PANGEA3 LLC

In the past two weeks, no less than six articles about upheavals in the U.S. legal industry have hit the legal press. (The titles and links to each article are below). I read these articles carefully, and many times, and tried to figure out just what is happening in the U.S. (and global) legal market. And I think there is a coherent and cohesive theme. When you add it all up, the simple conclusion is that the “social contract” between clients, law firms and law firm associates has been shattered.

Over the past few decades, that legal industry “social contract” went something like this:

Aspiring lawyers attended law school and got jobs at law firms upon graduation. Each year, associates received raises based on their law school graduating class and moved into a higher billing rate. And every few years or more firms raised their hourly rates for all classes/tiers of lawyers. As a result, profits per partner, the compensation benchmark at big firms, continued to rise – often dramatically – irrespective of client profitability. Those associates hired worked especially hard for 7-10 years, and some of them made partner. Others left along the way to become in-house counsel (my post-firm career path prior to Pangea3), join smaller firms, join businesses or open their own law practices. Throughout all this time, in-house legal departments, which were and still are made up predominantly of lawyers who had practiced at law firms earlier in their careers, hired law firms to handle a substantial percentage of the company’s work, and paid the perennially increasing hourly rates. This continued, with only minor hiccups, for about the last 30+ years.

Then came the great recession of 2008-2009. Corporations came under massive pressure to cut costs, both because of radically lower revenue, and because of cost structures that were, frankly, out of whack. The legal department, along with the other corporate cost centers - such as IT/MIS, HR, Shared Services, Marketing and Finance – came under pressure to cut costs. However, in this latest recession, legal was treated differently. In the past, legal departments had been able to claim that legal was different, that it was impossible to predict legal costs, and therefore impossible to fix those costs and implement traditional cost saving and cost-certainty measures. However, over the past decade (roughly since the last recession), all of the other traditional corporate cost centers had been subject to institutional cost-cutting and right-sizing, as a result of factors such as outsourcing (especially for Shared Services, IT/MIS and HR departments), technology, six sigma, lean and other process improvements and good old layoffs and downsizing. As a result, those departments (1) had the appearance of being relatively leaner (from a budget and spend perspective, if not from a headcount perspective) when viewed against the legal department and (2) were able to adapt quickly to the need to lower costs and become more productive. This time around, the corporations simply insisted that the legal department do its part to align costs to the business, and to simply figure out a way to control and predict costs.

So, for the first time, the legal departments of major corporations simply started refusing to pay higher rates, refused to accept straight hourly billing and insisted that the law firms’ needs for perpetually increasing profits-per-partner was unsustainable, and that the legal departments would no longer foot the bill. In short, the legal departments changed the legal industry social contract.

And the law firms responded – by decimating the associate ranks and in turns changing the social contract with associates and law students. Why? That part is easy. To cut costs, an organization really has three choices: Real Estate, Technology and Headcount. Law firms couldn’t do much about the first two costs, so the only lever that law firms had in order to cut their own costs (in other words, to maintain their own partner profitability) was headcount. Compounding this pressure from the legal departments was a plain reduction in work, as business itself contracted globally. That combination of forces led the firms to not merely break the social contract, but to do it severely and quickly.

So as I read these articles, it actually all does make sense, except for the New York Law Journal article about firms simply insisting that they need to raise rates. I particularly loved these two quotes:

“We can’t sit out two years without changing, so we are going to do so, hoping that client goodwill from last year will cushion us at this year’s hike,” said another.

One firm was more militant. “Firms need to push back on the clients’ unreasonable demands to hold rates at 2008 levels and give a 15 percent discount off those rates,” it said.

In short, the firms are saying that the clients simply cannot change the deal that was cut so many years ago. But the firms themselves already changed that deal with their associates, and everyone knows that the game has changed – all bets are off. So it’s not merely that the partners quoted above are greedy, it’s that they’re disingenuous. They want legal departments to honor the old social contract, but they’ve broken their contract with their associates and prospective associates.

We’ll see how this all plays out, but it’s clear that legal departments are going to allow a return to the old social contract. And since everything flows from the client demands on the law firm, it seems pretty clear that whatever new expectation and social contract emerges between firms and associates will not resemble the old regime. The game has changed – we just don’t know how it’s going to end.

1. “No Longer Their Golden Ticket,” New York Times, Sunday, January 17, 2010.

2.“As Economy Stays Down, Firms Say They Will Raise Rates,” New York Lawyer, January 15, 2010. _{[NYLJ Subscription Link]}

3. “Brief for India’s outsourcing lawyers: keep it cheap,” Times of London, January 15, 2010.

4. Inside India’s Legal Outsourcing Machine, The American Lawyer, January 19, 2010 and AmLaw Daily, January 15, 2010.

5. Outsourcing: It’s Cheap and Easy to Do, Above the Law, January 15, 2010.

6. THE AM LAW 100: Revenue, Profits Up at K&L Gates, AmLaw Daily, January 21, 2010.