live on their feet.