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Washington Lawyer

Cost and Effect

From Washington Lawyer, April 2010

By Joan Indiana Rigdon

jones Recessions have come and gone, but this one promises to leave a lasting impact on law firms both here in the District of Columbia and across the country.

Consider for a moment how the current recession has changed big law firms’ biggest clients. After nearly a decade of quietly accepting scheduled annual billing increases of 6 percent or more, these clients are starting to push back in a big way. With their own shareholders and boards of directors demanding more cost cutting, clients of big law firms are reconsidering everything, including law firm billing structures and practices that previously were never questioned.

These concerns have led to lowered or frozen billing rates, mounting threats to move litigation to lower-cost law firms, and less demand for less experienced lawyers. All of this has forced law firms to slash costs any way they can, starting with personnel. According to The National Law Journal, the nation ’s 250 largest law firms—also known as the NLJ 250—cut more attorneys in 2009 than they have since the Journal began tracking employment data three decades ago. In 2009 the NLJ 250 cut 5,259, or 4 percent of its lawyers.[1]

That’s just the start. Many law firms also froze salaries, which are only just now beginning to thaw, with a few announcements of “true-up” raises. (These raises usually put attorneys back at a pay level they would have had if salaries were never frozen in the first place.) Partner tracks are growing longer and iffier; Cravath, Swaine & Moore LLP, for one, did not make any partners in 2009. Some firms are eliminating partnership possibilities for less lucrative practices. Many are fiddling with pay structures and deferring start dates for first-year associates who were hired before the current downturn, while other firms are considering nonpartner career paths for associates.

Firms have even turned, hat in hand, to their partners for cash. In November DLA Piper LLP asked its nonequity partners to make capital contributions to the firm, in return for equity status. Howrey LLP made a similar request to both its equity and nonequity partners this year, but the firm will let nonequity partners maintain their status.

All told, “I have never seen it this bad,” says Jim Jones, comanaging director at Hildebrandt Baker Robbins, a professional consulting service that works with law firms around the country. “I graduated from law school 40 years ago, and I don’t think we have seen it quite like this, certainly not in my professional memory.”

On the other hand, Jones points out, it should not have been too difficult to see this type of economic hardship coming, given that it follows decades—even generations—of nearly nonstop growth, save for a blip of a slowdown during the shallow 2001 recession.

The law industry “managed to allow the overall cost of legal services to become disproportionately high during the go-go years. Law firms were raising rates every single year by 6 to 8 percent. There’s just no other industry that’s gotten away with that,” Jones says, and then pauses to correct himself: “The only other ones are higher education and health care.

“If you chart that out and then plot that against the inflation rate, the cost of legal services was growing at double the inflation rate. At some point, that just has to come to an end. The current downturn has obviously brought that to an end. It has finally galvanized clients to say, ‘We’re not going to do that anymore,’” Jones says.

The legal industry’s current reversal of fortunes was “probably inevitable,” he adds. But “I think the downturn has probably accelerated and even exacerbated” the pace of change in the industry.

Partner or Associate? No Difference
The math is looking ugly. While the biggest law firms reported a nearly 1 percent rise in the number of partners (as of January 31, they had a total of 53,468 partners, up from 52,980 the previous year, according to the Journal), associate head count plummeted by nearly 9 percent, to 61,733.[2]

The Journal adds that reductions in associate ranks were not strictly due to layoffs; much of the drop was the result of firms delaying start dates for first-year associates.

As big law firms move forward with fewer associates and partners, it becomes more obvious that at many firms partners are doing some of the work associates used to do.

As work for certain practice areas such as mergers and acquisitions has dried up, partners at big law firms began having more trouble finding partner-level work. They are doing associate work when they can justify billing that to the client, thus draining the market for associates, one D.C. area partner explains.

That starts a domino effect. A partner who, for example, bills $700 per hour “may be doing a bit more hands-on supervising him- or herself, rather than relying on the $500 per hour partner,” he says. “The $500-level partner is running out of matters, so he’s doing more work that might otherwise be done by the $400-level associate. The $400-level associate is hogging more of the junior-level work. Anytime there is a shortage of work, anybody in a position to delegate is going to become less generous about delegating.

