‘Mass Lateral’ Moves No Silver Bullet For Beleaguered Firms

Law360, New York (November 22, 2017, 3:26 PM EST) — BigLaw firms at risk of insolvency may find plenty to like about a “mass lateral” move to a competitor in lieu of a full wind-down, one of several routes that Sedgwick LLP has considered in the lead-up to its planned closure. However, choosing to walk away from the business rather than seek bankruptcy carries its own set of complications, as evidenced by the ongoing fallout from Novak Druce’s dissolution.

In that deal, 44 partners, associates and counsel from the IP-focused Novak Druce Connolly Bove & Quigg LLP headed to Polsinelli PC last year, creating a career path for the majority but also leaving behind unpaid lawyers, overdue bills and lawsuits, including one over a $10 million Citibank loan.

The mechanics of Sedgwick’s impending wind-down remain to be seen. The San Francisco-based firm told its employees Nov. 21 that it would close at the end of the year. It was unclear how many Sedgwick lawyers and staff already have offers or positions lined up elsewhere. In a statement Tuesday, the firm said most lawyers and staff “have opportunities with very fine firms.”

Sedgwick has been pursuing a merger, mass-lateral dissolution or other deal since at least early this year.

While firms facing collapse typically look long and hard for a “true” merger in which another firm assumes both its assets and liabilities, a number of major partnerships in recent years have simply moved as many lawyers elsewhere as possible and closed shop. While it may be a more direct route than a Chapter 11, it also means whatever last-minute revenue the firm pulls in has to go to pay off vendors, landlords and employees.

Those who aren’t made whole have to fend for themselves.

“This is one way to do it, to go to another firm and say, ‘Here, you can have all my people, but you can’t have my receivables, because we’re still going to need that,’” said Ron Minkoff of Frankfurt Kurnit Klein & Selz PC.

If the firm has a compliant partner willing to deal on the terms of the mass hire and enough money coming in to mollify creditors, that move can be mostly painless, at least compared to a prolonged and costly Chapter 11 and the possibility of ex-partners being hit with trustee clawback suits.

For firms looking to an asset sale, “the bigger problems come when you’ve drawn down on a credit line and then you have to come up with that money too,” Minkoff said. “And if you can’t, the bank comes after you.”

In one example of the difficulties of a firm wind-down, former Novak Druce leaders Gregory Novak and Tracy Druce were hit in August with a lawsuit by the firm’s former lender, Citibank NA. The bank claims it’s owed $3.2 million from a $10 million loan to the firm in 2013 — a loan the pair personally guaranteed.

The firm was also sued in Delaware by its Wilmington office landlord, The Buccini/Pollin Group, which claimed partners walked away from nearly $1.2 million in back rent and other costs.

In yet another dispute, a Delaware judge in September granted a default judgment against the firm for $36,000 for two nonequity IP partners, Curt Lambert and Zhun Lu. The pair sued after Novak stopped paying them in 2015, long before Polsinelli said it was bringing on scores of Novak Druce lawyers. The group included Novak and Druce, who remain at Polsinelli.

The judge in that case took sharp exception to what he called a purposeful attempt by the firm to make service of the suit impossible, even as it didn’t dispute it owed the lawyers back pay.

The firm had no registered agent in Houston, where Novak and Druce both have offices, and instructed Polsinelli staff — now occupying Novak Druce’s old Houston office — not to accept any mail for the old firm, according to the Sept. 25 decision. Novak Druce’s registered agent in Delaware, Jeffrey Bove, now of RatnerPrestia, was never told he’d been given the role, nor did he have the authority to accept the suit.

“Novak Druce apparently created a scheme during its winding-down process that made it almost impossible for a creditor to effect service of process,” the court said in awarding the lawyers’ motion for default judgment.

In California, the Novak firm is also on the hook for a $500,000 settlement with two former nonequity partners, Marcus Hall and Dean Morehous, for unpaid holdback or bonus payments going back to 2014.

As in the Lambert-Lu case, none of the California judgment has been paid, according to their attorney, Ara Jabagchourian. Jabagchourian said he’s preparing a motion to ask the court to amend the judgment to name Novak and Druce as personally liable for the judgment. If that avenue is unsuccessful, the next step would be to seek to get Polsinelli itself named as the judgment debtor.

