As reviewed in Part One last week, the example of the Morgan Lewis/Bingham McCutchen mass lateral transaction may serve to stimulate the pursuit of distressed firms by healthy firms. Although distressed law firm transactions are nothing new, the model of that deal plus two new legal developments may foster greater distressed law firm activity.
The first development was long awaited-the New York Court of Appeals’ decision on whether the “Unfinished Business Doctrine” is recognized under New York law. Answering with a resounding “no,” in Geron v. Seyfarth Shaw LLP the Court of Appeals directly paved the way for law firms to poach away a struggling law firm’s best lawyers and business generators. Whereas prior to Geron a raiding law firm risked having to share the unfinished business profit, now all the value in the transferred business belongs solely to the acquiring firm. While the decision is strictly limited to the application of New York law, it and a similar outcome under California law in Heller Ehrmann LLP v. Davis, Wright, Tremaine, LLP could influence other jurisdictions into largely gutting the Unfinished Business Doctrine and its associated risk to acquisitive firms.
The second development, coming from the United States Bankruptcy Court of the Southern District of New York in In re Dewey & LeBoeuf, LLP, et al., greatly increases the risk for the owners of failed New York law firms. In Dewey, the Bankruptcy Court determined that in constructive fraudulent conveyance litigation and certain New York partnership law litigation brought against former owners, no reasonably equivalent value or fair consideration defenses are available. In essence, the ruling may leave former owners strictly liable for all pre-bankruptcy funds received while the firm was insolvent or undercapitalized. Like in Geron, the Dewey decision is limited to New York law, but its influence in non-New York jurisdictions could be far reaching.
In a distressed acquisition world in which there is less risk to healthy law firms and greater risk to the owners of unhealthy ones, five reasons make it a perfect time for distressed law firm transactions.
The Healthy Law Firm’s Litigation Risk is Greatly Reduced. Without a fear of the Unfinished Business Doctrine, an acquisitive firm can scour the ranks of a struggling law firm and know that even if the target firm fails, having to share any profits with the failed firm’s bankruptcy trustee is substantially reduced. Its downside risk can be slight.
A Piecemeal Acquisition Can Be Attractively Structured for the Healthy Firm. With the reduced litigation risk to the healthy firm, a healthy firm can select the filet of the distressed firm, plus add some logical complimentary parts without having to take on under-performers. It can even over-pay a little for what it really wants in order to make the deal happen.
A Piecemeal Acquisition Can Be Attractively Structured for the Distressed Firm. Even though the distressed firm may be disappointed with a piecemeal offer, working with the healthy firm to consummate a transaction may help it avoid bankruptcy. Many of its owners, especially those that are part of the traveling squad that goes over to the healthy firm, will draw comfort from knowing that the risk of bankruptcy has been reduced.
For the Distressed Firm’s Owners, Even Onerous Terms or Being Excluded From the Deal Can Still Be Better Than Bankruptcy. It is one thing to be looking for a new firm when your old one ceases to exist, but it is another thing to be searching for a new home while staring down the barrel of Dewey like liability. A deal that simply avoids bankruptcy may be palatable, even if barely so.
The Haves and the Have Not’s May See Eye-to-Eye on a Piecemeal Deal. Traditionally, when a large number of owners are not offered the chance to go to the healthy firm, it can be very difficult to gain the necessary votes to gain approval of the distressed transaction. Yet a struggling firm does not have unlimited time and failure can be looming. In the aftermath of Dewey, the interests of all the firm’s owners, whether included in the deal or not, may be to get a deal done that protects against bankruptcy. Despite having very different opportunities, unanimity about the lesser evil may provide the electoral support needed to get a piecemeal deal done.
We can only speculate about the respective motivations that resulted in the Morgan Lewis/Bingham McCutchen deal. But with the recent outcomes in Geron and Dewey, there are a number of reasons to take a fresh look at distressed transactions. Will these reasons be enough to impact your strategic thinking?