Partnership Has Its Limitations
Perhaps because most law firms are partnerships, we don’t pay much attention to the practical implications of the partnership structure. This is understandable as there isn’t much of an alternative in our existing system at least so far as private practice is concerned.
A law firm partnership is very different than most ordinary businesses. In most businesses, the owners of the business are not involved in the business whether as workers or as managers. In contrast, law firms are owned and managed by people who provide services to customers (often with the assistance of others). In a law firm, the partners are the owners, the managers and the workers.
The combination of ownership, management and service provision in a law firm is particularly significant in that the partners provide the equity capital. In an ordinary business, equity capital is commonly raised through private capital or public capital. In a law firm, labour and capital come from the same source as does management – the partners.
There is another important difference between law firms and most other businesses. In many law firms, it is common for more young lawyers to be hired than will ultimately remain with the firm. Of course, some law firms are simply collections of sole practitioners who share overhead and perhaps an associate who will either join the firm as another sole practitioner once his or her practice is sustainable on its own or will leave the firm.
But in many law firms, a number of associates will be hired only some of whom will become partners. In these law firms, the model is “up or out” with some young lawyers becoming partners and others leaving. In the academic literature, this is sometimes described as the “tournament of lawyers”. Young lawyers compete with each other to stay with the firm. Academics once viewed this as a model applicable just to young lawyers but more recently the “tournament” has been said to continue throughout a partner’s career. Partners are said to continue to compete to continue as partners. While it was once less common, partners who are not seen as sufficiently valuable to the firm are often asked to leave.
This “tournament” is said to be a highly efficient (if perhaps harsh) way of organizing people. Unlike the ordinary business where there is hierarchical management, the lawyers in the “tournament” mostly manage themselves by figuring out what is necessary to win the prize. One of my partners once described this as a pie eating contest where the prize is more pie.
There must be a lot to be said for this structure as it clearly has been successful. One might hypothesize that it would be difficult to organize skeptical independent thinking professionals successfully in a traditional business organization. This structure is economically low cost in terms of management.
Yet the last thirty years have clearly shown that this is not the only effective way of providing legal services. The in-house model, whether business or government, has shown that ordinary business organization can deliver effective and sophisticated legal services. The in-house law department is not owned or capitalized by its lawyers. Hierarchical management is common. The “up or out” tournament model is not used in-house (or at least to the same extent).
There is of course one fundamental difference between the in-house lawyer and the private practice lawyer, namely finding work. The in-house lawyer exists to serve one client. The number and nature of the in-house lawyers is driven by the needs of the employer. For private practice lawyers, part of the tournament is finding and retaining clients for the lawyer and the firm.
So what are the implications of these observations about business structure. One implication may be diversity. It seems clear that in-house law departments do a better job of attracting and retaining women and, it seems, visible and other minorities. While other factors may well also be in play, I suspect that the nature of the “tournament” model is part of the reason. Where early success is determined by attracting work from within the firm (and thereby developing and getting better work) rather than by work allocation based on reasonably objective skill assessment and assessment of potential, there is ample opportunity for unconscious bias and even actual prejudice to have effect. I recently attended a sophisticated in-house group and found the explicit targeting of diversity results to be very interesting with managers being explicitly judged, in part, on meeting targets. In contrast, it would be difficult to identify who to similar incent and judge in a law firm where, mostly, no one is “in charge”. Causing change in private practice is indeed like managing cats given the very limited actual day-to-day management in law firms.
There are other significant issues to consider. In a private practice firm, it is difficult for partners to imagine doing things very differently. Why would a partner potentially render himself or herself redundant? Where a partner is mostly rewarded for their contributions to the firm, what incentive is there to invest time and effort in doing things in a way other than by partner contributions. The limited extent to which law firms are truly managed means that it is difficult for truly innovative decisions to be made (and implemented) rather than to just making the existing way of doing things better.
The combination of ownership with service provision is also important. In most firms, partners take out the profits annually and only keep enough equity capital in the firm as is required to provide infrastructure for existing practices. Partners have little, if any, economic interest in investing in anything that does not pay off in bettering existing practices. A significant long term investment in innovation is not very likely to provide returns for existing partners. Partners naturally prefer to enjoy the fruits of their labour (and capital). In contrast, the owners of a business with an in-house law department can make significant changes and innovations that are in the interest of the business but perhaps not in the interest of individual lawyers.
We see some of these challenges to innovation playing out in what some call “new law” where ownership is separated from those providing legal services. Cognition is a Canadian example in which legal services are being provided differently and attractively to clients. While the individuals who provide legal services are being compensated for their work, the long term enterprise value is enjoyed by the entrepreneurs who own and built the business. Yet it is clearly more difficult to finance a business when equity capital is not permitted from private or public markets and is not contributed by the lawyers doing the work. This limits growth and innovation.
