The Covid-induced recession has arrived—and the legal industry is not immune.
Many legal professionals are finding themselves furloughed or laid-off. Even more are waking up to pay cuts and hiring freezes. The industry-wide cost-reducing efforts suggest that law firms are wary of the economic outlook, and some are already scrambling for cash.
As the coronavirus disrupts both the economy and the courts, law firms face serious challenges regarding cash flow. For firms operating on an hourly basis, the ongoing economic disruption can mean backdue accounts receivable not being paid. For firms operating on a contingency basis, nationwide court closures may push back resolutions on their portfolios. In either case, law firm balance sheets may not look good.
It is during a time like this that litigation finance can provide unique and critical support for the industry. Not only will additional funding help small firms tide over any short term cash crunches, it will also enable small practices to seize emerging opportunities in commercial litigation.
A Time of Uncertainty for Law Firms
All times of crisis bring the same essential struggle to law firms: how to bridge a cash gap. The Covid-19 crisis is the most recent economic uncertainty that has thrown law firm finances into chaos, but other examples include the 2000 dot-com bubble bust and the 2008 financial crisis.
Each of these economic crises triggered a cascade of law firm closures due to cash shortage, not to mention the high-profile bankruptcies of seemingly impervious AmLaw 200 firms:
- In 2002, a 77-year-old San Francisco firm Broebeck, Phleger & Harrison shuttered after running into money trouble in the dot-com bubble.
- In 2008, a 730-lawyer Heller Ehrman collapsed because the bankruptcy of Lehman Brother left the firm cash poor.
In fact, according to a Harvard study, most collapsed firms crumpled when they were still current on their debts and earning a profit.
Even for law firms with ample cash reserves, the Covid-19 crisis has already disrupted the normal proceedings of their cases. While some oral arguments have moved online, most in-person proceedings such as jury trials remain postponed. With significant uncertainty surrounding trial proceedings, many law firms are burning cash without an end date in sight.
To make matters worse, banks are less willing to lend during recessions. As illustrated below, credit availability decreases during economic recessions. During the 2008 recession, despite a close-to-zero federal funds rate, commercial banks increased their balance maintained with federal reserve banks by about 500%, meaning that it became much more difficult for businesses to get a loan when they needed it the most. To a lesser extent, the same phenomenon happened during the 2001 recession.
In early April, the Federal Reserve lowered the target federal funds rate to the range of 0% to 0.25%. It is now up to commercial banks to assess the risks of lending during a time of economic uncertainty. Which makes it particularly challenging for law firms, because even during normal times, banks find it difficult to value law firms’ contingency portfolios. Now with the recession, law firms will likely have a harder time securing extended credit lines.
Building in Buffer Room With Litigation Finance
Without a financial buffer, law firms are prone to cash crunches during times of crisis, resulting in serious challenges to their business viability. During the 2008 financial crisis, troves of law firms went out of business because they ran out of cash. In September 2008, 118-year-old Heller Ehrman LLP expired two years after its most profitable year ever. The same circumstances befell 500-attorney,160-year-old Thacher Proffitt & Wood LLP, and many more.
This time, not all of those law firms have to go out of business. In 2008, many endangered law firms had valuable portfolios, client bases, and claims; they simply had a hard time monetizing these values. With litigation funding, similar firms today could access a life-saving financial buffer. Unlike traditional forms of credit, litigation finance is patient capital whose defining feature is that it is non-recourse, or only paid back if the underlying cases are successful.
Crucially, law firms who can foresee a cash crunch must take action now to ensure their success in obtaining litigation finance once necessary. The first step is to assess their portfolio of cases and determine how much funding they need to tide themselves over. To prepare their portfolio for the necessary due diligence any litigation funder will perform, law firms should assemble estimated damages, timeline, and relevant documents on any case they plan to submit for funding. Some of the most commonly sought documents include:
- A spreadsheet of cases and case numbers,
- Complaint or a draft of complaints,
- Copies of any other filed documents,
- Any past orders or memorandums from the court such as motion to dismiss or motion for summary judgment, and
- Relevant discovery.
One final tip is to plan ahead. The smartest law firms begin the search for litigation funding early, with plenty of runway for the process. Similarly, for cases where the client is billed hourly, attorneys should broach the idea of litigation funding to any client who may be experiencing the effects of the financial crisis before the arrears start to build.
Covid-19 Crisis Is Also an Opportunity
Despite the financial challenges, Covid-19 presents an opportunity for law firms to grow their businesses. Coronavirus-related litigation has already seen many filed claims, including personal injury claims against the Princess Cruises and thousands of commercial claims invoking force majeure. The law firms that maintain healthy cash flow will be best equipped to take advantage of the abundant litigation work available in times of economic crisis.
“I operated my own law firm from 2003-2010, and 2008 and 2009 were some of my best years,” Legalist General Counsel Curtis Smolar said. “Bankruptcy and litigation attorneys should see any economic downturn as a time of opportunity, provided that they use litigation finance to tide them over any short term cash crunches. The coronavirus might cause a short-term industry-wide recession, but for specific pockets such as commercial litigation, this is a time of opportunity.”
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Eva Shang is the CEO and co-founder of Legalist, a tech-enabled litigation finance firm. She is a Harvard drop-out, a Thiel Fellow, and was awarded Forbes 30 under 30 in 2018.
Robbie Li is a marketing assistant at Legalist. He researches and writes about litigation finance, litigation trends, and legal careers.