THE DEATH OF THE PARTNERSHIP

By Jean M. H. Fergus
World Law Business, London, England, July, 2000

Existing law firm structures will not work in the 21st century, according to Jean Fergus. Managing partners have to introduce new models or risk losing major clients to more innovative competitors.

Over the course of the last 20 years, the large international law firms have undergone major structural, economic and cultural transformation. These changes have been so fundamental that the partnership paradigm created in the early part of the 20th century no longer exists. In reality these large law firms are now in a chrysalis phase that one can term post-partnership.

As the pressure from clients with growing domestic and global needs increases, the organizational form will continue to evolve until a new structure is created, one that bears as little resemblance to the old structure as a caterpillar does to a butterfly. This new structure will in fact be organized and managed like a corporation.

The challenge for today's large law firms will be to manage this change and embrace the opportunity this moment in time offers.

Looking to the past
A quick examination of the old system helps underscore how radical these changes have been. The partnership form that became the model for today's large law firms was born in the early part of last century. As corporations grew larger, and their businesses became more sophisticated and more regulated, they needed a different type of legal service. Clients began to demand repetitive, high quality corporate business representation. Small one and two-partner offices could not produce the legal product required in this new business setting.

Paul Cravath is generally credited with the creation of the archetype that is used by the majority of today's international law firms. But he may have only been in the right place at the right time. The Cravath system consisted of hiring a number of top law school graduates; paying them a salary; providing training by having them work with more seasoned lawyers; assigning work to them from clients of the firm; and after a lengthy apprenticeship, offering partnership status to a select few.

The prospect of future partnership helped to maintain the quality of the legal service, assure institutional loyalty and promote high productivity. Strictly speaking, a partnership is an association of two or more persons to carry on, as co-owners, a business for profit. Under this system, however, certain other attributes were attached to the partner status: all partners had an equity interest in the partnership; all partners of the same seniority received an equal share of the firm's profits; all partners had an equal vote; and, once elected, partners were partners for life.

Central to the system's economic success was the innovative concept of leverage, the ability of the firm's partners to generate excess work that could be serviced by non-partners at various levels of experience and authority. A high associate-to-partner ratio allowed each partner to realize profits over and above what could be realized by virtue of his own efforts. Because not every associate could become a partner, leverage required a steady in-flow and out-flow of legal talent.

Thus, the characteristics of the early partnership model included a career track to partnership, profitability based on leveraging the time of other attorneys and, at the partner level, the attributes of equality, lockstep, co-management responsibility, and lifetime employment. This law practice model worked at that time to insure quality, profitability, collegiality and stability.

The transition
Starting in the 1980's, the large US firms experienced explosive growth as clients began to use their firms for more complex transactional work. Increasingly, clients were expanding domestically, through mergers and internationally through acquisitions and joint ventures. This required the firms to create and grow multi-city and international offices to service this demand. In addition, clients wanted their firms to offer a choice of jurisdiction governing their international contracts, initially in the international project finance field but soon expanding to other global practice areas. Now, the large US firms were actively seeking out and hiring non-US qualified attorneys at all levels, including at the partnership level.

Concerned with their economic stability and the costs involved in investing in new technology and expanded markets, the large law firm managers, particularly in the US, began to see that the organization designed in the early 1900s would not be able to solve the problems they were now facing. These new service demands mandated a more centralized organization so that the firm could better coordinate its resources. National and international practice groups managed by key partners replaced local practice fiefdoms. So too, as the firms grew, profit and cost sharing among partners had to be reevaluated, shifting profits into growth areas and compensating accordingly partners who generated the higher value work.

The result was a restructuring of the previously existing partnership model. This transitional post-partnership model attempted to blend aspects of the earlier 20th century model with ideas borrowed from the general corporate world. While maintaining its outer shell, the internal operations of the large law firm more closely resembled that of the corporate model. Surprisingly, these changes were put into place with very little disruption to the stability and underlying capabilities of the large firm.

And the changes were significant. What it meant to be a partner was redefined. Partners were terminated, de-equitized or forced into early retirement. Compensation systems were revised as lockstep gave way to newer models that ranged from multi-tiered hybrids to plans that emphasized individual performance. Management was streamlined placing authority in the hands of small groups. Lateral partners were aggressively recruited from competitor firms, changing the promotion to partner paradigm. In addition, multi-jurisdictional services were added giving the large firms US and UK capability.