“It’s very natural,” he adds. “Attorneys are going to look out for their own numbers first and try to get work from wherever they can. If it’s not the level of work they’re used to, they’re less inclined to delegate where they believe they can justify billing it to the client.”

The result: In practice areas where there is a shortage of work, clients end up getting more senior-level attorneys, but at the higher price those attorneys bill.

Depending on the work involved, bumping work up to more senior-level attorneys can be a good deal for clients. If the work is complex, the client might prefer to pay a premium for a partner’s attention to the matter.

But when the work is less complex, more sophisticated clients will question whether certain work could have been done by lower-level attorneys.

Let Me See That Bill Again
Over the past two years, several clients have won major battles with their firms, including securing agreements that they will no longer pay for any work done by first-year associates.

“We’ve seen a lot of pushback from clients on first-year associates. They are saying, ‘Do not bill me for first-year associates. I don’t care how good they are or what they’re doing. My assumption is that a first-year associate doesn’t know enough for me to be paying [his or her] fees,’” Hildebrandt’s Jones says.

“Once you’ve got them trained and experienced,” clients are willing to pay for them, he adds.

But the days of clients accepting annual billing increases are over, at least for now. Ronald F. Wick, a member (the equivalent of a partner) at Cozen O’Connor, says he saw numerous e-mails from clients at his previous firm in 2009 with form letters attached containing language, along the lines of, “Dear outside legal services providers, just so you know, we’re not going to be approving any rate increases for this year.”

Clients at midsize firms also have taken a closer look at billing rates and practices.

“I have seen larger clients being very rigorous in how they look at the bills,” says Shanlon Wu, who spent a decade working as a federal prosecutor, a solo practitioner, and at a midsize firm before cofounding his current, three-partner firm, Wu, Grohovsky & Whipple, which began operations in January.

Clients are not bickering over amounts, Wu says. “It’s more of whoever’s reviewing the bills at clients’ offices is now really reviewing them.” In contrast, when Wu worked at a midsize firm during the boom years, “It was pretty much bills went out and got paid with no questions asked.”

Just last year, at his previous small firm, Wheaton & Wu, one client questioned Wu over several particulars of a bill. He was not challenging, just questioning. “What did we mean by conferring? [One person’s ‘confer’ might be another person’s ‘e-mail,’ Wu notes.] And were we having several layers of editing? He wanted to understand the narrative.”

To get ahead of that trend, Wu says he offers to do some cases—such as defending students who are in minor trouble with the legal system, but in major trouble with their universities—for a flat fee.

In general, Wu says his firm is “looking at more flat fees rather than hourly billing.” Flat fees can be highly lucrative—or huge money pits. To be able to offer flat fees, “you have to know your own practice; that this type of case would generally take me this many hours. It’s difficult to do that in a large firm,” he says.

Also, at a small firm, “I don’t have the pressure of having to make sure that I can bill out a lot of work to a junior partner or junior associates. If there’s something that makes sense for one [other] lawyer to do, or if I can have a paralegal do” part of a case, then Wu will delegate that work to those levels of workers.

Wu says flat-fee billing is “a good direction to move in, particularly for small firms to really differentiate ourselves. I hear a lot of talk that large firms are considering different types of billing structures. I’ve heard some colleagues talking. But my impression is that large firms will continue to bill hourly.”

A Common Threat: Disaggregation
Hildebrandt’s Jones, however, sees changes coming to the way big firms bill. “We are finally seeing some serious inroads into the billable hour,” he says.

Some clients are making simple demands such as a percentage off the top of a bill (which some firms cope with by pushing through rate increases, so the net result is no bump in the billing rate).

But other clients are “demanding much more efficiency, and forcing that,” Jones says. “If you can’t lower the overall cost of doing this particular deal or transaction or litigation, I’m going to come in and lower cost for you by disaggregating services.

“Huge litigation that would normally be given to . . . pick a firm. And ordinarily that firm would have done litigation from soup to nuts. Clients are now saying, ‘I may want you to be lead counsel, but I’m not going to pay your fees to do all the intermediate jobs. For the initial set of depositions, I’m going to hire lower-cost firms I found in’” the Midwest, for instance, Jones says. “‘All electronic discovery is going to be handled by my outsourcing guy in India.’”

These threats “have been building up for the last two or three years. It’s really coming to hit now. It’s really forcing firms to completely rethink how they do their work,” he adds.

