Why a $2 Billion Law Firm Suddenly Collapsed | Odd Lots

Thanks for inviting me. It's a pleasure to be here.

It's not entirely clear. Surprisingly, there's not an obvious answer to that question. I'll answer the question on three levels. So the first is history. Well, firms started out this way, and because it doesn't require a lot of capital to start a law firm, it really just requires the labor of the workers and the human capital of the workers, you can start one without having outside investors. And so large law firms didn't appear, and by large, I mean even more than three or four lawyers, didn't appear until the mid-19th century in either the United States or the United Kingdom. But they've always been worker owned. The second level in which we'll answer that question is regulation. Today, the Model Rules of Professional Conduct, which have been adopted in some form in almost every state, generally require that a law firm be owned by lawyers, which as a practical matter tends to mean the lawyers who work at the firm. Then there's a third level at which we could answer that question, which is economics, a big, big debate about whether this pattern of ownership is efficient or not. Should law firms instead be owned by their investors? The best answer to that question was given by a Yale Law School professor named Henry Hansmann, who was my teacher and mentor. His argument was that in a law firm, the contributions of the workers are relatively easy to measure and perceive, which reduces the risk of conflict among the workers. Imagine if General Motors were owned by its workers. There would be huge conflict between the management and the people on the factory floor. There'd be lots of conflict about how much each of the executives paid, because it would be hard to measure their relative contributions. In a law firm, it's much easier to measure people's contributions because they bill by the hour, and you can often identify which clients they brought in.

That's right. That's the eat what you kill model. But even before the eat what you kill model, there were even simpler ways of identifying lawyers' productivity and structuring their pay, which was that every lawyer of a given level of seniority got paid the same amount. So worker ownership is more tenable in a law firm than in other kinds of businesses, because the workers tend to be more similar to one another. That's the idea.

So first off, there are investor backed, venture backed businesses doing that now.

It's harder to do that with a traditional law firm. In both types of businesses, the venture backed businesses and traditional law firms, you have these rules that prohibit non-lawyer ownership. The way the venture backed businesses get around those rules is by segregating the business into two chunks that each go into a different entity, with a slightly different set of owners. On the one hand, you have the law firm, which provides legal services and employs lawyers, and is owned exclusively by the lawyers. On the other hand, you have what's called a managed service organization or MSO. The MSO is owned by a mix of investors and the lawyers who work at the law firm. And the MSO does everything other than provide legal advice. It employs the word processing people, the administrative assistants, the finance, the accountants, the financial administrators. It holds the lease. It owns the computers. And so basically what happens is the clients pay fees to the law firm, and then the law firm pays a price for administrative support to the MSO.

Yeah, they're essentially legal ethics rules adopted by state bar associations and sometimes by state legislatures. The American Bar Association has promulgated a model set of rules called the Model Rules of Professional Conduct, and every state has adopted them in some form. A couple of states, namely Arizona and Utah, have altered those model rules to permit non-lawyer ownership of law firms, but only those states.

Because it's hard, is the answer. There's always a tension between law firm management on the one hand and individual partners on the other. The management wants to institutionalize all the clients and make sure that the client's loyalty is to the firm, not the partner. The partner wants to keep the clients individual to the partner so that the partner can leave. And also because under an eat what you kill system, the partner might get credit for bringing the business in, which means that the partner wants to make sure that the relationship is unique to that one partner and not spread across other partners as well. And there's a way in which law firms are undermining their own objectives by adopting an eat what you kill system. If you pay partners for tethering their clients' loyalty personally to themselves, that is naturally what they will do. But on the other hand, if you don't pay them for doing that, well, then they'll sit back and wait for other people to generate business. It's what in economics we call an optimization problem, you're trading off two variables that are in tension with one another.