Other innovations new to law practice, but staples of the business world, included hiring PR professionals, developing marketing strategies, investing in technology to keep up with client demands, proactively developing new business areas and emphasizing firm management to a much greater degree than ever before.

Looking to the future
Clearly, the post-partnership model changed the way law firms function externally and how they view themselves internally. And, it can be argued, it is because of those reactive changes that the large law firms are so robust today.

To complete the process, the large firms need to go further and create a new model, one that can work for the truly multi-national organizations that they have become. The mega-merger of London-based firm Clifford Chance with New York-based Rogers & Wells, and with Frankfurt-based Punder Volhard Weber & Axster has raised the stakes in the race for global dominance in the legal services arena. This international merger has ruptured conventional wisdom on how partnerships are organized and managed, as well as called into question traditional strategic thinking.

But unlike the traditional hierarchical American corporations that themselves were restructured over the last 20 years, the large law firms have an advantage as they have mainly been decentralized and owner managed. By combining the entrepreneurial qualities of its decentralized model and capturing efficiencies and combining resources in a newer, more centralized system, a new organizational structure can arise.

But first, the large law firms need to reevaluate two key elements held over from the earlier partnership model: the use of leverage as a primary producer of profits; and the associate-to-partner promotion career track.

As associate compensation skyrockets, leverage itself is being questioned as an efficient profit producer. The lemming-like response to the recent increase by the large firms occurred with very little internal evaluation as to its ultimate consequence. All this because a Californian firm, a firm unheard of a decade ago, raised the ante for talent. Partners are alarmed as they see their profits transferred to the bottom of the pyramid but still feel compelled to meet the new market price.

Leverage limits how a firm is able to price its product. By focusing on the selling of hours, alternate schemes are not pursued. The same California firm that started the recent escalation in associate compensation makes its money by also taking equity in its high tech start-up clients, a risk/reward system eschewed by the older large firms. However, this pricing allows them the flexibility to compete for highly sought talent.

Leverage, coupled with the associate-to-partner track system, requires great quantities of entry-level help to maintain the partner-to-associate ratio. It also requires a tiering of associates to support the pyramid structure with the greater number of associates clustered at the junior levels. Yet, it is the senior talent that is in demand and commands the higher market rate. One study by Altman & Weil demonstrated that a firm, after factoring the cost of recruitment, training, overheads etc, lost money on associates in the first three years of their practice at the firm.

Leverage relies on clients producing the type of work that is capable of being segmented into different levels of sophistication. Thus, the large firms have to bring in lower value work, in terms of price and skill requirements, to feed the bottom of the tier. With so much work coming in, partners fail to focus on what type of work will prove to be the most professionally satisfying and economically rewarding.

The partner promotion system now works against the large law firms' ability to preserve their intellectual capital. The law firms are, by definition, knowledge-based organizations and, as such, need to retain experienced and loyal talent. However, the promotion system requires that these very assets leave if they are not made partner. Clients, too, are frustrated when associate turnover affects the firm's ability to service their work. There is, after all, no business reason for having these experienced attorneys leave. By losing these assets to competitors or to in-house legal departments, the firm dilutes its capital. In addition, this loss of a firm's technology base creates additional competition for itself in the marketplace.

The old-style system of promotion was originally intended to assure loyalty, productivity and quality. Yet there has never been so much turnover at the associate and, more recently, the partner levels. Quality and productivity have suffered as a result. Partners now leave seeking better managed firms, typically those firms that can attract higher value work. Associates are increasingly unsatisfied personally with the partnership culture. In September, 1999, a US study conducted by the National Association for Law Placement (NALP) Foundation for Research and Education, revealed that attainment of partner status is not viewed by associates as necessarily desirable, even if attainable. These young professionals would willingly trade in the competitive partner track for a more predictable career path. That is why, for many, the in-house corporate law model is so attractive.

Large firms in the States have attempted to address the talent drain with a hodge-podge of programmes ranging from the creation of non-equity partner and counsel status to money inducements. Some firms now offer bonuses if an associate stays over three years. The amounts involved, however, are so small that they are ineffective. And they affect morale. Associates derisively termed these bonuses, tin handcuffs, instantly recognizing that throwing money at a problem will not make it go away.

Others firms offer sabbaticals, laptop computers, early associate reviews with assurances of employment, if not partnership, flexible work schedules, on site child-care facilities, while one firm has established an Associate Ombudsman programme to hear associates' complaints. None is a long-term solution and may only keep associates for an additional six to nine months. All this to address symptoms of the problem, and not the underlying cause.

