When a rich and powerful law firm like Dewey & LeBoeuf collapses, the inevitable post-mortem focuses on the particular events that led to the firm’s downfall. We are told that the firm foolishly guaranteed compensation to its partners, or expanded too rapidly into foreign markets or new practice areas. We are told that the firm’s business model was trampled as a result of the Great Recession or, a decade ago, the dot-com bust.

This search for the immediate causes of a firm’s demise is understandable, even necessary, but it misses the larger point. Wrong-headed decisions can be made — and are made — in any sector of the economy. Macroeconomic conditions can — and periodically will — take a turn for the worse. Despite its prominence and prestige, the legal profession is uniquely ill-equipped to bounce back from adversity, because it is governed by a unique and outmoded regulatory regime that cuts off the flow of capital when it is most needed to help firms expand, thrive or even, in hard times, survive.

The irony is that defenders of the status quo say that abandoning the ancient rules that hamstring the legal profession’s ability to raise capital would cause an apocalypse for law firms, their clients and the public interest. Precisely the opposite is true: Clinging to the old ways is having disastrous consequences for U.S. law firms, their domestic and international competitive position, and their ability to serve a broad base of clients who are desperately underserved. In the case of Dewey and several other prominent firms, the apocalypse is now.

The trouble is a rule, enforced in all 50 states but abandoned in the District of Columbia, Australia and Great Britain, that prohibits nonlawyers from owning equity interests in law firms. The unintended consequence is that law firms in need of capital cannot sell equity interests to investors who believe in the firms’ professionals, business model, client base and future prospects. Instead, a law firm has no choice but to borrow money to expand or meet its operational needs in times of trouble, placing itself under the thumb of banks and other lenders whose own business model is based on strict and timely repayment, and is indifferent to the law firm’s long-term success.

Naturally, a firm that is struggling with debt will seek any port in a storm — even if the result is the loss of a century or more of independence. Some firms have avoided disaster, at least temporarily, by merging with more successful firms. Dewey was itself the byproduct of such a merger. But if a merger partner cannot be found — because of a debt-heavy balance sheet, defections by rain-making partners or a clash of cultures — a firm may be unable to avoid bankruptcy or dissolution.

These two points — heavy debt loads and the failure of merger talks — recur again and again in the implosion of several elite law firms in recent years:

• Coudert Brothers, renowned as the first truly international law firm, dissolved after 152 years when merger discussions with Squire, Sanders & Dempsey and Baker & McKenzie fell through.

• Heller Ehrman collapsed when it failed to agree on merger terms with Mayer Brown.

• Brobeck, Phleger & Harrison, saddled with a $40 million loan from Citibank, announced its dissolution immediately after learning that Morgan, Lewis & Bockius would not agree to a merger.

• Howrey, based in Washington, filed for bankruptcy and dissolved in 2011 after failed merger discussions with Winston & Strawn — which nonetheless hired several Howrey partners.

• Most recently, Dewey filed for Chapter 11 protection after nine days of intensive merger talks with SNR Denton failed. Dewey’s filings with the U.S. bankruptcy court in New York show liabilities of $315 million, of which $225 million is debt owed to bank lenders.

Significantly, the defunct firms’ only potential merger partners were other law firms. No matter how appealing the struggling firms’ book of business and human capital might have been to a bank, venture capital firm or conglomerate, no white knight could have saved the law firms because the arcane rules governing the legal profession absolutely prohibit such investments. Moreover, while the details of each firm’s demise differ, the underlying structural problems are the same. As Leslie Corwin of Greenberg Traurig told The New York Times at the time of Coudert’s collapse, “If you look at major bankruptcies among professional services firms, the facts are remarkably similar. They grew, they were not able to get adequate capital infusion and they borrowed money to bring in practice groups.” As recent history has shown, the lack of independent sources of capital means that any difficulty in repaying debt can land a law firm in bankruptcy court.

If the underlying problem is obvious, so is the solution. Law firms will be better able to raise capital to fuel expansion and compete in the modern era, without incurring crippling debt, if they can raise capital from nonlawyer equity investors. Unfortunately, the current antiquated regulatory regime makes that impossible. The culprit is Rule 5.4(d) of the American Bar Association’s Model Rules of Professional Conduct, which provides in relevant part: “A lawyer shall not practice with or in the form of a professional corporation or association authorized to practice law for a profit, if (1) a nonlawyer owns any interest therein.” That rule, adopted in all 50 states (but not the District of Columbia), effectively prevents law firms from seeking, or accepting, infusions of badly needed capital from outside investors.

Tacitly acknowledging that Rule 5.4 is problematic, if not entirely outdated, the ABA drafted a proposal last year that would have allowed nonattorney investment in law firms, albeit on a limited and regulated basis. Unfortunately, the ABA abandoned even this limited proposal in April. While the stated reason was the lack of a “groundswell of support” for the proposal, an article posted on the ABA’s own Web site hints that the real reason may have been a desire to avoid controversy within the ABA. Dropping the proposal “forestalls the possibility of a tough debate” in the ABA’s policy-making House of Delegates, the article said.

