When the Music Stops: Risk Management & Lateral Lawyer Musical Chairs

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By Marian C. Rice

What lessons have been learned from the role lateral hiring played in the demise of formerly venerable firms like Dewey, Howery, and Heller Ehrman, to name a few? Have the cautionary tales dampened the enthusiasm for poaching talented lawyers as the prevalent growth strategy of law firms? Apparently not. The results of the American Lawyers 2014 15th Annual Lateral Partners Survey demonstrates that grabbing partners from other law firms  continues to be Big Law’s preferred growth strategy, notwithstanding the continued risk for both the firms and the partners they hire.

As the dust has barely settled on the remains of too many once-established firms to name and the ink is barely dry on mergers that just didn’t work, Am Law 200 law firms responding to the survey reported 2,736 lateral moves from Oct. 1, 2013, through Sept. 30, 2014, a 7% increase over last year’s survey.

There is no denying that aggressive lateral hires — and the concomitant compensation variables — can have devastating effects on the acquiring law firm. According to the law firm leaders responding to a 2014 Citi Private Bank Law Firm Group survey, only 54% of their laterals hired over the past five years “broke even,” a figure that is down from about 57% the previous year.

There are many reasons a law firm seeks growth through lateral hiring. A law firm may be looking to fulfill a specific client’s need, to expand into a practice area or geographic location previously lacking or to meet future continuity or succession issues. Without a defined strategy, however, lateral hires may end up costing the firm rather than promoting increased profits.

Identify the Firm’s Needs

Growth through laterally hiring for the sake of numbers alone rarely succeeds. Before any decision to recruit lateral candidates to the firm is made, the firm must identify its needs and determine whether the services lacking cannot be met with existing personnel. Assuming the need exists, the goal is to find the lateral hire that meshes with the law firm’s cultural, professional and financial structure.

Due Diligence

While many law firms may not be subject to the economic rollercoaster attributed to lateral hires in the now defunct law firms noted above, the damage to a law firm’s culture has the capacity to be equally devastating. Culture is an amorphous concept. The law firm should quiz the candidate — and independently research the responses — on such diverse topics as compensation, partnership and equity expectations, management style, time and billing expectations (and procedures), client rate structures, views toward law firm administration, associate mentoring, outside professional associations and activities, and client satisfaction goals.

The issue driving the lateral from his or her current position should also be explored. In this economy, many firms have raised the bar on partner performance. Attorneys whose levels may be lagging behind expectations may be looking to move before being asked to do so. Current clients of the lateral candidate may have been unwilling to accept the former firm’s fee structure or pose chronic collection issues.

Background checks are in order. A law firm should search Google, Facebook, LinkedIn, Westlaw, PACER and other Internet resources to verify the prospective candidate’s proffered credentials and good standing with the bar.

Try to talk to other former attorneys from the lateral hire’s current firm to ascertain the reasons the candidate is looking to move, whether the former firm lost business due to the potential lateral hire or whether the candidate has been the subject of a professional liability or disciplinary claim. While the existence of such a claim should not alone militate against the lateral hire, it does require further investigation. As any attorney representing law firms in legal malpractice actions will report, serial laterals are often the source of significant legal malpractice claims as they move from firm to firm sowing potential claims as they move on.

Compensation & Financial Issues

The financial commitment involved in hiring a lateral is significant. The fees charged by recruiting firms range from 20–30% of the lateral candidate’s first year compensation. Highly compensated partners who do not perform negatively affect the firm’s bottom line.

Too often firm decision-makers are blinded by representation of profitable books of business and fail to consider whether the incoming lateral hire will mesh with the firm’s existing culture or the impact upon the law firm’s current attorneys. In an effort to garner acceptance, law firm management overstates the value of the lateral hire leading to resentment among the ranks and inevitable disappointment when unrealistic targets are not met. Candidates must take care to provide realistic expectations as to the portability and growth of expected business. When the former firm competes for the book of business, a client tug of war ensues. The end result is usually an unhappy client. Consultants recommend that in making the decision to bring on a lateral hire, law firms expect the lateral to bring about one half of the client base originally represented.

Long-term compensation guarantees to incoming laterals that created the skewed compensation systems such as those that contributed to the Dewey demise are no longer assumed. Law firm managers are increasingly tying lateral hire compensation to actual performance. In that way, the law firm avoids long-term commitments to underperforming laterals. The downside, of course, for attorneys is that making lateral moves becomes even more chancy — but that perhaps is all for the good.