Jabagchourian called the Polsinelli deal a “de facto” merger through which the Novak partners hoped to avoid the hassles of a formal bankruptcy and paying their own debts.

“We know they have the money, so [an amended judgment] puts heat on them as individual debtors in hopes of getting something going,” he said. “My clients, they’ve moved on, they’ve done well for themselves, but a half a million dollars is still a lot of money.”

Another former Novak equity partner in California, Glenn Trost of Snell & Wilmer LLP, told Law360 he was similarly owed distributions from 2013 when he left the firm in mid-2014, well before the Polsinelli announcement.

An arbitration ended last year with a “100 cents on the dollar” award in favor of his contractual claim, he said. Trost declined to discuss specifics, citing arbitration confidentiality, but said he is still considering another legal action to try to get the judgment paid.

“From the perspective of a creditor, this appears to be a merger where they’re preserving the argument that it’s not a merger,” Trost said of the Polsinelli laterals.

“The whole idea was that [Novak and Druce] wouldn’t have to pay their creditors, and so far they’ve been successful,” with the exception of a partial repayment to Citibank, Trost said.

In the Delaware landlord suit against Novak Druce, The Buccini/Pollin Group said the firm already owed it more than $275,000 in back rent by the fall of 2015, and stopped paying on a 15-year lease altogether late last year. The firm ultimately abandoned the space, according to the suit.

The status of that suit claim was unclear on Tuesday; a message left for an attorney representing BPG was not returned. Messages left for Novak, Druce and a Polsinelli spokesperson were also not returned.

Novak is among a small but growing number of financially strapped firms that found refuge in mass-lateral moves. Boston-based Bingham McCutchen LLP, which grew rapidly through mergers in the late 1990s and 2000s, had hit hard times by 2013.

Unable to right the ship through a traditional merger and cutbacks, firm leaders ultimately opted to dissolve in 2014 in a deal in which some 750 lawyers and staffers went to Morgan Lewis & Bockius LLP.

Dickstein Shapiro LLP had stopped capital repayments to at least some recently departed partners when it cut a deal early last year with Philadelphia-based Blank Rome LLP to take on more than 100 lawyers from Dickstein’s Washington, D.C., and New York offices.

Financial services-focused Thacher Proffitt & Wood LLP also broke its bank loan agreements in the wake of the financial crisis, but arranged for scores of lawyers to join Sonnenschein Nath & Rosenthal LLP, later part of Dentons, just before closing shop for good at the end of 2008.

While mass-hire deals like these put partners in a take-it-or-leave-it position, experts said large firm leaders and any equity partner have good reason to want to avoid a Chapter 11 proceeding.

The chaotic Dewey & LeBoeuf LLP breakup, not surprisingly, was a financial disaster for many; the firm’s Chapter 11 included a settlement in which former partners put in $70.4 million to end the trustee’s clawback claims on money distributed while the firm was insolvent.

The trustee for the defunct Heller Ehrman LLP has aggressively pursued individual clawback claims and targeted firms where partners took unfinished business. In a closely watched case, four firms — Davis Wright Tremaine LLP, Foley & Lardner LLP, Jones Day and Orrick Herrington & Sutcliffe LLP —opted not to settle and have challenged the trustee. The case remains before the California Supreme Court.

In light of those difficult and prolonged closures, Minkoff said when a floundering firm’s primary debts are to a single bank and office landlords, taking the lateral-dissolution route can look very attractive.

“These are tough situations, and sometimes the better thing to do for all partners is just sell yourself to another firm,” he said. “Even though you know there are risks in that, at least you’re dealing with creditors directly, not through a process that will take years, and maybe there will be enough to satisfy them.”

Robert Hillman, a professor at the University of California, Davis School of Law, and a firm partnership expert, also emphasized that many firm leaders facing a breakup are often as concerned about giving lawyers a professional path forward as they are with finances.

“Trying to structure their future can be a choice, rather than just saying, ‘It’s every man for himself’,” he said. “They may feel that doing a package deal is really for the greater good of the lawyers and their professional futures.”