Over the past couple of decades, the strength of US law firms and the growth of legal markets have been measured by the size of transactional practices. From this viewpoint, litigation, at least among law firms listed in the AmLaw 100 and 200, is an important but supportive practice to the M&A and securities engines that drive law firms’ profitability. It may, therefore, come as a shock to some observers that litigation represents the largest practice among a majority of US law firms, and that the future of litigation practices may not be as bright as we might hope it would be.

Traditionally, general practice law firms, particularly larger firms in major cities, looked toward their corporate and transactional practices as the base of their business and the source of spin-off work for other supportive practices, including litigation. It was therefore common for a firm to be 60 to 65 percent transactional (including real estate and bankruptcy) and 35 to 40 percent dispute resolution (including employment and regulatory). This was a necessary ratio because the primary sources of litigation cases were the corporate relationships established and maintained by the transactional practices.

The Decline of the Corporate Law Firm

Over the past ten years, however, the relationship between the size of law firms’ corporate and litigation practices has undergone huge change. In fact, looking at the AmLaw 200, the average firm’s core litigation practice involves 35 percent of its lawyers, but the core corporate and securities practices is made up of only 23 percent of its lawyers (figure 1).That’s a substantial change from 1999 when the core litigation practice was 31 percent and the core corporate practice and securities was 28 percent. 1

Litigation 1

With the growth in private equity and M&A transactions, why is it that the average law firm’s corporate practice is declining and their litigation practice is increasing? There are a number of factors at play. First, the corporate marketplace has segmented dramatically with a growing majority of transactions going to a declining number of capital market firms (figure 2). Over the past ten years, there has been a large scale flow of deals from regional firms to capital market cities. In part, this has been driven by the demands of investment bankers who want to use firms they know and trust; but it is also related to the consolidation of large corporations. When a company is owned by a corporation headquartered elsewhere, it is increasingly difficult for local law firms to hang onto sophisticated work.

Litigation 2

Another factor has been the reaction of law firms to economic downturns. Traditionally, law firms viewed themselves as being immured from recessions. But over the past 20 years, the US has been hit with three major recessions that caused a decline in the volume and size of corporate transactions. On each occasion, law firms responded by reducing their number of corporate lawyers — either through the layoff of associates or the slowdown of law school and lateral hiring.

After recessions, when times improved, law firms needed to beef up their transactional capability, which they often attempted to do through mergers with smaller firms either locally or by moving into a new marketplace. Often these mergers brought in a disproportionate number of litigators compared to the corporate attorneys involved.

Firms involved in these mergers welcomed the growth in the size of their litigation practices because they brought predictability to the revenue flow of the combined firms — and that made the mergers less risky. The life cycle of a litigation matter may be several years while transactional matters usually last a few months. Law firm financial managers can quite accurately project litigation revenue a year or more ahead but find that transactional revenues are less predictable and, therefore, far more readily affected by economic circumstances.

Finally, the shift of many companies to foreign markets, specifically London and Luxembourg,2 and the increase in going-private transactions,3 in large part due to Sarbanes-Oxley and the low valuations in the US markets in recent years, has migrated a not insignificant amount of work from the US legal market to foreign markets and evaporated portions of securities and compliance work.

Growth in the Number of Lawyers

The impact of the growth of law firms’ dependence on litigation is magnified by the overall growth in the size of law firms (figure 3). The average size of an AmLaw 200 firm in 1999 was 345 lawyers. Last year it was just over 500 lawyers, a growth of 47 percent in eight years. That adds up to almost 13,000 more litigators in the AmLaw 200.

Litigation 3

Stagnant Case Volume

So as the sheer number of litigators has grown in the US, and their contribution to the revenues of their law firms has grown in importance, the obvious question is whether there has been a corresponding increase in the volume of legal work for litigators to actually do? Unfortunately, there has not.

The US Federal Courts caseload statistics report that the number of cases filed has remained stagnant over the past eight years at around 260,000 annually (figure 4).

Litigation 4

Worse news for our litigation heavier firms is that these cases have been heavily skewed toward high plaintiff volume cases that are more subject to discounted rates. For example, during this period, the number of products liability cases has increased by 14 percent while securities, commodities and exchange cases have decreased by 9 percent (figures 5 and 6).

