Characteristics of a Troubled Firm

Dewey & LeBoeuf LLP was the result of the merger in 2007 of New York-based law firms Dewey Ballantine LLP and LeBoeuf Lamb Greene & MacRae LLP. The merged firm, Dewey & LeBoeuf, was touted as “the 14th largest firm by headcount and the 16th largest firm by revenue in the United States.”  The merger was supposed to create “a catalyst for increased growth and profitability.” Instead, in May 2012, almost five years after its celebrated union, Dewey & LeBouef filed for bankruptcy protection. The Dewey bankruptcy was on record for being the largest bankruptcy of a law firm.

The criminal prosecution of three former law firm executives for accounting-related misconduct followed in March 2014, after disgruntled Dewey lawyers urged the Manhattan District Attorney to investigate. Steven Davis, Dewey’s chairman, Stephen DiCarmine, Dewey’s executive director, and Joel Sanders, Dewey’s chief financial officer, were accused of orchestrating millions of dollars of false accounting entries in order to deceive investors in a $150 million bond deal as well as a group of banks in securing a $100 million line of credit. That trial ended with a deadlocked jury in 2015, and Davis subsequently entered into a five-year deferred prosecution agreement with prosecutors. The retrial of DiCarmine and Sanders ended on May 8 with a guilty verdict for Sanders and a not-guilty verdict for DiCarmine. (Several other lower-level Dewey employees either pleaded guilty or entered into deferred prosecution agreements earlier in the case.)

Dewey is not the first Big Law firm to fail, but its very public bankruptcy and criminal prosecution of firm leaders for accounting irregularities and misconduct shed light on how one law firm sought to prop up its financial condition, all the while sinking into deeper financial distress. Of particular interest is how lacking the firm was in not having a viable financial plan for future sustainability, even though millions of dollars and the very life of the firm were at stake. What this demonstrates is that no firm is too big—or indeed, too small to fail. All firms have certain characteristics that portend financial trouble absent correction.

High Burn Rate

A troubled firm burns through cash at a rate faster than its ability to replenish. While a healthy firm has savings or the expectation of a continuous revenue stream to support operations (or both), a troubled firm does not have sufficient cash to pay expenses and stave off the financial bleeding. According to the New York Times:

Mr. Davis and his team had hoped that the firm’s revenue would eventually increase as the economy recovered. But by the end of 2009, Dewey owed its bank lenders about $206 million, needed to make payments totaling $240 million to its partners, yet had just $119 million in cash.

Dewey’s obligations exceeded its available cash. Despite its recent merger, Dewey & LeBoeuf was unable to generate sufficient revenue to increase its cash position. With only a finite amount of cash, Dewey needed to find another source of cash. Its burn rate was too high to sustain operations. Gross burn is the total amount of cash a firm spends per month. The net burn is the amount a firm is losing per month. The net burn takes into account the profit the firm receives each month to determine how long it will take before the firm needs to get financing to continue to support operations. As the New York Times noted:

[Dewey engaged in a private debt offering in 2010] in which Dewey raised $150 million from 13 insurers and an additional $100 million from a line of credit placed with several large banks. The firm used the offering to refinance its existing credit lines and buy itself more time.

No or Low Profit

The additional time that Dewey bought itself by refinancing its debt was not sufficient to permit the firm’s revenue to build a healthy cash position. Cash may be king, but no firm can sustain itself without a profit. Profit is the amount of revenue from a project remaining after all expenses, direct and indirect, for that project have been accounted for and paid. As indicated above, profit is necessary to reduce the burn rate. Without profit, a firm is digging into its diminishing cash reserves without replenishing it. It is only a matter of time before the cash reserves are depleted. Without cash, the firm dies.

For Dewey, the refinanced debt allowed the firm to “kick the can down the road” for a short time. The firm had already resorted to engaging in accounting irregularities to appear in compliance with its bank covenants before the refinancing and continued to manipulate the numbers after the refinancing. As Law360 reported:

 [Dewey was not only not profitable, bankruptcy trustee Alan Jacobs] claimed that Dewey was insolvent by no later than Jan. 1, 2009, and remained insolvent until it filed for bankruptcy on May 28, 2012.

[Thomas Mullikin, Dewey’s controller, took the stand in June 2015 and] told the jury that he made or directed millions of dollars in fraudulent accounting entries to fool banks and auditors into believing that Dewey was in compliance with its lending agreements.

Mullikin said that in 2008, when it became clear Dewey was not going to make enough money to satisfy its bank covenants, former Dewey finance director Frank Canellas instructed him to do things like reclassify expenses as income distributions to partners in order to bulk up the firm’s net income.