Many firms are now “looking into work process redesign. They’re saying, here’s a common transaction. When the economy was pumping along, we’d probably do 100 of these in a year.

“Let’s take the transaction and divide it into its constituent parts,” Jones says. “Let’s say there are 15 steps in the process. Let’s look at each step. Let’s look at services being done at the lowest level that they can be competently done. Can they be pushed down to a more junior level? Can they be done by a nonlawyer professional? Is this work worth outsourcing because we’re not in that business? How can we deliver these services more competently and efficiently?”

In other words, “The downturn is having repercussions that go far beyond layoffs,” Jones says.

As firms reconsider work structure, many are taking a keen interest in project managers. “Firms are now out looking for project managers, who may or may not be lawyers, who can manage big projects against big budgets with time charts and all that stuff,” Jones says.

He sees this skill as increasingly important, even for lawyers. “If I were giving advice to an associate who seemed on track to be partner, I would go out and want to develop some of those [project management] competencies as well. In D.C., for example [The George Washington University] has one of the best programs in project management in the country. A degree isn’t necessary; even a certification in project management could be a great career booster,” Jones says.

And if you are a partner, “Same advice,” he adds. “Figure out where the market is moving and make sure you have the right skills.”

You’re Hired, Now Wait
To keep costs down, many firms are delaying start dates for first-year associates by anywhere from six months to more than a year.

A few firms have offered plump incentives to wait: one-third to one-half of a first-year associate’s pay.

“[Skadden, Arps, Slate, Meagher & Flom LLP] got a lot of attention when it essentially agreed to pay people half. Take $80,000. Travel around world. At first blush it sounds kind of crazy. But from Skadden’s point of view, it allows them to keep these people—very good people—at a fraction of what it would have cost” to employ them, Jones says.

“Economically, it makes sense from the firm’s standpoint. But it looked bizarre,” he adds.

Elie Mystal, a former associate at a midsize firm in New York, quit the lawyering business to become managing editor of Above the Law,[3] a legal blog that relies on often-anonymous reports from attorneys around the nation to track gossip and trends in the legal industry, including pay and perks.

Mystal notes that most firms are not offering $80,000 to deferred associates, as Skadden did. “I’d say $60,000 or $50,000 is what we’ve heard,” Mystal says. “Very few firms get to $80,000. And they’re all coming down.” If Skadden defers future classes, it will probably offer them much less, he says.

As they read about the layoffs and deferrals ahead of them, many law students are questioning the stability of their chosen career.

“I talk to 2Ls and 3Ls in law school all the time,” Jones says. “They ask me, What should I do?’ . . . I tell them the long-term prospects are really good. It’s a great time to be coming into the profession if you take a long-term view. There will be many more opportunities as firms are restructuring work in different ways.”

Besides, Jones adds, “Demographics are on the side of young graduates. Consider that a very high percentage of lawyers practicing today are Baby Boomers. We’re retiring and dying. So the long-term opportunities are pretty good.”

The question is, What to do with the time between graduation and a deferred start date?

“The deferred time need not be wasted time,” Jones says. In fact, in many firms, it is not permitted: deferred associates must earn the money by working for legal services providers. This represents a huge windfall for the legal services providers who get six to 12 months of help from lawyers who graduated near the top of their class—and the salaries are entirely paid by the deferring firm.

“It’s a great opportunity for [lawyers] or us to be able to take care of some real issues,” Jones says. “This recession has been particularly hard on the poor. It’s been devastating for legal services organizations. If you could have a cadre of young lawyers who, for a year or two, would be willing to work in the public service industry, that would be hugely valuable” to society.

Mystal points out one downside to the arrangement. “There are people who went to law school—this is the untold part of the story—who had no intention other than to work for a public interest organization. They wanted to make a career out of that. Now these people are being squeezed out by people who don’t want to be there, but can work for free because they got a big firm job,” he says.

So “instead of hiring me, they’re going to hire a guy who did a summer for Big Law Firm X. And I, as the actual guy who wanted to do public interest work, don’t have an opportunity to do that. I was willing to take $35,000 to 40,000 a year, but I can’t afford to work for free.”

