Why Law Firms Collapse
42 Pages Posted: 20 Mar 2015 Last revised: 10 May 2019
Date Written: May 7, 2019
Law firms don’t just go bankrupt—they collapse. Like Dewey & LeBoeuf, Heller Ehrman, and Bingham McCutchen, law firms often go from apparent health to liquidation in a matter of months or even days. Almost no large law firm has ever managed to reorganize its debts in bankruptcy and survive. This pattern is puzzling, because it has no parallel among ordinary businesses. Many businesses go through long periods of financial distress and many even file for bankruptcy. But almost none collapse with the extraordinary force and finality of law firms. Why?
Drawing on quantitative and qualitative data from a careful study of 37 large law firm collapses, I argue that law firms are fragile because they are owned by their partners, rather than by investors. Partner ownership creates the conditions for a spiraling cycle of withdrawals that resembles a run on the bank. As the owners of a business, the partners of a law firm are the ones who suffer declines in profits and who have to disgorge their compensation in the event the firm becomes insolvent. So if one partner leaves and damages the firm, it is the remaining partners who bear the loss. Each partner’s departure thus has the potential to worsen conditions for those who remain. The resulting losses can push still more partners to depart, eventually producing an accelerating race for the exists. This kind of run-on-the-partnership is often thought to be an unavoidable consequence of financial distress. But if law firms were not owned by their partners, these spiraling withdrawals would not happen. Indeed, the only large law firm in the history of the common law world that has ever managed to survive a prolonged insolvency also happens to be one of the only large law firms that has ever been owned by investors. These insights have extensive implications for how we understand law firms and for the theory of corporate organization more generally.
Keywords: Law firms, partnership, bank runs, organization
JEL Classification: G33, K22
Suggested Citation: Suggested Citation