An intense and long-running battle is set to begin over the assets of Dewey & LeBoeuf which, as many observers had long predicted, filed for Chapter 11 bankruptcy protection in the US Bankruptcy Court in Manhattan on 28 May.
The filing sets the stage for a struggle between creditors that experts predict could run for years in a process that one observer likened to ‘bear-baiting’.
Dewey has instructed Albert Togut of New York bankruptcy firm Togut, Segal & Segal as counsel in the US. The UK LLP has also gone into administration, with accountancy firm BDO acting as the administrators.
The beleaguered firm’s demise represents the largest law firm failure in history, dwarfing those of Howrey, Heller Ehrman and Halliwells.
With debts of $245m but assets of $193m, the scramble is now on for creditors to get their money. This is where difficulties may arise.
In theory, the rules of priority between creditors under a Chapter 11 bankruptcy are straightforward. Creditors with perfected security interests in particular assets are paid first in full, up to the value of their collateral. Then the administrative expenses of the Chapter 11 procedure are paid out, including legal fees and any post-bankruptcy lending.
‘Bankruptcy lawyers do not work for free, and any lender who provides post-bankruptcy lending will want some kind of super-priority,’ said Richard Gibson, a bankruptcy expert at Los Angeles firm Rick Gibson Law.
Next in the pecking order, according to Gibson, is ‘a grab bag of different kinds of debts – largely taxes – that are given priority,’ and general unsecured creditors are next in line.
At the bottom of the list of those owed money are the owners of the business, in this case, the equity partners of Dewey.
‘Aggressive tactics could make the bear-baiting entertainment of Shakespeare’s era seem tame.’
Edwin Reeser, Edwin B Reeser
But in reality, things tend to be much more complicated than the theory. There are often battles between secured creditors over which one has priority over a particular piece of collateral. In this case, as regards the $125m bond Dewey issued in 2010, the suggestion is that the bondholders and the banks have an equal position over most of the collateral, which consists largely of receivables and work in progress (WIP).
There was also the perennial issue of whether operating the business for some time would have been a good idea and, if so, who should pay for that. If Dewey was simply shut down, then the value of the accounts receivables and WIP would predictably decline. If the firm continues to trade, however, then day-to-day costs will need to be covered. Last month, the bankruptcy court permitted Dewey to continue operating, with a six-week budget of $24.8m, allowing the firm to stay open and collect outstanding fees from clients.
‘Will that money be a dead loss to secured creditors, or will it increase their eventual recovery?’ asked Gibson.
However, three of the four secured lenders – Citi Private Bank, Bank of America, and HSBC – sold their debt at a discount to distressed debt investors, such as CRT Capital Group, who had been circling round Dewey for some time. This leaves only JPMorgan Chase, which served as the placement agent for the bond, representing the secured bank lenders.
The distressed debt investors have been exploring the recourse debt reach to the individual partners of Dewey, which would allow them as secured creditors to pursue any or all of the individual partners’ assets. This, according to Edwin Reeser, former managing partner of Sonnenschein Nath & Rosenthal’s Los Angeles office and now president of Edwin B Reeser, A Professional Law Corporation, could be worth hundreds of millions of dollars.
‘The secured creditors tried to gain priority over this arena but the judge rebuffed the overture, at least for now,’ he said.
Should the secured creditors succeed in getting access to individual partners’ assets, they would almost certainly obtain 100% recovery on the face value of the loans and bonds, according to Reeser. That would make for a stellar return for the distressed debt investors that purchased those interests at a discount.
Reeser added that the aggressive tactics employed by both secured and unsecured creditors will be unlike any seen during previous law firm failures. ‘It could make the bear-baiting entertainment of Shakespeare’s era seem tame,’ he said. This is because if the purchasers of the bond and bank debt have enough of an interest to wrest control of the collection strategy and process – which is likely otherwise they would not have bought the debt in the first place – things could get nasty as they look to get a return on their investment.
However, other legal commentators are more dubious over whether creditors will get any return at all. ‘The creditors in the bankruptcy would be very lucky to get their bus fare home,’ said one City legal recruitment specialist.
Whatever happens, this saga will drag on for many years, especially considering that the failure of a considerably smaller firm, Brobeck, Phleger & Harrison in 2003 is ongoing. It seems likely that the secured lenders should get at least some of their money back from the Dewey collapse and the venture capital companies who bought the debt at a cut price could even turn a profit. The unsecured lenders might not be so lucky but are unlikely to give up without a fight. One thing is certain: this is far from over.