Above the Law has heard from several lawyers in that situation, Mystal says. “We’ve got stories about people who are bartending, people who left the profession, people trying to take the initiative, and basically as a recent graduate, trying to start their own firms. There are all kinds of things people are trying to do to cope with this.”

He adds: “People thought that it’s nothing but a positive” to have deferred associates work for legal aid. “It might be a net positive, but there’s a cost here. Where are the new legal aid professionals going to come from? These people on deferrals—the minute they can get back to private practice, that’s where they’re going to go. That’s where they wanted to be.”

Jones points out the benefit legal services providers get from lots of free labor far outweighs the plight of those lawyers who wanted to go into public interest law, but have been underbid by essentially free competitors.

“The world is not perfect or fair. If you’re looking for some ways to try and make lemons out of lemonade,” focusing on the squeezed-out public service lawyers would be it, Jones says.

A Plugged Pipeline
Deferred offers have become the norm because under traditional recruiting agreements between firms and law schools, firms make offers to top students as early as two years before they graduate and are not allowed to rescind those offers.

“The rules that had been evolved by the law schools and NALP [founded as the National Association for Law Placement, it is now known as the NALP—the Association for Legal Professionals] were such that firms were locked in to having to make offers very early, and they were forbidden from rescinding those offers. Those rules were developed during a period of go-go boom years when everything was great and growing. Jobs were plentiful and so forth,” Jones says.

So, when jobs had to be cut, “they couldn’t turn off the spigot easily. It’s like maneuvering a supertanker. You have to plan well in advance to be able to control the intake of new people.”

Another factor plugging the pipeline: a sheer drop in the percentage of associates willing to quit. “Prior to 2008, firms routinely had voluntary associate attrition of 16 to 18 percent. In 2008, when the recession hit, that attrition dropped to zero. All of a sudden, you had no one leaving. At the same time more [first-year associates] dropped in on top of firms.

“It was absolutely inevitable in late 2008” that firms were going to have to cut head count, Jones says.

“It was also obvious in late 2008 that the layoffs imposed then were not going to be enough.” Those layoffs took reduced attrition rates into account. “But they still hadn’t accounted for more people coming in,” Jones says.

Realizing that mistake, in the first two quarters of 2009 “most firms acted very aggressively. They tried to do all the layoffs they thought they would have to do. It’s demoralizing to have a series of layoffs, so most firms cut pretty deeply. I think in most firms, that worked pretty well,” he continues.

This year things are starting to look up. Jones says firms are seeing “an uptick in demand. The statistics we run on a monthly basis indicate that in the fourth quarter of 2009, we were beginning to see some uptick in productivity across a wide variety of practices.”

Of course, “some of that can be misleading. You would expect an uptick in productivity [among the survivors] if you had laid off a bunch of people. It’s not clear how much of that is real growth or just the way numbers are working,” Jones says.

Overall, however, “We do think we’ve probably seen a bottoming out,” he adds.

Jones does not expect a strong rebound. “I don’t think anyone expects a robust recovery this year. We are actually projecting for this year that revenue in law firms are going to be essentially flat to up a little bit. Profits per partners will probably be up 3 to 5 percent mostly because of continuing really aggressive cost-cutting measures. Firms are managing costs much more aggressively.”

Partners, Partners Everywhere
As part of their efforts to cut costs, firms are beginning to fiddle aggressively with the partner track. In addition to lengthening the track to eight or nine years, up from seven about a decade ago, firms are trying to be more selective.

During the boom years, firms were not selective enough; they made partners of people who should not have been made partners because they were afraid of losing talent under the up-and-out system, says Susan Manch, a founding principal of Shannon & Manch, LLP, which provides outplacement services and career management services to law firms and lawyers.

“Partners are supposed to be able to support themselves or be agreed-on service partners to bigger, heavy-hitter rainmakers. In the past few years, we sort of lost sight of [the partner] selection criteria and we promoted people to partner just because they were really great lawyers. Partners have to be more than just really great lawyers.”

In 2009 the layoffs targeted associates. This year certain firms have begun to quietly cut partners, and some of them are showing up on Manch’s doorstep.

Of the attorneys to whom Shannon & Manch provided outplacement services in 2009, 87 percent were associates, 7 percent were of counsel, and 6 percent were partners. But since those statistics were compiled in October, partners have been coming to us “in increasing numbers,” Manch says.