What is the basis for the hoary prohibition on the legal profession’s freedom to raise capital from investors who are freely inclined to supply it in the hope of future profits? Defenders of the rule cite a parade of horrors, based on the presumption that attorneys would abandon their professional judgment and sell out their clients in an attempt to please their investors. These apocalyptic visions have not come to pass in Britain, Australia or Washington, and there are safeguards already in place to ensure that they do not come to pass in any state that liberalizes its ban on nonlawyer investment in law firms.


It is important to recognize that each state’s rules of professional conduct — and the ABA rules on which they are based — are often referred to as “ethical” rules for the practice of law. In fact, some of the rules set ethical standards for attorneys, and others are simply business regulations for the conduct of the profession, with no special ethical weight. Rule 5.4 falls in the latter category. Whatever its defenders may claim, it is both unnecessary and irrelevant to induce ethical conduct by attorneys. Take, for example, the idea that lawyers will allow investors to dictate legal tactics at the expense of clients. It is difficult to see how or why an investor would even try to do this; an investment in a law practice will only pay off if the practice provides good client service — winning cases, negotiating favorable transactions and the like. Would an investor really try to prevent an attorney from rendering outstanding customer service to control costs? If so, the lawyer is under an ethical obligation to do the right thing. The source of that obligation is not Rule 5.4, but several other provisions of the Model Rules.

These and other rules governing the ethical aspects of legal practice and attorney-client relations are more than sufficient. The vast majority of practitioners would not risk career suicide by breaching client confidences or providing less than diligent representation.

As the plaintiff explained in a federal court action challenging the constitutionality of Rule 5.4: “The two principles — independence of judgment and robust, diverse sources of financing — are distinct and separate concepts. The ethical practitioner will not become less so if adequately capitalized and the unethical practitioners exist even with the present proscriptions.”

That argument was made in support of Jacoby & Meyers, a pioneer in legal advertising and providing legal services to a broad base of lower-income clients. In response, the state of New York argued that there is a rational basis for Rule 5.4 because nonlawyer investors would not be subject to the Rules of Professional Conduct, such as those concerning client confidentiality and conflicts of interest. But that is a red herring; those strictures would still apply to the attorneys, who would face the dire consequences (including an ethical inquiry and potential disbarment) for violating the rules. Thus, there is no need to impose the same obligations on passive nonlawyer investors. (Jacoby & Meyers’ challenge was dismissed for lack of subject-matter jurisdiction; that decision is now on appeal in the U.S. Court of Appeals for the Second Circuit.)

In short, the evils that would result from allowing nonlawyers to invest in law firms are not merely overblown and unproven; they are nonexistent. On the other hand, law firms are living with — and some dying of — the very real adverse consequences of Rule 5.4′s prohibition.

It would be bad enough if Rule 5.4 affected only big law firms, helping drive Dewey and others to an early grave. Even large and once-prosperous firms should have the ability to insulate themselves from market forces — and their own misjudgments — by seeking infusions of capital. But the consequences are still more far-reaching. Unlike Manhattan’s major firms, smaller firms do not generally serve Fortune 500 corporations. Most command far less than the $1,000 an hour rates that the so-called Big Law firms can use to invest in new technologies, marketing and recruiting top-notch associates and paralegals. But these smaller firms provide essential legal services to small businesses and individuals — sometimes at a lower hourly rate, sometimes on a contingent-fee basis. These are precisely the firms that, even if they are run on sound and conservative business principles, may require new sources of capital to invest in technology, marketing and recruitment.

The concern is not only for the welfare of these scrappy, ambitious, but undercapitalized law firms. It is for a fairer and more equitable competitive landscape, and for the potential clients who need legal representation but who could not dream of paying $1,000 an hour. Chief Judge Jonathan Lippman of New York has launched a vigorous public campaign against the “justice gap” — a severe shortage of legal representation in civil matters for low-income people facing foreclosure and other hardships. The Legal Aid Society, the nation’s largest provider of such services, turns away nine of every 10 prospective clients in civil matters. To remedy this shortage, New York will require new lawyers to provide 50 hours of free legal services to the poor. But a much greater good would be served by letting private, for-profit firms that seek to represent low-income clients raise capital through private investment. Abandoning the absolute prohibition on such investment would also help avoid future Dewey-style bankruptcies and dissolutions.

James R. Denlea is a partner at Meiselman, Denlea, Packman, Carton & Eberz in White Plains, N.Y. He represents Jacoby & Meyers, mentioned in the piece, in its challenge to New York’s rule prohibiting nonlawyer investment in law firms.