Litigation 5

Litigation 6

At the state level (according to the National Center for State Courts) the volume of civil cases has increased from around 13 million to 14.5 million from 1996 to 2005, an average annual increase of a little over one percent (figure 7). A large contributor to this sluggish growth in cases has been tort reform and the resulting 21 percent decrease in the number of tort cases over that same period (figure 8).

Litigation 7

Litigation 8

Collapse of Business Sources

With litigation practices increasing in size, but the volume of litigation remaining fairly stagnant, firms are then drawn to examine the decline in traditional corporate work and whether anything can be done to stem the tide, as it were, or to significantly (re)build their corporate and securities practice of old. To evaluate such an effort, it would be wise to examine the traditional sources of the firm’s legal work and why those sources are no longer yielding the same level and sophistication of legal work.

Traditionally, general practice law firms garnered their legal work from three sources:

Internal Referrals. Transactional practices — particularly corporate and real estate — have the potential of “spinning off” significant amounts of work to other areas, especially litigation. For some firms, this spun-off work may represent 50 to 60 percent of their case load.

External Referrals. These are referrals from other law firms, either due to the location where the case is situated or because of conflicts. These referrals are often due to personal relationships between lawyers or through affiliate organizations.

Direct Engagement. This is work that comes to a firm directly from clients, either as the result of the firm’s reputation in handling a specific type of case, strong ties to a specific industry, or because the firm has an iconic litigation partner with a strong personal reputation and contacts.
Unfortunately, many large law firms are seeing a decline in all three sources of business. As firms’ transactional practices decline and there are proportionately fewer transactional lawyers feeding work to other practices in law firms, the volume of litigation work referred internally declines, particularly in relation to the increased litigation capability in most firms. At the same time, the decline in the overall volume of litigation work has caused a number of firms to discontinue referrals in all situations other than conflicts; as such, firms are now trying more cases outside of their geographic locations to maintain a stable litigation practice. Beyond that, the traditional means of litigation referrals, such as the American College of Trial Lawyers, is declining in importance as its standards decline, and are being replaced by reciprocity among firms that have a history of making referrals to each other. Finally, the desire of many general practice firms to cast as broad a net as possible and to institutionalize clients and reputations has meant that many firms do not have a unique reputation for experience in any particular area, or for any specific partner.

The Future of the US Litigation Practice

The result of these circumstances is, for too many firms, a chronic lack of litigation work at a time when the number of litigators in many firms is reaching an all time high. This draws us to several conclusions:

Segmentation. The level of segmentation will increase between the major firms handling significant corporate transactional work and sophisticated litigation and the tier of firms below them handling less sophisticated litigation. An elite group of A-level firms will be recognized by the sophistication of their corporate practices, their handling of major commercial litigation, their level of lawyer recruiting and their profitability.

The Focus on Litigation is Permanent. The shift to a greater focus on litigation is a long-term change for most firms and would require an equally long term to reverse. Since there is no indication of a fundamental change in the demand for corporate work performed by firms outside of capital markets, there are few other viable options.

More Down Stream Work. The low utilization of lawyers causes firms to seek “downstream work” — litigation that is less sophisticated and is billed at lower rates — to fill litigators’ plates with billable work.

Multi-Case Clients. The desire / need for firms to maintain a predictable revenue stream will drive firms to increasing tort defense.

Profitability Levers. The lack of differentiation among litigation firms will drive profitability away from billing rates and more toward extreme leverage and cost management.

Managing the New Litigation Practice

There may be room for a tier of litigation practice between the top tier in capital market cities and the level of practice described above. Pursuit of this tier, however, would require a dedication and focus that few firms are able to achieve within a consensus-based partnership. For firms that are able to pursue a strategy for litigation dominance, there are seven tactics that could be the cornerstone of operating a general practice firm with a large litigation practice.

Find One Or Two Areas of Expertise and Develop a Top Reputation. Getting known as being among the best firms in the country in a few specific areas will always be a drawing card that permits firms to obtain work through external referrals and directly through clients. Further, it permits billing rates that are less sensitive to competitive forces.

Reduce Emphasis on Trial Lawyers. Trial lawyers enjoy a unique skill set beyond litigators. But the demand for trial lawyers has and will continue to decline for all but the most price sensitive work. The firm must accept that “having more trial to verdict experience than any competitor” has limited value in competing for high level work.