High Fixed Costs

Troubled firms have difficulty reducing their expenses in response to declining revenue. The lack of revenue and inability to lower expenses causes many firms to borrow more, which further hinders the ability to respond to and address future financial distress. Some firms, like Dewey & LeBoeuf, resort to growth as a way to increase revenue. As Fortune noted:

The firm collapsed as a result of mismanagement that left the firm more than $300 million in debt. While other “Big Law” firms with more than 1,000 lawyers and global reach are suffering from the twin troubles of lingering recession and overpaying for lawyers to expand into new practice areas, few borrowed nearly as much money as Dewey & LeBoeuf did—its credit line included a private bond placement of $125 million in 2010. In the face of diminished business in 2008 and 2009, Dewey’s management team essentially “doubled down” by accelerating the hiring of high-priced partners from outside in an effort to expand the firm out of trouble.

This “doubling down” to expand the firm out of trouble belies the fact that the cost per lawyer tends to rise as the firm expands. In his article, “Mining the Surveys: DISeconomies of Scale,” Ward Bower of Altman Weil stated that generally, economies of scale don’t apply in private law practice:

Larger firms almost always spend more per lawyer on staffing, occupancy, equipment, promotion, malpractice and other non-personnel insurance coverages, office supplies and other expenses than do smaller firms. This is counterintuitive, in the sense that larger firms should be able to spread fixed costs across a larger number of lawyers, reducing per lawyer costs, overall. However, that principal does not take into account the excess plant and equipment capacity necessary to support growth, or the increases in staff and communications costs as firms become larger.

Compensation Pegged to Unproductivity Rather Than to Productivity

Further complicating Dewey’s ability to correct its downward trajectory was its compensation system for partners. Despite a partnership agreement that permitted partners to be compensated based on the profits of the firm, Dewey leadership provided pay guarantees to nearly one-third of the partnership. Dewey partner Martin Bienenstock commented in an interview with the Wall Street Journal that several partners on both the Dewey and LeBoeuf sides were given four-year contracts to ensure that these business generators remained with the firm.

Some people’s contracts guaranteed money no matter what the firm’s income was. Other deals were contingent on the firm’s income. Laterals were attracted and also had other types of contracts. Some were guarantees, others were based on projections of income; others were a little of both.

The failure of partner compensation to be tied to profits as well as the unequal rewards system—star partners paid at the expense of rank-and-file partners—contributed to the demise of the firm. Disgruntled partners and star partners who did not receive their guaranteed payments defected. The ability of Dewey & LeBoeuf to generate income was further compromised.

Thin Capitalization

Dewey leadership not only made high distributions to partners, it relied on loans and future partner earnings to fund those payments. In fact, according to Law360, the partner compensation schedule exceeded actual earnings for several years:

Dewey’s many alleged problems — overoptimistic revenue targets, a secretive culture, a less-than-collegial atmosphere — were compounded by early reliance on bank debt. Amid the financial crisis of 2008, Dewey’s first full year of operation, the firm was already shouldering more than $100 million in term debt and credit lines of more than $130 million, prosecutors say.

Dewey’s thin capitalization precluded its ability to save cash and build a rainy day fund. With no savings, it collapsed under the weight of excessive debt load, high overhead, and the accelerated decline of revenue resulting from partner defections.


Dewey & LeBoeuf’s demise may represent an extreme example of law firm mismanagement. Yet, it teaches lessons for every type and size of firm.

Debt ≠ Income

A firm should be careful to not allow debt to become a permanent means for survival. Debt should be used as a stopgap measure with a clear plan on how and when it will be paid off. It should not be viewed as a means of funding the firm and critical operations on a long-term basis.

Debt ≠ Cash

Debt as a source of cash is an illusion of fiscal health, if revenue is insufficient to pay the debt while still generating a profit. Debt may ease a cash shortage, but it will not on its own eliminate the cash shortage. In fact, without sufficient revenue to reduce the cash shortage, debt will increase the deficient cash position.

Cash ≠ Profit

Generating cash is not the same as generating profit. Every firm needs both, but profit is necessary to accumulate cash.

Bigger ≠ Better

Dewey & LeBoeuf saw expansion as a way to get out of its financial problems. However, expansion without a strategy to support the increased activities and costs that come with such growth only exacerbates an already unhealthy fiscal position. Prestige, global reach and all the trappings of Big Law do not give the firm a pass from having to follow principles of basic financial management. Additionally, the larger the firm, the harder it is for a firm to be able to nimbly align itself with different financial realities.

Profit = Necessary Precursor to Sustained Cash Flow and Liquidity

The goal of every firm should be to generate enough profit to pay all of its immediate and short-term obligations (liquidity), manage its longer-term obligations, plan for growth, and build a cash reserve for rainy days. Taking on debt or selling off an asset can generate short-term cash. However, a sustained, healthy cash position that results in a robust cash flow and ample liquidity occurs only by having strong and sustained profits. Increasing revenue, contracting operations to reduce expenses, or both, can generate such profit.

About the Author

Joan R.M. Bullock is a professor of law and associate dean for teaching and faculty development at Florida A&M University College of Law, and is the former chair of the ABA Law Practice Division. Contact her on Twitter @ReformedLawProf.

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