Okay, so let's break it into two pieces. One is, how does that partner's departure damage the firm? And then second, how do the other partners get hurt as a result? Okay. So for the first piece, is when that partner leaves, especially if that partner is a rainmaker, and especially if that partner's clients are personally loyal to him or her, then that partner will take revenues with her. Right. The clients will leave and the firm will have fewer revenues as a result. Now, that's not obviously bad for the firm because in addition to losing revenues, it also gets rid of some costs. You no longer have to pay that partner's compensation. And indeed, sometimes law firms deliberately fire or de-equitize partners because the partners are bringing in less than they're taking out. But if the partner's bringing in more than they're taking out, then to lose the partner is a loss. Here's the bigger issue, though: you often can't cut costs as quickly as you lose revenues. So when the partner leaves, you still got to pay the lease on that partner's corner office, and you can lay off associates, but that's kind of a bad thing to do. You can lay off staff, but that's a bad thing to do. You might have debts to pensioners and retirees from the firm. You might have bank debts, none of which go away simply because that partner left. There might also be other partners who depend on that partner for work. If I'm an M&A partner, for example, I'm expected to bring in business. But if I'm a tax partner, all I really do is work on business brought in by the M&A partners. So if the M&A guy leaves, well, we still got to pay the tax partners, and now they don't have any business. So you can't cut costs as quickly as you can cut revenues. Right. So the answer to the second piece is a bit more complicated. Why does that hurt the partners who stay? Well, the answer is because the partners are owners of the firm and not merely employees. And that causes them to suffer for two reasons. The first is that as owners of the firm, they are paid in shares of the profits. And so if the revenues have gone down while the costs stay fixed, the profits have to go down as well. That's just simple math, which means that once that rainmaker has left, there are fewer profits left over to pay the partners who remain, just as a matter of arithmetic. They can't all be paid the same, so their pay has to go down. The second reason they suffer is that if the firm eventually files for bankruptcy, and we'll talk about the snowball or the run that might propel it into a bankruptcy, but if it ever does wind down, the partners can face a bunch of forms of liability that are unique to their status as owners of the firm. The most important is a doctrine called fraudulent transfer liability. The basic intuition behind that doctrine is that we don't want a debtor to give away assets on the eve of bankruptcy. If I'm about to file for bankruptcy, we don't want me to give away my car and my house to my girlfriend and my uncle. So basic rules of bankruptcy say if you give away money between the period you become insolvent and the period you file for bankruptcy, all of those giveaways can be voided or clawed back by the creditors. And here's the catch: a distribution on profits is a giveaway under that doctrine, because it doesn't actually have to be paid. Wages have to be paid because they're contractual debts. If your administrative assistants have worked for two weeks, they have a right to claim against the firm. By contrast, all the partners are entitled to receive is a discretionary distribution of dividends, which the firm can choose not to pay. So, for example, Berkshire Hathaway is sitting on billions of dollars of profits, which it's never paid out as a dividend because it doesn't have to. So what happens in law firm bankruptcies is after the firm goes south, the creditors show up and say, look, there was a ten-month period during which we consider the firm to have been insolvent, but during which you were making payments to partners. We want to claw that all back. And the partners say, you can't do that. We were workers. Those were wages. And the court saying, you were not employees, you were owners of the firm. And those were not wages, those were discretionary distributions of profits, which under standard law can be clawed back in bankruptcy. The more a partner thinks that a firm might be heading for failure, the more risk there is that their compensation could be clawed back and that they could be liable for some parts of the business if it actually fails completely.

So this is what I call the leave-stay decision. You might not wake up as a law firm partner on a Wednesday morning and think, should I stay or should I go? But implicitly, you face that decision every day. And so you're going to walk through three kinds of calculus. The first is to say, well, because that guy left and took revenues with him, and the costs of the firm are going to stay the same, we in the aggregate, me and my other partners, have to be paid less as a result. So I'm going to get paid less. But the amount I can get paid by moving across the street to Cravath is going to stay the same. So whereas previously I was making 5 million at Weil and being offered 4 million in Cravath, if now I'm making 3.98 at Weil, suddenly I might begin to move. The second thing I'll ask myself is, well, what about my liabilities? And I'll be saying, if everybody follows the same logic I'm following, they might leave before me. And then one guy leaves and another guy leaves, and all of a sudden we're in a run on the bank. And if the firm ultimately collapses, I'm going to have to give back all or a portion of the money I received from the firm between now and the date of collapse. So suppose that I'm a partner at Weil Gotshal in this past September, and I think most of my compensation is going to be paid to me in January. This is a typical feature of law firm compensation. Partners get paid a little bit every month or every quarter, and then they get paid a big chunk, maybe 50% or more of their compensation in January, after the books for the prior year have been settled. And you say, okay, it's September, I think there's a 50% chance this firm is gone in February. If it is, every dollar of compensation I receive between now and February is going to get taken back from me. So if I'm expecting $2 million in compensation over that period, I have to apply a 50% discount. It's really only worth a million to me. So then if Gibson Dunn comes and offers me 1.5 million, it looks on paper like a pay cut, because Weil is offering me two. But in fact, it's a pay raise because the expected value of comp at Weil is a million, whereas at Gibson it's 1.5, and it's also less risky. The third calculus I'll be making is what about the viability of my practice? So most law firms now, including Weil, have eat what you kill compensation systems, you get paid according to your productivity. Well, if I'm a tax lawyer and I'm in the business of servicing M&A deals brought in by M&A lawyers, then if all the M&A lawyers have left, I'm not going to look even to my own firm's managing partners as if I'm being very productive. In other words, my own practice might become unsustainable. So as each partner leaves, the predicament of the remaining partners gets worse and worse in a spiraling cycle that becomes a kind of run on the bank.

