By Steven Benathen
Illinois Business Law Journal
Associate classes are smaller. Partners are leaving firms. Equity partnerships are off the table for promoted associates. Mid-size firms only want laterals. Law firm hiring is not looking great these days. As the recession wages on law firms, and clients for that matter, are tightening up. Firms don’t have the work available to hire new associates. For the associates there, firms can’t afford to provide partnership, let alone equity partnership. Perhaps part of the problem is the model by which law firms have operated. Unlike most other businesses (and the practice of law for-profit is as much a business as anything else), law firms are not open for outside ownership and investment. Rather firms’ own principals are their owners. With dwindling work, it stands to reason new equity partners might not see returns on their initial investments, hence limitations on equity partnerships. Outside of America, other countries like England and Australia are embracing the idea and allowing for outside investment. However, stateside, the idea is firmly opposed.
Last month, the United States District Court for the Southern District of New York dismissed a lawsuit filed by Jacoby & Myers, a large personal injury law firm, against the Appellate Division of the New York Supreme Court. The firm was seeking a declaratory judgment that Rule 5.4 of the Model Code of Professional Conduct in New York was unconstitutional. Specifically, Jacoby & Myers contended that Rule 5.4 impermissibly interfered with interstate commerce by preventing the firm from raising capital through private investments. Jacoby & Myers is a nationwide operation with offices ranging from the New York City to Los Angeles. The firm contended that they could not deliver cost-effective legal services without the aid of outside investment. As a plaintiff’s firm operating on a contingency basis, the firm wanted to utilize funds from outside investors to stay competitive in matching the resources of large law firms that bill hourly for defense-side work. The District Court however, dismissed for lack of standing. Jacob & Myers had failed to raise a particularized injury. While Rule 5.4 did prevent them from raising outside capital, numerous other professional conduct rules in the State of New York did as well. Accordingly, the Southern District refused to issue what would essentially have been an advisory opinion.
While for now it seems well settled that non-lawyers won’t be owning law firms anytime soon (all 50 states prevent it and only local practice rules of the DC bar allow it), law firm ownership is possible for non-lawyers in England. The Solicitors Regulatory Authority is beginning to approve applications for Alternative Business Structures (“ABS”). British lawyers expect the opportunity to allow outside investment to create more cost-effective options for clients. Britons expect smaller shop services like will-writing to be affected first, but even Britain’s “Magic-Circle” firms might start to turn a weary eye. Large firms like Allen & Overy and Clifford Chance are not completely immune to the global recession. Allen & Overy opened a satellite office in Belfast and Clifford Chance plans to open one in India later this year. As noted by a British consultant in a recent article on the matter in The Economist, “if lawyers, ‘insist they’re not a business, they will carry on until they are out of business.’”
The above quote is certainly telling for American law firms as well. The British plan to liberalize law firm ownership may help struggling law firms as the recession continues to be slow in its resolution. Australian firm Slater & Gordon has nearly tripled its revenue since opening itself up to outside investment in 2007.
The American system wherein partners do all the owning might be wise to consider the change. A recent article in The Am Law Daily on St. Louis firm Husch Blackwell, is telling. The firm recently demoted 25 partners from equity status to fixed income. It also reduced its equity partnership by more than 4 percent. Liberalizing firm ownership could change the playing field on this type of issue. Psychologically in the workplace, the vaunted status of equity partner might have a different meaning if non-lawyers could have ownership of the firm. Simply put, the expectations of young associates would be far different if firm ownership extended beyond the firm. Non-equity partnership would hardly carry the sting it seems to today. Firms could in turn divert their revenue more efficiently toward paying fixed salaries. If shares of law firms went on the market, equity partners might be enticed to cash out. As partners departed, associates advancing toward partnership could all be placed on a non-equity track with the option to purchase shares of the firm. The opportunity to obtain a share of the firm’s revenue would still exist but without the superficial layer of prestige. Additionally, outside investing would presumably allow for businessmen to become part of the management of law firms. Excellent lawyers are not always excellent businessmen; management might actually find itself in more capable hands.
The main contention against this has been that allowing clients to own part of the firm would create a conflict of interest. At the same time however, equity partnership has always created a perverse incentive for firms to bill inefficiently. As a moneymaking business, the practice of law can never truly avoid money-motivated conflicts of interest. However, ownership by outsiders might allow firms a chance to meet the demands of recession-weary clients, to become more sustainable should another recession present itself, and to benefit from the insight and business management skills of full-time business people.