When Law Firms Fail, Partners Feel

By JENNIFER SMITH

For many attorneys, a law-firm partnership provides a life of steady—and significant—income flow.

But for Andrew Ness and others who work at firms that fail, the road can be much bumpier.

Jones Day
Andrew Ness of Jones Day has lost three equity stakes in law firm partnerships over his career.

Over the course of his career, Mr. Ness, a partner who specializes in construction law in the Washington, D.C., office of Jones Day, has lost three equity stakes, the chunks of money often totaling hundreds-of-thousands of dollars that lawyers pay into a firm upon making partner.

Early on, the small boutique firm where Mr. Ness was first made partner dissolved, taking his money with it. Later Mr. Ness joined Thelen LLP and then Howrey LLP, two now-defunct firms that entered bankruptcy in 2009 and 2011, respectively.

"I did not see a dime of capital returned and don't expect to see a dime," Mr. Ness said.

To be sure, partners at big law firms are typically in a better position—and have a more ample financial cushion—than the legions of secretaries and associate attorneys who lose their jobs when such firms fail.

But partners who flee failing law firms such as Dewey & LeBoeuf LLP, which is heavily indebted and winding down its affairs after a rocky five-month run of partner exits, face a dilemma most job seekers don't. When those lawyers land a new gig, they have to pony up money to join the partnership, often without any guarantee that they will recoup their capital stakes from the previous firm.

The financial hit is magnified for partners like Mr. Ness unlucky enough to have hopped from one dying firm to another.

"These are huge sums of money," said one former Dewey partner. "It's kind of like your retirement fund…You want to go someplace that's stable at this point, because you just can't afford to take another hit."

Like large medical practices or accounting firms, big law firms are jointly owned by partners. Each has a stake in the business: They invest money into the firm to help it operate, and take in a share of the profit.

Depending on the firm, capital requirements might range from 20% to as much as 60% of what a partner expects to earn in a given year. A young partner could be on the hook for $100,000 to $200,000.

But a seasoned lateral hire from another law firm who pulls in $1 million to $2 million a year might be asked to put inasmuch as half of what he or she expects to earn in a year. Often, the money is due upfront.

To smooth the path, many firms offer loan programs that allow partners to borrow money at attractive rates while they wait for their old firms to pay back their capital. Repayment can take anywhere from one to five years, depending on a firm's partnership agreement.

Law-firm lenders say capital-loan programs have expanded in recent years, as more firms ask partners to pay equity stakes in full, instead of deducting a portion each year from each partner's share of the profit.

Another boost to loan programs: Firms looking to tidy up their balance sheets and minimize bank debt also have been leaning on partners for additional infusions of cash.

Once a partner signs off on the loans, the money flows from the bank to the law firm. When that partner leaves, the firm sends capital payments straight to the bank until the loan is repaid.

But the lawyer is ultimately on the hook for the loan—and that can be a problem if law firms don't pay the money back as agreed.

Dewey & LeBoeuf has yet to pay return capital owed to dozens of partners who left Dewey Ballantine LLP before it merged with LeBoeuf, Lamb, Greene & MacCrae LLP in 2007, according to those former partners. Those who took out loans from Barclays Bank PLC's corporate-banking division say Dewey began skipping bank payments in 2008 and 2010, citing a lack of funds, then set up a new payment schedule that further delayed the return of capital.

In 2011, Dewey sent those partners quarterly statements indicating that money was being deducted from the firm's capital account and paid back to the bank.

But a former partner who contacted Barclays earlier this year was told that no payments on the loan principal had been made in 2011. In a February email shared with an online group of former partners, Dewey's general counsel, Janis Meyer, said the mix-up was because the statements didn't provide enough room to explain the situation, and promised to pay interest on the missed payments.

Representatives for Dewey & LeBoeuf and Barclays declined to comment.

Many of the partners who joined Dewey & LeBoeuf in 2011 took out loans to satisfy their capital contributions. That burden will likely weigh even more heavily on a number of partners who joined Dewey from Howrey as that firm collapsed. In essence, these partners are down two capital stakes.

Dewey leadership put "a lot of pressure on lateral partners during 2011 to pay their capital in advance," said former partner Henry Bunsow, one of several partners who joined the firm from Howrey.

Brad Hildebrandt, the chairman of Hildebrandt Consulting LLC, said partners whose firms have failed can face serious financial problems.

"It's unfortunate, because most partners didn't have control over the situation," Mr. Hildebrandt said.

When firms fail, he added, "Partners rarely get any capital back, they often have to write checks, and they rarely have any recourse."

Write to Jennifer Smith at jennifer.smith@wsj.com