I do, and I want to be clear, I don't have any inside knowledge.

I'm just speaking based on what I've read in news reports. In terms of the news reports and your framework, I think one of the things that people found especially striking and prescient about my framework, if I can be a little bit immodest for a moment, I specifically predicted that a firm could collapse even when it had no meaningful debts, and even when its profits were not just large, but increasing. A firm can collapse basically whenever its profits are not increasing as quickly as its peers, in other words, what I call its relative profitability is decreasing. And that was unambiguously true of Weil. Weil's position in the profits per partner ranking fell from 9 in 2020 to, I think, 20 in 2025. And I think that the fall was even starker if we go back further in history. So why did Weil fall relative to its peers? And I want to be clear, its profits were still increasing year over year, just not as quickly as Kirkland and Ellis. So why did Weil's profitability falter relative to its peers? I think the answer basically is that it didn't expand and it didn't shrink. Law is big law. That's the term that we'll use, big law is in the midst of this sorting that actually resembles the sorting we've seen in many other industries, where the middle is getting hollowed out. And you're seeing this gravitation towards either becoming humongous or becoming really small. And Weil was uncomfortably in the middle, and that was a deliberate choice. My understanding is that there was a very powerful rainmaker there named Michael Yellow, whose departure in September was kind of the final straw that really, to mix metaphors here, pushed things over the edge. And Yellow, understandably, in my opinion, wanted to work at a place that wasn't gigantic. He thought, you know, he was a little bit wistful, like Lloyd Blankfein, about the kind of smaller familial feel of the old Weil Gotshal, which is why, by the way, the firm he left for was Cravath, which still has that feel. But the problem was that Weil wasn't keeping pace with its competitors, and clients increasingly want firms that can offer a very large platform with a high degree of specialization. And that's something you can do if you're like Kirkland and Ellis, and you're really gigantic. It's much harder to do on a smaller platform. There's only a couple of law firms that manage to stay small in the corporate transactional space and do really well. Basically, it's Wachtell and Cravath, but even those firms have been struggling. They've made it work by doing only very, very premium work on super duper high end stuff like public company M&A. But even those firms are experiencing a bunch of poaching. They are under profound pressure. And Weil just was not strong enough to withstand that.

The answer is Rule 5.6 of the Model Rules of Professional Conduct, which prohibit a lawyer from signing any agreement that would restrict their right to practice. So that includes non-competes and similar kinds of agreements. And to be clear, other countries don't have these rules. In the United Kingdom, lawyers are free to sign non-compete agreements, and law firms generally require that they do. And my understanding is that they are frequently enforced. Those restrictions also don't appear in other industries. You can impose those kinds of restrictions in accounting and engineering and management consulting. I would say, by the way, Joe, so you'd asked earlier what is preventing investors from owning law firms? Well, one answer, and the most commonly given answer, is the one that I gave a moment ago, which is the rules limiting investor ownership. But another and perhaps more important answer is these rules prohibiting non-competes. And the reason is this: if you're a private equity fund looking at investing in a law firm, you're going to pay all these partners a bunch of cash to buy out their equity interests. And then what are they going to do? They can leave the next day. Yeah. And you can't force them to sign an agreement committing not to leave. So the best solution you have is to give them equity in the MSO and require them to forfeit that if they leave, because that's not a restriction on the right to practice. Right. That's a forfeiture condition on an equity stake in an unrelated business. And like a distinct business, it works pretty well, but whether it works well enough is going to be one of the central questions of the new private equity boom in law firms.