All of this suggests to me that law firms may be particularly resistant to business and social innovation because of their nature. That said, it isn’t clear what to do with this observation if true. There is much about law firms that is clearly good for clients and for the lawyers in those firms. From a regulatory perspective, it is much easier to regulate when the owners, managers and workers are all regulated and subject to sanctions that can affect their future livelihoods.
There seems to me something of a “baby and the bath water problem”. Can we encourage/permit innovation in ways that aren’t too disruptive? I also wonder if the existing model isn’t more powerful than it appears since there is clearly room for business structure innovation despite limited actual innovation. It also seems odd to me that we know so little about the business of law both from theoretic perspectives and from empiric perspectives.
And so this column is more by way of musing and thinking out loud than anything else. As always, but particularly on this topic, comments welcomed!
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[1] Small law firms are quite like other small proprietorships where the owner is actively involved in the business.
[2] Tournament of Lawyers, 1991, Galanter and Palay
[3] The Elastic Tournament: The Second Transformation of the Big Law Firm, 2008, Galanter and Henderson, 60 Stanford Law Review
Great piece! Elaborating on the implications of the partnership model for diversity, see also this Slaw golden oldie:
Linda Robertson, “Law Firm Partnerships and the Retention of Women Lawyers” (2011) http://www.slaw.ca/2011/12/21/law-firm-partnerships-and-the-retention-of-women-lawyers/> (last accessed: 3 March 2015)
With respect, not a “great piece”. With respect, Malcolm’s article strikes me as another attempt to subtly deride how the legal profession is structured in hopes that ABS will somehow be regarded as a means of bringing about supposed improvements.
However, he also states that “There must be a lot to be said for this structure as it clearly has been successful…This structure is economically low cost in terms of management.”
ABS would not be low cost in terms of management as it would add at least two layers of hierarchy to be paid for and to be beholden to. Imagined economies of scale deriving from two new layers are illusory. Even if economies of scale could be found, the savings would go to the profit-seeking outside investors, not to the lawyers, not to the public. And it is highly, highly doubtful that there would even be economies of scale.
Malcolm is, with respect, incorrect when he says that “In most businesses, the owners of the business are not involved in the business whether as workers or as managers”. A substantial majority of businesses in Canada are small businesses where the owners are very hands-on both as managers and as workers. Virtually every one of my many business clients is in that hands-on category. I cannot think of one that isn’t. What Malcolm meant, I think, is that in most big business, the owners are not involved. Big businesses are the businesses served by firms like his. In the legal world in which firms like his operate, it may seem that most businesses do not have hands-on owners, but that world is not the world of the vast majority of lawyers who are in small firms and whose clients are small businesses. Note that small does not mean unprofitable or unsuccessful. Many of my business clients are worth a ton and often make me think I went into the wrong field, but the point is they are hands-on.
A “tournament of lawyers” in the big firms is not very different from the competition faced by lawyers in small firms. We all compete to make our livings, whether inside a big firm or in competition with other small firms. There are big firm associates who do not make partner. For some of them, that is really too bad. For others, it turns out to be the best thing that ever happened to them. There are small firm lawyers who give up small firm practice because the entrepreneurial life is not for them. Some leave private practice altogether often for very sensible life balance reasons. In Ottawa, government service has many attractions including, for most, reduced hours, steady pay, and benefits and pensions. Every single lawyer, a majority of them female, whom I have talked to about their decision to join the government has said that they do not regret leaving private practice to join the government one iota. Conversely, a huge majority of the lawyers who are in private practice much prefer to be there, as they would chafe under a bureaucratic structure. In other words, people find the niche they are comfortable in and, as educated adults, make sensible decisions for themselves.
Btw, the Law Society research charts show that the least diverse category of law firms is the big firm category. The sole and small firm categories are full of diversity, and we love it.
We do not need non-lawyer, profit-seeking investor owners to make big firms more diverse. They can easily do it themselves.
Malcolm also says, “In a private practice firm, it is difficult for partners to imagine doing things very differently. Why would a partner potentially render himself or herself redundant? Where a partner is mostly rewarded for their contributions to the firm, what incentive is there to invest time and effort in doing things in a way other than by partner contributions. The limited extent to which law firms are truly managed means that it is difficult for truly innovative decisions to be made (and implemented) rather than to just making the existing way of doing things better.”
I disagree that it is difficult for partners to imagine doing things very differently. Think back a few years. The practice of law has changed dramatically. Does anyone out more than 15 years still practice the way they did then? We happily and readily adopt any useful innovations that come along. We have to, or face losing out to the competition. We face redundancy only if we do not adapt. So it is incorrect to suggest that lawyers cannot imagine doing things differently. There seems to be this belief among some that somehow small firm lawyers are hide-bound geezers who are still using quill pens and that only the lawyers in the big firms or in nimble boutiques (but in the same towers) are cutting edge lawyers. Nonsense.
