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Will a bad economy force more changes in the profession?

By Diane Curtis
Staff Writer

Michael Roster

While some people hope the flagging economy will get law firms to rethink how they bill clients, others are warning that associates had better churn up the billable hours or face the prospect of losing their jobs.

“The poor economy has definitely gotten everyone’s attention, so in that sense, it’s helpful,” said Michael Roster, chairman of the Association of Corporate Counsel’s (ACC) Value Challenge Steering Committee. He referred to the need to draw attention to how law firms bill. The challenge was launched in September to get in-house legal counsel and outside law firm leaders to rethink the current financial structure of law firms.

The main issue for the Value Challenge, said Roster, retired general counsel for Golden West Financial and Stanford University and former managing partner at Morrison & Foerster in Los Angeles, “is getting cost related to value . . . The constant increase in rates without an accompanying increase in productivity is unacceptable.” The goal at corporations is to reduce costs while increasing productivity. “We look at law firms and see none of that behavior.”

A survey by the Corporate Executive Board found that large-company spending on law firms grew by 49 percent between 2002 and 2005. And while non-law firm costs increased by 20 percent over the past 10 years, large law firms’ prices jumped almost 75 percent in the same period.

At the same time, legal jobs are declining. Reports of law firm retrenchment are frequent — Heller Ehrman and Thelen going belly up; Orrick, Herrington & Sutcliffe, Reed Smith, White & Case, Proskauer, among others, announcing layoffs. According to the Bureau of Labor Statistics, the number of legal jobs declined for the sixth consecutive month in November, moving from 1,180,700 in May 2007 to 1,163,500 in November 2008. The drop between October and November was the sharpest monthly drop since the decline began in June.

Peter Keane

Peter Keane, dean emeritus and professor at Golden Gate University School of Law in San Francisco, said the economy is going to push more law firms into being more competitive. “To become more competitive, you lower your rates,” he said. But the economy isn’t the only reason for the change that’s going to hit law firms, Keane added. Clients are balking at paying a gigantic bill for the partner-rate work of a first-year associate, and unhappy associates who are asked to continually increase their billable hours are making their unhappiness known. “It’s reaching a point of critical mass,” Keane said.

Few lawyers agree that rates are going to be lowered. “It’s just like lowering associate salaries. It’s not anything I’ve ever heard of happening,” said Mark Kelson, a partner and chair of the Capital Markets Practice Group at Manatt, Phelps & Phillips LLP in Los Angeles. Billable rates never go down,” said Chuck Fanning, partner in the San Francisco office of the legal search firm Major, Lindsey & Africa. “Discounts go up. It’s one of those funny games that get played. A firm’s not going to lower its rates because that looks bad.” Instead, they’ll offer discounts.

Geoff Howard, managing partner of the San Francisco office of Bingham McCutchen LLP, said his firm is definitely responding to the calls for cost savings — and he denied that the billable hour is the culprit. “I don’t think it’s right to make a statement about billable hours being good or bad,” he said. “It’s too simplistic.” However, he said, consideration of value “is appropriate” because it focuses on providing a service whose quality and cost are acceptable to both the client and the law firm. “In many cases, that would continue to be the billable hour.”

Bingham took steps in the wake of earlier economic downturns to be ready for dips in the economy, although few say they predicted the extent of the current decline. Bingham diversified — plenty of corporate work but also more than half of the practice in such counter cyclical work as financial restructuring and insolvency — so that it would be in a better position to weather down times.

Mark Helm

Munger, Tolles & Olson also has been careful to diversify, with 50 percent litigation as well as a lot of corporate work. Mark Helm of Los Angeles, co-managing partner for Munger Tolles, said the firm is not seeing a decrease in work but he expects there will be some pressure from clients for discounts and resistance to rate increases. “We are always trying to make sure that we’re delivering value to our clients and sometimes there are times when we have to increase our rates, but we hope when we do that we are delivering good service.”

Bingham’s Howard said that Bingham has “done very well in the last few years, although because we are built this way I think we don’t reach the peaks some firms do in the good economic times,” Howard said, a point also made by Helm. “I think we do very well,” Howard said, “but we’re not feeling the same degree of pain that some groups do that don’t have this diversification.”

At the same time, to “be responsive to the pricing pressures our clients were feeling,” Bingham created a staff attorney program that employs permanent off-track attorneys to provide institutional, long-term quality control over electronic discovery document processes as opposed to using highly paid junior associates. “Clients get more value at lower cost,” Howard said.

Munger, Tolles’ Helm said his firm’s “conservative” approach means it has no debt and a 1-to-1 partner/associate ratio. “We obviously are affected by increases in associate salaries but not to the extent that some of these other places are,” he said. The pyramid structure of associate-to-partner leverage — hiring more and more associates for every partner — can be a real problem in an economic downturn because associates’ salaries get bid up to the point where the firm can’t pay them, he said. Helm also said Munger Tolles is careful in how partners draw down money. They’re made to wait until the end of the year to get a very large part of their compensation.

Golden Gate University’s Keane said at many other firms, partners draw down their money each quarter both for tax reasons and to push up per-partner profits, the number by which firms are sometimes judged.

“People are chasing a phantom and doing it to their own detriment,” Keane said. “ When identity is based on some false totem — per-partner profit — value to clients and the quality of legal services don’t matter, and that’s unfortunate.” He said that if firms are constantly distributing income, then what happens is they’re totally dependent on lines of credit when business gets slow. Some observers have said the demise of Heller Ehrman and Thelen was in part due to banks shutting down credit lines as partners defected.

At the same time, associates ignore billable hours at their peril, especially in the current economy, according to legal recruiters. “I think if I were giving any advice to associates — and I get calls from a lot of associates — it would be to keep your head down and keep your billable hours high,” said Seth Davis, managing partner of the San Francisco office of Laurence Simons International, a legal recruiting firm. “It’s the ones who are not reaching their numbers who are going to be laid off first.” Fanning of Major, Lindsey & Africa concurred. “There are two ways to attack decreased profitability: Increase worker productivity and cut expenses … If I were an associate billing 1,500 hours, I’d be very nervous.”

Richard Gary, principal of Gary Advisors in Tiburon and a former chair of Thelen, Reid and Priest, said there is no correlation between per-partner profit and debt. Debt is incurred for such reasons as investing in a new practice, building out new space, opening a new office, bringing new lateral partners into the firm and occasionally funding distributions to partners as an advance on income. “Partner profits are what they are without reference to how they’re distributed,” Gary said. “Profits are determined by revenue and expense. They are what they are.”

The end of Heller Ehrman and Thelen, Gary said, has more to do with poor leadership, seeking external help in the form of a merger and partner defections. “I don’t think either firm had to fail,” he said. “I think if they had taken an internal approach to their problems and perhaps had different leadership, they could have been saved.” The economy was a factor, Gary said, “but look at all the firms out there in this economy who are making it … I think it was more culture and this whole notion of looking for outside solutions.”

Gary said he does believe there will be pressure from clients on fees. “There always is on an economic downturn and this is the steepest decline.” Still, he said, he doesn’t think the billable hour is going to disappear. “We’ve been talking about going to a different model for 20 years and it’s never happened. Maybe young people will come up with a different mousetrap.” However, he added, “I still think it’s the best way to measure value because it is a mechanism of measuring the amount of work that a lawyer did for a client on a particular matter.”

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