Why Law Firms Implode
Law firm failures do not merely signify bankruptcy - they are spectacles of grand implosions. American law firms suffer from unique structural risks that can drive these formidable institutions to not just falter, but rapidly collapse even where their balance sheets and profitability would suggest more durability. This phenomenon, far from random, stems from the fragile ownership structure unique to the legal industry. In an interview with Yale Law Professor John Morley, we take a deep dive into the inherent risks and dramatic consequences of law firm failures, and why this topic should command our attention.
Law firms are peculiar entities in the realm of business: partner-owned and restricted from nonlawyer investment or ownership, as mandated by the ABA's Model Rules of Professional Conduct. When a law firm faces a financial crisis, this fragile structure can trigger a devastating cascade. Senior partners, or 'rainmakers', may depart, taking clients, associates, and their capital contributions with them, leading to a 'partner run'. This domino effect of departures, combined with the onerous burden of unfinished business liability and potential clawback provisions, makes the failing law firm's situation perilous. Professor Morley's interview provides enlightening perspectives and unpacks the intricate complexities that have contributed to some of the most notorious law firm collapses, such as Dewey & LeBoeuf and Brobeck, Phleger & Harrison.
Drawing on detailed analysis, Professor Morley not only discusses potential management strategies to reduce costs, build loyalty, and disincentivize partner runs, but also policy solutions like modifying restrictions on partner withdrawals or even rethinking the prohibition on non-lawyer ownership.
Additional Resources
Why Law Firms Collapse – a Yale Law and Economics Research Paper by John Morley (Revised 2020)
Relevant Ethics Rules
- Rule 5.4(d): Professional Independence of a Lawyer
(d) A lawyer shall not practice with or in the form of a professional corporation or association authorized to practice law for a profit, if
(1) a nonlawyer owns any interest therein, except that a fiduciary representative of the estate of a lawyer may hold the stock or interest of the lawyer for a reasonable time during administration;
(2) a nonlawyer is a corporate director or officer thereof or occupies the position of similar responsibility in any form of association other than a corporation ; or
(3) a nonlawyer has the right to direct or control the professional judgment of a lawyer.
- Rule 5.6: Restrictions on Rights to Practice Share
Law Firms And Associations A lawyer shall not participate in offering or making: (a) a partnership, shareholders, operating, employment, or other similar type of agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement; or (b) an agreement in which a restriction on the lawyer's right to practice is part of the settlement of a client controversy.