Malcolm refers to “We see some of these challenges to innovation playing out in what some call “new law” where ownership is separated from those providing legal services”, and cites Cognition. But isn’t Cognition simply a law firm owned by lawyers that provides legal services to clients in innovative ways? And they did it without selling out their ownership to non-lawyers. Cognition has said that they want to access outside capital to expand. Presumably, they see outside equity capital as the easiest way. But is it the best way? Not at all. What the UK experience is increasingly showing is that accessing outside equity capital is really a means of trying to consolidate the marketplace into the hands of fewer and fewer, larger and larger owners, an evolution that most certainly will not benefit the public. Let Cognition expand by building on their success and borrowing money if necessary. At least with borrowed money, someday you get rid of the lender. With equity, you never, ever get rid of the outside owners.
Malcolm says, “All of this suggests to me that law firms may be particularly resistant to business and social innovation because of their nature. ” With respect, he is wrong about that. The wise lawyers who are opposed to ABS are not resistant to innovation. We are resistant to profit-seeking non-lawyers owning us and engaging in an orgy of anti-competitive consolidations (see the UK). We embrace innovation, just not that one because it is permanently retrograde.
He says, “There is much about law firms that is clearly good for clients and for the lawyers in those firms. ” He is right about that.
He says, “From a regulatory perspective, it is much easier to regulate when the owners, managers and workers are all regulated and subject to sanctions that can affect their future livelihoods.” Currently, the owners, managers and workers are all lawyers, and they are all regulated by the Law Society. There is talk about going to “entity regulation”, but that really means making a partner (or committee) in a firm responsible for ensuring that the members of the firm abide by the Rules of Professional Conduct and reporting to the Society as appropriate. As long as the entities we are regulating are lawyer-owned law firms, no problem. And if other entities are engaged in the unauthorized or illegal practice of law, then the Society should be using its injunctive and other remedies to uphold the law and protect the public.
ABS was first proposed as a means of enhancing access to justice. The UK experience has shown that it does not do that. Common sense, history and economics show that it never will but will instead, increasingly over time, worsen access to justice. ABS attacks low-cost areas of practice – areas where, if there are barriers to access, they are the height of freshly mown golf-greens grass. It does nothing about the real barrier, the one that dwarfs Everest, the ruinous time and cost of litigation (the RTCL”).
One of the proponents of ABS expressed to me that there is no independent evidence that the Society needs a task force to look into how to address the RTCL. I was flabbergasted (and quite disappointed) by that comment. The public quite rightly and overwhelmingly points to RTCL in its complaints about the cost of legal services. The media quite rightly focus virtually exclusively on RTCL. When Cross Country Checkup did a show on the cost of legal services, every single caller focussed on litigation examples. Not one complained about solicitor services.
Barristers candidly admit that they cannot afford their own services. Even lawyers who are in the Society’s discipline process more often than not fail to retain counsel. As Bill Trudell has pointed out, the reason they usually give is the cost. No small firm solicitor will ever say that they cannot afford their own services for the simple reason that their services are phenomenally affordable. Yet it is those services that ABS would most harm while doing nothing about RTCL. Indeed, the profit-seeking outsiders would stand to profit from the outrageously high cost of litigation by taking percentages of it.
We have utterly wasted two years on the excrementally awful idea of permanently and irreversibly selling the profession out to profit-seekers who do not, cannot and never will share our ethos. We have seen attempts to soft-sell the idea with thin edges of wedges. We have seen proponents of this goofiness go farther and farther out on limbs trying to justify the unjustifiable instead of simply realizing that, with the benefit of more insight, their initial, and forgivable, infatuation with ABS was misplaced.
What we need to do is focus on identifying ways to deal with the real barrier, not the fake ones. We need to firmly announce that there is no way in Heaven or Hell that we are going to sell ourselves out to non-lawyers. We need to assure the public that we will preserve our ethos of putting the clients’ interests always ahead of our own (even though some lawyers do not, most of us do). We need to kill ABS and deal with the RTCL. We should have started that years ago. We should start now.
Gotta go.
Note also that all business structures, like everything in life, has limitations. What we do not want to do is replace good and successful structures with other structures that, while different, merely replace one set of disadvantages with another set of disadvantages, only this time worse ones that are permanently harmful and that dispense with the previous advantages. Change for the sake of change is not usually a good policy. Worse, change for the sake of profit-seeking opportunists who, privately, cannot believe that we would ever consider turning our profession over to them, is not only not a good policy, it is a positively permanently deleterious policy. Why would anyone want the legal profession to be owned, run like or run by such potential opportunists as American title insurance companies? Big oil companies? Pure profit motivated investment houses headquartered who knows where? Offshore subsidiaries of car insurance companies? Companies fronting money laundering enterprises? And on and on.