Sedgwick: Death By Billable Hours

Am Law 200 firm Sedgwick LLP had great clients and plenty of work: how did it go bust?

There’s a phenomenon called “rabbit starvation” that gets taught in survival training courses.  If you’re trying to get by in the wild, and your choice is to eat rabbit or eat nothing, your best bet is to eat nothing.  Rabbit meat is so lean that no matter how much you eat, your body will end up burning more calories digesting it than you can take in by eating it. A rabbit-only diet is a recipe for malnutrition, starvation, and ultimately death.

Am Law 200 firm Sedgwick LLP’s shock announcement on Tuesday that it would close shop after 80-plus years of operation suggests that rabbit starvation applies to law firms too.

Sedgwick’s implosion was widely reported as the story of a merger gone awry. For much of 2017, Sedgwick was in public merger discussions with the British firm Clyde & Co. The acrimony of the merger discussions evidently triggered an exodus of over a quarter of the firm’s partnership over that time. Although losing that many partners in less than a year is never peachy, it was particularly bad at Sedgwick, where the firm had to repay the partners’ large capital contributions. With so many partners departing at once, it appears the firm’s capital payout obligations became more than the balance sheet could support and the firm collapsed on itself.

But this is too easy of an explanation. Merger talks — even contentious ones — don’t have to end with an apocalypse. Read the legal periodicals on any given day and you’ll see reports of countless firms in public merger discussions — most of which never work out. To get a full understanding of what actually happened with Sedgwick, you have to look at the firm’s foundation against the backdrop of what’s happening in the broader legal market. And when you do, you see a firm that had all the outward indicators of success, but that was in reality a slow-motion disaster waiting to happen.

The Rolls Royce of Insurance Firms

Sedgwick was a go-to firm for insurance companies. Even a cursory scan of the firm’s website (which remains active as of the day of this article) shows that its insurance roots run deep. For much of its lifespan, a venerated specialty firm like Sedgwick would have been the insurance industry’s Rolls Royce — high cost, high performance, and a brand synonymous with trust, competence, and old-school cred. The firm could use its cache to bring in seemingly endless billable hours from clients that reliably pay their bills, and do so at a rate that eclipsed the typical small-firm insurance shop.

But after the bottom fell out in 2008, it became hard for insurance companies to justify a Rolls where a Kia would do. The years following the Great Recession saw a major shift in the power structure of Biglaw pricing. The supply of high-level attorneys swelled as law schools continued to pump out graduates, but demand for external counsel shrank as clients took their work in-house. That demand continues to shrink today, as more companies find ways to get what they need internally or from non-traditional sources. Law firms in the Am Law 101-200 and below have increasingly had to compete with one another through pricing, steadily shifting leverage to the clients that want to hire them.

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It’s hard to think of an industry better suited to squeeze the billable hour than insurance. Think about it: insurance companies typically work with dozens, if not hundreds of law firms. Keeping meticulous records of the cost of transactions in order to predict those costs into the future is their bread and butter. Insurance companies with access to vast amounts of data, and the analytic skill to use it, are going to know exactly what it costs to handle their cases. They know that side of the legal market better than the firms they hire. So, any firm that wants to earn or keep an insurance company’s business has to be prepared to slash its margins to the bone. An equity partner’s negotiated hourly rate on insurance matters can easily be less than the rack rate for a first-year associate at the same firm.

Sedgwick was #137 on Am Law’s last rankings, smack dab in the “hollow middle” of American law, and was undoubtedly feeling pressure both from the top-tier firms above and the agile, low-overhead boutiques below. Its focus on plentiful-but-cheap insurance work meant it probably had plenty of work to keep its attorneys busy, but wasn’t likely pulling in the margins of the Am Law 100 firms in the skyscrapers next door.

Making It Up on Volume

Thin margins don’t provide much wiggle room, and leave a firm vulnerable to interruptions in its revenue flow. As each equity partner left over the course of 2017, they took revenue out of Sedgwick’s budget while requiring payouts from the capital fund. Every one of those moves made the firm less appealing both as a merger target and as a home for its existing rainmakers, meaning more partners left and the possibility of being saved by a merger got more remote with each defection.

Hindsight being 20/20, it’s possible Sedgwick wouldn’t be closing if it had spent the last 10 years getting leaner and meaner, perfecting the art of case management, and aggressively adjusting overhead. It’s the model that many employment boutiques and plaintiffs’ practices have employed with great success as the legal economy continues to shift away from the old Biglaw models.

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But getting lean and mean isn’t as sexy as being a big, bad powerhouse with a massive geographical footprint, and Sedgwick evidently got caught in the trap of too much expansion without the sound finances and high billing rates to back it up. In the years following the 2008 financial collapse, when many other firms were tightening their belts, Sedgwick made a play to become the new Dentons or DLA Piper by opening offices in Kansas City, Seattle, Washington, D.C., and Miami.

Sedgwick just kept eating more rabbit and wondering why it was still feeling hungry.

Having new offices and new sources of revenue is often a boon for everyone involved, but on thin profit margins, those new offices may have just increased the firm’s vulnerability to slight downturns in revenue. A house of cards doesn’t get more stable when you add a second floor. If the basic structure of a firm is susceptible to collapse because of industry changes and low billing rates, expanding rapidly and giving off the appearance of success can only last for so long.

The thing about rabbits is, even if you can’t survive off them, they make great magician’s assistants. Maybe that’s how these rabbits ended up making Sedgwick disappear.


James Goodnow

James Goodnow is an attorney, commentator and Above the Law columnist. He is a graduate of Harvard Law School and the co-author of Motivating Millennials, which hit number one on Amazon in the business management and legal communications categories. You can connect with James on Twitter (@JamesGoodnow) or by email at jgoodnow@fclaw.com.