Non-Compete Clauses & ‘Unfinished Business’

In the event the candidate had a partnership or employment agreement, potential non-compete clauses must be evaluated. Where the candidate is bringing work from a dissolved or economically troubled law firm, careful analysis of the exposure to “unfinished business” claims is warranted. Across the country, courts are permitting lawsuits seeking to claw back the profit earned by law firms that hire lateral attorneys who brought with them clients from their former financially impaired law firms, even where the legal work is billed on an hourly basis. Recognizing New York’s “strong public policy encouraging client choice and, concomitantly, attorney mobility,” the Court of Appeals in Thelen v. Seyfarth Shaw, 20 N.E.3d 264 (2014), reasonably concluded that “[t]reating a dissolved firm’s pending hourly fee matters as partnership property … would have numerous perverse effects, and conflicts with basic principles that govern the attorney-client relationship under New York law and the Rules of Professional Conduct.” Id. While it would appear the New York courts have rejected the “unfinished business” doctrine, in the absence of Jewel v. Boxer, 203 Cal. Rptr. 13 (1984), waivers in their partnership agreements, law firms having principal places of business in other jurisdictions may still be subject to exposure if the financial solvency of the incoming attorney’s former firm is in question.

Conflict Issues

The existence of conflicts and potential for resolution must be fully explored before an offer is made to the lateral hire candidate. Conflict searches must be performed to identify not just the existence of any issues between the new engagements accompanying the lateral hire and the law firm’s existing clients, but also between the clients of the former firm and the new firm. Positional conflicts must also be explored — an advocate of a position diametrically opposed to that of an existing client can wreak havoc with client relationships.

Absent the informed consent of the involved clients, New York does not recognize screening as an acceptable means of avoiding a conflict due to a lateral hire. New York does, however require law firms to clear conflicts whenever the firm hires or associates with another lawyer or non-lawyer. N.Y. Rule of Professional Conduct (RPC) 1.10(e); NYS Bar Assn. Committee on Professional Ethics, Opinion 720. Attorneys were provided little guidance on how to ethically fulfill this obligation.

Under R 1.6(a), attorneys are required to maintain the client’s confidential information and may not disclose the information for their own advantage or the advantage of third parties. Model Rules of Prof. Conduct R. 1.6(a). How then does one reconcile the need of a lateral hire to disclose sufficient new information to his or her proposed new law firm so that the appropriate search can be made for conflicts with the confidentiality mandated under Rule 1.6? Under the ABA Model Rule 1.6(b)(7), an attorney is expressly authorized to disclose confidential information in order to detect and resolve conflicts of interest arising from changes in employment provided the attorney-client privilege is not violated or the client is otherwise prejudiced. Id. R. 1.6(b)(7).

On the premise that New York’s definition of confidentiality in Rule 1.6(a) is narrower than the ABA’s definition, NYSBA’s Committee on Standards of Attorney Conduct (COSAC) concluded that an amendment to New York’s Rule 1.6 was neither required nor desirable. COSAC did find that attorneys needed additional guidance on what may or may not be disclosed when lawyers and law firms consider lateral moves or mergers. In December 2014, COSAC issued Proposed Comments, to be addressed at the June 2015 NYSBA House of Delegates meeting, that offer guidance not only for disclosures of information needed to check for conflicts, but also for disclosures of information needed to enable lawyers and law firms to evaluate the viability of a proposed lateral hire or law firm merger.

For the purposes of assessing the financial and strategic concerns relevant to going forward with a prospective lateral hire, including performing a conflict check, basic information is not considered confidential under Rule 1.6 and may be disclosed without client consent. Proposed Comment [18A]. This includes information such as (i) the identity of the clients and other parties, (ii) a summary of the status or nature of the matter, (iii) publicly available information, (iv) the lawyer’s total book of business; (v) rate structure or financial terms, and (vi) information about the client’s current and historical payment of fees. Proposed Comment [18A].

Even this basic information, however, may not be disclosed without client consent if the attorney knows or has reason to believe that the client expects the information to be protected by the attorney-client privilege, has requested that the specific basic information be kept confidential or if the content would be detrimental or embarrassing to the client. Proposed Comment [18C]. By way of example, the proposed Comment notes an attorney may be aware a client would not want the attorney disclosing late payments, the total amount paid on legal expenses, forecasts about financial prospects, or sensitive issues such as marital advice, a criminal investigation or an unannounced corporate takeover. Id. In that event, even basic information may not be disclosed without the client’s consent.

Before disclosing any data, the Proposed Comments caution that both the moving attorney and the law firm involved must take reasonable steps to minimize the risk of any improper, unauthorized or inadvertent disclosure even if the information is not confidential under the Rules. Suggested steps to implement the process include (i) disclosing client information in stages as discussions move forward, (ii) limiting disclosure to the discrete people at the firm who need to make the business decision whether to move forward with the lateral hire or who are charged with identifying and resolving conflicts, and (iii) agreeing in advance to non-disclosure outside the firm while the proposed lateral move or merger is explored or even after. Proposed Comment 18[F].