As long as the firm's only career path is the ultimate prized status of partner, associate level turnover will continue. The real ghost that needs to be exorcised from the system is the concept that partnerships represent the highest form of professional practice.

The challenge ahead
The new global economy of the 21st century presents an opportunity to create a new workplace organizational paradigm. Partnerships need to focus on the true goal of legal practice: to deliver real value to the firm's clients as well as to create profits for those who work for the enterprise itself.

As firms evolve into multinational entities, they will need to replace the post-partnership model they have already outgrown. However they first need to identify and replace the vestigial cultural attributes of the old system that hinder this development. Mergers, for the most part, end in disagreements over cultural issues as firms are unwilling to think strategically. Leverage and promotion policies are held in place even though they are counter-intuitive to all good business principles. Emphasis is placed on trying to make the model work instead of looking at the clients' needs and the services they require.

It is axiomatic that no one likes to change. But as ancient Buddhists believe, all suffering comes from the attempt to impose permanence in a universe of impermanence. Will Sullivan & Cromwell become Sullivan & Cromwell Inc.? Perhaps. Goldman, its lead client, has done so and, as with all recent law firm changes, the client has led the way.

The question ...
Is the current partnership model sustainable in the new century? If not, how should it be modified?

Geoff Brown, chief executive partner of Clayton Utz, Sydney

It may be questioned whether there is a single "current partnership model" nowadays. While solicitors in Australia are still far from being employee shareholders, large firms - with their professional management and services departments - are structurally much more akin to their corporate clients than to small suburban practices.

The partnership has therefore proved to be a flexible business structure to date. However, we may well be approaching the elastic limit of that structure (as evidenced by recent and largely unsuccessful legislation allowing limited liability partnerships). That is one reason why Australian lawyers and lawmakers are currently debating the merits of allowing solicitors to incorporate.

Nick Holt, London managing partner of Klegal

As a lawyer who has been a partner in a law firm and (at different times, I hasten to add) a director of a listed PLC, I think both structures have strengths and weaknesses.

The real issue however is one of governance. This applies irrespective of structure. It is a commonly held view that the traditional partnership is not well suited to the large multinational law firms that we see being created. This need not be the case as long as the management, voting and other rights and responsibilities of the partners are clearly defined. Clifford Chance, for example, are to be applauded for the way they pushed through the Rogers & Wells and Punder mergers - showing strong management and a clear strategic vision.

I might also observe, sitting where I do now, that the big five professional services firms have also succeeded in blending a more corporate style of management with the traditional partnership structure to great success. There is a lot of life left in partnership.

Tony Williams, worldwide managing partner of Andersen Legal

To suggest a stark choice between a partnership espousing professional values and a corporation which is rapacious and commercial is nonsense. Partnerships are infinitely flexible structures.

Modern international firms, although notionally partnerships, operate as major businesses and increasingly in accordance with corporate principles and structures. In fact, it is this business-like approach that protects rather than destroys professionalism. These large firms fully understand their professionalism is their core asset and they do everything possible to protect and enhance it.

The next major development will be the abandonment of the lockstep. This socialist approach will increasingly became untenable as modern firms adapt to the reality of modern partner remuneration models.

Harold Paisner, senior partner of Paisner & Co, UK

Existing partnership structures have at least three major disadvantages.

Firstly there is the question of management. A partnership is based on principles of equality and consensual decision taking between partners and good management works against this principle. The larger the partnership the more unworkable the traditional structure becomes.

Then there are the matters of unlimited liability and joint and several liability. The limited liability partnership which is to become available as an alternative structure next year will largely resolve these two problems but at the cost of disclosure of accounts.

Finally, I should mention the disadvantages of partnerships in relation to retained profits. In a company, profits will be taxed at the corporation tax rate - 30% or less - whereas in a partnership the individual is taxed at his marginal rate, which could be up to 40%.

Many partnerships will probably wish to carry on in the future as limited liability partnerships rather than incorporating because the advantages of practicing in that structure are still perceived (correctly or not) as outweighing the disadvantages.
Jean Fergus

Jean Fergus is a principal and founder of Fergus Partnership Consulting, an international legal search firm with offices in London and New York. She specializes in partner and partner-group placements. She has more than 20 years of experience as a legal search consultant and has published numerous articles. Jean has practiced as in attorney in New York.










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