Over the past few months the issue of law firm failures has repeatedly appeared on our agenda. This may appear counterintuitive given that the economy is improving, but of course insolvency practitioners have demonstrated many times that the start of the upturn is the most dangerous part of the business cycle.

This issue has been raised at conferences and seminars, in surveys and across the blogosphere. The Association of Partnership Practitioners (APP) has held seminars both on detecting decline – including the key symptoms – and on restructuring and other options for stressed firms.

Reports have also emerged from the major accountancy firms indicating both the overall buoyancy of the sector and the increasing divergences in performance between winners and potential losers.

The Australian consultancy Beaton capital has produced a very interesting report suggesting that client feedback can indicate a change in fortunes of the firm well in advance of the financial metrics. The legal sector has always relied on lagging indicators, but perhaps this provides a leading indicator, if partners can be convinced to take on board the implications.

Across the Pond

The American legal press has been focusing on a small number of large firms which appear to be engaged in restructuring exercises. Meanwhile the author Ed Reeser appears convinced that something sizeable and unpleasant is about to break shortly. His most popular articles in recent weeks have all been around the issue of firm failure.

In the midst of all this activity the American bar Association published “The Failing Law Firm -Symptoms and Remedies” by David J Parnell. This book extrapolates from the experience of 42 failed American law firms in the last 20 years to create a compelling picture of the process of decline. Our separate article delves deeper into this book.

Surprise, Surprise

Discussions with highly experienced practitioners following the APP seminars have highlighted the extent to which the decline and fall of firms has been seen as a surprise, particularly to those involved. This is a concern for two main reasons.

Firstly, the indicators of financial difficulty are well known to accountants, financiers and financial managers. There are some particularly unusual features of the legal landscape, but for the most part law firms are not unique. In most cases the warning signs had been there for some time but had not been heeded and acted upon by the firms involved. It is unclear whether this was because of a lack of understanding by the firm’s management or through an inability of the leaders to get the partnership to take the necessary medicine, although it is telling that in most cases the failed firms have lacked a strong finance director.

Secondly, and perhaps even more worryingly, financial difficulties came as a complete surprise to many of the partners involved, and who consequently suffered significantly. They only became aware of the state of the firm’s finances when it was too late for remedial action to be effective. Once again it is not clear whether this was because information was withheld from them deliberately, whether the financial reporting packages were inadequate, or whether the partners concerned did not understand the information put before them. This seems to have reached its ultimate in the case of Dewey and Leboeuf, where some partners have petitioned the New York courts claiming they could not be responsible for the firm’s demise because they did not understand the accounts!

Whatever the underlying reason, it is patently unsatisfactory for partners to be marching through low cloud towards the edge of a cliff without any idea of the direction in which they are heading.

Recommended Posts