(Reuters) - As law firm Dewey & LeBoeuf embarks on the humbling process of working through bankruptcy, creditors and former partners are bracing themselves for a nasty court battle that could drag on for years.
Dewey, a storied firm with deep Wall Street connections, filed for Chapter 11 protection on Monday night. The firm had veered toward collapse over the last six months amid revelations of fat salary guarantees, risky loans and a culture of secrecy.
Some former partners have hired lawyers in anticipation of clawback suits by the estate. Law firms that offered positions to former partners could also get embroiled in fights over rights to client fees. Creditors ranging from banks to temp services have started jockeying for position to maximize limited payouts.
Some contentiousness was on display at a bankruptcy hearing in Manhattan on Tuesday. Lenders were especially aggressive, asking the judge to approve a lien on certain litigation proceeds in exchange for letting Dewey fund its bankruptcy with money owed to the lenders. Judge Martin Glenn denied that request as unreasonable, at least in the interim, saying he would prefer to wait to make his decision until an official committee of unsecured creditors was in place.
There also appeared to be communications issues during the hearing. Albert Togut, Dewey's bankruptcy attorney, announced that the firm was "close" to a settlement framework. But he was contradicted by Mark Zauderer, an attorney representing a group of ex-Dewey lawyers, who said settlement talks were only preliminary.
WHEN ASSETS WALK AWAY
In a typical Chapter 11, a corporation uses its existing assets to continue generating revenue to fund a reorganization. The theme park Six Flags, for example, continued to sell tickets while in Chapter 11 in 2009. The company also had tangible assets -- the theme-park rides themselves, real estate, merchandise -- which could have been sold off to raise money for creditors had it been necessary.
Dewey has different kinds of assets: Its lawyers and their books of business, or clients. Once the lawyers walked away -- by now nearly all of its 300 partners have left the firm - the company had little means to produce revenue.
"Our assets went home every night," Togut said, "until one night, they went home and never came back."
According to bankruptcy filings, all that is left of Dewey's once-robust operations are accounts receivable of about $255 million, about $13 million in cash, various pieces of artwork of unknown value, and about $11 million invested in an insurance consortium.
How effective Dewey will be in getting clients to pay those accounts is unclear, especially since the incentive of an ongoing client-firm relationship has disappeared. "You find reasons not to pay," said Jonathan Landers of Jager Smith, who represented Citigroup Inc in prior law firm collapses.
CREDITORS, GET IN LINE
As of now, Dewey & LeBoeuf effectively exists to service its creditors, whose place in line to collect will be determined by a number of factors, including whether the debts were secured or not, and the vagaries of bankruptcy and employment law.
Typically, secured creditors get first dibs under federal bankruptcy statutes. In the Dewey proceeding, those include Dewey's lenders and bondholders. JPMorgan Chase & Co and a group of lenders had a tab of $76.5 million under a secured credit agreement, according to bankruptcy filings. A group of investors who bought privately placed bond notes that Dewey issued in April 2010, meanwhile, are owed $150 million, according to court papers.
Next in line come employees who were terminated in the period prior to the bankruptcy. Under U.S. law, these people have priority status, ahead of other unsecured creditors.
Then the other unsecured creditors get their shot. Among these the U.S. Pension Benefit Guaranty Corporation has asserted the largest claim. The PBGC sued Dewey earlier this month to seize three pension funds it said were underfunded by $80 million. Dewey's New York landlord, Paramount Group, claims to be owed $3.78 million for a lease at Dewey's Manhattan headquarters on Avenue of the Americas.
Other unsecured creditors include HireCounsel, a staffing firm that put in a claim for $1.56 million, and HBR Consulting LLC, a legal consulting firm that claims about $656,700. Thomson Reuters, the parent of legal research company Westlaw as well as Reuters, entered a claim for $2.36 million, and rival Reed Elsevier's Lexis-Nexis said it is owed $1.41 million.
A spokesman for PBGC said the pension fund is continuing efforts to take over the pension plans. Representatives for Paramount group, HireCounsel, HBR Consulting and Thomson Reuters Corp did not return calls for comment. A representative for Reed Elsevier declined to comment.
The last group to recover money would likely be the former partners themselves. The firm, like most of its contemporaries, required members to make a capital investment at the time of partnership. Dewey's fund as of Monday stood at $52.4 million. It is far from clear whether there will be money left in that fund for ex-partners. What's more, some of them could be vulnerable to clawbacks that would offset any money they are owed.
Former partners have said privately for weeks that they've anticipated both bringing claims and being sued. Tracy Klestadt, who represents about 20 ex-Dewey partners, said he expected the estate would consider filing claims against all of Dewey's partners.
Already one former Dewey partner, James Woods, has initiated arbitration before the New York City Bar Association for compensation he's owed, according to bankruptcy filings. Woods, now with Mayer Brown, did not respond to requests for comment.
While Dewey's bankruptcy attorney Togut said Tuesday that Dewey was nearing a settlement with former partners, it is unclear how many would participate. "I just heard it for the first time in court," said Klestadt.
GOING AFTER THE FIRMS
The firms that poached the former Dewey partners could also be vulnerable to litigation by the Dewey estate.
When partners leave one firm for another they typically take their clients along. In some past law-firm bankruptcies the trustee for the bankrupt firm claimed that at least some of the fees generated by those clients belonged to the estate.
Just last week a U.S. district court judge in Manhattan ruled that revenues generated by former Coudert Brothers lawyers on cases they took with them after that firm dissolved in 2006 belong to Coudert's bankruptcy estate.
That ruling could pave the way for the Dewey estate to pursue its former partners' new employers to collect on the profits of the so-called unfinished business. Among the firms that recruited the most Dewey & LeBoeuf partners are Morgan Lewis & Bockius; DLA Piper; Willkie Farr & Gallagher; Proskauer Rose; and Sutherland Asbill & Brennan.
Spokespeople for Willkie, DLA, Morgan Lewis and Sutherland declined comment, while a representative for Proskauer had no immediate comment.
CHAPTER CHOICE
Until fairly recently, liquidations like Dewey's usually were pursued under Chapter 7 of the bankruptcy code. Chapter 7 puts a debtor's estate under the control of a trustee tasked with selling assets quickly and using the proceeds to pay off creditors.
Dewey, though, has chosen to file under Chapter 11, which provides for a more cooperative, deliberative process. Debtors typically prefer Chapter 11 because it lets them remain in control of their estate, usually without interference from a trustee.
Creditors often prefer Chapter 11 as well, because it allows them to form official committees paid for by the estate, gives them access to operating reports, and lets them exercise more control over how the debtor liquidates and how their bankruptcy claims are treated.
Given the sheer volume of competing interests and unresolved issues in the Dewey case, the unwinding could be slow going. According to Dewey's bankruptcy attorney Togut, about 90 firm employees are working to conclude the process.
"We're ready to work to maximize recoveries ... and not have this case deteriorate into chaos," Togut said.
The bankruptcy is In re Dewey & LeBoeuf LLP, U.S. Bankruptcy Court, Southern District of New York, No. 12-12321.
(Editing by Eileen Daspin, Eric Effron and Prudence Crowther)