Most of Shannon & Manch’s outplacement clients —about 35 percent—went to small firms; just shy of one-quarter went in-house; 14 percent went to large firms; 12 percent to government; and the rest went to academia or other nonlegal jobs or are no longer working.

Manch says laid off lawyers in the District of Columbia “were the luckiest of all because they have the government to fall back on. The government has been hiring furiously throughout this process.” Federal jobs are especially appealing to people who wanted to work for the government but took positions at big law firms to pay off student loans.

Plenty of agencies have been hiring throughout the recession. In addition to the U.S. Department of Justice and the U.S. Securities and Exchange Commission, “There are a lot of really interesting positions at Homeland Security, CIA, FBI, the Department of Agriculture and the State Department. Treasury was a huge employer [in 2009]. The whole TARP program was an amazing boon to people who had banking and transaction experience. Those were the people who were most disadvantaged whose business had dried up completely,” Manch says.

The fewest opportunities are with the prestigious large firms, she adds.

Cherry Pickers
There are exceptions, however. Cozen O’Connor, for one, had its best year in 2009, says Wick, who joined the firm in January 2010. As for his previous firm: “Baker & Hostetler LLP thrives in a down market. They have no debt. They can weather periods like this,” he says.

“Firms like that find themselves buyers right now. This is the time they can nab top-notch associates that they couldn’t get otherwise. They can get the editor of the Harvard Law Review, somebody like that. They can also poach not just top-level lateral associates but also grab some disgruntled lateral partners who have good books of business that they might otherwise not have a shot at,” Wick says.

“Baker had some fantastic lateral acquisitions that it would not have had the chance to get in a normal market. I’ve only been at Cozen for [a few] weeks, but certainly one thing we want to do is build the D.C. office.” Lateral partners may be attracted to Cozen and other firms with stable financials because “Stability has suddenly become a very highly prized quality in a law firm, much more so than it was in the ’80s or ’90s,” Wick explains.

“The biggest firms’ clients are Fortune 100s and it’s really feast or famine for them, whereas some of the second 50 firms…aren’t high fliers, but are more of steady performers.”

Some of the biggest winners will be the smallest firms. This recession “may open some real opportunities for smaller and more regional firms than we’ve seen in the past. . . . Clients are so concerned about cost right now that I think they are diverting more work to smaller firms,” Jones says.

Wu, in his newly founded three-partner firm, is in fact feeling quite secure. “I think for solo and smaller firms, we’re well positioned to ride it out. We just have more flexibility if the client is feeling the pinch, whether the client is an individual or a small company, we have a more fluid ability to adjust to that. We have lower overhead.”

Virtual firms are also trying to make the best of the market. They may have the lowest cost structures of all because they do not rent space for all of their lawyers; they work from home and communicate through e-mail or teleconferencing.

In 2009 Char Pagar left her job as a partner with Manatt, Phelps & Philips, LLP to become a home-based partner at Virtual Law Partners [VLP], a nationwide firm of about 50 lawyers who are connected by computer networks, teleconferences, and telephones. She brought her book of advertising clients with her. The move made sense, she says, because of the structure of her practice.

Pagar advises clients on advertising agreements and rules in different states—how to run a sweepstakes, for instance. A former counsel for the U.S. Federal Trade Commission, she also handles government investigations into corporate advertising practices.

“My practice is an expertise-based practice, not something that requires an army of individuals,” she says.

“Large law firms are very good at many things, but the kind of practice I was developing, to me, didn’t fit in the structure of [Manatt]. I just never got the sense that the way my projects came and went and my clients came, I didn’t think it fit well. It was like that for quite a long time. Then I saw some article about VLP and the whole thing clicked in my head.”

VLP has nearly 50 attorneys who work with each other. Instead of salaries, partners receive a portion of their collections. Pagar is happy with the arrangement, and clients have responded well to the low overhead. “Clients are very, very favorably disposed to this.”

Attorneys who have their own practices and fear being laid off “might want to consider this option.…” The virtual firm structure “is appealing for someone looking for an alternative to a big law structure,” Pagar says.

