A recent Law 360 story by Aebra Coe, “Clients’ Speed Paying Bills Could Make or Break Law Firms” reports that a report out shows law firms have fared "surprisingly well" financially during the coronavirus pandemic so far, but experts say there is still a danger that some firms could run out of cash because of difficulty collecting payments from struggling clients.
Most law firms do not have deep cash reserves and rely on monthly collections from client payments to continue operating. With the possibility those payments could dry up due to clients' lack of ability or willingness to pay, liquidity is a major concern for some law firms right now, according to Michael Blanchard, managing director of the Law Firm Advisory Team at Aon. "A lot of firms now are starting to realize that productivity may not be the issue but that liquidity from clients paying in a timely fashion is a bigger challenge to a lot of firms," Blanchard said.
According to the report released by Wells Fargo Private Bank Legal Specialty Group, "the legal industry has fared surprisingly well" so far financially during the coronavirus pandemic when compared to other industries, with demand for the surveyed law firms' services down just 1.4% from the start of the year through June 1 compared to the same five-month period last year.
But that modest decline in demand is skewed by a very strong start to the year, with steep declines in demand in April and May, according to Joe Mendola, senior director of sales for the bank's legal specialty group. That could result in corresponding declines in the payments law firms receive from clients over the next three to four months since there is a lag between when firms perform work and when they are paid, he said. Demand appears to have "bottomed out" in May, which would likely translate to the largest dip in cash in hand from payments by around August, Mendola said.
In addition to the problem of fewer bills owed in the second half of the year because of declines in demand during April and May, law firms could also face trouble collecting in a timely fashion and being paid in full as clients themselves struggle financially and seek steep discounts, which could lead to cash-flow difficulties for law firms. "Certainly, through the first five months of 2020, the legal industry has fared better than most industries. But I think the more challenging months will be ahead of us," Mendola said.
The Wells Fargo survey found that while demand was down during the first five months of the year, the amount of money in the pipeline owed to firms, called inventory, was actually up by 7%, suggesting that collections are lagging, Mendola said. Additionally, 54% of the firms surveyed said client requests for discounts increased in May over the previous month, and 52% said they saw more payment extension requests from clients in May.
"I think the key to 2020's final results [for law firm financials] will be how collections play out," Mendola said. While firms have taken a hit and likely will continue to when it comes to collecting bills, the damage has not been as substantial as the industry first predicted, according to Gretta Rusanow, managing director at Citi Private Bank's Law Firm Group.
Surveys her bank conducted found that at the start of April, firms anticipated that they would see a 15% drop in demand, a 15% drop in revenue and an 11% lengthening in the collections cycle. But the actual numbers for April and May, according to Rusanow, ended up showing an average decline in demand of 6.2%, a decline in revenue of 1.3% and a slowdown in collection times of 3.4%.
"The bottom line is: Going into this there was very much a concern that not only would activity levels drop, but it would be hard to collect from clients, and in fact what's happened is it hasn't been as bad as anticipated at the industry level," Rusanow said. But Rusanow and Mendola both noted that there was significant dispersion in the industry during the first few months of the year, with some firms performing well and others performing poorly, all of which is wrapped up in those averages.
Actions that firms have taken during this time — likely as a result of fear of major drops in revenue and demand — have made a big impact on preserving their financial health, the experts said. "Probably the thing resounding across the industry in the past few months has been a very much disciplined approach around billing and collections," Rusanow said.
That means firms have buckled down on attorneys getting their time tracked and bills promptly sent out to clients, and many are having conversations with clients about their ability to pay, she said. Some firms have drawn on their lines of credit for cash flow, according to Mendola.
In addition, GLC Business Services CEO Michael Hayes said that smaller firms have been able to rely on the federal government's Paycheck Protection Program for loans that are either forgivable or are to be paid back at a very low interest rate. "The Paycheck Protection Program has added liquidity to small firms and their clients," Hayes said. "It pushes off the potential for danger at least until the end of year."
In addition to turning a closer eye to getting paid for the work they do and finding ways to keep money flowing in, law firms have also cut costs in anticipation of a dip in revenue, according to Aon's Blanchard. That has meant reduced partner draws, reductions in associate and staff pay, some layoffs, some cuts in real estate expenses as attorneys and staff work from home, and less money spent in areas like travel, training and firm retreats.
"I think firms have started looking at different ways to improve their margins," Blanchard said. Mendola said the belt-tightening has helped. His survey found that at the end of May the industry has reported good liquidity with almost 90% of the responding firms showing three months or more coverage of monthly expenses excluding partner draws. "I think those cost-cutting measures are paying off. It's better to be prudent and readjust than not be ready," he said. "Once money is out the door, you're not going to get it back."