How Dewey & LeBoeuf Became the Biggest Law Firm Bankruptcy Ever

Dewey BankruptcyIt's official. The law firm of Dewey, Cheatem, & Howe -- sorry, I mean "Dewey & LeBoeuf" -- has declared bankruptcy.

[Pause for cheers.]

Now that that's out of the way, let's move on to the details.

Formed from the merger of Dewey Ballantine LLP and LeBoeuf, Lamb, Greene, & MacRae LLP in 2007, New York-based Dewey & LeBoeuf was one of the world's great law firms. Even if you've no exposure to the legal world yourself, you've probably heard of at least a few of the deals this firm was involved in over the past few years.
  • Dewey played a leading role in Disney's 2009 acquisition of Marvel Entertainment.
  • That same year, Dewey helped eBay sell its Skype subsidiary to a group of private investors. (The subsidiary ultimately wound up as part of Microsoft.)
  • And Dewey was Mark Cuban's lawyer as well, helping to defend the Dallas Mavericks owner when the SEC investigated him on charges of insider trading.
With 1,300 attorneys and a support staff of thousands more, Dewey operated out of two dozen offices spanning 12 countries on five continents and generated revenues in excess of $900 million a year.

This makes the Dewey & LaBoeuf bankruptcy quite simply the largest law-firm failure ... ever.

How did a business this good manage to go broke? The answers may contain lessons for all of us.

"Our People Are Our Most Valuable Asset."

Companies mouth this line all the time (often while simultaneously freezing their pensions, raising their insurance deductibles, and demanding more overtime). But at Dewey, it really was true. In fact, it's true at most law firms -- and that's not always a good thing.

The problem with Dewey, and with law firms in general, is that their workers are highly mobile individuals, and they're often worth more to other firms than to the firm they already work for. Over time, a law firm partner tends to build up a portfolio of paying clients. But partners aren't necessarily paid in proportion to the amount of money they bring in -- up until the moment they jump ship for a different firm that wants the clients for itself.

At Dewey, fears that the firm was in trouble took a steady toll on the company's most valuable employees and the revenue they brought in.

During the first three months of this year, 20% of the company's equity partners left, taking their clients with them. By the time Dewey declared bankruptcy, partner defections had climbed past 80%.

By the time the firm realized it was bankrupt, there was hardly any "firm" left.

TANSTAAFL (There Ain't No Such Thing As A Free Lunch)

But how did Dewey get in such as state as to scare its partners off in the first place? The answers may (or may not) surprise you: high salaries and guaranteed bonuses.

Now, everyone knows that lawyers make good wages. At Dewey, your average "associate" attorney was pulling down better than $170,000 a year, according to Glassdoor, and the partners made much more. But in an effort to attract top talent and keep it in-house, Dewey's managers went a bridge too far.

Many of the firm's partners were guaranteed bonuses on top of their salaries. Reportedly, the top 100 partners at Dewey had contractual guarantees topping $100 million in total bonuses. Some individual partners were promised at least $6 million a year -- performance not necessarily required.

How could Dewey afford to be so generous?

Simple. It couldn't.

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So rather than pay what it could afford, Dewey did the next logical thing: It borrowed like mad.

According to bankruptcy court filings, by the time the firm went kaput, Dewey had racked up $245 million in debt, and maybe even more. Between obligations to secured lenders, long-term lease obligations, and accounts-payable, pension, and deferred-compensation claims, Dewey is said to be in hock to the tune of perhaps $315 million.

As one local lawyer put it: "The combination of outsized debt and widely spread pay guarantees divorced from performance put the firm in a situation with almost zero margin for error."

Highest Paid CEO's
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How Dewey & LeBoeuf Became the Biggest Law Firm Bankruptcy Ever

In 2011, Ford (F) paid Mullaly $29.5 million, a 11% raise over the previous year. Mullaly has long had an interesting, somewhat fraught, relationship with compensation. In 2008, as the auto industry was taking a nosedive, he drew fire when he and other auto execs traveled to Washington, D.C., on private jets seeking help for the industry. Shortly thereafter, Mullaly sold most of Ford's corporate jets and drove a hybrid car to Washington for his next meeting. That year, Mullaly agreed to accept a $1 annual salary if Ford received a government bailout. Instead, the automaker kept its head above water without federal aid, and Mullaly took home $13.6 million. The next year, he made $17.9 million.

