Your law firm dissolution: what next?

Law firm dissolutions are occurring at an alarming rate, with Heller Ehrman, Thelen and Thatcher Profitt & Wood having all dissolved in the last few months.

There is very little precedent to guide law firms through the hairy process of dissolution, and as a result, law firm dissolutions are largely misrepresented in the media and misunderstood by firms contemplating dissolution.

Any law firm contemplating dissolution will quickly learn that the limited liability partnership act governing their particular partnership agreement provides very little guidance. US case law is equally sparse. The result is that law firm dissolutions are understood by a relatively small set of professionals and are mostly governed by practical considerations such as collection of receivables and the payment of critical expenses.

The largest stakeholder in most law firm dissolutions is the firm’s lender, which typically has a blanket security interest in the law firm’s receivables and other assets. Thus a typical dissolution begins with a default under the firm’s credit agreement and with the bank largely taking control of the firm’s use of its cash.

From the firm’s perspective, the key to an orderly firm dissolution is ensuring that certain mechanisms are in place to handle the first 90 days of dissolution, which are by far the most hectic and time-consuming. It is imperative that the firm form a Liquidation Committee - many firm partnership agreements have provisions for such, but if not, the partnership agreement should be amended prior to dissolution to provide for a committee to facilitate and oversee the firm’s dissolution.

The committee’s first tasks should be to i) negotiate a dissolution budget with the lender; ii) focus on collecting the firm’s receivables and generating a plan and accurate estimate for such collections; iii) pay critical expenses (employee, critical vendors, malpractice insurance, etc); and iv) pro-actively speak with landlords for the firm’s offices about the dissolution. There is also a myriad of employment, tax, benefits and other issues that need to be managed.

Landlords are typically the largest creditors and can be aggressive in seeking to evict the firm during the dissolution process. Landlords are also usually the largest threat for the filing of an involuntary bankruptcy action against the dissolving firm. Accordingly, communications with landlords are critical to a successful dissolution.

It is important for partners to consider potential fraudulent conveyance and other avoidance risks when receiving distributions from the partnership at a time when the firm may be insolvent. There are various state and federal laws in the US that provide that distributions by a partnership to its partners are subject to recovery by a creditor or bankruptcy trustee if such distributions were illegal or were made for inadequate consideration (less than reasonably equivalent value) when the entity was insolvent or under-capitalized, or would become so as a result of such distributions.

This was the case when Brobeck Phleger & Harrison dissolved – in January 2005 the Brobeck Trustee sued 222 partners to recover $275m in various distributions made in 2001 and 2002. For many of these lawsuits, the Trustee was able to generate settlements in light of the costs and uncertainty of litigation, and ultimately recovered over $22m for the Brobeck estate.

Peter Gilhuly (pictured) represented Brobeck Phelger & Harrison in its pre-bankruptcy restructuring and liquidation, and Gilhuly and Heather Fowler currently represent Thelen in its dissolution.