Create a Separate Plaintiffs’ Unit to Assemble and File Contingent Fee and Class Action Cases. Plaintiffs’ cases can represent a huge revenue stream for litigation practices (recognizing that the type of case must be consistent with the primary practices). However, it is virtually impossible for a traditional litigation practice to operate a plaintiffs’ practice within its conventional standards. The plaintiffs’ practice must be a completely separate operation under a discrete management structure.

Reverse Growth and Create a Highly Leveraged Business Model. The equity partner — non-equity partner — associate structure can not create sufficient leverage without the ability to adjust the legal resources to available work. This means a dramatically smaller firm with lots of contract and staff associates.

Reduce Geographic Locations. Many litigation based firms have too many offices in areas that do not generate work for the overall firm and do not provide a strategic advantage. Unnecessary offices cost money, sap management focus and get in the way of the firms’ strategic directions.
Eliminate Practices in Which the Firm is not Competitive. The more diverse the litigation practice, the more difficult it is to create a focus.

Seek Mergers That Strengthen the Most Important Litigation Practices While Adding Transactional Lawyers.  The shift to a predominant litigation practice came upon most firms subtly. As a result, firms that think of themselves as a “transactional firm with a strong litigation practice” may have difficulty accommodating the new reality. The core strategy that firms must use as a backdrop to their future strategic decision-making is that while they want to build on their litigation strengths, they need to constantly consider the source of litigation business. This probably means taking appropriate and aggressive actions to maintain as strong a transactional practice as possible for the primary purpose of sustaining a continuing source of litigation.

Notes:

1 – We studied AmLaw 200 firms from 1999 (the first year of the AmLaw200) to 2008, creating a population of 134 firms that (i) were in the AmLaw 200 in 1999, 2003, and 2008, (ii) were not boutiques or the result of multiple mergers, and (iii) provided sufficient practice area data for each measurement period in the National Association for Law Placement publication  “Directory of Legal Employers.” In counting lawyers as corporate or litigation, we focused on the core practices, e.g., for corporate — mergers and acquisitions, securities, corporate governance, etc. to the exclusion of related practices of tax, real estate, bankruptcy, etc. The purpose of this was to compare apples to apples — true core transactional practice to true core litigation practice during the respective periods.

2 –  “In 2000, 90 percent of the dollars foreign companies raised through IPOs were in the New York Stock Exchange. Five years later, that number was down to 10 percent, with most foreign companies opting instead to go public in London or Luxembourg. In 2005, thirteen companies went public in New York, compared with 48 in London, and exchanges in London and Luxembourg captured $9.5 billion in new capital to New York’s $1.3 billion.” Kinnan, The Call to Reform Section 404 (Oct. 2, 2006) ; Feeney, John & Pollock, Reforming Sarbanes-Oxley: How to Restore American Leadership in World Capital Markets (lecture delivered on June 27, 2006) (“The New York Stock Exchange has purchased a London-based exchange so that it can send its new customers to London to avoid Sarbanes-Oxley. The NASDAQ is undergoing a purchase right now. At the time Sarbanes-Oxley was passed, 9 out of every 10 dollars raised by foreign entrepreneurs in a new, initial public offering was raised in the United States. Last year, just four years later, 90 percent of capital for new foreign companies was raised in foreign markets. The London Stock Exchange has had over 31 different presentations for American entrepreneurs who are considering going public, or for investors, where they brag on every page of their brochure that they are Sarbanes-Oxley-free.”)

3 – “[A]ccording to Mergerstat, going-private transactions have risen steadily, from 197 in 2000 to 316 in 2002, with 93 announced as of April 1[, 2003].” By the end of 2003, it was expected that an estimated 372 going-private transactions would occur. Tim Reason, Sarbox Fallout: Going Private Going Up, CFO Magazine, May 19, 2003; also see Morganstern & Nealis, Going Private: A Reasoned Response to SarbanesOxley?, p.1 n.3 (2004) http://www.sec.gov/info/smallbus/pnealis.pdf  (“Some empirical data suggests that the frequency of going-private transactions has increased following the passage of Sarbanes-Oxley.”)