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When the end finally came, Pennie & Edmonds’ death certificate revealed few surprises. The firm had been bleeding key partners and was facing a serious real estate crunch, with its New York office lease nearing expiration and too few partners willing to be on the hook for another 15 years with personal guarantees. But the firm’s funeral in December took an unexpected turn. Rather than simply dismantle its practice or merge with a general practice firm, as many expected it would, the 120-year-old New York-based IP boutique did something in between: It ceased its operations and sent nearly 100 attorneys, including an estimated 29 partners, to Jones Day, a firm with which it had been in on-and-off discussions for years. Not all Pennie lawyers were asked to make the move, and some chose on their own to bail out. In all, at least 16 of Pennie’s original lawyers will not end up at Jones Day. Conflicts of interest with Jones Day clients were to blame in some cases, including part of the group that joined Morgan, Lewis & Bockius shortly before Pennie’s dissolution. But a merger-repellent accounting system, among other potential liabilities, also shares the blame. When Pennie and Jones Day started talking about joining forces in late 2000, a full merger was the presumptive strategy. But not long into this preliminary round of talks — which stalled in early 2001 and then resumed a few months ago — the strategy changed to a lateral move, recalls Pennie’s litigation chair Brian Poissant. Pennie would shut down and then ship the bulk of its lawyers to Jones Day. Why the backpedaling? It wasn’t for a lack of a rapport between the firms. Lawyers at Pennie and Jones Day had worked together as cocounsel since the mid-eighties. Nor, insist top partners at both firms, did it reflect Jones Day’s waning interest in taking the entirety of Pennie’s practice — litigation and patent prosecution alike. With profits per partner of $835,000 in the latest Am Law 100, Pennie partners say the firm’s financial health was just fine. The culprit, say several partners involved in the deal, was Jones Day’s reluctance to inherit Pennie’s liabilities. Most notably, there was Pennie’s accrual accounting method. Unlike Jones Day’s more typical cash-based accounting, which recognizes income when cash is actually collected, Pennie’s method recognized income earlier in the billing cycle, as soon as clients were charged for the firm’s work. Which was all fine for Pennie. But the liability arises when an accrual firm like Pennie tries to convert to a cash basis upon merging. A chunk of the resulting firm’s receivables — the amount it has billed but not yet been paid — will already have been counted as income under the defunct accrual system. To avoid double-counting the same dollars, the cash-operated firm creates an unfunded obligation from the firm to its partners, an often significant liability. “Accrual to cash is a complication,” says Jones Day’s New York office head, Dennis LaBarre, who adds that no firm is without its liabilities, and for that reason, Jones Day is wary of merging in general. But still, LaBarre and Pennie’s managing partner, John Normile, both admit that the accounting issue was a factor in the decision not to merge. “It’s not an impossibility,” says LaBarre of merging with an accrual firm, “but it certainly contributed to the idea that we didn’t really want to combine firms.” Normile adds that not merging also held its benefits for Pennie, by allowing his firm to hold on to its assets. This “black hole” problem — as Hildebrandt International’s Kenneth Hildebrandt calls it — isn’t always a merger killer. “It’s a big hurdle,” Hildebrandt says, noting he has no knowledge of Pennie’s particular case, “but you can make this kind of situation manageable.” After all, other firms have merged despite the same issue. Philadelphia’s cash-based Dechert Price & Rhoads (now Dechert) merged with the accrual-based Titmuss Sainer Dechert of London in 2000. Cash-based Steptoe & Johnson merged with Rakisons, also a London-based accrual firm, in 2001. Pennie’s accounting system may not have been the only liability that gave pause to Jones Day. The firm is a defendant in a pending malpractice suit brought by Pfizer Inc. and the University of Rochester. Damages could amount to tens of millions of dollars, says Pfizer’s lawyer, Richard Seltzer of Kaye Scholer, although Pennie lawyers maintain that damages and defense costs will be handled by the firm’s insurance carrier and Jones Day lawyers deny having been swayed by the suit. (Now that Pennie has dissolved, Seltzer says the firm’s estate will remain liable for any damages.) Whatever combination of factors made Pennie’s last days messier than they might have been, the lesson is clear for the few remaining giant IP boutiques: Take a closer look at your balance sheet before searching too hard for a merger partner.
Where the Pennie & Edmonds Pieces Went Nearly 100 lawyers: Jones Day offices in New York, California and Washington, D.C. The entire seven-lawyer Palo Alto office and one lawyer from the firm’s D.C. office, all handling patent prosecution or litigation: Morgan, Lewis & Bockius Litigators James Dabney and Stephen Rabinowitz: New York’s Fried, Frank, Harris, Shriver & Jacobson Litigator Kelly Talcott: the New York office of Pittsburgh’sKirkpatrick & Lockhart Five lawyers, including senior partner David Weild: New York trademark boutique Fross Zelnick Lehrman & Zissu Nanotechnology practice chair Brian Siff: New York office of D.C.’s Dickstein Shapiro Morin & Oshinsky

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