Daane has been the CEO of Altera (ALTR) since 2000. One of the nation's largest producers of programmable logic devices, the company is a major player in semiconductors. Daane's 2011 salary was $29.6 million, a 278% increase over the prior year.

In 2011, Marathon (MRO) paid Cazalot $29.9 million, a 239% raise over the previous year. Unlike many top CEOs, Cazalot's training isn't in law or business, but rather in geology, and under his leadership, Marathon has vastly expanded its overseas investments. While Marathon has certainly had a good year, the majority of Cazalot's raise came from a change in the company's incentive program, and likely will not be repeated.

In 2011, Iger was paid $31.4 million. A modest 12% increase over the previous year, Iger might be one of the few CEOs who was underpaid that year. A major force behind the studio's 2009 purchase of Marvel Entertainment, Iger's management decision that has given Disney (DIS) a major cash cow. With The Avengers breaking box office records and sequels to Thor, Iron Man 2, Captain America, The Avengers and The Hulk in the pipeline, it looks like Iger's purchase will continue paying for itself long into the future.

Cote has been leading Honeywell (HON) for 10 years, but 2011 was a particularly good one. He was paid $35.7 million, a 135% raise over the previous year. Then again, Honeywell seems to have a lot of money to spend: Between 2008 and 2010, it spent over $18.3 million on lobbying, laid off 968 workers, made $4.9 billion in profits and increased compensation by 15% for its top five executives. During the same period, it not only paid no taxes, but actually received $34 million in tax rebates.

On the surface, Dauman's $43.1 million 2011 salary seems to be a disappointment; after all, it's a 49% drop from the previous year. Then again, he received a 148.6% raise in 2010, the top CEO raise that year. And things might be a bit tight in the Dauman household: Earlier this month, he sold 286,447 shares of Viacom stock (VIA), almost a third of his personal holdings, for $13.8 million.

Motorola Mobility CEO Jha was widely reviled by his employees. In fact, he has received a 50% approval rating from Motorola workers, who also give their workplace a failing grade of 2.6 out of 5. So why did the mobile phone exec receive a 2011 compensation package worth $47.2 million -- a 262 percent increase over his 2010 pay? Well, this huge windfall reflects Google's purchase of the company, a deal that gave Jha a golden parachute of three times his yearly salary, in addition to an eventual payout of $52.5 million for his stock options.

In 2011, Discovery Communications (DISCA) paid Zaslav $52.4 million to run its collection of networks. A 23% increase over his 2010 salary, this reflects, among other things, Zaslav's efforts to develop OWN, the Oprah network.

Depending on who's doing the accounting, Moonves' compensation package in 2011 totaled either $68.4 or $69.9 million. Either way, he got a salary boost of over 20% last year, making him the highest paid media CEO in the U.S. Several pundits have questioned his high salary and amazing bonuses, but CBS' stock (CBS) took a 42% boost last year, and it is currently the top-rated television network, a position that many credit to Moonves' stewardship.

In addition to being the highest paid CEO in the U.S., Simon also got the biggest raise. In 2011, he brought home $137.2 million, a 458% increase over his previous year's salary. Shares in Simon Property Group (SPG) -- America's largest mall operator -- went up by 22% last year, a promising trend in a business that has long been facing declining sales.

Like a consumer with high debt but a few credit cards in his wallet and a love of cash advances, Dewey was able to keep the game rolling for a while. But once partners began defecting, the cash flow dried up, and Dewey had nowhere left to turn: "Cash flow was insufficient to cover capital expenses and full compensation expectations."

The sad implication: Had Dewey been just a bit less profligate with its spending, and its lawyers just a little less greedy, they -- and the thousands of Dewey employees who weren't collecting seven-figure bonus checks -- might have still had a firm to call home.

Motley Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Walt Disney and Microsoft. Motley Fool newsletter services have recommended buying shares of eBay, Microsoft, and Walt Disney, as well as creating a bull call spread position in Microsoft.
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