Unlike the ABA Model Rules, under the New York Rule of Professional Conduct 1.10 the burden to affirmatively vet the lateral hire’s prior engagements falls squarely on the hiring firm. N.Y. Rules of Prof. Conduct R. 1.10. To assist in fulfilling that duty, COSAC has suggested proposed amendments to the Comments under Rule 1.10 as well. Before hiring the lateral, the Proposed Comments suggest the new law firm should obtain information such as (i) the identity of each client the lateral candidate currently represents, (ii) the identify of clients that the lateral hire formerly represented going back a reasonable period of time or clients about whom the proposed new attorney acquired material confidential information, (iii) the identities of the other parties in the matters the lateral attorney represented those clients; and (iv) the general nature of each such matter. Proposed Comment [10]. As noted above, the hiring law firm may request appropriate financial data to aid in its evaluation of the potential hire.

Again, depending upon the nature of the representation and the specific client involved, the lateral candidate must make the decision whether disclosure of the information sought is permitted without the client’s consent.

One hopes that the guidance provided in the Proposed Comments will provide a transparent framework for the lateral hire process that assists both the lateral candidate and the hiring law firm and which will ultimately inure to the benefit of the client. An inadequate conflict analysis can cause the loss of a significant client — not a propitious beginning to the relationship.

On the flip side, a belatedly discovered conflict may result in the retraction of the lateral hire’s employment offer. The decision in Ogden Allied Abatement & Decontamination Services, Inc. v. Con Ed, 2000 WL 34487117 (N.Y. Sup. 2000), presents a factual scenario that constitutes the ultimate nightmare for any lateral hire. After making an offer to an associate from an adverse law firm during a pending litigation, the new law firm withdrew the offer when the adverse law firm made a motion to disqualify after the associate gave notice. Id. at *2. While the Ogden court did not disqualify the law firm that had made — and withdrawn — the offer to the associate because the associate did not actually start employment, the court soundly criticized the law firm’s conduct in continuing the interview process while the litigation was pending with knowledge of the associate’s involvement in the representation. Id. at *4.

Professional Liability Considerations

There are several ways a lateral hire may increase the new law firm’s professional liability exposure. Angry former law firms may impede the transfer of files and adversely impact the clients. If the prior firm dissolved or its fate is uncertain, the lateral hire may seek or the new firm may offer prior acts coverage for their attorneys. In this event, the lateral hire will be covered for suits arising prior to joining the new firm. While such coverage may keep a valuable lateral hire from being distracted by a potentially uncovered claim emanating from the prior law firm, the obvious downside is that the new law firm’s deductible and policy limits may be eroded by claims stemming from the conduct of clients not selected by the firm and lawyers unknown to the firm. In any event, before a lateral hire comes on board, the details of prior professional liability coverage should be obtained.

Integration

During the due diligence process, the compatibility of the lateral hire with the firm’s existing culture should be aggressively addressed. But even if it appears the cultures mesh, the relationship can go awry if efforts are not made to assimilate the attorney into the fabric of the firm after his or her arrival. The manner in which a lateral hire is integrated into the firm can make all the difference. A mentor within the firm should be designated to assist the lateral hire in the transition. Coordination with existing attorneys within the same practice area should be a priority. Introductory events should be designed to educate both the existing firm members and the lateral hire about each other’s strengths and to explore opportunities for cross-marketing. The effort does not end with the lateral’s entry to the firm. Continued assimilation beyond the “honeymoon” is key to the successful integration of a lateral hire.

Conclusion

Navigating the intricacies of successful lateral hiring is a difficult but important aspect of law firm management. A misfit lateral hire may have consequences beyond the significant financial investment associated with the hire. There may be professional liability consequences, disciplinary concerns, and disruptions to firm culture that cannot be remedied. Yet with the ever-increasing reluctance of clients to pay for entry level associate services, lateral hires are often a necessity. Detailed attention to the hiring process will increase the chances that the lateral attorney will enhance the reputation, capabilities and profitability of his or her new home.

Marian C. Rice is the Chair of the Attorney Professional Liability Group at L’Abbate Balkan Colavita & Contini, LLP in Garden City. In addition to representing attorneys for over 30 years, Ms. Rice is a past President of the Nassau County Bar Association and has served as a member of the ABA Standing Committee on Lawyers Professional Responsibility. She is currently co-chair of the NYSBA Law Practice Management Committee and may be reached at mrice@lbcclaw.com or 516-836-7415.

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