The conventional wisdom is that Dewey & LeBoeuf failed because of an overly aggressive growth strategy that relied too heavily on large salary “guarantees” for lateral hires of “megarainmaker” partners. That analysis, while not inconsistent with the facts now known, may be both incomplete and too simplistic.
From what we now know, Dewey did not plunge into bankruptcy solely because the salary guarantees of many partners were no longer economically feasible. Instead, the most direct contributing factor to the firm’s failure appears to have been the speed and ease with which partners left the firm when it became apparent that the full amounts of their guarantees could no longer be paid. At that point some partners simply “jumped ship” and took their lucrative practices to other firms. Others soon followed suit, and as a result the entire firm quickly spiraled into insolvency.
Had it been more difficult for partners to depart the firm, and if the mass exodus of Dewey’s top-producing talent could have been avoided or mitigated, then the firm might have weathered the storm and survived. The reasons for the hasty departures of those partners may run deeper than concerns about their salary guarantees. Once unusual, lateral moves by law partners now are commonplace in the United States. Absent a special penalty provision in a partnership agreement or some other disincentive to partner departures, it is particularly easy for partners to walk away from a New York law partnership that is organized as a registered limited liability partnership — an LLP — as Dewey & LeBoeuf was. One reason for this heightened mobility can be found in the liability-protection provisions of the New York LLP law.
The first LLP statute was enacted by the Texas Legislature in 1991 in response to the savings and loan crisis of the late 1980s. Texas law firms lobbied the state legislature for relief because they feared the consequences of the shared liability that every partner in a traditional general partnership faces for the actions of any other partner in connection with partnership business. Each partner in a non-LLP general partnership is personally liable for any liability, whether arising from a tort claim or some other cause, incurred by another partner in connection with the partnership business. Thus misconduct by one partner in a law firm, perhaps unknown to other partners in the firm (as reportedly occurred at one large Dallas law firm where a single partner had engaged in professional misconduct while representing failed savings and loan associations), potentially could wipe out the personal assets of all the firm’s other partners, if the firm’s insurance and other assets were insufficient to satisfy the liability.
SHIELD AGAINST TORT LIABILITIES
The Texas law firms’ lobbying efforts were successful. The Texas Legislature granted some relief by enacting a statute that provided for the creation of a limited liability partnership in which partners were not personally liable for the misconduct of other partners in the partnership, so long as they did not participate in or supervise the misconduct. The assets of the partnership, including insurance proceeds and other assets, were still at risk, of course, but the personal assets of “innocent” partners were protected. Importantly, the original Texas statute shielded only against tort liabilities, such as malpractice claims, not contractual liabilities of the partnership, such as a lease for a law partnership’s office space.
Other states have since enacted LLP statutes, and as the law has evolved, LLP statutes now come in two basic varieties: “partial-shield” statutes and, more recently, “full-shield” statutes. States retaining the original Texas approach have what are known as partial-shield statutes because they do not absolve individual partners from personal liability for contractual obligations of the partnership. An example is Section 8204 of the Pennsylvania LLP statute, which protects partners only from claims “that arise from any negligent or wrongful acts or misconduct committed by another partner or other representative of the partnership.” All partners are responsible for their own misconduct and any misconduct of persons they supervise, and they all are personally liable for contractual obligations entered into by the partnership. Arguably, as discussed below, that level of protection is adequate, but a number of states, including New York, have gone further and provided full-shield protection.
New York law permits professionals who are authorized by law to render a professional service in New York to form a registered limited liability partnership. Section 26 of the statute protects a partner in a registered LLP from personal liability for any claims against the partnership “whether arising in tort, contract or otherwise,” so long as the claim is not “for any negligent or wrongful act or misconduct committed by him or any person under his direct supervision or control while rendering professional services” on behalf of the LLP. Thus the statute retains the element of responsibility for a partner’s own acts and the acts of persons a partner supervises, but protects the partners from personal liability for both tort and contract liabilities of the partnership — a full-shield liability protection. (Individual partners may, however, be liable for “all or specified debts, obligations, or liabilities” of the partnership “to the extent that at least a majority of the partners shall have agreed” to impose personal liability on individual partners. In light of what happened at Dewey, New York law LLPs may wish to consider taking advantage of this ability to force sharing of at least some contractual obligations of the partnership, provided by Section 26(d) of the New York statute.)
This full-shield liability protection allowed the Dewey partners to jump ship and leave the firm, without concern for any personal liability for existing contractual liabilities of the partnership, whether lease obligations for the firm’s office space, payments due to employees and general creditors, or other contractual obligations of the firm. In a partial-shield state those significant potential personal liabilities might have caused at least some partners to hesitate before departing the firm. The prospect of facing personal liability for a substantial contractual obligation of the partnership — for example the office-space lease — might have caused some Dewey partners to stay and try to work through the challenges facing the firm, rather than running to whatever competing firm offered the highest bid for a partner’s “book of business” and practice group.
Whether New York’s full-shield protection from partnership contractual obligations in fact contributed to the sudden, cascading wave of partner departures at Dewey may never be known for certain, but reports to date indicate that the Dewey partners felt under no constraint to remain at the firm. For generations the most widely cited authority on the duties of partners to one another, the opinion of then-judge Benjamin Cardozo of the New York Court of Appeals in Meinhard v. Salmon, 249 N.Y. 458 (1928), has taught that partners owe one another “a duty of the finest loyalty” and that “[n]ot honesty alone, but the punctilio of an honor the most sensitive” is the standard of conduct for partners who engage in business together. Even if the teachings of that case are now no more than an aspirational anachronism, the massive, immediate partner defections at Dewey fall far short of what most would hope to see in a partnership of professionals.
Assuming that the Dewey bankruptcy proceedings establish that New York’s full-shield liability protection played some role in the partner defections that brought down the firm, legislators in states with full-shield LLP statutes may wish to reconsider the wisdom of those statutes from a public policy perspective. Partial-shield protection from malpractice and other tort liabilities should be adequate to protect professionals from the arguably unfair prospect of personal liability for wrongful conduct of another partner in which they played no part. If partial-shield protection is adequate for that purpose, and if full-shield protection makes it more likely that partners will abandon a professional-services partnership that otherwise might be saved, then the costs of full-shield protection may outweigh its benefits. This is especially true if full-shield liability protection and the resulting partner mobility it fosters ultimately are a cause of the collateral damage to employees, creditors and clients that inevitably results when a large professional-services partnership fails.
In that scenario, the legislatures in New York and other full-shield states should consider amending their LLP statutes to provide professional-services partnerships only partial-shield protection, like the Pennsylvania statute. Partial-shield protection is both more consistent with the original intent of the LLP concept and more likely to protect innocent third parties from a partnership failure like the Dewey & LeBoeuf debacle.
Lance Cole is professor of law and director of the Center for Government Law and Public Policy Studies at Pennsylvania State University Dickinson School of Law.