Solo School
Lawyers are not yet flocking to virtual firms, but they have a renewed interest in going solo or setting up shop with a few friends. Daniel M. Mills, manager for the D.C. Bar Practice Management Advisory Service, can see this trend in the number of students who sign up for the Bar’s “Basic Training: Learn About Running a Law Office” workshop, which covers how to get a solo office up and going in the District of Columbia.

He started offering the workshop as a half-day event in November 2008. Back then, he did not think it would take off.

“When we put this thing together … we thought we’d do it quarterly for about six lawyers.

“The first one we did filled before we announced it,” Mills says. He offered three workshops the following month, because suddenly, everyone was interested. “Back then, big firms laid off in groups of 20 and 30. Now, they don’t because that gets a lot of media attention. Now they do it in twos and threes,” he adds.

These days the workshop, which is free to members of the D.C. Bar, runs a full day, two or three times a month, in a private conference room, and in groups of 15 to 25, an increase from the dozen or so participants when the workshops started.

Mills spends the morning covering nuts and bolts, including how many bank accounts a firm should have, and what money should be held where. “I use baskets to represent accounts, and I get actual dollars out and move them from basket to basket, so they can see, the advance fee goes into trust account; then you move it …” Mills adds that he did not start out being so basic, but he realized he had to cover the fundamentals based on the types of questions he was fielding. In the afternoon, he discusses bigger concepts such as marketing and productivity planning.

As of January, 430 students had moved through his workshop, including Shanlon Wu. The participants typically have about 15 to 25 years of practice experience, though that is not required.

Students must register before they show, but they will not know who else is in the workshop until they arrive. Once, Mills recalls, two members of the same firm were surprised to find themselves in the same workshop. Another time, a student asked Mills for a roster of students so he could make sure no one at his firm would learn he was considering going solo. Mills would not provide that information and ended up accommodating that student by offering him the workshop separately, one on one.

“It’s rare. Most people are not in that kind of a predicament,” Mills says. Many participants use their law firm’s e-mail addresses to register, and some firms recommend students.

To keep it fun, Mills invites former students to regular networking outings at pubs throughout the city.

The New Partner Track
For those who choose to stay at firms, the partner track will never be the same. Lawyers who graduated during the recession are bearing the brunt of this new reality.

For those with deferred start dates, “It’s going to be really hard for people who truly thought that their passion would be big firm law practice. Any number of those folks may not get to live out that passion. Associate-hood is such a limited time frame, and it is difficult to join that progress midstream,” Manch says.

Those lawyers who did land at firms, but joined severely hit practices such as mergers and acquisitions, are facing a gloomy future. “If you today have been out of law school for three years and you think of yourself as a merger and acquisitions attorney, yet it’s been three years, and you’ve been working on litigation document review, you’re not an M&A attorney, and it will be hard for you to become one,” Manch says.

“If an M&A case comes up today, you’re too expensive to staff on a case. I’m going to take that first-year associate rather than put you, the third-year associate, billing at a third-year-rate.”

To avoid this scenario, Manch favors competency models such as those being adopted by DLA Piper LLP; Orrick, Herrington & Sutcliffe LLP; and Wilmer Hale LLP, to name a few. These firms are grouping associates in three tiers, rather than eight classes, on the road to partnership. That means pay will move to three tiers, instead of lockstep raises based on longevity at the firm.

Associates have focused on how this new system would lower their pay, but there are other benefits, Manch says.

Under these newer models, “People would have the potential to move through the system more quickly, but there is also the potential for people to take longer” to make partner. “It gives some flexibility for people who need longer to develop. It takes pressure off the firm to keep” increasing billing rates for associates based on their longevity at the firm, she adds.

Jones thinks law firms will eventually evolve into “the talent management model that you would see in an accounting firm or big consulting firm.”

In those firms, “there are all kinds of levels of professionals. There is not just the expectation that every one at every one of those levels is going to progress up and be a partner at the firm. My hunch is that a few years from now, large law firms, in terms of staffing models, are going to look a lot more like accounting firms or big professional service firms than the old thing of partners and associates, because frankly, it makes more economic sense.”

Freelance writer Joan Indiana Rigdon wrote about the future of affirmative action in the December 2009 issue of Washington Lawyer.

Notes
[1] www.law.com/jsp/article.jsp?id=1202435276422#.
[2] www.law.com/jsp/article.jsp?id=1202435276422#.
[3] www.abovethelaw.com.